UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549




FORM 10-K




x
            
            ANNUAL REPORT PURSUANT TO SECTION 13 OR
      15(d) OF THE SECURITIES EXCHANGE ACT OF 1934FOR THE FISCAL YEAR ENDED DECEMBER 31,
      2009ORo
            
            TRANSITION REPORT PURSUANT TO SECTION 13
      OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934FOR THE TRANSITION PERIOD FROM_____TO _____


Mechanical Technology,
Incorporated (Exact name of registrant as
specified in its charter)_________




New York
            0-6890
            14-1462255(State or Other
      Jurisdiction
            (Commission File
Number)
            (IRS Employerof Incorporation)
            
            Identification
  No.)


431 New Karner Road, Albany, New York
12205 (Address of registrant’s principal executive
office)




(518) 533-2200 (Registrant’s telephone number, including area code)




Securities Registered Pursuant to
      Section 12(b) of the Act:Title of each class
            Name of each exchange on which
      registeredNone
            None


Securities
      Registered Pursuant to Section 12(g) of the Act:
            Common
      Stock($0.01 par
      value)Title of
      Class


Indicate by check
mark if the registrant is a well-known seasoned issuer, as defined in Rule 405
of the Securities Act.  Yes o No x




Indicate by check mark if the registrant is not
required to file reports pursuant to Section 13 or Section 15(d) of the
Act.  Yes oNo x




Indicate by check
mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days.  Yes xNo o




Indicate by check
mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K
(Section 229.405 of this chapter) is not contained herein, and will not be
contained, to the best of the registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.x




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


Large Accelerated Filero
            Accelerated Filero
            Non-Accelerated Filero
            Smaller reporting companyx


Indicate by check
mark whether the registrant is a shell company (as defined in Rule 12B-2 of the
Act).  Yes oNo x




The aggregate market
value of the voting and non-voting common equity held by non-affiliates as of
June 30, 2009 (based on the last sale price of $0.66 per share for such stock
reported on the over-the-counter market for that date) was $3,090,339. Such
value excludes common stock held by executive officers, directors, and 10% or
greater stockholders as of June 30, 2009. The identification of 10% or greater
stockholders as of June 30, 2009 is based upon Schedule 13G and amended Schedule
13G reports publicly filed before June 30, 2009. This calculation does not
reflect a determination that such parties are affiliates for any other
purposes.




As of March 24, 2010,
the Registrant had 4,771,658 shares of common stock outstanding.




Documents
incorporated by reference: Portions of the registrant’s Proxy Statement for its
2010 Annual Meeting of Stockholders are incorporated by reference into Part III
of this Form 10-K.




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PART I




Item 1: Business




Unless the context requires otherwise in this
Annual Report, the terms “we”, “us” and “our” refer to Mechanical Technology,
Incorporated, “MTI Micro” refers to MTI MicroFuel Cells, Inc., and “MTI
Instruments” refers to MTI Instruments, Inc. We have a registered trademark in
the United States for “Mobion”. Other trademarks, trade names, and service marks
used in this Annual Report are the property of their respective
owners.




Mechanical
Technology, Incorporated, (“MTI” or the “Company”), a New York corporation, was
incorporated in 1961. MTI operates in two segments, the New Energy segment which
is conducted through MTI MicroFuel Cells Inc. (“MTI Micro”), a majority-owned
subsidiary, and the Test and Measurement Instrumentation segment, which is
conducted through MTI Instruments, Inc. (“MTI Instruments”), a wholly-owned
subsidiary.




MTI Micro was
incorporated in Delaware on March 26, 2001, and is developing Mobion®, a handheld
energy-generating device to replace current lithium-ion and similar rechargeable
battery systems in many handheld electronic devices for the military and
consumer markets. Mobion® handheld generators
are based on direct methanol fuel cell (DFMC) technology, which has been
recognized as enabling technology for advanced portable power sources by the
scientific community and industry analysts. As the need for advancements in
portable power increases, MTI Micro is developing Mobion® as a solution for
advancing current and future electronic device power needs and addressing the
multi-billion dollar portable electronics market. As of December 31, 2009, the
Company owned approximately 61.81% of MTI Micro’s outstanding common
stock.




MTI Instruments was
incorporated in New York on March 8, 2000. MTI Instruments is a worldwide
supplier of precision non-contact physical measurement solutions, condition
based monitoring systems, portable balance equipment and wafer inspection tools.
MTI Instrument’s products use a comprehensive array of technologies to solve
complex, real world applications in numerous industries including manufacturing,
semiconductor, solar, commercial and military aviation, automotive and data
storage. Our products consist of electronic gauging instruments for position,
displacement and vibration application within the design,
manufacturing/production, test and research market; wafer characterization of
semi-insulating and semi-conducting wafers within both the semiconductor and
solar industries; and engine vibration analysis systems for both military and
commercial aircraft.




The New Energy Segment




MTI Micro is
developing and commercializing off-the-grid power solutions for various portable
electronic devices. Our patented proprietary direct methanol fuel cell
technology platform called Mobion, converts 100% methanol fuel to usable
electricity capable of providing continuous power as long as necessary fuel
flows are maintained. Our proprietary fuel cell power solution consists of two
primary components integrated into an easily manufactured device: the direct
methanol fuel cell power engine, which we refer to as our Mobion Chip, and
methanol fuel cartridges. Our current Mobion Chip weighs less than one ounce and
is small enough to fit in the palm of one’s hand. The methanol used by the
technology is fully biodegradable. We have demonstrated power density of over 84
mW/cm2, while
producing more than 1,800 Wh/kg or 1.4 Wh/cc of fuel from its direct methanol
fuel feed. For these reasons, we believe our technology offers a superior power
solution compared to current lithium-ion and similar rechargeable battery
systems currently used by original equipment manufacturers and branded partners,
or OEMs, in many handheld electronic devices, such as smart phones, mobile phone
accessories, digital cameras, portable gaming devices, e-readers and other
portable devices. We believe our platform will facilitate further developments
of numerous electronic product advantages, including smaller size, environmental
friendliness, greatly extended run-time of current portable devices, and
simplicity of design, all critical for commercialization in the consumer market.
We also believe our platform can be implemented as three different product
options: a handheld power generator for consumer electronic devices, a snap-on
or attached power accessory, or an embedded fuel cell on handheld devices. We
have strategic agreements with a global Japanese consumer electronics company,
with a U.S. based developer and marketer of universal chargers, with a global
power tool manufacturer and a letter of intent with Duracell, part of the
Procter & Gamble Company. Our goal is to become the leading provider of
portable power for various types of electronic devices and, assuming available
financing, we intend to commercialize Mobion products in 2010.




Our Mobion technology
is protected by a patent portfolio that includes 54 patents and 57 U.S. patent
applications covering five key technologies and manufacturing areas, one of
which is the process that eliminates the need for active water recirculation
pumps or the inclusion of water as a fuel dilutant. The water required for the
electrochemical process is transferred internally within the Mobion Chip from
the site of water generation on the air-side of the cell. This internal flow of
water takes place without the need for any pumps, complicated re-circulation
loops or other micro-plumbing tools.




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Industry Background




Technological
advances in semiconductor manufacturing, LED displays, memory costs and
availability, wireless technologies, and software applications have resulted in
a dramatic increase in the number of portable electronic devices, their usage,
and especially, their power requirements. In addition, there are a number of new
handheld electronic devices, such as smart phones, mobile phone accessories,
digital cameras, portable gaming devices, e-readers and other portable devices
that have been introduced into the market. Consumer demand for these portable
electronics that offer an enhanced experience include the ability to communicate
any time, anywhere and have effectively enabled the creation of an “always-on”
environment independent of the consumer’s location. This trend towards increased
functionality in portable electronic devices has led to a “power gap” in which
the disparity between a device’s power supply, typically a rechargeable
lithium-ion battery, and its power need, is growing. This power gap leads to a
need for the end user to plug in their devices to the electrical grid more
frequently, which limits their mobility of using these electronic devices where
and when the need arises.




Improvements in
rechargeable battery technology have not kept pace with the evolution of
consumer electronic device performance. Over the last ten years, device
performance as measured by silicon processor speed has increased by a factor of
128 times, while the energy density of lithium-ion technology has only doubled.
We believe that further gains in lithium-ion technology for portable electronics
will be incremental at best, as any achievable benefits may be outweighed by the
decreasing stability, availability, integrity, and relative safety of these
higher energy output batteries. In addition to their performance shortfalls,
lithium-ion battery technology poses an environmental risk as the various heavy
metals incorporated in these batteries require special disposal to prevent
contamination of waste disposal sites.




According to a report
dated May 2009 by Freedonia Group, Inc., an independent research firm,
commercial demand for fuel cell systems, which totaled 17,800 units in 2008,
will expand exponentially through 2013, when unit sales will reach 1.3 million,
and then climb another sevenfold to 9.95 million units in 2018. Although market
gains are projected to be strong for most applications, virtually all of this
increase will be attributable to an increase in portable fuel cell systems
demand, which is expected to account for 98 percent of all unit sales in
2018.




OEMs are actively
seeking improved power sources to replace existing rechargeable lithium-ion
batteries to keep up with the additional technology improvements to their mobile
electronic devices. The development of new products using technologies that
already exist, such as radio frequency, touch screen technologies, camera
functionality, increase in processor speeds and 4G wireless capabilities, is
being slowed down on mobile devices due to the unavailability of portable,
compact, economical and rechargeable/replaceable higher energy density,
including micro fuel cells.




Our Solution




At the core of our
solution is our proprietary Mobion Chip engine, a design architecture that
embodies a reduction in the size, complexity, and cost of fuel cell
construction, which results in a reliable, manufacturable, and affordable power
solution that we believe provides higher energy density and portability over
competing rechargeable battery technologies. Our proprietary fuel cell power
solution consists of two primary components integrated in an easily manufactured
device: the direct methanol fuel cell power engine, which we refer to as our
Mobion Chip, and methanol replacement cartridges. Our Mobion Chip weighs less
than one ounce and is small enough to fit in the palm of one’s hand. For these
reasons, we believe that our Mobion platform is ideally suited to provide a
replacement for rechargeable lithium-ion batteries. Based upon our ability to
provide a compact, efficient, clean, safe, and long-lasting power source for
lower power applications, we intend to initially target power solutions for
applications such as universal handheld power generators, power tools, remote
sensors, smart phones, mobile phone accessories, digital cameras, portable
gaming devices, e-readers and other portable devices.




For handheld consumer
electronic applications, we have demonstrated power density of over 84mW/cm2 with energy
efficiencies of 1.4 Wh/cc of fuel, which is a direct result of our Mobion
platform’s ability to use 100% methanol – a widely available, environmentally
friendly, inexpensive, and biodegradable fuel. These advantages result in higher
energy density and reduced size, cost, and complexity of our power solution
offering consumers portable on-demand power, independence from power outlets,
and freedom from the need to constantly recharge their devices.




Our Strategy




Our goal is to become
a leading provider of portable power for handheld electronic devices. Key
elements of the MTI Micro strategy designed to achieve this objective include
the following:




Business Focus. We
are focusing our efforts on the development and commercialization of our
portable power source products. Our fuel cell boasts of a flexible architecture
that is applicable to various kinds of electronic devices. We continue to
partner with different OEM’s that will co-develop the integration of Mobion to
their devices.




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Design for Mass Manufacturing. Our portable power source products will be
manufactured using standard processes, such as injection molding and automated
test and assembly, which are broadly employed throughout the electronics
manufacturing industry. In preparing Mobion for commercialization, our current
Mobion Chip is designed for mass manufacturing. In addition, we have continued
integrating more functionality into our Mobion Chip while reducing its part
count to one piece. Our current Mobion Chip is small enough to fit in the palm
of a hand.




Outsource Manufacturing. We plan to outsource manufacturing of our products to allow us to expand
rapidly and diversify our production capacity. This strategy will allow us to
maintain a variable cost model in which we do not incur most of our
manufacturing costs until our proprietary fuel cell power solution has been
shipped and billed to our customers. We intend to concentrate on our core
competencies of research and development and product design. This approach
should reduce our fixed capital expenditures and allow us to efficiently scale
production.




Utilize our Technology to Provide Compelling Products. We plan to utilize our intellectual property
portfolio and technological expertise to develop and offer portable power source
products across multiple electronic device markets. We intend to employ our
technological expertise to reduce the overall size and weight of our portable
power source products while increasing their ease of manufacturing, power
capacity, and power duration and decreasing their cost. We believe that these
efforts will enable us to meet customer expectations and to achieve our goal of
supplying on a timely and cost-effective basis the most environmentally friendly
portable power source products to our target markets. We believe our products
will offer advantages in terms of performance, functionality, size, weight, and
ease of use. We plan to continue enhancing our customers’ industrial design
alternatives and device functionality through innovative product development
based on our existing capabilities and technological advances.




Capitalize on Growth Markets. We intend to capitalize on the growth of the
electronic device markets, including new products that may be brought about by
the convergence of computing, communications, and entertainment devices. We
believe our portable power source products will address the growing need for
portability, connectivity, and functionality in the evolving electronic device
markets. We plan to offer power solutions to OEM customers that enable them to
offer products with advantages in terms of size, weight, power duration, and
environmental friendliness. We plan to utilize our existing technologies, as
well as aggressively pursue new technologies and evolving markets that demand
enhanced power solutions.




Develop Strong Customer Relationships. We plan to develop strong and long-lasting
customer relationships with leading electronic device OEMs and to provide them
with power solutions for their products. We believe that our portable power
source products will enable our OEM customers to deliver a more positive user
experience and to differentiate their products from those of their competitors.
We will attempt to enhance the competitive position of our customers by
providing them with innovative, distinctive, and high-quality portable power
supply products on a timely and cost-effective basis. We will work continually
to improve our portable power source products, reduce costs, and accelerate the
speed of delivery of our products while addressing the power requirements and
compatibility they need. We will endeavor to streamline our designs and delivery
processes through ongoing design, engineering, and production improvement
efforts. We will also devote considerable effort to support our customers after
the purchase of our portable power source products.




Pursue Strategic Relationships. We intend to develop and expand strategic
relationships to enhance our ability to offer value-added customer solutions,
penetrate new markets, and strengthen the technological leadership of our
portable power source products.




Products




MTI Micro is
developing three product categories of our Mobion technology: (i) external power
charger products, (ii) snap-on or attached power source products, and (iii)
embedded power source products. In addition, we are working with our strategic
partners and suppliers to develop removable methanol cartridges that will be
used to fuel our portable power source products.




External Power Charger: Our design for an external power charger is a standalone device that
uses a standard and widely used universal serial bus, or USB, interface as a
power output connector that can be used to recharge handheld mobile devices. Our
current design for the device is roughly the size of two decks of playing cards
(see photo below) and employs a 100% methanol fuel cartridge, which occupies the
same volume as a pack of chewing gum. For each removable cartridge, our current
prototype external power charger provides up to one month of power for the
typical mobile phone. It can also be designed to enable a professional
photographer to take over 5,000 pictures using a high end digital camera from a
single cartridge. Our device is designed to provide 2.5 watts of power output
from its USB interface and also offer fast charge, ultra-long run time and
self-charging modes.




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Mobion external power charger with removable cartridge
prototype




Snap-on or Attached Power Source
Products: Similar to
aftermarket battery attachments, our snap-on direct methanol fuel cell power
solution is an attached power supply that is compatible with existing portable
electronic devices and offers users extended run-time power. In this category,
we envision a number of product applications, including attachments for digital
cameras, portable media players, GPS devices, and other consumer and electronic
products. Our initial prototype is a direct methanol fuel cell camera-grip (see
photo below) that replaces comparable rechargeable lithium-ion battery-pack
grips and is designed to provide twice as much energy as similar rechargeable
lithium-ion battery-based products. Our Mobion direct methanol fuel cell camera
grip allows photographers the benefits of extended usage plus the freedom to
refill using a methanol cartridge rather than by plugging into a wall
outlet.




Sample Mobion attached power source camera-grip
prototype




Embedded power source
products: Our goal is to
produce direct methanol fuel cells that can be embedded into portable electronic
devices in order to increase their run time and to provide fast charge
capability by hot-swapping 100% methanol cartridges. We have developed an
embedded fuel cell prototype for a handheld GPS unit that we believe will
generate three times as much usage time as GPS devices powered by conventional
disposable AA batteries (see photo below.)




Prototype of a GPS unit with an embedded Mobion power
source




We have also
developed an embedded fuel cell concept model designed for a smart phone (see
photo below) and believe that this concept model highlights the anticipated
future product direction for our portable power source products in the consumer
market.




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Concept model of a smart phone with an embedded Mobion power
source




Advantages of our Portable Power Source
Products




We believe that our
portable power source products will offer the following advantages:


- Off-the-grid power source.Our products provide
  users of consumer electronic devices with extended mobility by providing power
  without having to attach to a wall outlet to recharge their
  devices.
- Mobility.Our power source provides off-the-grid power
  both indoors and outdoors, using the power generated from its methanol fuel;
  it does not need sunlight or wind to generate electricity.
- Small size and low weight.The dimensions of our
  products will offer our OEM customers the flexibility to further enhance and
  reduce the overall size and weight of their products.
- Power density.Our products have demonstrated power density
  of over 84 mW/cm2 and high energy
  efficiencies of 1.4 Wh/cc of methanol.
- Power duration.Our products do not limit power capacity
  found with a typical battery that just stores electricity. Our product
  continually generates electricity as you refuel with
  methanol.
- Ease of manufacturing.Our products will be manufactured using
  traditional injection molding techniques and system assembly operations that
  will easily transfer to mass-manufacturing production lines.
- Safety.Our products will utilize methanol fuel,
  which has been determined by the ICAO (International Civil Aviation
  Organization) and the US DOT to be safe; methanol cartridges can be carried on
  airplanes. In addition, methanol does not require storage under pressure or at
  low temperatures.
- Environmentally friendly.Our products will
  utilize fully biodegradable methanol fuel. Also, methanol can be sourced from
  environmentally friendly sources like wood pulp and lumber tailings which
  yield a carbon neutral impact while generating electricity.

Codes and Standards




In 2004, we became
the world’s first company to develop micro fuel cell safety compliance
certifications for a fuel cell product with Underwriter’s Laboratory and CSA
International. In addition, fuel cells were given United Nations packaging
standards and our methanol cartridges are designed to be compliant by the U.S.
Department of Transportation for worldwide cargo shipment. Certification is
required for every commercial product prior to its shipment. Based upon our
previous experiences with these regulatory agencies, we do not anticipate delays
associated with seeking Underwriter’s Laboratory and CSA International product
testing for our commercial products, which, assuming available financing, are
anticipated to begin shipping in 2010.




We also assisted in
the development of a proposal adopted by the United Nations to provide methanol
fuel cartridges a separate classification and, working with other micro fuel
cell companies and the appropriate regulatory bodies, generated the first draft
of the international standards for methanol safety and use related to transport
on commercial airplanes. As a result of our industry coalition efforts, the
International Civil Aviation Organization (ICAO) technical instructions and the
International Air Transport Association Dangerous Goods Regulations now permit
airline passengers and crew to carry on and use certain fuel cell power systems
and fuel cell cartridges containing methanol. On April 30, 2008, the U.S.
Department of Transportation issued a notification of final rules for adopting
the regulations permitting commercial aircraft passengers and crew to bring in
their carry-on baggage methanol fuel cell cartridges and fuel cell systems
designed for portable electronic devices. The effective date of the final rule
making was February 13, 2009.




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Technology




A fuel cell is an
electrochemical energy conversion device, which is similar to a battery that
produces electricity from a liquid or gaseous fuel, such as methanol, and an
oxidant, such as oxygen. Fuel cells are different from batteries in that they
consume a reactant that can be replenished, while batteries store electrical
energy chemically in a closed system. Generally, the reactants flow in and
reaction products flow out of the fuel cell. While the electrodes within a
battery react and change as a battery is charged or discharged, a fuel cell’s
electrodes are catalytic and relatively stable.




A direct methanol
fuel cell relies upon the reaction of water with methanol at the catalytic anode
layer to release protons and electrons, and form carbon dioxide. The electrons
pass through a circuit and generate electricity that can be used to power
external devices. The protons generated through this reaction pass through the
proton exchange membrane to the cathode, where they combine to form water. The
anode and cathode layers of a direct methanol fuel cell are usually made of
platinum ruthenium particles and platinum particles embedded on either side of a
proton exchange membrane.




Methanol fuel cells
need water at the anode and therefore pure methanol cannot be used without the
provision of water via either active transport, such as the pumping of water
generated at the cathode back to the anode layer (see Chart A), or a passive
recirculation mechanism that incorporates pressurized internal ducts or piping.
Without either an active or a passive recirculation mechanism, a direct methanol
fuel cell would require the inclusion of water as a dilutant in the methanol
fuel, which limits the energy content of the diluted fuel (see Chart B).




Direct Methanol Fuel Cell with Active
      Water Transport
            
            Methanol Fuel Cell with Water as a Fuel
      Dilutant(Chart A)
            
            (Chart B)




Our Mobion technology
eliminates the need for active water recirculation pumps or the inclusion of
water as a fuel dilutant. The water required for reaction at the anode is
transferred internally within the Mobion Chip from the site of water generation
on the air-side of the cell through a proprietary, passive design that
eliminates the need for water movement by external pumps, complicated
recirculation loops or other micro-plumbing tools (see Chart C).




Our Mobion Technology with 100% Methanol
      and Passive Water Recirculation (Chart C)


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Our Mobion solution
contains a passive water recirculation sub-system that allows for the
consumption of 100% methanol, results in a reduced parts count design and offers
the advantage of higher energy density than competing fuel cell technologies for
portable electronic devices.




Strategic
Agreements




On April 16, 2009, we
entered into a $4.8 million cost-shared development contract with the U.S.
Department of Energy, or the DOE, for the commercialization of our Mobion
product solutions. Through December 2009, the DOE has authorized $4.1 million of
spending on a cost-shared basis. This contract expires on March 31,
2010.




On April 21, 2009, we
entered into an agreement with a leading manufacturer of power tools to evaluate
our product for their future cordless power tool products. Because of Mobion’s
flexible architecture, we were able to pursue opportunities beyond the consumer
electronics market.




On October 31, 2008,
we signed an agreement with a U.S. based developer and marketer of universal
chargers to evaluate the feasibility, development and production of our Mobion
products. This agreement, which took effect on August 29, 2008, will enable us
and this developer to collaborate in evaluating and adopting our Mobion
technology for use with a number of their products.




On September 10,
2008, MTI Micro and Duracell, part of The Gillete Company, which is part of the
Procter & Gamble Company (“Duracell”) entered into a letter of intent
whereby both parties agree to explore a new relationship to collaborate on the
market development and commercialization of Mobion based fuel cell systems and
methanol fuel cartridges for the consumer market.




On April 28, 2008, we
entered into a development agreement with a global Japanese consumer electronics
company to evaluate the feasibility, development, and production of our Mobion
products. This agreement will enable us and this developer to collaborate in
evaluating and adopting our Mobion technology for use in various precision
imaging applications, including digital cameras. On May 12, 2008, we announced
that we delivered a Mobion prototype to this company for their
evaluation.




On December 13, 2007,
we entered into an agreement with Trident Systems, Inc. to pursue opportunities
to leverage our consumer market platform into low-power military markets.
Teaming opportunities include demonstrations of unattended ground sensor
prototypes powered by Mobion and evaluations and potential submissions of
proposals for military programs.




Manufacturing




We plan to outsource
manufacturing of our portable power source products through third-party
relationship contract manufacturers. We believe this strategy will provide us
with a business model that allows us to concentrate on our core competencies of
research and development and technological know-how and reduce our capital
expenditures. In addition, this strategy will significantly reduce our working
capital requirements for inventory because we will not incur most of our
manufacturing costs until we have actually shipped our portable power source
products to our customers and billed those customers for those products. To
date, we have established an internal developmental pilot production line to
test our design and engineering capabilities and a representative office in
Shanghai to facilitate our efforts to develop relationships with manufacturers
and low cost component suppliers in China. Although we have developed an
internal developmental pilot production line, we intend to rely upon third
parties to forecast production requirements and have established the basic
design, function, and performance of our in-house engineering capabilities to
foster the successful commercialization of our products.




The commercialization
of our Mobion power solution will depend upon our ability to reduce the costs of
our portable power source products, as they are currently more expensive than
existing rechargeable battery technologies. In addition, we continue to work on
enhancing our Mobion power source design, including our injection molded Mobion
Chip, to ensure its manufacturability (including engineering, verification and
product testing), design for assembly, design for testability, and design for
serviceability, all of which are critical to successful high-volume
production.




Sales and Marketing




We plan to sell our
portable power source products for incorporation into the products of our OEM
customers or to be sold as accessories using their own brand. We plan to
generate sales to OEM customers through direct sales employees as well as
outside sales representatives and distributors. We have established sales
representatives in the United States, South Korea and Japan.




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We build awareness in
our target markets through a series of targeted campaigns, which include our
website, e-mails, conferences, tradeshows, and other standard marketing efforts.
In addition, we provide progress reports on our Mobion developments through a
wide array of publications, active public relations, updates with industry
analysts and the investment community, and speaking engagements.




Competition




We expect that the
primary competitive factor in our portable power source business will be market
acceptance of our portable power source products as an alternative power source
to conventional lithium-ion and other rechargeable batteries. Market acceptance
of our portable power source products will depend on a wide variety of factors,
including the compatibility of direct methanol fuel cell power sources with
portable electronic devices and the market’s assessment of the advantages
offered by our products in terms of size, weight, power density and duration,
safety, reliability, and environmental friendliness when measured against price
disadvantages. We anticipate direct competition from large Asian-based
companies, including Toshiba (Corporation), which recently introduced a fuel
cell charger, and some of our potential OEM customers.




Product Development




Over the past three
years, we have developed and built a number of engineering prototypes used to
validate our technology and to generate discussions with potential customers
about the inclusion of our technology in new products. During the same period,
we have created four generations of external power charger prototypes, each of
which has shown a dramatic size reduction over the previous generation. Our
latest external power charger prototype achieved a 60% reduction in volume over
our first generation prototype and it has incorporated a removable methanol
cartridge.




We have improved the
capabilities of our Mobion Chip technology during the last three years, which we
expect will continue to evolve as we integrate greater functionality into our
designs. This continuous iterative integration process is intended to reduce the
size, simplify the design and construction, and reduce assembly complexity of
our technology. We continue to improve the product design of the Mobion Chip and
believe that future product generations will deliver performance improvements in
terms of energy density, size, weight, and power duration. The Mobion Chip
should also be able to provide power directly to wireless electronic devices for
refueling/repowering at a speed of 0.5 seconds, compared to rechargeable
lithium-ion batteries that need approximately 2 hours.




Intellectual Property and Proprietary
Rights




We rely on a
combination of patents (both national and international), trade secrets,
trademarks, and copyrights to protect our intellectual property. Our strategy is
to apply for patent protection for all significant design requirements.
Additionally, we systematically analyze the existing intellectual property
landscape for direct methanol fuel cells to determine where the greatest
opportunities for developing intellectual property exist. We also enter into
standard confidentiality agreements with our employees, consultants, vendors,
partners and potential customers and seek to control access to and distribution
of our proprietary information.




As of December 31,
2009, we had filed over 111 U.S. patent applications, 54 of which have been
awarded. Of the awarded patents, 45 are assigned to us and 9 are assigned to
Duracell as part of our strategic alliance agreement with them. We have filed 33
Patent Cooperation Treaty Applications in multiple countries, including Japan,
the European Union, South Korea and Australia. We have developed a portfolio of
patent applications in areas including fuel cell systems, fuel refill and
packaging, fuel, components, manufacturing processes, and system
packaging.




The Test and Measurement Instrumentation
Segment




MTI Instruments is a
worldwide supplier of metrology, portable balancing equipment and inspection
systems for semiconductor wafers. Our products use state-of-the-art technology
to solve complex real world applications in numerous industries including
automotive, semiconductor, solar cell manufacturing, commercial and military
aviation and data storage. We are continuously working on ways to expand our
sales reach, including expanded sales coverage in Europe and the Far East, as
well as a focus on internet marketing. We have industry recognized customer
service and have worked with hundreds of companies worldwide.




Products




Our test and
measurement segment has three product groups: general dimensional gauging,
semiconductor/solar and aviation. Our products consist of electronic,
computerized gauging instruments for position, displacement and vibration
applications for the design, manufacturing and test markets; metrology tools for
wafer characterization of semiconductor and solar wafers; and engine balancing
and vibration analysis systems for both military and commercial
aircraft.




8




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General Dimensional
Gauging: The Precision
Instruments employ fiber optic, laser and capacitance technologies to make
nano-accurate measurements in product design and quality related processes.
Gauging products include laser, fiber-optic and capacitance systems that measure
a variety of parameters including displacement, position, vibration and
dimension.




Listed below are
selected MTI Instruments’ Precision Instruments product offerings:




Product
            
            Description
            
            Markets ServedAccumeasure SeriesUltra-high precision capacitive gauging system offering
      nanotechnology accuracy.
            
            General manufacturing, semiconductor, automotive, R&D,
      government.MTI-2100 FotonicTM Sensor
      SeriesFiber-optic based vibration sensor systems with extremely high
      frequency response.
            
            General manufacturing, semiconductor, automotive, R&D,
      government.MicrotrakTM IIHigh speed laser sensor systems utilizing the latest complementary
      metal-oxide semiconductor/charge-coupled device technology.
            
            General manufacturing, semiconductor, automotive, R&D,
      government.


Semiconductor and Solar: Our family of wafer metrology systems range
from manually operated units to fully automated systems which test key wafer
characteristics critical to producing high quality chips used in the
semiconductor industry. These units are used as quality control tools delivering
highly precise measurements for thickness variations, bow, warp, resistivity,
and flatness. These systems can be used on substrates varying widely in size and
materials. In addition, using push/pull capacitance probe technology, we have
expanded our line of products to include product offerings to the solar industry
for the measurement of solar wafer thickness.




The semiconductor and
solar metrology systems include the following products:




Product
            
            Description
            
            Markets ServedProformaTM200SA/300SASemi-automated, full wafer surface scanning for thickness, TTV,
      bow, warp, site and global flatness. The ProformaTM200SA can be used for all wafer
      materials and accommodates diameters of 75 – 200 mm.
            
            Wafer metrology segment of the semiconductor industry.


9




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ProformaTM 300/300GManual,
      non-contact measurement of wafer thickness, TTV and bow. The ProformaTM 300
      measures all wafer materials including Silicon, Gallium-Arsenide,
      Indium-Phosphide and wafers mounted to sapphire or tape. The ProformaTM
      300/G can accept wafers from 50 to 300 mm.
            
            Wafer
      metrology segment of the semiconductor industry.PV 1000The PV
      1000 module provides up to three pairs of probes for measurement of
      maximum, minimum and average thickness, as well as total thickness
      variation (TTV) and wafer bow of solar wafers.
            
            Solar cell
      manufacturing




Aviation: The computer-based PBS products automatically
collect and record aircraft engine vibration data, identify vibration or balance
trouble in an engine, and calculate a solution to the problem. These units are
used and recommended by major aircraft engine manufacturers and are also used
extensively by the U.S. Air Force, other military and commercial airlines and
gas turbine manufacturers.




Our aviation and
industrial vibration measurement systems products include vibration analysis and
engine trim balance instruments and accessories for commercial and military
jets. These products are designed to quickly pinpoint engine problems and
eliminate unnecessary engine removals. Selected products in this area include:




Product
            
            Description
            
            Markets ServedPBS-4100+ Portable Balancing
      SystemThe
      standard of the aviation industry worldwide, the portable PBS-4100 Plus
      detects if an engine has a vibration problem or a trim balance problem and
      provides a solution. This system works on all engine types and models from
      all engine manufacturers.
            
            Major
      commercial airlines, regional carriers, and the U.S. Military.PBS-4100R Test Cell
      Vibration Analysis & Trim Balance System
            
            Advanced trim balancing and diagnostic features for engine test
      cells.
            
            Major
      commercial airlines, regional carriers, and the U.S. MilitaryPBS-3300
            
            A compact
      balancing and vibration system for use in mobile test cells and
      distributed test stands.
            
            Major
      commercial airlines, regional carriers, and the U.S. Military.




Marketing and Sales




We market our
products and services using channels of distribution specific to each of our
product groups and customer base. The general dimensional gauging product group
markets it products through a combination of manufacturer representatives in the
United States and distributors overseas. The semiconductor product group markets
its products directly to end customers in the United States and internationally
through distributors, while the aviation group primarily sells direct to the end
user.




10




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To supplement these
efforts, the company utilizes both commercial and industrial search engines,
targeted newsletters and appropriate trade shows to identify and expand its
customer base.




Comparisons of sales
by class of products, which account for over 10 percent of MTII’s sales, are
shown below for the years ended December 31:




2009
            
            2008
            
            2007(Dollars in thousands)
            Sales
            
            %
            
            Sales
            
            %
            
            Sales
            
            %Aviation
            $
            2,768
            
            
            44.19
            %
            
            $
            1,977
            
            
            31.76
            %
            
            $
            3,664
            
            
            40.58
            %General Gauging
            
            2,619
            
            
            41.81
            
            
            
            2,983
            
            
            47.93
            
            
            
            4,490
            
            
            49.73Semiconductor and Solar
            
            876
            
            
            14.00
            
            
            
            1,264
            
            
            20.31
            
            
            
            874
            
            
            9.69Total
            $
            6,263
            
            
            100.00
            %
            
            $
            6,224
            
            
            100.00
            %
            
            $
            9,028
            
            
            100.00
            %


Product Development and
Manufacturing




MTI Instruments
conducts research and develops technology to support its existing products and
develop new products. Management believes that the success of the enterprise
depends to a large extent upon innovation, technological expertise and new
product development.




Our most recent
product offerings include:


- In semiconductors, for 2009, the
  introduction of the PV 1000 product line servicing the Solar cell
  manufacturing industry.
- In aviation, introduction of the
  PBS-4100+ – an advanced and compact portable jet engine balancing and
  vibration diagnostics system for use by both military and commercial
  carriers.
- In the general gauging area, the
  introduction of the MTI-2100 FotonicTM Sensor - a "next generation" fiber-optic
  sensor for high-resolution, non-contact measurement of high frequency
  vibration and motion analysis. The amplifier replaced the MTI-2000 Fotonic
  Sensor.
- MTI Instruments also added the
  1515 low-noise amplifier to its Accumeasure product line, which is designed to
  meet the stringent requirements of brake rotor measurement applications in the
  automotive industry.

We seek to achieve a
competitive position by continuously advancing our technology rather than
relying on patent protection. MTI Instruments has one patent supporting its
semiconductor line.




MTI Instruments
assembles and tests its products at its facilities located in Albany, New York.
Management believes that most of the raw materials used in our products are
readily available from a variety of vendors.




Intellectual Property and Proprietary
Rights




We rely on trade
secret laws and patents to establish and protect the proprietary rights of our
products. In addition, we enter into standard confidentiality agreements with
our employees and consultants and seek to control access to and distribution of
our proprietary information. Even with these precautions, it may be possible for
a third party to copy or otherwise obtain and use our products or technology
without authorization or to develop similar technology independently. In
addition, effective patent and trade secret protection may be unavailable or
limited in certain foreign countries. We have one patent issued supporting our
semiconductor product line.




Significant
Customers




MTI Instruments’
largest customer is the U.S. Air Force. We also have strong relationships with
companies in the manufacturing, semiconductor, automotive, aerospace, aircraft
and research industries. In the Test and Measurement Instrumentation Segment, in
2009, the U.S. Air Force accounted for $1,188 thousand or 19.0% of product
revenues; in 2008, it accounted for $974 thousand or 15.7% of product revenues;
and in 2007, the U.S. Air Force accounted for $2.4 million, or 26.3%, of product
revenue.




Recent Contracts




In 2009, MTI
Instruments was awarded a multi-year U.S. Air Force contract to service and
repair its existing fleet of PBS-4100 jet engine balancing systems with the
latest diagnostic and balancing technology, which could potentially generate up
to a total of $6,500 thousand in sales for the Company between the years 2009
and 2014. As of December 31, 2009, MTI Instruments had recorded $439 thousand in
orders, approximately 6.8% of the five-year contract’s total value.




11




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In 2007, we were
awarded a multi-year U.S. Air Force contract for the purchase of up to $2,280
thousand in PBS4100+ portable aircraft engine balancing systems. As of December
31, 2009, we had recorded $2,109 thousand in orders, approximately 92.5% of the
three-year contract’s total value.




In 2002, we were
awarded a multi-year $8,800 thousand U.S. Air Force contract to service and
retrofit its existing fleet of PBS-4100 jet engine balancing systems. This
contract has generated a total of $8,009 thousand in sales for the Company
between the years 2002 and 2009. Although, this contract has expired, one
delivery order remains open under the contract as of December 31, 2009.




Competition




We are subject to
competition from several companies, many of which are larger than MTI
Instruments and have greater financial resources. MTI Instruments’ competitors
include KLA-Tencor, Sigma Tech Corporation, E+H Eichhorn+Hausmann GmbH,
Chadwick-Helmuth Company, Inc., ACES Systems, Micro-Epsilon, and Keyence
Corporation.




While MTI Instruments
has a share of its respective specialized market segments, it does not consider
its share to be dominant within its industry. The primary competitive
considerations in MTI Instruments’ markets are product quality, performance,
price, timely delivery, and the ability to identify, pursue and bring new
customers. MTI Instruments believes that its employees, product development
skills, sales and marketing systems and reputation are competitive advantages.




Research and Development




MTI Micro’s research
and development team is responsible for advanced research, product planning,
design and development, and quality assurance. Through our supply chain, we are
also working with subcontractors in developing specific components of our
technologies. The primary objective of our research and development program is
to advance the development of our direct methanol fuel cell technology to
enhance the commercial value of our products and technology, as well as to
develop next generation fuel cell products.




MTI Instruments
conducts research and develops technology to support its existing products and
develop new products. Management believes that the success of the enterprise
depends to a large extent upon innovation, technological expertise and new
product development.  MTI, through its subsidiaries MTI
Micro and MTI Instruments has incurred research and development costs of
approximately $11.8 million, $8.3 million and $3.3 million for the years ended
December 31, 2007, 2008, and 2009, respectively. We expect to continue to invest
in research and development in the future.




Employees




As of December 31,
2009, we had 52 employees. Of these employees, 21 were involved in our new
energy segment and 31 were involved in our test and measurement instrumentation
business. Two of our employees are also involved in corporate functions.




Properties




We presently lease
two premises in the United States and one office in Shanghai, China. MTI
Instruments is located at 325 Washington Avenue Extension, Albany, New York.
This premise consists of approximately 17,424 useable square feet of space, with
the lease expiring in late 2014. MTI Micro and MTI are located at 431 New Karner
Road, Albany, NY. This premise consists of approximately 20,000 useable square
feet of space, with the lease expiring in August 2010. Together, the premises
are adequate for our current and foreseeable needs. The office in Shanghai,
China is a representative office, with approximately 310 usable square feet of
space. The lease expires in 2010.




Legal Proceedings




We are not currently
involved in any legal proceeding that we believe would have a material adverse
effect on our business or financial condition.




Availability of Information




We make available
through our website (http://www.mechtech.com), free of charge, our Annual Reports on Form 10-K, Quarterly Reports on
Form 10-Q, Current Reports on Form 8-K, and amendments to those reports, filed
or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act
of 1934, as amended, as soon as reasonably practicable after such reports are
electronically filed with, or furnished to, the SEC. These reports may be
accessed through our website’s Investor Relations page.




The public may read
and copy any materials we file with the SEC at the SEC Public Reference Room at
100 F Street, NE, Room 1580, Washington, DC 20549. The public may obtain
information on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. We file electronically with the SEC and the SEC maintains an
Internet site (http://www.sec.gov) that contains reports, proxy and information
statements, and other information regarding issuers that file electronically
with the SEC.




12




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Item 1A: Risk Factors




Factors Affecting Future Results




This Annual Report on
Form 10-K and the documents we have filed with the SEC that are incorporated by
reference into this Annual Report on Form 10-K contain forward-looking
statements that involve risks and uncertainties. Any statements contained, or
incorporated by reference, in this Form 10-K that are not statements of
historical fact may be forward-looking statements. When we use the words
“anticipate,” “estimate,” “plans,” “projects,” “continuing,” “ongoing,”
“expects,” “management believes,” “we believe,” “we intend,” “should,” “could,”
“may,” “will” and similar words or phrases, we are identifying forward-looking
statements. Forward-looking statements involve risks, uncertainties, estimates
and assumptions which may cause our actual results, performance or achievements
to be materially different from those expressed or implied by forward-looking
statements. These factors include, among others:


- our need to raise additional
  financing for our New Energy segment;
- our history of recurring net
  losses and the risk of continued net losses;
- our independent auditors have
  included a going concern paragraph in their opinion:
- sales revenue growth of our test
  and measurement instrumentation business may not be achieved;
- the dependence of our test and
  measurement instrumentation business on a small number of customers and
  potential loss of government funding;
- our ownership position in MTI
  Micro may be reduced as a result of our plans to seek external financing for
  MTI Micro’s operations;
- risks related to developing Mobion
  direct methanol fuel cells and whether we will ever successfully develop
  reliable and commercially viable Mobion fuel cell solutions;
- our portable power source products
  or our customers’ products that utilize our portable power source products may
  not be accepted by the market;
- our inability to build and
  maintain relationships with our customers;
- our limited experience in
  manufacturing fuel cell systems on a commercial basis;
- our dependence on others for our
  production requirements for our portable power source
  products;
- our dependence on our
  manufacturing subcontractors to provide high levels of productivity and
  satisfactory delivery schedules for our portable power source
  products;
- our dependence on third-party
  suppliers for most of the manufacturing equipment necessary to produce our
  portable power source products;
- our inability to obtain sufficient
  quantities of components and other materials, including platinum and
  ruthenium, necessary for the production of our portable power source
  products;
- our dependence on OEMs integrating
  Mobion fuel cell systems into their devices;
- our lack of long-term purchase
  commitments from our customers and the ability of our customers to cancel,
  reduce, or delay orders for our products;
- risks related to protection and
  infringement of intellectual property;
- our new technologies may not
  result in customer or market acceptance;
- our inability to commercialize our
  proposed portable power source solutions and develop new product solutions on
  a timely basis;

13




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- our inability to develop and
  utilize new technologies that address the needs of our customers;
- intense competition in the direct
  methanol fuel cell and instrumentation businesses;
- changes in policies by U.S. or
  foreign governments that hinder, disrupt, or economically disadvantage
  international trade;
- the impact of future exchange rate
  fluctuations;
- the uncertainty of the U.S.
  economy;
- the historical volatility of our
  stock price;
- the cyclical nature of the
  electronics industry;
- failure of our strategic alliances
  to achieve their objectives or perform as contemplated and the risk of
  cancellation or early termination of such alliance by either
  party;
- product liability or
  defects;
- risks related to the flammable
  nature of methanol as a fuel source;
- the loss of services of one or
  more of our key employees or the inability to hire, train, and retain key
  personnel;
- significant periodic and seasonal
  quarterly fluctuations in our results of operations;
- our dependence on sole suppliers
  or a limited group of suppliers for both business segments;
- risks related to the limitation of
  the use of our net operating losses in the event of certain ownership changes;
  and
- other factors discussed under the
  headings “Risk Factors” below.

Except as may be
required by applicable law, we do not undertake or intend to update or revise
our forward-looking statements, and we assume no obligation to update any
forward-looking statements contained in, or incorporated by reference into, this
Annual Report on Form 10-K as a result of new information or future events or
developments. Thus, assumptions should not be made that our silence over time
means that actual events are bearing out as expressed or implied in such
forward-looking statements.




Risk Factors




Set forth below are certain risks and
uncertainties that could adversely affect our results of operations or financial
condition and cause our actual results to differ materially from those expressed
in our forward-looking statements. Also refer to Factors Affecting Future
Results.




We have incurred recurring net losses and anticipate continued net losses
as we execute our commercialization plan for our portable power source business.
If we do not raise financing in the next few months, we will be required to
dramatically downsize, discontinue, or sell our portable power source business
and/or our test and measurement instrumentation business.




We have incurred
recurring net losses, including net losses of $9.6 million in 2007, $12.5
million in 2008, and $3.1 million in 2009. As a result of ongoing operating
losses, we had an accumulated deficit of approximately $121 million as of
December 31, 2009. Subject to cash availability, we expect to continue to make
significant expenditures and incur substantial expenses as we develop and
commercialize our proposed portable power source products; develop our
manufacturing, sales, and distribution networks; implement internal systems and
infrastructure; and hire additional personnel. As a result, we expect to
continue to incur significant losses as we execute our plan to commercialize our
portable power source business and may never achieve or maintain profitability.
We will be unable to satisfy our current obligations solely from cash generated
from operations or become profitable until we successfully commercialize our
portable power source business. If we continue to incur substantial losses and
are unable to secure additional financing, we could be forced to discontinue or
curtail our business operations; sell assets at unfavorable prices; or merge,
consolidate, or combine with a company with greater financial resources in a
transaction that may be unfavorable to us.




14




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At present, the
Company does not expect to continue to fund MTI Micro on a long-term basis.
Based on the Company’s projected cash requirements for operations and capital
expenditures and its current cash and cash equivalents of $785 thousand at
December 31, 2009, management believes it will have adequate resources to fund
its current operations, excluding MTI Micro operations, but there can be no
assurance. Since the company will no longer fund MTI Micro, the subsidiary has
sought other sources of funding, but there is no assurance that such funding
will be available on acceptable terms, if at all.




We currently do not have sufficient funds to commercialize our portable
power source products.




In order to continue
full commercialization of its micro fuel cell solution, MTI Micro will need to
do one or more of the following to raise additional resources, or reduce its
cash requirements:


- obtain additional government or
  private funding of the Company’s direct methanol fuel cell research,
  development, manufacturing readiness and commercialization;
- secure additional debt or equity
  financing; or
- further reduce its current
  expenditure run-rate.

There is no guarantee
that resources will be available to MTI Micro on terms acceptable to it, or at
all, or that such resources will be received in a timely manner, if at all, or
that MTI Micro will be able to reduce its expenditure run-rate without
materially and adversely affecting its business. MTI Micro had cash and cash
equivalents as of December 31, 2009 of $163 thousand. Subsequent to December
2009, MTI Micro collected outstanding receivable billings from the DOE of $307
thousand and received $660 thousand through the Common Stock and Warrant
Purchase Agreement (the “Agreement”). Additionally, MTI Micro has $1,340
thousand of available borrowing capacity through the Agreement, and the
remaining $191 thousand for the DOE contract as work is performed. However, the
funds available through the Agreement are only available to us in increments of
$330 thousand bi-monthly. Our next available draw down is May 2010.




In order to conserve
cash and extend operations while we pursue any additional necessary financing,
we would be required to reduce operating expenses. There is no assurance that
funds raised in any such a financing will be sufficient, that the financing will
be available on terms favorable to us or to existing stockholders and at such
times as required, or that we will be able to obtain the additional financing
required for the continued operation and growth of our business. During the last
sixteen months, MTI Micro has raised $3.1 million in external debt and equity
financing. If we raise additional funds by issuing equity securities, MTI
Micro’s stockholders will experience further dilution. Additional debt
financing, if available, may involve restrictive covenants. Any debt financing
or additional equity financing may contain terms that are not favorable to us or
our stockholders. If we raise additional funds through collaboration and
licensing arrangements with third parties, it may be necessary to relinquish
some rights to our technologies or our products, or grant licenses on terms that
are not favorable to us. If we are unable to raise adequate funds, we may have
to liquidate some or all of our assets or delay, reduce the scope of or
eliminate some or all of our research and development programs, or discontinue
our portable power source business. Without other resources, management
currently believes it will need to make significant changes to its operations
during the month of April of 2010.




Continuing uncertainty of the U.S. economy may have serious implications
for the growth and stability of our business and may negatively affect our stock
price.




The revenue growth
and profitability of our business will depend significantly on the overall
demand for test and measurement instrumentations as well as electronic devices.
Softening demand in these markets caused by ongoing economic uncertainty may
result in decreased revenue or earnings levels. The U.S. economy has been
historically cyclical and market conditions continue to be challenging, which
has resulted in individuals and companies delaying or reducing expenditures.
Further delays or reductions in spending could have a material adverse effect on
demand for our products, and consequently on our business, financial condition,
results of operations, prospects, stock price, and ability to continue to
operate.




We currently derive all of our product revenue from our test and
measurement instrumentation business.




Our test and
measurement instrumentation business is subject to a number of risks, including
the following:


- a continued slow down or
  cancellation of sales to the military as a result of a potential redeployment
  of governmental funding;
- the company may not be able to
  maintain, improve, or expand its direct and indirect channels of
  distribution;
- a failure to expand or maintain
  the business as a result of competition, a lack of brand awareness, or market
  saturation; and
- an inability to
  launch new products as a result of intensive competition, uncertainty of new
  technology development, and developmental timelines.

15




---



In addition, our test
and measurement instrumentation products can be sold in quantity to a relatively
few number of customers, resulting in a customer concentration risk. This
business experienced a significant decline in sales in 2008 and sales were
comparable in 2009. The further loss of any significant portion of such
customers or a material adverse change in the financial condition of any one of
these customers could have a material adverse effect on our business.




If we are required to
discontinue our portable power source business due to lack of funding, all of
our corporate overhead costs would be allocated to the test and measurement
instrumentation business.




We have not generated any product revenue from our portable power source
business and currently have no portable power source commercial products.




We have not generated
any product revenue from our portable power source business and currently have
no portable power source commercial products. The successful development and
commercialization of our portable power source products will depend on a number
of factors, including the following:


- continuing our research and
  development efforts;
- finalizing the design of our
  portable power source products;
- securing OEM customers to
  incorporate our portable power source products into products sold by
  them;
- arranging for adequate
  manufacturing capabilities; and
- completing, refining, and managing
  our supply chain and distribution channels.

Additionally, our
technology is new and complex, and there may be technical barriers to the
development of our portable power source products. The development of our
portable power source products may not succeed or may be significantly delayed.
Our portable power source products will be produced through manufacturing
arrangements that have not been finalized or tested on a commercial scale. If we
fail to successfully develop or experience significant delays in the development
of our portable power source products, or if there are significant delays in
commercialization, we are unlikely to recover those losses, thus making it
impossible for us to become profitable through the sales of these products. This
would materially and adversely affect our business and financial condition. If
adequate funds are not available by the second quarter of 2010, we may have to
delay development or commercialization of our portable power source products, or
license to third parties the rights to commercialize products or technologies
that we would otherwise seek to commercialize. Any of these factors could harm
our business and financial condition.




Any revenue derived
in the relatively near-term relating to our portable power source business
likely will result from governmental contracts or other governmental funding. We
can offer no assurance that we will be able to secure continued government
funding. The loss of such contracts or the inability to obtain additional
contracts could materially harm our business.




Our ownership position in MTI Micro may be reduced as a result of
external financing for MTI Micro's operations, which could limit our ability to
control the operations.




As of December 31,
2009, we owned approximately 61.8% of the outstanding equity in MTI Micro and
have control over the operations of this subsidiary. As a result of the
negotiated conversion in December 2009 of an aggregate principal and accrued
interest amount of $3,910,510 outstanding under the Bridge Notes, the Company’s
ownership interest in MTI Micro decreased from approximately 97.3% to
approximately 61.8%, or 67.8% on a fully-diluted basis including the Micro
Warrants issued to all current MTI Micro stockholders and the Bridge Warrants.




On January 11, 2010,
MTI Micro entered into a Common Stock and Warrant Purchase Agreement (the
“Purchase Agreement”) with Counter Point Ventures Fund II, L.P. (“Counter
Point”). Pursuant to the Purchase Agreement, MTI Micro may issue and sell to
Counter Point up to 28,571,429 shares of common stock of Micro at a purchase
price per share of $0.070, over a period of twelve months, and warrants
(“Warrants”) to purchase shares of Micro Common Stock equal to 20% of the shares
of Micro Common Stock purchased under the Purchase Agreement at an exercise
price of $0.070 per share. If MTI Micro were to issue and sell all of the
28,571,429 shares under the Purchase Agreement, the Company would continue to
hold an aggregate of 55.8% of the fully-diluted capital stock of MTI Micro.




16




---



In addition, we do
not currently expect to advance additional long-term resources to MTI Micro to
fund its continued direct methanol fuel cell development and commercialization
programs. Instead, MTI Micro will seek additional capital from external sources
to fund future development and operations. Depending on the valuation of MTI
Micro at the time of future financings, if any, our ownership position could be
substantially diluted, and we may no longer have sufficient equity to control
the operations of MTI Micro. If MTI Micro is unable to secure the necessary
additional external financing, we may be forced to substantially downsize or
eliminate its operations.




We may experience an ownership change which would result in a limitation
of the use of our net operating losses.




As of December 31,
2009, we had approximately $65 million of net operating loss, or NOL,
carryforwards. As a result of the conversion of the Bridge Notes, MTI no longer
maintains an 80% or greater ownership of MTI Micro. Thus MTI Micro will no
longer be included in the MTI and subsidiaries consolidated federal and combined
New York State tax returns, effective December 9, 2009. A reattribution of a
portion of MTI Micro’s NOLs is expected, which will reduce MTI Micro’s NOLs to
approximately $13 million, and MTI’s balance will be approximately $52 million.
Also as a result of the conversion of the bridge note, MTI Micro may have
experienced a Section 382 ownership change, which would further reduce their
NOLs by an estimated $6.7 million. Our ability to utilize both the MTI and MTI
Micro NOL carryforwards, including any future NOL carryforwards that may arise,
may be limited by Section 382 of the Internal Revenue Code of 1986, as amended,
if we or MTI Micro undergo any further “ownership changes” as a result of
subsequent changes in the ownership of our outstanding common stock pursuant to
the exercise of the warrants, the conversion of the MTI Micro’s bridge notes, or
otherwise. A corporation generally undergoes an “ownership change” when the
ownership of its stock, by value, changes by more than 50 percentage points over
any three-year testing period. In the event of an ownership change, Section 382
imposes an annual limitation on the amount of post-ownership change taxable
income a corporation may offset with pre-ownership change NOL carryforwards and
certain recognized built-in losses.




Our common stock was delisted from the NASDAQ Stock Market, which could
adversely affect the price of our stock and the ability of our stockholders to
trade in our stock.




In April 2009, we
voluntarily delisted our common stock from the NASDAQ Stock Market to reduce
expenses and to avoid a likely involuntary delisting for failure to comply with
the continued listing requirements. Our common stock subsequently began trading
on the Pink Sheets under the symbol “MKTY PK.” As a result of the delisting, the
liquidity in our stock may decrease, which could adversely affect the price of
our stock and make it more difficult for you to trade in our stock.




Our portable power source products may not be accepted by the market.




Any portable power
source products that we develop may not achieve market acceptance. The
development of a successful market for our proposed portable power source
products and our ability to sell those products at favorable prices may be
adversely affected by a number of factors, many of which are beyond our control,
including the following:


- our failure to produce portable
  power source products that compete favorably against other products on the
  basis of price, quality, performance, and life;
- competition from conventional
  lithium-ion or other rechargeable battery systems;
- the ability of our technologies
  and product solutions to address the needs of the electronic device markets,
  the requirements of OEMs, and the preferences of end users;
- our ability to provide OEMs with
  portable power source products that provide advantages in terms of size,
  weight, peak power, power duration, reliability, durability, performance, and
  value-added features compared to alternative solutions; and
- our failure to develop and
  maintain successful relationships with OEMs, manufacturers, distributors, and
  others as well as strategic partners.

Target markets for
our proposed portable power source products, such as those for mobile phones
(including smart phones) and mobile phone accessories, digital cameras, portable
media players, PDAs, and GPS devices, are volatile, cyclical, and rapidly
changing and could continue to utilize existing technology or adopt other new
competing technologies. The market for certain of these products depends in part
upon the development and deployment of wireless and other technologies, which
may or may not address the needs of users of these new products.




Many manufacturers of
portable electronic devices have well-established relationships with competitive
suppliers. Penetrating these markets will require us to offer better performance
alternatives to existing solutions at competitive costs. The failure of any of
our target markets to continue to expand, or our failure to penetrate these
markets to a significant extent, will impede our sales growth. We cannot predict
the growth rate of these markets or the market share we will achieve in these
markets in the future.




17




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If our proposed
portable power source products fail to gain market acceptance, it could
materially and adversely affect our business and financial condition.




Market acceptance of our customers’ products that utilize our portable
power source products may decline or may not develop and, as a result, our sales
will be harmed.




We plan to produce
portable power source products that our OEM customers incorporate into their
products. As a result, the success of our proposed portable power source
products will depend upon the widespread market acceptance of the products of
our OEM customers. We will not control or influence the manufacture, promotion,
distribution, or pricing of the products that incorporate our portable power
source products. Instead, we will depend on our OEM customers to manufacture and
distribute products incorporating our portable power source products and to
generate consumer demand through their marketing and promotional activities.
Even if our technologies and products successfully meet our customers’ price and
performance goals, our sales would be harmed if our OEM customers do not achieve
commercial success in selling their products to consumers that incorporate our
portable power source products.




Any lack of adoption
in the use of our portable power source products by OEM customers in the
electronic device markets, the reduced demand for our OEM customers’ products,
or a slowdown in their markets would adversely affect our sales.




If we fail to build and maintain relationships with our customers and do
not satisfy our customers, we may lose future sales and our revenue may stagnate
or decline.




Because our success
depends on the widespread market acceptance of our customers’ products, we must
develop and maintain our relationships with leading global OEMs of electronic
devices, such as mobile phones (including smart phones) and mobile phone
accessories, digital cameras, portable media players, PDAs, and GPS devices. In
addition, we must identify areas of significant growth potential in other
markets, establish relationships with OEMs in those markets, and assist them in
developing products that use our portable power source products and
technologies. Our failure to identify potential growth opportunities,
particularly in new markets, or establish and maintain relationships with OEMs
in those markets, would prevent our business from growing in those markets.




Our ability to meet
the expectations of our customers will require us to provide portable power
source products for customers on a timely and cost-effective basis and to
maintain customer satisfaction with our product solutions. We must match our
design and production capacity with customer demand, maintain satisfactory
delivery schedules, and meet specific performance goals. If we are unable to
achieve these goals for any reason, our customers could reduce their purchases
from us and our sales would decline or fail to develop.




Our customer
relationships also can be affected by factors affecting our customers that are
unrelated to our performance. These factors can include a myriad of situations,
including business reversals of customers, determinations by customers to change
their product mix or abandon business segments, or mergers, consolidations, or
acquisitions involving our customers.




We have no experience manufacturing portable power source products on a
commercial scale.




To date, we have
focused primarily on research, development, and pilot production, and we have no
experience manufacturing any portable power source products on a commercial
scale. Our pilot production efforts to date have been limited in scale. It is
our intent to manufacture our portable power source products through OEM
customers and third-party manufacturers. Failure to secure manufacturing
capabilities could materially and adversely affect our business and financial
condition.




We will rely on others for our production, and any interruptions of these
arrangements could disrupt our ability to fill our customers’ orders.




We plan to rely on
others for all of our production requirements for our portable power source
products. The majority of this manufacturing is anticipated to be conducted in
Asia by manufacturing subcontractors that also perform services for numerous
other companies. We do not expect to have a guaranteed level of production
capacity with any of our manufacturing subcontractors. Qualifying new
manufacturing subcontractors is time consuming and might result in unforeseen
manufacturing and operating problems. The loss of any relationships with our
manufacturing subcontractors or assemblers or their inability to conduct their
manufacturing and assembly services for us as anticipated in terms of cost,
quality, and timeliness could adversely affect our ability to fill customer
orders in accordance with required delivery, quality, and performance
requirements. If this were to occur, the resulting decline in revenue would harm
our business.




18




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We will depend on third parties to maintain satisfactory manufacturing
yields and delivery schedules, and their inability to do so could increase our
costs, disrupt our supply chain, and result in our inability to deliver our
portable power source products, which would adversely affect our results of
operations.




We will depend on our
manufacturing subcontractors to maintain high levels of productivity and
satisfactory delivery schedules for our portable power source products from
manufacturing and assembly facilities likely located primarily in Asia. We plan
to provide our manufacturing subcontractors with rolling forecasts of our
production requirements. We do not, however, anticipate having long-term
agreements with any of our manufacturing subcontractors that guarantee
production capacity, prices, lead times, or delivery schedules. Our
manufacturing subcontractors will serve other customers, many of which will have
greater production requirements than we do. As a result, our manufacturing
subcontractors could determine to prioritize production capacity for other
customers or reduce or eliminate deliveries to us on short notice. We may
experience lower than anticipated manufacturing yields and lengthening of
delivery schedules. Lower than expected manufacturing yields could increase our
costs or disrupt our supply chain. We may encounter lower manufacturing yields
and longer delivery schedules while commencing volume production of any new
products. Any of these problems could result in our inability to deliver our
product solutions in a timely manner and adversely affect our operating results.




We plan to rely on third-party suppliers for most of our manufacturing
equipment.




We plan to rely on
third-party suppliers for most of the manufacturing equipment necessary to
produce our portable power source products. The failure of suppliers to supply
manufacturing equipment in a timely manner or on commercially reasonable terms
could delay our commercialization plans and otherwise disrupt our production
schedules or increase our manufacturing costs. Further, our orders with certain
of our suppliers may represent a very small portion of their total orders. As a
result, they may not give priority to our business, leading to potential delays
in or cancellation of our orders. If any single-source supplier were to fail to
supply our needs on a timely basis or cease providing us with key components, we
would be required to substitute suppliers. We may have difficulty identifying a
substitute supplier in a timely manner and on commercially reasonable terms. If
this were to occur, our business would be harmed.




Shortages of components and raw materials may delay or reduce our sales
and increase our costs, thereby harming our results of operations.




The inability to
obtain sufficient quantities of components and other materials, including
platinum and ruthenium, necessary for the production of our portable power
source products could result in reduced or delayed sales or lost orders. Any
delay in or loss of sales could adversely impact our operating results. Many of
the materials used in the production of our portable power source products will
be available only from a limited number of foreign suppliers, particularly
component suppliers located in Asia. In most cases, neither we nor our
manufacturing subcontractors will have long-term supply contracts with these
suppliers. As a result, we will be subject to economic instability in these
Asian countries as well as to increased costs, supply interruptions, and
difficulties in obtaining materials. Our customers also may encounter
difficulties or increased costs in obtaining the materials necessary to produce
their products into which our product solutions are incorporated.




From time to time,
materials and components necessary for our portable power source products or in
other aspects of our customers’ products may be subject to allocation because of
shortages of these materials and components. Shortages in the future could cause
delayed shipments, customer dissatisfaction, and lower revenue.




We will be subject to lengthy development periods and product acceptance
cycles, which can result in development and engineering costs without any future
revenue.




We plan to provide
portable power source solutions that are incorporated by OEMs into the products
they sell. OEMs will make the determination during their product development
programs whether to incorporate our portable power source solutions or pursue
other alternatives. This process may require us to make significant investments
of time and resources in the design of portable customer-specific power source
solutions well before our customers introduce their products incorporating our
product solutions and before we can be sure that we will generate any
significant sales to our customers or even recover our investment. During a
customer’s entire product development process, we will face the risk that our
portable power source products will fail to meet our customer’s technical,
performance, or cost requirements or that our products will be replaced by
competing products or alternative technological solutions. Even if we complete
our design process in a manner satisfactory to our customer, the customer may
decide to delay or terminate its product development efforts. The occurrence of
any of these events could cause sales to not materialize, to be deferred, or to
be cancelled, which would adversely affect our operating results.




19




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We will not have long-term purchase commitments from our customers, and
their ability to cancel, reduce, or delay orders could reduce our revenue and
increase our costs.




Customers for our
portable power source products will not provide us with firm, long-term volume
purchase commitments, but instead will issue purchase orders to buy a specified
number of units. As a result, customers may be able to cancel purchase orders or
reduce or delay orders at any time. The cancellation, delay, or reduction of
customer purchase orders could result in reduced revenue, excess inventory, and
unabsorbed overhead. We currently have no presence in the electronic device
markets. Our success in the electronic device markets will require us to
establish the value added proposition of our products to OEMs that have
traditionally used other portable power solutions. All of the markets we plan to
serve are subject to severe competitive pressures, rapid technological change
and product obsolescence, which may increase our inventory and overhead risks,
resulting in increased costs.




Variability of customer requirements resulting in cancellations,
reductions, or delays may adversely affect our operating results.




We will be required
to provide rapid product turnaround and respond to short lead times. A variety
of conditions, both specific to individual customers and generally affecting the
demand for OEMs’ products, may cause customers to cancel, reduce, or delay
orders. Cancellations, reductions, or delays by a significant customer or by a
group of customers could adversely affect our operating results. Customers may
require rapid increases in production, which could strain our resources and
reduce our margins.




If we are unable to adequately protect our intellectual property, our
competitors and other third parties could produce products based on our
intellectual property, which would substantially impair our ability to compete.




Our success and
ability to compete depends in part upon our ability to maintain the proprietary
nature of our technologies. We rely on a combination of patent, trade secret,
copyright, and trademark law and license agreements, as well as nondisclosure
agreements, to protect our intellectual property. These legal means, however,
afford only limited protection and may not be adequate to protect our
intellectual property rights. We cannot be certain that we were the first
creator of inventions covered by pending patent applications or the first to
file patent applications on these inventions. In addition, we cannot be sure
that any of our pending patent applications will issue. The United States Patent
and Trademark Office, or other foreign patent and trademark offices may deny or
significantly narrow claims made under our patent applications and, even if
issued, these patents may be successfully challenged, designed around, or may
otherwise not provide us with any commercial protection.




We may in the future
need to assert claims of infringement against third parties to protect our
intellectual property. Regardless of the final outcome, any litigation to
enforce our intellectual property rights in patents, copyrights, or trademarks
could be highly unpredictable and result in substantial costs and diversion of
resources, which could have a material and adverse effect on our business and
financial condition. In the event of an adverse judgment, a court could hold
that some or all of our asserted intellectual property rights are not infringed,
or are invalid or unenforceable, and could award attorneys’ fees to the other
party.




We may become subject to claims of infringement or misappropriation of
the intellectual property rights of others, which could prohibit us from selling
our products, require us to obtain licenses from third parties or to develop
non-infringing alternatives, and subject us to substantial monetary damages and
injunctive relief.




We may receive
notices from third parties that the manufacture, use, or sale of any products we
develop infringes upon one or more claims of their patents. Moreover, because
patent applications can take many years to issue, there may be currently pending
applications, unknown to us, which may later result in issued patents that
materially and adversely affect our business. Third parties could also assert
infringement or misappropriation claims against us with respect to our future
product offerings, if any. Whether or not such claims are valid, we cannot be
certain that we have not infringed the intellectual property rights of such
third parties. Any infringement or misappropriation claim could result in
significant costs, substantial damages, and our inability to manufacture,
market, or sell any of our product offerings that are found to infringe. Even if
we were to prevail in any such action, the litigation could result in
substantial cost and diversion of resources that could materially and adversely
affect our business. If a court determined, or if we independently discovered,
that our product offerings violated third-party proprietary rights, there can be
no assurance that we would be able to re-engineer our product offerings to avoid
those rights or obtain a license under those rights on commercially reasonable
terms, if at all. As a result, we could be prohibited from selling products that
are found to infringe upon the rights of others. Even if obtaining a license
were feasible, it may be costly and time-consuming. A court could also enter
orders that temporarily, preliminarily, or permanently enjoin us from making,
using, selling, offering to sell, or importing our portable power source
products, or could enter orders mandating that we undertake certain remedial
activities. Further, a court could order us to pay compensatory damages for such
infringement, plus prejudgment interest, and could in addition treble the
compensatory damages and award attorneys’ fees. These damages could materially
and adversely affect our business and financial condition.




20




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Confidentiality agreements with employees and others may not adequately
prevent disclosure of our trade secrets and other proprietary information, which
could limit our ability to compete.




We rely on trade
secrets to protect our proprietary technology and processes. Trade secrets are
difficult to protect. We enter into confidentiality and intellectual property
assignment agreements with our employees, consultants, and other advisors. These
agreements generally require that the other party keep confidential and not
disclose to third parties confidential information developed by the party or
made known to the party by us during the course of the party’s relationship with
us. However, these agreements may not be honored and enforcing a claim that a
party illegally obtained and is using our trade secrets is difficult, expensive
and time-consuming, and the outcome is unpredictable. The failure to obtain and
maintain trade secret protection could adversely affect our competitive
position.




Our efforts to develop new technologies may not result in commercial
success, which could cause a decline in our revenue and could harm our
business.




Our research and
development efforts with respect to our technologies may not result in customer
or market acceptance. Some or all of those technologies may not successfully
make the transition from the research and development lab to cost-effective
production as a result of technology problems, competitive cost issues, yield
problems, and other factors. Even when we successfully complete a research and
development effort with respect to a particular technology, our customers may
decide not to introduce or may terminate products utilizing the technology for a
variety of reasons, including the following:


- difficulties with other suppliers
  of components for the products;
- superior technologies developed by our competitors and
  unfavorable comparisons of our solutions with these
  technologies;
- price considerations;
  and
- lack of anticipated or actual
  market demand for the products.

The nature of our
business will require us to make continuing investments for new technologies.
Significant expenses relating to one or more new technologies that ultimately
prove to be unsuccessful for any reason could have a material adverse effect on
us. In addition, any investments or acquisitions made to enhance our
technologies may prove to be unsuccessful. If our efforts are unsuccessful, our
business could be harmed.




We may not be able to enhance our product solutions and develop new
product solutions in a timely manner.




Our future operating
results will depend to a significant extent on our ability to provide new
portable power source products that compare favorably with alternative solutions
on the basis of time to introduction, cost, performance, and end-user
preferences. Our success in attracting customers and developing business will
depend on various factors, including the following:


- innovative development of new
  portable power source products for customer products;
- utilization of advances in
  technology;
- maintenance of quality
  standards;
- efficient and cost-effective
  solutions; and
- timely completion of the design
  and introduction of new portable power source products.

Our inability to
commercialize our proposed portable power source solutions and develop new
product solutions on a timely basis could harm our operating results and impede
our growth.




21




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If we do not keep pace with technological innovations, our products may
not be competitive and our revenue and operating results may
suffer.




Technological
advances, the introduction of new products, and new design techniques could
adversely affect our business prospects unless we are able to adapt to the
changing conditions. Technological advances could render our proposed portable
power source products obsolete, and we may not be able to respond effectively to
the technological requirements of evolving markets. As a result, we will be
required to expend substantial funds for and commit significant resources
to


- continue research and development
  activities on portable power source products;
- hire additional engineering and
  other technical personnel; and
- purchase advanced design tools and
  test equipment.

Our business could be
harmed if we are unable to develop and utilize new technologies that address the
needs of our customers, or our competitors do so more effectively than we
do.




New technology solutions that achieve significant market share could harm
our business.




New portable power
source solutions could be developed. Existing electronic devices also could be
modified to allow for a different power source solution. Our business could be
harmed if our products become noncompetitive as a result of a technological
breakthrough that allows a new power source solution to displace our solution
and achieve significant market acceptance.




Our inability to respond to changing technologies will harm our
business.




The electronic,
semiconductor, solar, automotive and general instrumentation industries are
subject to constant technological change. Our future success will depend on our
ability to respond appropriately to changing technologies and changes in product
function and quality. If we rely on products and technologies that are not
attractive to end users, we may not be successful in capturing or retaining any
significant market share. In addition, any new technologies utilized in our
portable power source products may not perform as expected or as desired, in
which event our adoption of such products or technologies may harm our
business.




International sales and manufacturing risks could adversely affect our
operating results.




We anticipate that
the manufacturing and assembly operations for our portable power source products
will be conducted primarily in Asia by manufacturing subcontractors. We also
believe that many of our OEM customers will be located and much of our sales and
distribution operations will be conducted in Asia. These international
operations will expose us to various economic, political, and other risks that
could adversely affect our operations and operating results, including the
following:


- difficulties and costs of staffing
  and managing a multi-national organization;
- unexpected changes in regulatory
  requirements;
- differing labor
  regulations;
- potentially adverse tax
  consequences;
- tariffs and duties and other trade
  barrier restrictions;
- possible employee turnover or
  labor unrest;
- greater difficulty in collecting
  accounts receivable;
- the burdens and costs of
  compliance with a variety of foreign laws;
- potentially reduced protection for
  intellectual property rights; and
- political or economic instability
  in certain parts of the world.

The risks associated
with international operations could negatively affect our operating
results.




22




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Our business may suffer if international trade is hindered, disrupted, or
economically disadvantaged.




Political and
economic conditions abroad may adversely affect the foreign production and sale
of our portable power source products. Protectionist trade legislation in either
the United States or foreign countries, such as a change in the current tariff
structures, export or import compliance laws, or other trade policies, could
adversely affect our ability to sell our portable power source products in
foreign markets and to obtain materials or equipment from foreign
suppliers.




Changes in policies
by the U.S. or foreign governments resulting in, among other things, higher
taxation, currency conversion limitations, restrictions on the transfer of
funds, or the expropriation of private enterprises also could have a material
adverse effect on us. Any actions by countries in which we conduct business to
reverse policies that encourage foreign investment or foreign trade also could
adversely affect our operating results. In addition, U.S. trade policies, such
as “most favored nation” status and trade preferences for certain Asian nations,
could affect the attractiveness of our products to our U.S. customers and
adversely impact our operating results.




Our operating results could be adversely affected by fluctuations in the
value of the U.S. dollar against foreign currencies.




We transact our
business predominantly in U.S. dollars and bill and collect our sales in U.S.
dollars. In 2009, approximately 38% of our revenue was from customers outside of
the United States. A weakening of the dollar could cause our overseas vendors to
require renegotiation of either the prices or currency we pay for their goods
and services. Similarly, a strengthening of the dollar could cause our products
to be more expensive for our international customers, which could cause the
demand for our products and our revenue to decline.




In the future,
customers may negotiate pricing and make payments in non-U.S. currencies. If our
overseas vendors or customers require us to transact business in non-U.S.
currencies, fluctuations in foreign currency exchange rates could affect our
cost of goods, operating expenses, and operating margins and could result in
exchange losses. In addition, currency devaluation can result in a loss to us if
we hold deposits of that currency. Hedging foreign currencies can be difficult,
especially if the currency is not freely traded. We cannot predict the impact of
future exchange rate fluctuations on our operating results.




We expect that a majority of our manufacturing subcontractors will be
located in Asia, increasing the risk that a natural disaster, labor strike, war,
or political unrest in those countries would disrupt our
operations.




We expect that a
majority of our manufacturing subcontractors will be located in Asia. Events out
of our control, such as earthquakes, fires, floods, or other natural disasters,
or political unrest, war, labor strikes, or work stoppages in Asia could disrupt
their operations, which would impact our business. In addition, there is
political tension between Taiwan and China that could lead to hostilities. If
any of these events occur, we may not be able to obtain alternative
manufacturing capacity. Failure to secure alternative manufacturing capacity
could cause a delay in the shipment of our products, which would cause our
revenue to fluctuate or decline.




The electronics industry is cyclical and may result in fluctuations in
our operating results.




The electronics
industry has experienced significant economic downturns at various times. These
downturns are characterized by diminished product demand, accelerated erosion of
average selling prices, and production overcapacity. In addition, the
electronics industry is cyclical in nature. We will seek to reduce our exposure
to industry downturns and cyclicality by providing design and production
services for leading companies in rapidly expanding industry segments. We may,
however, experience substantial period-to-period fluctuations in future
operating results because of general industry conditions or events occurring in
the general economy.




Our strategic alliances may not achieve their objectives, and their
failure to do so could impede our growth.




We plan to explore
additional strategic alliances designed to enhance or complement our technology
or to work in conjunction with our technology; to provide necessary know-how,
components, or supplies; and to develop, introduce, and distribute products
utilizing our technology. Any strategic alliances may not achieve their intended
objectives, may be cancelled by either party, and parties to our strategic
alliances may not perform as contemplated. The failure of our current alliances
or our inability to form additional alliances may impede our ability to
introduce new products and enter new markets.




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Product liability claims against us could result in adverse publicity and
potentially significant monetary damages.




As a seller of
consumer products using a flammable material such as methanol, we will face an
inherent risk of exposure to product liability claims in the event that injuries
result from product usage by customers. It is possible that our products could
result in injury, whether by product malfunctions, defects, improper
installation, or other causes. If such injuries or claims of injuries were to
occur, we could incur monetary damages and our business could be adversely
affected by any resulting negative publicity. The successful assertion of
product liability claims against us could result in potentially significant
monetary damages and, if our insurance protection is inadequate to cover these
claims, could require us to make significant payments from our own
resources.




We expect to face intense competition that could result in failing to
gain market share and suffering reduced revenue from our portable power source
products.




We plan to serve
intensely competitive markets that are characterized by price erosion, rapid
technological change, and competition from major domestic and international
companies. This intense competition could result in pricing pressures, lower
sales, reduced margins, and lower market share. Most of our competitors have
greater market recognition, larger customer bases, and substantially greater
financial, technical, marketing, distribution, and other resources than we
possess and that afford them competitive advantages. As a result, they may be
able to devote greater resources to the promotion and sale of products, to
negotiate lower prices for raw materials and components, to deliver competitive
products at lower prices, and to introduce new product solutions and respond to
customer requirements more quickly than we can. Our competitive position could
suffer if one or more of our customers decides not to utilize our portable power
source products and instead contracts with our competitors or uses alternative
technologies.




Our ability to
compete successfully will depend on a number of factors, both within and outside
our control. These factors include the following:


- our success in designing and
  introducing new portable power source products;
- our ability to predict the
  evolving needs of our customers and to assist them in incorporating our
  technologies into their new products;
- our ability to meet our customer’s
  requirements for small size, low weight, peak power, long power duration, ease
  of use, reliability, durability, and small form factor;
- the quality of our customer
  services;
- the rate at which customers
  incorporate our products into their own products;
- product or technology
  introductions by our competitors; and
- foreign currency fluctuations,
  which may cause a foreign competitor’s products to be priced significantly
  lower than our products.

We depend on key personnel who would be difficult to replace, and our
business will likely be harmed if we lose their services or cannot hire
additional qualified personnel.




Our success will
depend substantially on the efforts and abilities of our senior management and
key personnel. The competition for qualified management and key personnel,
especially engineers, is intense. Although we maintain non-competition and
non-disclosure covenants with most of our key personnel, we do not have
employment agreements with most of them. The loss of services of one or more of
our key employees or the inability to hire, train, and retain key personnel,
especially engineers, technical support personnel, and capable sales and
customer-support employees outside the United States, could delay the
development and sale of our products, disrupt our business, and interfere with
our ability to execute our business plan.




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Our operating results may experience significant
fluctuations.




In addition to the
variability resulting from the short-term nature of our customers’ commitments,
other factors will contribute to significant periodic and seasonal quarterly
fluctuations in our results of operations. These factors include the
following:


- the cyclicality of the markets we
  serve;
- the timing and size of
  orders;
- the volume of orders relative to
  our capacity;
- product introductions and market
  acceptance of new products or new generations of products;
- evolution in the life cycles of
  our customers’ products;
- timing of expenses in anticipation
  of future orders;
- changes in product
  mix;
- availability of manufacturing and
  assembly services;
- changes in cost and availability
  of labor and components;
- timely delivery of product
  solutions to customers;
- pricing and availability of
  competitive products;
- introduction of new technologies
  into the markets we serve;
- pressures on reducing selling
  prices;
- our success in serving new
  markets; and
- changes in economic conditions.

Accordingly, you
should not rely on period-to-period comparisons as an indicator of our future
performance. Negative or unanticipated fluctuations in our operating results may
result in a decline in the price of our stock.




25




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Item 2: Properties




We lease office,
manufacturing and research and development space in the following
locations:




Approximate Number ofLocation
            Segment
            Primary Use
            Square Feet
            Lease ExpirationAlbany, NY
            Test and Measurement
            Manufacturing, office and
sales
            17,424
            
            2014InstrumentationAlbany, NY
            New Energy
            Corporate headquarters, office and
            20,000
            
            2010research and developmentShanghai,
            New Energy
            Representative office
            310
            
            2010China


We believe our
facilities are generally well maintained and adequate for our current needs and
for expansion, if required. We further believe that a lease renewal on
reasonable terms for these properties may be achieved.




Item 3: Legal Proceedings




At any point in time,
we may be involved in various lawsuits or other legal proceedings. Such lawsuits
could arise from the sale of products or services or from other matters relating
to its regular business activities, compliance with various governmental
regulations and requirements, or other transactions or circumstances. We do not
believe there are any such proceedings presently pending which could have a
material adverse effect on our financial condition.




Item 4: Reserved




26




---



PART II




Item 5: Market for Registrant’s Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity
Securities




Price Range of Common
Stock




Our common stock is
traded on the OTC Markets at PinkSheets.com under the symbol “MKTY.PK”. The
following table sets forth the high and low sale prices of our common stock as
reported by Pink Sheets for the periods indicated (for periods prior to May 16,
2008, such prices have been derived by multiplying the actual prices by eight to
reflect the reverse split of our common stock that was approved by our
stockholders at a meeting held on May 15, 2008, pursuant to which every eight
shares of our common stock were combined into one share of our common
stock):




High
            
            LowFiscal Year Ended December 31, 2008First Quarter
            $
            7.44
            
            $
            3.77Second Quarter
            
            7.80
            
            
            1.11Third Quarter
            
            5.50
            
            
            .79Fourth Quarter
            
            1.93
            
            
            .75Fiscal Year Ended December 31,
      2009First Quarter
            $
            1.87
            
            $
            .75Second Quarter
            
            1.00
            
            
            .10Third Quarter
            
            1.90
            
            
            .51Fourth Quarter
            
            1.54
            
            
            .30


27






---



Item 6: Selected Financial
Data




The following table
sets forth our summary consolidated financial data for the fiscal years ended
December 31, 2007, 2008, and 2009 which was derived from our audited
consolidated financial statements included elsewhere in this Annual Report on
Form 10-K. We derived our summary consolidated financial data for the years
ended December 31, 2005 and 2006 set forth in the following table from our
audited consolidated financial statement not included in this report. You should
read the following summary consolidated financial data together with the
information under “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” and our consolidated financial statements, including
the related notes thereto.




(In thousands, except per share data)
            
            Years Ended December
  31,2005
            
            2006
            
            2007
            
            2008
            
            2009Statement of Operations
      DataProduct revenue
            $
            6,012
            
            
            $
            7,667
            
            
            $
            9,028
            
            
            $
            6,224
            
            
            $
            6,263Funded research and development revenue
            
            1,829
            
            
            
            489
            
            
            
            1,556
            
            
            
            1,154
            
            
            
            2,043Gain (loss) on derivatives
            
            (10,407
            )
            
            
            182
            
            
            
            2,967
            
            
            
            655
            
            
            
            (29
            )Net gain (loss) on sale of securities available for sale
            
            10,125
            
            
            
            4,289
            
            
            
            2,549
            
            
            
            1,018
            
            
            
            —(Loss) income from continuing operations
      before income taxes,equity in holdings’ losses and non controlling interest
            
            (14,949
            )
            
            
            (12,980
            )
            
            
            (7,609
            )
            
            
            (10,760
            )
            
            
            (3,572
            )Income tax (expense) benefit
            
            (1,587
            )
            
            
            (1,895
            )
            
            
            (2,548
            )
            
            
            (2,004
            )
            
            
            208Non controlling interests in losses of
      consolidated subsidiary
            
            1,442
            
            
            
            1,208
            
            
            
            582
            
            
            
            260
            
            
            
            265Net loss
            
            (15,094
            )
            
            
            (13,667
            )
            
            
            (9,575
            )
            
            
            (12,504
            )
            
            
            (3,099
            )Basic and Diluted (Loss) Earnings Per
      ShareLoss from continuing
operations
            $
            (3.93
            )
            
            $
            (3.46
            )
            
            $
            (2.01
            )
            
            $
            (2.62
            )
            
            $
            (0.65
            )Loss per share
            $
            (3.93
            )
            
            $
            (3.46
            )
            
            $
            (2.01
            )
            
            $
            (2.62
            )
            
            $
            (0.65
            )Balance Sheet Data (as of period
      end):Working capital
            $
            33,045
            
            
            $
            23,076
            
            
            $
            11,347
            
            
            $
            252
            
            
            $
            1,233Securities available for sale
            
            18,947
            
            
            
            10,075
            
            
            
            4,492
            
            
            
            —
            
            
            
            —Total assets
            
            41,267
            
            
            
            33,811
            
            
            
            18,716
            
            
            
            5,511
            
            
            
            3,741Total long-term obligations
            
            —
            
            
            
            3,664
            
            
            
            904
            
            
            
            254
            
            
            
            70Total stockholders' equity (deficit)
      before noncontrolling interest
            
            32,916
            
            
            
            22,871
            
            
            
            13,803
            
            
            
            1,515
            
            
            
            (1,135
            )


28




---



Item 7: Management’s Discussion and Analysis
of Financial Condition and Results of Operations




The following discussion of our financial
condition and results of operations should be read in conjunction with our
Consolidated Financial Statements and the related notes included elsewhere in
this Annual Report. This discussion contains forward-looking statements, which
involve risk and uncertainties. Our actual results could differ materially from
those anticipated in the forward-looking statements as a result of certain
factors, including those discussed in Item 1A: “Risk Factors” and elsewhere in
this Annual Report.




Overview




MTI operates in two
segments, the New Energy segment conducted through MTI MicroFuel Cells, Inc.
(MTI Micro) and the Test and Measurement Instrumentation segment, through MTI
Instruments, Inc. (MTI Instruments).




New Energy Segment - MTI Micro is developing and commercializing
off-the-grid power solutions for various portable electronic devices. Our
patented proprietary direct methanol fuel cell technology platform called
Mobion, converts 100% methanol fuel to usable electricity capable of providing
continuous power as long as necessary fuel flows are maintained. Our proprietary
fuel cell power solution consists of two primary components integrated in an
easily manufactured device: the direct methanol fuel cell power engine, which we
refer to as our Mobion Chip, and methanol fuel cartridges. Our current Mobion
Chip weighs less than one ounce and is small enough to fit in the palm of one’s
hand. The methanol used by the technology is fully biodegradable. We have
demonstrated power density of over 84 mW/cm2, while producing more
than 1,800 Wh/kg or 1.4 Wh/cc of fuel from its direct methanol fuel feed. For
these reasons, we believe our technology offers a superior power solution
compared to current lithium-ion and similar rechargeable battery systems
currently used by original equipment manufacturers and branded partners, or
OEMs, in many handheld electronic devices, such as smart phones, mobile phone
accessories, digital cameras, portable gaming devices, e-readers and other
portable devices. We believe our platform will facilitate further developments
of numerous electronic product advantages, including smaller size, environmental
friendliness, greatly extended run-time of current portable devices and
simplicity of design, all critical for commercialization in the consumer market,
and can be implemented as three different product options: a handheld power
generator for consumer electronic devices, a snap-on or attached power
accessory, or an embedded fuel cell in handheld devices. We have strategic
agreements with a global Japanese consumer electronics company, with a U.S.
based developer and marketer of universal chargers, with a global power tool
manufacturer, and a letter of intent with Duracell, part of the Procter &
Gamble Company. Our goal is to become the leading provider of portable power for
various types of electronic devices and, assuming available financing, we intend
to commercialize Mobion products in 2010.




Our Mobion technology
is protected by a patent portfolio that includes 54 patents and 57 U.S. patent
applications covering five key technologies and manufacturing areas, one of
which is the process that eliminates the need for active water recirculation
pumps or the inclusion of water as a fuel dilutant. The water required for the
electrochemical process is transferred internally within the Mobion Chip from
the site of water generation on the air-side of the cell. This internal flow of
water takes place without the need for any pumps, complicated re-circulation
loops or other micro-plumbing tools.




Test and Measurement
Segment – MTI Instruments
is a worldwide supplier of metrology, portable balancing equipment and
inspection systems for semiconductor wafers. Our products use state-of-the-art
technology to solve complex real world applications in numerous industries
including automotive, semiconductor, solar cell manufacturing, commercial and
military aviation and data storage. We are continuously working on ways to
expand our sales reach, including more sales coverage in Europe and the Far
East, as well as a focus on internet marketing. We have industry recognized
customer service and have worked with hundreds of companies
worldwide.




Our test and
measurement segment has three product groups: general dimensional gauging,
semiconductor/solar and aviation. Our products consist of electronic,
computerized gauging instruments for position, displacement and vibration
applications for the design, manufacturing and test markets; metrology tools for
wafer characterization of semiconductor and solar wafers; and engine balancing
and vibration analysis systems for both military and commercial aircraft.




Liquidity




Our cash requirements
depend on numerous factors, including completion of our portable power source
products development activities, our ability to commercialize our portable power
source products, market acceptance of our portable power source products, and
other factors.




29




---



Several key
indicators of our liquidity are summarized in the following table:




(Dollars in thousands)
            
            Years ended December
  31,2007
            
            2008
            
            2009Cash and cash equivalents
            
            $
            7,650
            
            
            $
            1,662
            
            
            $
            785Securities available for sale
            
            
            4,492
            
            
            
            —
            
            
            
            —Working capital
            
            
            11,347
            
            
            
            252
            
            
            
            1,233Net loss
            
            
            (9,575
            )
            
            
            (12,504
            )
            
            
            (3,099
            )Net cash used in operating
      activities
            
            
            (11,683
            )
            
            
            (10,346
            )
            
            
            (2,170
            )Purchase of property, plant and equipment
            
            
            (414
            )
            
            
            (181
            )
            
            
            (7
            )


From inception
through December 31, 2009, we have incurred an accumulated deficit of $121
million, and we expect to incur losses for the foreseeable future as we continue
micro fuel cell product development and commercialization programs. We expect
that losses will fluctuate from year to year and that such fluctuations may be
substantial as a result of, among other factors, operating results of our
businesses.




At present, the
Company does not expect to continue to provide equity funding for MTI Micro’s
development and commercialization of its portable power source products. MTI
Micro had cash and cash equivalents as of December 31, 2009 of $163 thousand.
Subsequent to December 2009, MTI Micro collected outstanding receivable billings
from the DOE of $307 thousand.




On January 11, 2010,
MTI Micro entered into a Common Stock and Warrant Purchase Agreement (the
“Purchase Agreement”) with Counter Point Ventures Fund II, L.P. (“Counter
Point”). Counter Point is managed by Dr. Walter L. Robb, a member of the Board
of Directors of the Company and MTI Micro, and is a current stockholder of MTI
Micro. Dr. Robb and Counter Point beneficially held approximately 29.5% of the
fully-diluted capital stock of MTI Micro of December 31, 2009, and as of March
15, 2010 hold an aggregate of approximately 30.7% of the fully-diluted capital
stock of MTI Micro.




Pursuant to the
Purchase Agreement, MTI Micro may issue and sell to Counter Point up to
28,571,429 shares of common stock, par value $0.01 per share (the “Micro Common
Stock”), at a purchase price per share of $0.070, over a period of twelve (12)
months, and warrants (“Warrants”) to purchase shares of Micro Common Stock equal
to 20% of the shares of Micro Common Stock purchased under the Purchase
Agreement at an exercise price of $0.070 per share. The sale and issuance of the
Micro Common Stock and Warrants shall occur over multiple closings (each, a
“Closing”) occurring over two (2) one month closing periods and five (5)
two-month closing periods (each, a “Closing Period”). Three Closings have
occurred through March 15, 2010, with MTI Micro raising $660,000 from the sale
of 9,428,571 shares of Micro Common Stock and Warrants to purchase 1,885,714
shares of Micro Common Stock to Counter Point. Subsequent Closings may occur
thereafter at MTI Micro’s sole discretion during the Closing Periods upon
delivery of written notice by MTI Micro to Counter Point of its desire to
consummate a Closing, and Counter Point’s acceptance of such offer under the
Purchase Agreement on the terms agreed upon with MTI Micro. In the event the
terms and conditions of the Purchase Agreement no longer reflect current market
conditions or otherwise, either party may elect not to participate in a
Subsequent Closing(s) or the parties may amend the Purchase Agreement on
mutually agreeable terms with respect to such Subsequent Closing(s). If MTI
Micro were to issue and sell the remainder of the 28,571,429 shares under the
Purchase Agreement, the Company would continue to hold an aggregate of 55.8% of
the fully-diluted capital stock of MTI Micro.




Additionally, MTI
Micro has the remaining $191 thousand for the DOE contract to bill as work is
performed. However, the funds available through the Purchase Agreement are only
available to us in increments of $330 thousand bi-monthly. Our next available
draw down is May 2010. MTI Micro will be required to raise additional funds
through issuance of its equity or debt, government funding and/or explore other
strategic alternatives including but not limited to the sale of assets and/or
the company. If MTI Micro is unable to raise additional financing, it may be
required to discontinue or severely reduce its business operations.




In order to conserve
cash and extend operations while we pursue any additional necessary financing,
we would be required to reduce operating expenses. There is no assurance that
funds raised in any such a financing will be sufficient, that the financing will
be available on terms favorable to us or to existing stockholders and at such
times as required, or that we will be able to obtain the additional financing
required for the continued operation and growth of our business. During the last
sixteen months, MTI Micro has raised $3.1 million in external debt and equity
financing. If we raise additional funds by issuing equity securities, MTI
Micro’s stockholders will experience further dilution. Additional debt
financing, if available, may involve restrictive covenants. Any debt financing
or additional equity financing may contain terms that are not favorable to us or
our stockholders. If we raise additional funds through collaboration and
licensing arrangements with third parties, it may be necessary to relinquish
some rights to our technologies or our
products, or grant licenses on terms that are not favorable to us. If we are
unable to raise adequate funds, we may have to liquidate some or all of our
assets or delay, reduce the scope of or eliminate some or all of our research
and development programs, or discontinue our portable power source business.
Without other resources, management currently believes it will need to make
significant changes to its operations during April 2010.





30




---



Management believes
that MTI Instruments will continue to generate positive cash flow and would be
able to fund its current operations. However, no assurances can be provided on
this subsidiary’s ability to continue as a going concern given the level of
uncertainty involved with the parent company’s operations.




Restructuring




In March 2007, the
Company announced the suspension of MTI Micro’s high power direct methanol fuel
cell program in response to decreased funding and sales opportunities in the
military market. In connection with this action, the Company accrued
restructuring charges of $344,000 pre-tax, consisting primarily of cash-based
employee severance and benefit costs related to the reduction of 23 positions
within its New Energy segment and Corporate staff. Restructuring expenses were
classified as selling, general and administrative expenses within the Company’s
Consolidated Statements of Operations for the period. All amounts under this
plan were settled by March 31, 2008.




In August 2008, the
Board of Directors approved a restructuring plan (the “Restructuring”), which
was designed to help the Company reduce expenses and preserve cash. As part of
the Restructuring, a total of 29 positions across the Company and its
subsidiaries were eliminated. The Company paid total severance and other benefit
charges of approximately $342,000 in connection with this plan by the end of the
first quarter of 2009.




Results of Operations




Results of Operations for the Year Ended December 31, 2009 Compared to
December 31, 2008.




Product Revenue:  Product revenue in our test and measurement instrumentation business rose
slightly from $6.22 million in 2008 to $6.26 million in 2009; an increase of
less than 1%. As with the prior year, the U.S. Air Force remained the top
customer for the segment, accounting for 19.0% of product revenue in 2009 and
15.6% in 2008. In addition, during 2009, a single U.S. based commercial customer
accounted for 9.9% of total product revenue, versus 2008 when a single Japanese
based commercial distributor accounted for 13.9% of total product
revenue.




Information regarding
government contracts included in product revenue is as follows:




(Dollars in thousands)
            
            
            
            
            Revenue
            
            
            
            
            Total ContractYear Ended
            
            Revenue
            
            Orders ReceivedDecember 31,
            
            Contract to Date
            
            to DateContract(1)
            
            Expiration
            
            2008
            
            2009
            
            Dec. 31, 2009
            
            Dec. 31, 2009$2.3 million Air Force New PBS-4100
      Systems
            
            07/28/2010
            (2)
            
            $
            —
            
            $
            513
            
            $
            2,109
            
            $
            2,109$8.8 million Air Force Retrofit and Maintenance of PBS-4100
      Systems
            
            06/19/2008
            (3)
            
            $
            594
            
            $
            50
            
            $
            8,009
            
            $
            8,009$6.5 million Air Force Retrofit and
      Maintenance of PBS-4100 Systems
            
            09/27/2014
            (4)
            
            $
            —
            
            $
            439
            
            $
            439
            
            $
            439


(1)
            
            Contract values represent maximum potential values and may not be
      representative of actual results.(2)
            
            Date
      represents expiration of contract, including all three potential option
      extensions.(3)
            
            The
      contract expiration date has passed, however, one delivery order remains
      open under the contract.(4)
            
            Date
      represents expiration of contract, including all four potential option
      extensions.




Funded Research and Development Revenue: Funded research and
development revenue in our new energy segment increased by $890 thousand, or
77%, to $2.04 million for the year ended December 31, 2009 from $1.15 million
for the year ended December 31, 2008. The increase in revenue was primarily the
result of the full year of recognition under the new DOE contract awarded in
2009 for the commercialization of our fuel cell product and an increase in our
cost reimbursement rates, while in 2008, the DOE contract was for research and
development costs.




31




---



(Dollars in thousands)
            
            
            
            Revenue Year Ended
            
            Revenue Year Ended
            
            RevenueContract
            
            Expiration
            
            December 31, 2008
            
            December 31, 2009
            
            Contract to Date$3.0 million DOE(2)
            
            03/31/09
            
            $
            1,154
            
            $
            -0-
            
            $
            3,000$2.4 million DOE(3)
            
            03/31/10
            
            
            -0-
            
            
            2,043
            
            
            2,043Total
            
            
            
            $
            1,154
            
            $
            2,043
            
            $
            5,043


(1)
            
            Dates
      represent expiration of contract, not date of final billing.(2)
            
            The
      DOE contract was a cost share contract. DOE funding for this contract was
      suspended during January 2006 and reinstated during May 2007. During 2007,
      we received notifications from the DOE of funding releases totaling $1.0
      million and also received an extension of the termination date for the
      contract from July 31, 2007 to September 30, 2008. During 2008, we
      received notification from the DOE of a funding release of $325,000, and
      an extension of the termination date for the contract from September 30,
      2008 to March 31, 2009.(3)
            
            The
      DOE contract is a cost share contract.




Cost of Product Revenue: Cost of product revenue in our test and
measurement instrumentation business decreased by $516,000, or 16.2%, to $2.7
million during the year ended December 31, 2009 from $3.2 million for the year
ended December 31, 2008. As a percentage of product revenue, the annual cost of
product revenue decreased eight percentage points (43% in 2009 compared to 51%
in 2008). Margin improvements were attributed to a $406,000 (33%) decrease in
manufacturing overhead costs and a $322,000 decrease in the annual inventory
reserve expense. These were partially offset by a one percentage point drop in
product margins due to the 2009 product mix.




Unfunded Research and Product Development
Expenses: Unfunded
research and product development decreased by $4.5 million, or 76%, to $1.3
million in 2009. Of this, the new energy segment decreased by $3.8 million and
the test and measurement instrumentation segment decreased by $685 thousand from
the prior year due to staff reductions and substantial cut backs in external
development spending.




Selling, General and Administrative Expenses: Selling, general and
administrative expenses decreased by $5.1 million, or 40%, to $3.3 million for
the year ended December 31, 2009 from $8.4 million for the year ended December
31, 2008. This decrease was primarily the result of (a) a $1.5 million overall
decrease in payroll costs due to staff reductions in 2008, with a full year
impact in 2009, offset slightly by an increase in salary allocated to funded
research and development (b) $568,000 in corresponding decreases in benefit
related costs, bonuses and commissions (c) a $715,000 decrease in stock
compensation related expenses (d) a $531,000 decrease in legal fees (e) a
$329,000 decrease in travel expenditures (f) a decrease in $300,000 for outside
consultants and audit fees and (g) the decreases in general operating expenses
representing management efforts to reduce expenditures due to decreases in
funding sources.




Operating Loss: Operating loss for the year ended December 31,
2009 compared with the operating loss for the year ended December 31, 2008
decreased by $9.35 million to $3.1 million, a 76% decrease, as a result of the
factors noted above.




Gain on Sale of Securities Available for Sale: During 2008, we sold
1,137,166 shares of Plug Power common stock at a weighted average price of $2.67
per share, with gross proceeds to us of $3.3 million. As of December 31, 2008,
we no longer owned any Plug Power common stock or other securities available for
sale.




Gain (loss) on Derivatives: We recorded a loss on derivative accounting
of $29 thousand for the year ended December 31, 2009 and a gain of $655 thousand
on derivative accounting for the year ended December 31, 2008. Both the 2009
loss and 2008 gain are the result of derivative treatment of the freestanding
warrants issued to investors in conjunction with our December 2006 capital
raise.




Income Tax (Expense)
Benefit: Our income tax
rate for the year ended December 31, 2009 was 6%, while the income tax rate for
the year ended December 31, 2008 was (19%). These tax rates were primarily the
result of losses generated by operations, changes in the valuation allowance,
state true-ups upon tax return filings, permanent deductible differences for the
derivative valuation, and disproportionate effects of reclassification of gains
on Plug Power security sales included in operating loss.




The valuation
allowance against our deferred tax assets at December 31, 2009 was $26.4 million
and at December 31, 2008 was $27.9 million. We determined that it was more
likely than not that the ultimate recognition of certain deferred tax assets
would not be realized.




32




---



Results of Operations for the Year Ended December 31, 2008 Compared to
December 31, 2007.




Product Revenue: Product revenue in our test and measurement
instrumentation business for 2008 decreased by $2.8 million, or 31.1%, to $6.2
million for the fiscal year ended December 31, 2008 from $9.0 million for the
fiscal year ended December 31, 2007. The revenue decrease was primarily the
result of a $1.5 million decrease in general dimensional gauging sales from
significantly lower sales to a Japanese OEM. Aviation sales also decreased $1.4
million due to lower sales to the U.S. Air Force and commercial engine balancing
system revenues decreased by $0.3 million. These declines were partially offset
by an increase in semiconductor/solar equipment sales of $0.4 million.




In our test and
measurement instrumentation business during 2008, the U.S. Air Force accounted
for $1.0 million, or 15.7%, of product revenue while during 2007, the U.S. Air
Force accounted for $2.4 million, or 26.3%, of product revenue. Additionally,
during 2008, Koyo Precision, our Japanese distributor, represented $0.9 million,
or 13.9%, of product revenue while during 2007, Koyo Precision represented $2.5
million, or 22.9%, of product revenue.




Information regarding
government contracts included in product revenue is as follows:




(Dollars in thousands)
            
            
            
            
            Revenue
            
            
            
            
            Total ContractYear Ended
            
            Revenue
            
            Orders ReceivedDecember 31,
            
            Contract to Date
            
            to DateContract(1)
            
            Expiration
            
            2007
            
            2008
            
            Dec. 31, 2008
            
            Dec. 31, 2008$2.3 million Air Force New PBS-4100
      Systems
            
            07/28/2010
            (2)
            
            $
            1,596
            
            $
            0
            
            $
            1,596
            
            $
            1,881$8.8 million Air Force Retrofit and Maintenanceof PBS-4100 Systems
            
            06/19/2008
            (3)
            
            $
            738
            
            $
            594
            
            $
            7,959
            
            $
            7,959


(1)
            
            Contract values represent maximum potential values and may not be
      representative of actual results.(2)
            
            Date
      represents expiration of contract, including all three potential option
      extensions.(3)
            
            The
      contract expiration date has passed, however, three delivery orders remain
      open under the contract.




Funded Research and Development Revenue: Funded research and
development revenue in our portable power, or new energy business decreased by
$0.4 million, or 25%, to $1.2 million for the year ended December 31, 2008 from
$1.6 million for the year ended December 31, 2007. The decrease in revenue was
primarily the result of the completion of the Samsung alliance, the SAFT
contract and the NCMS contract in 2007. All revenues for 2008 were a result of
reimbursement for research and development costs under the DOE contract with the
final billing occurring in January of 2009. The DOE funding was suspended in
2006, and was reinstated during May 2007, thus only eight months of funding was
recognized in 2007, or $675,000. Revenue during 2007 also included $418,000 from
the SAFT contract, for which revenue recognition had been deferred until the
delivery under the contract was accepted during the first quarter of 2007,
revenue recognized under the Samsung alliance agreement of $448,000 and revenue
from the NCMS contract of $15,000.




(Dollars in thousands)
            
            
            
            
            
            
            
            RevenueRevenue Year
      Ended
            
            Revenue Year
      Ended
            
            Contract to DateContract
            
            Expiration(
            
            December 31, 2007
            
            December 31, 2008
            
            Dec. 31, 2008$3.0 million DOE(2)
            
            03/31/09
            
            $
            675
            
            $
            1,154
            
            $
            3,000$1.0 million Samsung(3)
            
            07/31/07
            
            
            448
            
            
            
            
            
            875$418,000 SAFT(4)
            
            12/31/06
            
            
            418
            
            
            
            
            
            418$15,000 NCMS(5)
            
            06/30/07
            
            
            15
            
            
            
            
            
            15Total
            
            
            
            $
            1,556
            
            $
            1,154
            
            $
            4,308


(1)
            
            Dates
      represent expiration of contract, not date of final billing.(2)
            
            The
      DOE contract was a cost share contract. DOE funding for this contract was
      suspended during January 2006 and reinstated during May 2007. During 2007,
      we received notifications from the DOE of funding releases totaling $1.0
      million and also received an extension of the termination date for the
      contract from July 31, 2007 to September 30, 2008. During 2008, we
      received notification from the DOE of a funding release of $325,000, and
      an extension of the termination date for the contract from September 30,
      2008 to March 31, 2009.(3)
            
            The
      Samsung contract was a research and prototype contract. This contract
      included one up-front payment of $750,000 and two milestone payments of
      $125,000 each for the delivery of prototypes. The contract was amended on
      October 22, 2007 as we agreed to issue a credit in the amount of the last
      invoice in recognition of our continuing collaboration with Samsung.
      Therefore, revenue under this contract totaled $875,000.(4)
            
            The
      SAFT contract was a fixed price contract. This is a subcontract with SAFT
      under the U.S. Army CECOM contract. The purchase order received in
      connection with this subcontract was revised on November 14, 2006
      eliminating one milestone. As a result, the contract value was reduced
      from $470,000 to $418,000 and the expiration date was extended from
      September 30, 2006 to December 31, 2006.(5)
            
            This
      contract was a cost plus catalyst research contract with the National
      Center for Manufacturing Sciences, or
NCMS.




33




---



Cost of Product Revenue: Cost of product revenue in our test and
measurement instrumentation business decreased by $0.2 million, or 6%, to $3.2
million during the year ended December 31, 2008 from $3.4 million during the
year ended December 31, 2007. The decrease primarily resulted from a change in
product sales mix to a higher concentration of standard products, partially
offset by higher inventory reserves for potentially obsolete inventory.




Gross profit as a
percentage of product revenue decreased by 13.1% to 48.9% for the year ended
December 31, 2008. The decrease resulted from a change in the product sales mix
to a higher concentration of standard products which yielded a lower gross
margin as well as the increase in inventory reserves for potentially obsolete
inventory.




Funded Research and Product Development
Expenses: Funded research
and development expenses in our new energy business increased $0.5 million, or
26%, to $2.4 million for the year ended December 31, 2008 from $1.9 million for
the year ended December 31, 2007. This is a result of a full year of recognition
of costs associated with the DOE contract, with reimbursement also increasing by
$0.5 million for 2008.




Unfunded Research and Product Development
Expenses: Unfunded
research and product development expenses decreased $4.0 million, or 41%, to
$5.9 million for the year ended December 31, 2008 from $9.9 million for the year
ended December 31, 2007. This decrease is attributable to three factors (a) a
$0.5 million decrease in development costs that were related to the DOE contract
that was in effect for the entire year, which relates to the increase in funded
research and product development expenses, (b) the maturity of development of
our principle product for the new energy business line and (c) continued cost
reductions by management due to decreases in funding.




Selling, General and Administrative Expenses: Selling, general and
administrative expenses decreased by $0.3 million, or 4%, to $8.4 million for
the year ended December 31, 2008 from $8.7 million for the year ended December
31, 2007. This decrease was primarily the result of (a) a $756,000 decrease in
payroll costs due to staff reductions in 2007, with a full year impact in 2008,
and further layoffs in 2008 (b) $605,000 in corresponding decreases in benefit
related costs, bonuses and commissions (c) a $715,000 decrease in stock
compensation related expenses and (d) a $583,000 decrease in general operating
expenses representing management efforts to reduce expenditures due to decreases
in funding sources. These decreases in expenditures were offset by increases in
outside fees, including audit legal, and consulting fees of $248,000 and a
$2,000,000 increase related to a decrease in allocations of expense from
SG&A to funded and unfunded research and development costs for overhead and
other costs allocable to research and development programs.




Operating Loss: Operating loss for the year ended December 31,
2008 compared with the operating loss for the year ended December 31, 2007
decreased by $0.9 million to $12.5 million, a 7% decrease, as a result of the
factors noted above.




Gain on Sale of Securities Available for Sale: The gain on sale of
securities available for sale for the year ended December 31, 2008 was $1.0
million compared with a gain of $2.5 million for the year ended December 31,
2007. During 2008, we sold 1,137,166 shares of Plug Power common stock at a
weighted average price of $2.67 per share, with gross proceeds to us of $3.3
million. As of December 31, 2008, we no longer own any Plug Power common stock.




Gain (loss) on Derivatives: We recorded a gain on derivative accounting
of $0.7 million for the year ended December 31, 2008 and a gain of $3.0 on
derivative accounting for the year ended December 31, 2007. Both the 2008 and
2007 gains are the result of derivative treatment of the freestanding warrants
issued to investors in conjunction with our December 2006 capital raise.




Income Tax (Expense)
Benefit: Our income tax
rate for the year ended December 31, 2008 was 19%, while the income tax rate for
the year ended December 31, 2007 was 33%. These tax rates were primarily the
result of losses generated by operations, changes in the valuation allowance,
state true-ups upon tax return filings, permanent deductible differences for the
derivative valuation, and disproportionate effects of reclassification of gains
on Plug Power security sales included in operating loss.




The valuation
allowance against our deferred tax assets at December 31, 2008 was $27.9 million
and at December 31, 2007 was $22.3 million. We determined that it was more
likely than not that the ultimate recognition of certain deferred tax assets
would not be realized.




Liquidity and Capital Resources




We have incurred
significant losses as we continue to fund the development and commercialization
of our portable power source business. We expect that losses will fluctuate from
year to year and that such fluctuations may be substantial as a result of, among
other factors, our operating results, the availability of equity financing,
including warrants issued in connection with the December 2006 capital raise,
and the ability to attract government funding resources to offset research and
development costs. As of December 31, 2009, we had an accumulated deficit of
$120.7 million. During the year ended December 31, 2009, our results of
operations resulted in a net loss of
$3.1 million and cash used in operating activities totaling $2.17 million. This
cash use in 2009 was funded primarily by cash and cash equivalents on hand as of
December 31, 2008 of $1.7 million and results of operations of MTII.




34




---



We expect to continue
to incur losses during this global economic slowdown, and we expect to continue
funding our operations from current cash and cash equivalents, proceeds, if any,
from debt or equity financings and government funding. We expect to spend
approximately $1.1 million in research and development on MTI Instruments’
products during 2010.




We have no other
commitments for funding future needs of the organization at this time and
financing during 2010 may not be available to us on acceptable terms, if at all.
We may also seek to supplement our resources through additional debt or equity
financings, sales of assets (including MTI Micro or MTI Instruments), and
additional government funding.




Working capital was
$1.2 million at December 31, 2009, a $1.0 million increase from $.2 million at
December 31, 2008. This increase was primarily the result of a continued hold on
expenses and capital raised through the Bridge Note.




At December 31, 2009,
the Company’s order backlog was $419 thousand, compared to $1.3 million at
December 31, 2008.




Our inventory
turnover ratios and average accounts receivable days sales outstanding for the
years ended December 31, 2008 and 2009 and their changes are as follows:




Years Ended December
      31,2008
            
            2009
            
            ChangeInventory turnover
            
            1.5
            
            2.0
            
            0.5Average accounts receivable days sales outstanding
            
            48
            
            38
            
            (10
            )


The increase in
inventory turnover is driven by a 23% decrease in the average inventory balances
on a comparable sales volume in 2008.




The decrease in
average accounts receivable days sales outstanding in 2009 compared with 2008
was primarily attributable to our decision to grant our largest commercial
customer 90-day payment terms during 2007. This customer accounted for 14% of
our total product revenue in 2008. These extended payment terms were eliminated
in conjunction with the expiration of our formal distribution agreement in
September 2008 and the customer is now back to net 30 payment terms.




Cash flow used by
operating activities was $2.2 million during 2009 compared with $10.3 million
during 2008. This cash use decrease of $8.1 million reflects a net decrease in
cash expenditures to fund operations, together with net balance sheet changes
which decreased cash expenditures by $0.5 million, reflecting the timing of cash
payments and receipts, particularly an increase in accounts receivable of $0.7
million and a reduction of inventory of $0.8 million.




Capital expenditures
were $7 thousand during 2009, a decrease of $174 thousand from the prior year of
$181 thousand. This decrease was attributable to lower laboratory equipment
expenditures to support our micro fuel cell business. Capital expenditures in
2009 included computer equipment for our Shanghai operations. We had no
outstanding commitments for capital expenditures as of December 31, 2009.




During 2008, we sold
our remaining 1,137,166 shares of Plug Power common stock with proceeds totaling
$3.0 million and gains totaling $1.0 million. These proceeds reflect our
previously announced strategy to raise additional capital through the sale of
Plug Power stock to fund our micro fuel cell operations. We expect the net gains
to be offset by our operating losses for purposes of computing taxable income.
We estimate that as of December 31, 2009, our remaining net operating loss
carryforwards were approximately $65.4 million.




Off-Balance Sheet Arrangements




There were no off
balance sheet arrangements.




Contractual Payment Obligations




We have entered into
various agreements that result in contractual payment obligations in future
years. These contracts include financing arrangements for current manufacturing,
laboratory and office facility lease agreements. The following table summarizes
cash payments that we are committed to make under the existing terms of
contracts to which we are a party as of December 31, 2009. This table does not
include contingencies.




35




---



Less
            
            
            
            
            
            
            
            MoreContractual Payment
      Obligations
            
            Than 1
            
            1-3
            
            3-5
            
            Than 5(in thousands)
            
            Year
            
            Years
            
            Years
            
            Years
            
            TotalOperating Leases / Total Contractual Payment Obligations
            
            $
            441
            
            $
            828
            
            $
            269
            
            $
            —
            
            $
            1,538


Market Risk




Market risk is the
risk that changes in market conditions will adversely affect earnings or
cashflow. We categorize our market risks as interest rate risk and credit risk.
Immediately below are detailed descriptions of the market risks and explanations
as to how each of these risks are managed.




Interest Rate Risk. Interest rate risk is the risk that changes in interest rates could adversely
affect earnings or cashflows. The Company’s cash equivalents are sensitive to
changes in interest rates. Interest rate changes would result in a change in
interest income due to the difference between the current interest rates on
cash. Interest rate risk sensitivity analysis is used to measure interest rate
risk by computing estimated changes in cashflow as a result of assumed changes
in market interest rates. A 10% decrease in 2009 interest rates would be
immaterial the Company’s consolidated financial statements.




Credit Risk. Credit
risk is the risk of loss we would incur if counterparties fail to perform their
contractual obligations. Financial instruments that subject the Company to
concentrations of credit risk principally consist of cash equivalents,
marketable securities, trade accounts receivable and unbilled contract costs.




Our trade accounts
receivable and unbilled contract costs and fees are primarily from sales to
commercial customers, the U.S. government and state agencies. We do not require
collateral and have not historically experienced significant credit losses
related to receivables or unbilled contract costs and fees from individual
customers or groups of customers in any particular industry or geographic area.




Our deposits are
primarily in cash and investments in marketable securities, primarily deposited
in commercial banks and investment companies. Credit exposure to any one entity
is limited by Company policy.




Critical Accounting Policies and Significant
Judgments and Estimates




The following
discussion and analysis of our financial condition and results of operations is
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America. Note 2 to the consolidated audited financial statements includes a
summary of our most significant accounting policies. The preparation of these
financial statements requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenue, and expenses, and related
disclosure of assets and liabilities. On an ongoing basis, we evaluate our
estimates and judgments, including those related to revenue recognition,
inventories, securities available for sale, income taxes, share-based
compensation and derivatives. We base our estimates on historical experience and
on various other factors that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. Periodically, we review our critical accounting
estimates with the Audit Committee of our Board of Directors.




The significant
accounting policies that we believe are most critical to aid in fully
understanding and evaluating our financial statements include the following:




Revenue Recognition. We recognize revenue from development
contracts based upon the relationship of actual costs to estimated costs to
complete the contract. These types of contracts typically provide development
services to achieve a specific scientific result relating to direct methanol
fuel cell technology. Some of these contracts require us to contribute to the
development effort. The customers for these contracts are commercial customers
and various state and federal government agencies. While government agencies are
providing revenue, we do not expect the government to be a significant end user
of the resulting products. Therefore, we do not reduce funded research and
product development expense by the funding received. When it appears probable
that estimated costs will exceed available funding on fixed price contracts and
we are not successful in securing additional funding, we record the estimated
additional expense before it is incurred.




We apply accounting
guidance on Revenue Recognition in the evaluation of commercially funded fuel
cell research and prototype agreements to determine when to properly recognize
income. Payments received in connection with commercial research and prototype
agreements are deferred and recognized on a straight-line basis over the term of
the agreement for service-related payments.




36




---



For milestone and
prototype delivery payments, if and when achieved, revenue is deferred and
recognized on a straight-line basis over the remaining term of the agreement.
When revenue qualifies for recognition it will be recorded as funded research
and development revenue. The costs associated with research and
prototype-producing activities are expensed as incurred. Expenses in an amount
equal to revenue recognized are reclassified from unfunded research and product
development to funded research and product development.




We recognize product
revenue when there is persuasive evidence of an arrangement, delivery of the
product to the customer or distributor has occurred, at which time title
generally is passed to the customer or distributor, and we have determined that
collection of a fixed fee is probable, all of which occur upon shipment of the
product. If the product requires installation to be performed by us, all revenue
related to the product is deferred and recognized upon the completion of the
installation.




Inventory. Inventory is valued at the lower of cost or
the current estimated market value of the inventory. We periodically review
inventory quantities on hand and record a provision for excess or obsolete
inventory based primarily on our estimated forecast of product demand, as well
as based on historical usage. Demand and usage for products and materials can
fluctuate significantly. A significant decrease in demand for our products could
result in a short-term increase in the cost of inventory purchases and an
increase of excess inventory quantities on hand. Therefore, although we make
every effort to assure the accuracy of our forecasts of future product demand,
any significant unanticipated changes in demand could have a significant impact
on the value of our inventory and our reported operating results.




Share-Based Payments . We grant options to purchase our common
stock and award restricted stock to our employees and directors under our equity
incentive plans. The benefits provided under these plans are share-based
payments subject to the appropriate accounting provisions regarding Share-Based
Payments. Effective January 1, 2006, we use the fair value method of accounting
with the modified prospective application, which provides for certain changes to
the method for valuing share-based compensation. The valuation provisions apply
to new awards and to awards that are outstanding on the effective date and
subsequently modified. Under the modified prospective application, prior periods
are not revised for comparative purposes. Share-based compensation expense
recognized under these accounting methods for the year ended December 31, 2009
was $0.5 million. At December 31, 2009, total unrecognized estimated
compensation expense related to non-vested awards granted prior to that date was
$0.1 million, which is expected to be recognized over a weighted average period
of 1.24 years.




We began estimating
the value of share-based awards on the date of grant using a Black-Scholes
option-pricing model effective January 1, 2006. Prior to this adoption, the
value of each share-based award was estimated on the date of grant using the
Black-Scholes model for the pro forma information required to be disclosed. The
determination of the fair value of share-based payment awards on the date of
grant using an option-pricing model is affected by our stock price as well as
assumptions regarding a number of complex and subjective variables. These
variables include our expected stock price volatility over the term of the
awards, actual and projected employee stock option exercise behaviors, risk-free
interest rate, and expected dividends.




If factors change and
we employ different assumptions for the accounting methodology during future
periods, the compensation expense that we record may differ significantly from
what we have recorded in the current period. Therefore, we believe it is
important for investors to be aware of the high degree of subjectivity involved
when using option-pricing models to estimate share-based compensation.
Option-pricing models were developed for use in estimating the value of traded
options that have no vesting or hedging restrictions, are fully transferable and
do not cause dilution. Because our share-based payments have characteristics
significantly different from those of freely traded options, and because changes
in the subjective input assumptions can materially affect our estimates of fair
values, in our opinion, existing valuation models, including the Black-Scholes
Option Pricing model, may not provide reliable measures of the fair values of
our share-based compensation. Consequently, there is a risk that our estimates
of the fair values of our share-based compensation awards on the grant dates may
bear little resemblance to the intrinsic values realized upon the exercise,
expiration, cancellation, or forfeiture of those share-based payments in the
future. Certain share-based payments, such as employee stock options, may expire
worthless or otherwise result in zero intrinsic value as compared to the fair
values originally estimated on the grant date and expensed in our financial
statements. Alternatively, value may be realized from these instruments that are
significantly in excess of the fair values originally estimated on the grant
date and expensed in our financial statements. There currently is neither a
market-based mechanism nor other practical application to verify the reliability
and accuracy of the estimates stemming from these valuation models, nor a way to
compare and adjust the estimates to actual values. Although the fair value of
employee share-based awards is determined using a qualified option-pricing
model, that value may not be indicative of the fair value observed in a willing
buyer/willing seller market transaction. Estimates of share-based compensation
expenses are significant to our financial statements, but these expenses are
based on the aforementioned option valuation model and will never result in the
payment of cash by us.




Theoretical valuation
models and market-based methods are evolving and may result in lower or higher
fair value estimates for share-based compensation. The timing, readiness,
adoption, general acceptance, reliability, and testing of these methods is
uncertain. Sophisticated mathematical models may require voluminous historical
information, modeling expertise, financial analyses, correlation analyses,
integrated software and databases, consulting fees, customization, and testing
for adequacy of internal controls.




37




---



For purposes of
estimating the fair value of stock options granted during the twelve months
ended December 31, 2009 using the Black-Scholes model, we used the historical
volatility of our stock for the expected volatility assumption input to the
Black-Scholes model, consistent with the proper accounting guidance. The
risk-free interest rate is based on the risk-free zero-coupon rate for a period
consistent with the expected option term at the time of grant. We do not
currently pay nor do we anticipate paying dividends, but we are required to
assume a dividend yield as an input to the Black-Scholes model. As such, we use
a zero dividend rate. The expected option term is estimated using both
historical term measures and projected termination estimates.




Income Taxes. As part of the process of preparing our
consolidated financial statements, we are required to estimate our income taxes
in each of the jurisdictions in which we operate. This process involves the
estimation of our actual current tax exposure together with assessing temporary
differences resulting from differing treatment of items for tax and accounting
purposes. Included in this assessment is the determination of net operating loss
carry forwards. These differences result in a net deferred tax asset. We must
assess the likelihood that our deferred tax assets will be recovered from future
taxable income and, to the extent that we believe that recovery is not likely,
we must establish a valuation allowance.




Significant
management judgment is required in determining our provision for income taxes,
our deferred tax assets and liabilities, and any valuation allowance recorded
against our net deferred tax assets. We have recorded a valuation allowance as a
result of uncertainties in our ability to realize certain net deferred tax
assets, primarily consisting of net operating losses being carried forward. In
the event that actual results differ from these estimates or we adjust these
estimates in future periods, we may need to adjust the recorded valuation
allowance, which could materially impact our financial position and results of
operations. We have recorded a full valuation allowance against our net deferred
tax assets of $26.4 million as of December 31, 2009.




During June 2006
accounting standards on Accounting for Uncertainty in Income Taxes were
released, which became effective for us beginning in fiscal 2007. This
methodology addresses the determination of how tax benefits claimed or expected
to be claimed on a tax return should be recorded in the financial statements.
Under this methodology, we must recognize the tax benefit from an uncertain tax
position only if it is more likely than not that the tax position will be
sustained on examination by the taxing authorities, based on the technical
merits of the position. The tax benefits recognized in the financial statements
from such a position are measured based on the largest benefit that has a
greater than 50% likelihood of being realized upon ultimate resolution. The
impact of our reassessment of our tax positions for these standards did not have
a material impact on our results of operations, financial condition, or
liquidity.




Derivative Instruments . We account for derivative instruments and
embedded derivative instruments in accordance with the accounting standard for
Accounting for Derivative Instruments and Hedging Activities, as amended. The
amended standard requires an entity to recognize all derivatives as either
assets or liabilities in the statement of financial position and measure these
instruments at fair value. Fair value is estimated using the Black-Scholes
Pricing model. We also follow accounting standards for the Accounting for
Derivative Financial Instruments Indexed to and Potentially Settled in, a
Company’s Own Stock, which requires freestanding contracts that are settled in a
company’s own stock, including common stock warrants, to be designated as an
equity instrument, asset or a liability. Under these provisions a contract
designated as an asset or a liability must be carried at fair value, with any
changes in fair value recorded in the results of operations. A contract
designated as an equity instrument can be included in equity, with no fair value
adjustments required.




The asset/liability
derivatives are valued on a quarterly basis using the Black-Scholes Pricing
model. Significant assumptions used in the valuation included exercise dates,
closing prices for our common stock, volatility of our common stock, and a proxy
risk-free interest rate. Gains (losses) on derivatives are included in “Gain
(loss) on derivatives” in our consolidated statement of operations.




New Accounting Pronouncements




Effect of Recent Accounting
Pronouncements :




In December 2007, the
FASB revised the authoritative guidance for business combinations, which
establishes that all business combinations are still required to be accounted
for at fair value under the acquisition method of accounting but it changed the
method of applying the acquisition method in a number of significant aspects.
The guidance is effective on a prospective basis for all business combinations
for which the acquisition date is on or after the beginning of the first annual
period subsequent to December 15, 2008, with the exception of the accounting for
valuation allowances on deferred taxes and acquired tax contingencies.
Adjustments made to valuation allowances on deferred taxes and acquired tax
contingencies associated with acquisitions that closed prior to the effective
date of the policy would also apply the provisions of this policy. The Company’s
adoption of this guidance on January 1, 2009 did not have a material effect on
its financial statements.




38




---



In December 2007, the
FASB issued authoritative guidance which establishes reporting standards that
require companies to more clearly identify in the financial statements and
disclose the impact of noncontrolling interests in a consolidated subsidiary on
the consolidated financial statements. Noncontrolling interests are now
classified as equity in the financial statements. The consolidated income
statement is presented by requiring net income to include the net income for
both the parent and the noncontrolling interests, with disclosure of both
amounts on the consolidated statement of income. The calculation of earnings per
share continues to be based on income amounts attributable to the parent. Prior
period amounts related to noncontrolling interests have been reclassified to
conform to the current period presentation. The Company adopted this guidance on
January 1, 2009.




In March 2008, the
FASB issued authoritative guidance regarding disclosures about derivative
instruments and hedging activities, which requires enhanced disclosures about
derivative instruments and is effective for fiscal periods beginning after
November 15, 2008. This was effective for our Company on January 1, 2009. Other
than the required disclosures, the adoption of new guidance had no impact on the
Financial Statements.




In April 2008, the
FASB issued authoritative guidance regarding the determination of the useful
life of intangible assets. This guidance amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset and requires enhanced disclosures
relating to: (a) the entity’s accounting policy on the treatment of costs
incurred to renew or extend the term of a recognized intangible asset; (b) in
the period of acquisition or renewal, the weighted-average period prior to the
next renewal or extension (both explicit and implicit), by major intangible
asset class and (c) for an entity that capitalizes renewal or extension costs,
the total amount of costs incurred in the period to renew or extend the term of
a recognized intangible asset for each period for which a statement of financial
position is presented, by major intangible asset class. The Company’s adoption
of this Standard on January 1, 2009 did not have a material effect on its
financial statements.




In May 2008, the FASB
issued authoritative guidance pertaining to the hierarchy of generally accepted
accounting principles, which identifies the sources of accounting principles and
the framework for selecting principles to be used in the preparation of
financial statements of nongovernmental entities that are presented in
conformity with generally accepted accounting principles in the United States.
The FASB does not expect that this will result in a change in current practice.
However, transition provisions have been provided in the unusual circumstance
that the application of the provisions of this guidance results in a change in
practice and is effective 60 days following the SEC’s approval of the Public
Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of
Present Fairly in Conformity With Generally Accepted Accounting Principles.” The
Company’s adoption of this on January 1, 2009 did not have a material effect on
its financial statements.




In May 2008, the FASB
issued authoritative guidance for the accounting for convertible debt
instruments that may be settled in cash upon conversion including partial cash
settlement. This applies to convertible debt instruments that, by their stated
terms, may be settled in cash (or other assets) upon conversion, including
partial cash settlement, unless the embedded conversion option is required to be
separately accounted for as a derivative. This also requires the issuer to
separately account for the liability and equity components of convertible debt
instruments in a manner that reflects the issuer’s nonconvertible debt borrowing
rate on the instrument’s issuance date when interest cost is recognized. The
Company’s adoption of this Standard on January 1, 2009 did not have a material
effect on its financial statements.




In June 2008, the
FASB issued authoritative guidance to determine whether instruments granted in
share-based payment transactions are participating securities. This guidance
states that unvested share-based payment awards that contain nonforfeitable
rights to dividends or dividend equivalents (whether paid or unpaid) are
participating securities and shall be included in the computation of earnings
per share pursuant to the two-class method. The Company’s adoption of this
Standard on January 1, 2009 did not have a material effect on its financial
statements.




In April 2009, the
FASB issued authoritative guidance which provides instruction for estimating
fair value when the volume and level of activity for an asset or liability have
significantly decreased in relation to normal market activity for the asset or
liability, and for identifying circumstances that may indicate that a
transaction is not orderly. Additionally, the guidance requires disclosure about
fair value measurements in interim and annual reporting periods. The guidance is
effective for interim and annual reporting periods ending after June 15, 2009.
The Company’s adoption of this Standard on January 1, 2009 did not have a
material effect on its financial statements.




In April 2009, the
FASB issued authoritative guidance on the timing of impairment recognition and
greater clarity about the credit and noncredit components of impaired debt
securities that are not expected to be sold. The guidance also requires
additional disclosures about impairments in interim and annual reporting periods
and was effective for interim and annual reporting periods ending after June 15,
2009. The Company’s adoption of this Standard on January 1, 2009 did not have a
material effect on its financial statements.




In June 2009, the
FASB issued the FASB Accounting Standards Codification (Codification). The
Codification became the single source of all authoritative GAAP recognized by
FASB to be applied for financial statements issued for periods ending after
September 15, 2009. The Codification did not change GAAP and did not have a
material affect on our financial position, results of operations or
liquidity.




39




---



Item 7A. Quantitative and Qualitative
Disclosures About Market Risk




The Company is
exposed to market risk from changes in interest rates and credit risk, which
could affect its future results of operations and financial condition. We manage
our exposure to these risks through regular operating and financing activities.
(See “Market Risk”, included in Item 7, Management’s Discussion and Analysis of
Financial Condition and Results of Operations above.)




Item 8: Financial Statements and Supplementary
Data




The financial
statements filed herewith are set forth on the Index to Consolidated Financial
Statements on Page F-1 and are incorporated herein by reference.




Selected Quarterly Financial
      Data(Unaudited and in thousands except per share amounts)
            
            Q1
            
            Q2
            
            Q3
            
            Q42008Product revenue
            
            $
            1,980
            
            
            $
            1,720
            
            
            $
            1,400
            
            
            $
            1,124Funded research and development revenue
            
            
            173
            
            
            
            309
            
            
            
            399
            
            
            
            273Gross profit – product revenue
            
            
            1,140
            
            
            
            894
            
            
            
            565
            
            
            
            444Gross loss – funded research and development
            
            
            (183
            )
            
            
            (325
            )
            
            
            (420
            )
            
            
            (327
            )Net
      loss
            
            $
            (3,187
            )
            
            $
            (3,278
            )
            
            $
            (4,016
            )
            
            $
            (2,023
            )Loss per Share (Basic and
      Diluted):Net loss
            
            $
            (0.67
            )
            
            $
            (0.69
            )
            
            $
            (0.84
            )
            
            $
            (0.42
            )2009Product revenue
            
            $
            1,550
            
            
            $
            1,309
            
            
            $
            1,439
            
            
            $
            1,965Funded research and development revenue
            
            
            517
            
            
            
            542
            
            
            
            526
            
            
            
            458Gross profit – product revenue
            
            
            885
            
            
            
            681
            
            
            
            855
            
            
            
            1,177Gross loss – funded research and development
            
            
            (518
            )
            
            
            (545
            )
            
            
            (528
            )
            
            
            (461
            )Net
      loss
            
            $
            (742
            )
            
            $
            (946
            )
            
            $
            (882
            )
            
            $
            (529
            )Loss per Share (Basic and
      Diluted):Net loss
            
            $
            (0.15
            )
            
            $
            (0.20
            )
            
            $
            (0.19
            )
            
            $
            (0.11
            )


Item 9: Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure




None.




40






---



Item 9A: Controls and Procedures




(a) Evaluation of Disclosure Controls and
Procedures Evaluation of
Disclosure Controls and Procedures: Our management, with the participation of our
chief executive officer and acting chief financial officer, evaluated the
effectiveness of MTI’s disclosure controls and procedures as of December 31,
2009. The term “disclosure controls and procedures,” as defined in Rules
13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other
procedures of a company that are designed to ensure that information required to
be disclosed by a company in the reports that it files or submits under the
Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the SEC’s rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required
to be disclosed by a company in the reports that it files or submits under the
Exchange Act is accumulated and communicated to the company’s management,
including its principal executive and principal financial officers, as
appropriate to allow timely decisions regarding required disclosure. We
recognize that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving their objectives
and we necessarily apply our judgment in evaluating the cost-benefit
relationship of possible controls and procedures. Based on the valuation of our
disclosure controls and procedures as of December 31, 2009, our chief executive
officer and acting chief financial officer concluded that, as of such date, our
disclosure controls and procedures were effective at the reasonable assurance
level.




(b) Management’s Report on Internal Control
Over Financial Reporting Management of our Company is responsible for establishing and maintaining
adequate internal control over financial reporting, as that term is defined in
Exchange Act Rules 13a-15(f) and 15d-15(f). Our internal control over financial
reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted accounting
principles.




Because of its
inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness to
future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.




Under the supervision
and with the participation of our management, including the principal executive
officer and principal financial officer, we conducted an evaluation of the
effectiveness of our internal control over financial reporting using the
criteria set forth in Internal Control—Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. We determined that we had a material
weakness in our internal control over financial reporting for the year ended
December 31, 2008 because of staffing turnover in our finance area and lack of
resources necessary to maintain effective controls. The Company has corrected
this material weakness by retaining an outside consulting firm to provide
controllership and chief financial officer related services. Additionally, on
June 18, 2009, the Company appointed an Acting Chief Financial Officer. Based on
our evaluation using the criteria set forth in Internal Control—Integrated Framework, Management has concluded that our internal
control over financial reporting was effective as of December 31,
2009.




This annual report
does not include an attestation report of our registered public accounting firm
regarding internal control over financial reporting. Our report was not subject
to attestation by our independent registered public accounting firm pursuant to
temporary rules of the SEC that permit us to provide only Management’s Report in
this annual report.




/s/ Peng K. Lim
            /s/ Frederick W.
  JonesChief Executive Officer
            Acting Chief Financial Officer(Principal Executive Officer)
            (Principal Financial Officer)


(c) Changes in Internal Control over Financial
Reporting There have
been no changes in our internal control over financial reporting, as such term
is defined in Rules 13a-15(f) and 15d-15(1) under the Exchange Act, during our
fiscal quarter ended December 31, 2009 that have materially affected, or are
reasonable likely to materially affect our internal control over financial
reporting.




Item 9B: Other Information




None.




41




---



PART III




Item 10: Directors, Executive Officers and
Corporate Governance




(a) Directors Incorporated herein by reference is the
information appearing under the captions “Information about our Directors” and
“Compliance with Section 16(a) of the Securities Exchange Act of 1934” in our
definitive Proxy Statement for our 2010 Annual Meeting of Stockholders to be
filed with the SEC.




(b) Executive Officers Incorporated herein by reference is the
information appearing under the captions “Executive Officers” and “Compliance
with Section 16(a) of the Securities Exchange Act of 1934” in our definitive
Proxy Statement for our 2010 Annual Meeting of Stockholders to be filed with the
SEC.




Incorporated herein
by reference is the information appearing under the caption “Board of Director
Meetings and Committees – Audit Committee” in our definitive Proxy Statement for
our 2010 Annual Meeting of Stockholders to be filed with the SEC.




Code of Ethics: We have adopted a Code of Ethics for
employees, officers and directors. The Code of Ethics is intended to comply with
Item 406 of Regulation S-K of the Securities Exchange Act of 1934. A copy may be
obtained at no charge by written request to the attention of our Secretary at
431 New Karner Road, Albany, New York 12205. A copy of the Code of Ethics is
also available on our website at http://www.mechtech.com.




Item 11: Executive Compensation




Incorporated herein
by reference is the information appearing under the caption “Executive
Compensation” in the Company’s definitive Proxy Statement for our 2010 Annual
Meeting of Stockholders to be filed with the SEC.




Item 12: Security Ownership of Certain
Beneficial Owners and Management and Related Stockholder Matters




Incorporated herein
by reference is the information appearing under the caption “Principal
Stockholders” in our definitive Proxy Statement for our 2010 Annual Meeting of
Stockholders to be filed with the SEC.




Equity Compensation
Plans As of December
31, 2009, we have three equity compensation plans, each of which was originally
approved by our stockholders; the Mechanical Technology, Incorporated 1996 Stock
Incentive Plan (the “1996 Plan”), 1999 Employee Stock Incentive Plan (the “1999
Plan”) and 2006 Equity Incentive Plan (the “2006 Plan”). The 2006 plan was
amended and approved by our Board of Directors in 2009. We refer collectively to
these as the Plans. See Note 13 to the Consolidated Financial Statements
referred to in Item 8 for a description of these Plans.




The following table
presents information regarding these plans:




Number of Securities
  RemainingAvailable for Future
  IssuanceNumber of Securities To Be
            
            
            
            
            
            UnderIssued Upon Exercise of
            
            Weighted Average Exercise
            
            Equity Compensation PlansOutstanding
            
            Price of Outstanding
            
            (excluding securities reflected
    inOptions, Warrants, Rights(1)
            
            Options, Warrants, Rights
            
            column (a))Plan
Category
            
            (a)
            
            (b)
            
            (c)Equity compensation plansapproved by security holders
            
            
            438,869
            
            
            
            $23.22
            
            
            
            -0-Equity compensation plansnot approved by security
    holders
            
            
            277,534
            
            
            
            4.51
            
            
            
            316,216


(1)
            
            Under
      the 1996, 1999 and 2006 Plans, the securities available under the Plans
      for issuance and issuable pursuant to exercises of outstanding options may
      be adjusted in the event of a change in outstanding stock by reason of
      stock dividend, stock splits, reverse stock splits,
  etc.




42




---



Item 13: Certain Relationships and Related
Transactions, and Director Independence




Incorporated herein
by reference is the information appearing under the caption “Certain
Relationships and Related Transactions” in our definitive Proxy Statement for
the 2010 Annual Meeting of Stockholders to be filed with the SEC.




Item 14: Principal Accountant Fees and
Services




Incorporated herein
by reference is the information appearing under the caption “Independent
Accountants” in our definitive Proxy Statement for the 2010 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission.




43




---



PART IV




Item 15: Exhibits, Financial Statement
Schedules




15(a) (1) Financial
Statements: The financial
statements filed herewith are set forth on the Index to Consolidated Financial
Statements on page F-1 of the separate financial section which accompanies this
Report, which is incorporated herein by reference.




15(a) (2) Financial Statement
Schedules: The following
consolidated financial statement schedule for the years ended December 31, 2007,
2008, and 2009 is included pursuant to Item 15(d):




Report of Independent Registered Public Accounting Firm on Financial
Statements Schedule;Schedule II - Valuation and Qualifying Accounts.




All other financial
statement schedules not listed have been omitted because they are either not
required, not applicable, or the information has been included elsewhere in the
consolidated financial statements or notes thereto.




15(a) (3) Exhibits: The exhibits listed in the Exhibit Index
immediately preceding the exhibits are filed as part of this Annual Report on
Form 10-K.




The following
exhibits are filed as part of this Report:




ExhibitNumber
            
            Description3.1
            
            Certificate of Incorporation of the
      registrant, as amended and restated. (17)3.2
            
            Certificate of Amendment of the
      Certificate of Incorporation of the registrant. (18)3.3
            
            By-Laws of the registrant, as amended
      and restated. (16)4.1
            
            Form of Common Stock Purchase Warrant to
      be issued by the Company. (13)10.14
            
            Mechanical Technology, Incorporated 1996
      Stock Incentive Plan. (1)10.30
            
            Mechanical Technology, Incorporated 1999
      Employee Stock Incentive Plan. (2)10.38
            
            Lease dated August 10, 1999 between Carl
      E. Touhey and Mechanical Technology, Inc. (3)10.43
            
            Lease dated April 2, 2001 between
      Kingfisher LLC and Mechanical Technology, Inc. (4)10.44
            
            First Amendment to lease dated March 13,
      2003 between Kingfisher LLC and Mechanical Technology, Inc.
  (5)10.132
            
            Second Amendment to lease dated December
      12, 2005 between Kingfisher, LLC and Mechanical Technology, Incorporated.
      (7)10.139
            
            Employment Agreement dated May 4, 2006
      between Peng K. Lim and MTI MicroFuel Cells Inc (10) (amended and restated
      on December 31, 2008). (20)10.140
            
            Form of Restricted Stock Agreement for
      the 1996 and 1999 Mechanical Technology, Inc. Stock Incentive Plans.
      (11)10.142
            
            Third Amendment to lease dated August 7,
      2006 between Kingfisher, LLC and Mechanical Technology, Incorporated.
      (12)10.145
            
            Mechanical Technology, Incorporated 2006
      Equity Incentive Plan. (9)10.147
            
            Employment Agreement dated March 27,
      2007 between Robert Kot and MTI Instruments, Inc (terminated January
      2009). (14)10.148
            
            Fourth Amendment to lease dated August
      6, 2007 between Kingfisher LLC and Mechanical Technology, Incorporated.
      (15)10.151
            
            Employment Agreement dated April 3, 2006
      between James K. Prueitt and MTI MicroFuel Cells Inc (21) (amended and
      restated on December 31, 2008) (20).10.152
            
            Separation Agreement dated September 4,
      2008 between Cynthia A. Scheuer and Mechanical Technology, Incorporated
      (19)


44




---



10.153
            
            Form of Convertible Note and Warrant
      Purchase Agreement dated September 18, 2008 (19)10.154
            
            Amended and Restated Employment
      Agreement dated December 30, 2008 between James K. Prueitt and MTI
      MicroFuel Cells Inc. (20)10.155
            
            Amended and Restated Employment
      Agreement dated December 31, 2008 between Peng K. Lim and Mechanical
      Technology, Inc. (20)10.156
            
            Amendment to Employment Agreement dated
      March 27, 2007 between Robert Kot and MTI Instruments, Inc.
  (20)10.157
            
            Separation Agreement and Release
      Agreement dated January 16, 2009 between Robert Kot and MTI Instruments,
      Inc. (20)10.158
            
            Amendment No. 1 to Convertible Note and
      Warrant Purchase Agreement dated February 20, 2009 (20)10.159
            
            Letter Agreement dated February 24, 2009
      between Peng K. Lim and Mechanical Technology, Inc. (20)10.160
            
            Letter Agreement dated February 24, 2009
      between James K. Prueitt and MTI MicroFuel Cells Inc. (20)10.161
            
            Amendment No. 2 to Convertible Note and
      Warrant Purchase Agreement dated April 15, 2009 (21)10.162
            
            Secured Convertible Promissory Note
      Negotiated Conversion Agreement, dated December 9, 2009, by and among the
      Company, MTI Micro and the Bridge Investors (22)10.163
            
            Form of Common Stock Warrant
    (22)10.164
            
            Mechanical Technology, Incorporated
      Amended and Restated 2006 Equity Incentive Plan (23)10.165
            
            Fifth Amendment to lease dated August 6,
      2007 between Kingfisher LLC and Mechanical Technology,
    Incorporated10.166
            
            Amendment No 1 to Lease Agreement
      Between Mechanical Technology Inc. and Carl E. Touhey10.167
            
            MTI MicroFuel Cells Inc. 2009 Stock
      Plan14.1
            
            Code of Ethics. (8)21
            
            Subsidiaries of the Registrant.
      (6)23.1
            
            Consent of Independent Registered Public
      Accounting Firm – PricewaterhouseCoopers LLP.31.1
            
            Certification of Chief Executive Officer
      Pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
            
            Certification of Acting Chief Financial
      Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
  200232.1
            
            Certification of Chief Executive Officer
      Pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
            
            Certification of Acting Chief Financial
      Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002


45




---



Certain exhibits were
previously filed (as indicated below) and are incorporated herein by reference.
All other exhibits for which no other filing information is given are filed
herewith:





(1)
            
            Filed as Appendix
      A to the registrant’s Definitive Proxy Statement Schedule 14A filed
      November 19, 1996.(2)
            
            Filed as an
      Exhibit to the registrant’s Proxy Statement, Schedule 14A, dated February
      13, 1999.(3)
            
            Filed as an
      Exhibit to the registrant’s Form 10-K Report for the fiscal year ended
      September 30, 1999.(4)
            
            Filed as an
      Exhibit to our Form 10-K Report for the fiscal year ended September 30,
      2001.(5)
            
            Filed as an
      Exhibit to the registrant’s Form 10-K Report for the year ended December
      31, 2002.(6)
            
            Filed as an
      Exhibit to the registrant’s Form 10-K Report for the year ended December
      31, 2003.(7)
            
            Filed as an
      Exhibit to the registrant’s Form 8-K Report dated December 12,
    2005.(8)
            
            Filed as an
      Exhibit to the registrant’s Form 10-K Report for the year ended December
      31, 2005.(9)
            
            Filed as an
      Exhibit to the registrant’s Proxy Statement, Schedule 14A, dated April 3,
      2006.(10)
            
            Filed as an
      Exhibit to the registrant’s Form 8-K Report dated May 4,
2006.(11)
            
            Filed as an
      Exhibit to the registrant’s Form 8-K Report dated May 18,
  2006.(12)
            
            Filed as an
      Exhibit to the registrant’s Form 10-Q Report for the quarter ended June
      30, 2006.(13)
            
            Filed as an
      Exhibit to the registrant’s Form 8-K Report dated December 15,
    2006.(14)
            
            Filed as an
      Exhibit to the registrant’s Form 8-K Report dated March 28,
  2007.(15)
            
            Filed as an
      Exhibit to the registrant’s Form 10-Q Report for the quarter ended June
      30, 2007.(16)
            
            Filed as an
      Exhibit to the registrant’s Form 8-K Report dated December 14,
    2007.(17)
            
            Filed as an
      Exhibit to the registrant’s Form 10-K Report for the year ended December
      31, 2007.(18)
            
            Filed as an
      Exhibit to the registrant’s Form 8-K Report dated May 15,
  2008.(19)
            
            Filed as an
      Exhibit to the registrant’s Form 10-Q Report for the quarter ended
      September 30, 2008.(20)
            
            Filed as an
      Exhibit to the registrant’s Form 10-K Report for the year ended December
      31, 2008.(21)
            
            Filed as an
      Exhibit to the registrant’s Form 8-K Report dated April 15,
  2009.(22)
            
            Filed as an
      Exhibit to the registrant’s Form 8-K Report dated December 15,
    2009.(23)
            
            Filed as an
      Exhibit to the registrant’s Form S-8 Registration Statement dated
      September 18, 2009




46




---



Signatures




Pursuant to the
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.




MECHANICAL
      TECHNOLOGY, INCORPORATEDDate: March 31, 2010
            By:
            /s/ Peng K.
    LimPeng K. LimChief Executive
  Officer


Pursuant to the
requirements of the Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and in the capacities
and on the dates indicated.




Signature
            
            Title
            
            Date/s/
      Peng K. Lim
            
            Chairman, Chief Executive Officer,Peng K. Lim
            
            (Principal Executive Officer and Director)
            
            March 31, 2010/s/
      Frederick W. Jones
            
            Acting Chief Financial Officer and SecretaryFrederick W. Jones
            
            (Principal Financial and Accounting Officer)
            
            March 31, 2010/s/
      Thomas J. Marusak
            
            DirectorThomas J. Marusak
            
            
            
            March 31, 2010/s/
      William P. Phelan
            
            DirectorWilliam P. Phelan
            
            
            
            March 31, 2010/s/ E.
      Dennis O’Connor
            
            DirectorE. Dennis O’Connor
            
            
            
            March 31, 2010/s/
      Walter L. Robb
            
            DirectorDr. Walter L. Robb
            
            
            
            March 31, 2010


47




---



REPORT OF INDEPENDENT REGISTERED
PUBLICACCOUNTING FIRM ON FINANCIAL STATEMENT SCHEDULE




To the Board of
Directors and Stockholdersof Mechanical Technology, Incorporated:




Our audits of the
consolidated financial statements referred to in our report dated March 31, 2010
appearing on page F-2 of this Form 10-K of Mechanical Technology, Incorporated,
also included an audit of the financial statement schedule listed in Item
15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.




/s/PricewaterhouseCoopers
LLP




Albany, New
YorkMarch 31, 2010




48




---



MECHANICAL TECHNOLOGY, INCORPORATED AND
SUBSIDIARIESVALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN THOUSANDS)




Balance at
            
            
            
            
            AdditionsBeginning of
            
            Additions Charged to
            
            Charged to
            
            
            
            
            Balance at End ofDescription
            
            Period
            
            Costs and Expenses
            
            Other Accounts
            
            Deductions
            
            PeriodAllowance for doubtful accounts
      (accounts receivable) for the years ended:December 31, 2007
            
            $
            —
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            $
            —December 31, 2008
            
            $
            —
            
            $
            —
            
            
            $
            —
            
            
            $
            —
            
            $
            —December 31, 2009
            
            $
            —
            
            $
            92
            
            
            $
            —
            
            
            $
            —
            
            $
            92Valuation allowance for deferred tax
      assets for the years ended:December 31, 2007
            
            $
            18,815
            
            $
            3,518
            
            
            $
            —
            
            
            $
            —
            
            $
            22,333December 31, 2008
            
            $
            22,333
            
            $
            5,547
            
            
            $
            —
            
            
            $
            
            
            $
            27,880December 31, 2009
            
            $
            27,880
            
            $
            (1,495
            )
            
            $
            
            
            
            $
            
            
            $
            26,385Inventory reserve for the years
      ended:December 31, 2007
            
            $
            150
            
            $
            137
            
            
            $
            28
            
            
            $
            133
            
            $
            182December 31, 2008
            
            $
            182
            
            $
            446
            
            
            $
            (42
            )
            
            $
            75
            
            $
            511December 31, 2009
            
            $
            511
            
            $
            124
            
            
            $
            (48
            )
            
            $
            59
            
            $
            528




49




---



MECHANICAL TECHNOLOGY, INCORPORATED AND
SUBSIDIARIESINDEX TO CONSOLIDATED FINANCIAL STATEMENTS




PageReport of Independent Registered Public
      Accounting Firm
            F-2Consolidated Financial Statements:Balance Sheets as of December 31, 2008 and 2009
            F-3Statements of Operations for
      the Years Ended December 31, 2007, 2008, and 2009
            F-4Statements of Stockholders’ Equity and Comprehensive Loss for
theYears Ended December 31, 2007, 2008, and 2009
            F-5Statements of Cash Flows for
      the Years Ended December 31, 2007, 2008, and 2009
            F-6Notes to Consolidated Financial
      Statements
            F-7 to
F-32


F-1




---



Report of Independent Registered Public
Accounting Firm




To the Board of
Directors and Shareholders ofMechanical Technology,
Incorporated:




In our opinion, the
accompanying consolidated balance sheets and the related consolidated statements
of operations, shareholders' equity and comprehensive loss, and of cash flows
present fairly, in all material respects, the financial position of Mechanical
Technology, Incorporated and its subsidiaries at December 31, 2009 and 2008, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2009 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 the standards of the
Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether 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.




As discussed in Note
2 to the consolidated financial statements, the Company changed the manner in
which it accounts for noncontrolling interest in 2009.




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 suffered recurring losses from operations and has an accumulated
deficit that raises 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 Albany, New YorkMarch 31, 2010




F-2




---



MECHANICAL TECHNOLOGY, INCORPORATED AND
SUBSIDIARIESCONSOLIDATED BALANCE SHEETS December 31, 2008 and 2009




(Dollars in thousands)
            December 31,2008
            
            2009AssetsCurrent Assets:Cash and cash equivalents
            $
            1,662
            
            
            $
            785Accounts receivable, less
      allowance for doubtful accounts ($92 in 2009, $-0- in 2008)
            
            540
            
            
            
            1,142Inventories, net
            
            1,509
            
            
            
            789Prepaid expenses and other
      current assets
            
            272
            
            
            
            166Total Current Assets
            
            3,983
            
            
            
            2,882Property, plant and equipment,
      net
            
            1,528
            
            
            
            859Total Assets
            $
            5,511
            
            
            $
            3,741Liabilities and Stockholders’
      EquityCurrent Liabilities:Accounts payable
            $
            508
            
            
            $
            323Accrued liabilities
            
            1,648
            
            
            
            1,290Deferred revenue
            
            8
            
            
            
            16Bridge note payable – related
      party, at fair value
            
            1,544
            
            
            
            —Income taxes payable
            
            23
            
            
            
            20Total Current Liabilities
            
            3,731
            
            
            
            1,649Long-Term Liabilities:Uncertain tax position liability
            
            213
            
            
            
            —Derivative liability
            
            41
            
            
            
            70Total Long-Term-Liabilities
            
            254
            
            
            
            70Total Liabilities
            
            3,985
            
            
            
            1,719Stockholders’ Equity:Common stock, par value $0.01 per share, authorized 75,000,000;5,776,750 issued in both 2008 and 2009
            
            58
            
            
            
            58Paid-in-capital
            
            132,781
            
            
            
            133,286Accumulated deficit
            
            (117,570
            )
            
            
            (120,725
            )Common stock in treasury, at
      cost, 1,005,092 shares in both 2008 and 2009
            
            (13,754
            )
            
            
            (13,754
            )Total MTI stockholders’ equity (deficit)
            
            1,515
            
            
            
            (1,135
            )Noncontrolling
    interest
            
            11
            
            
            
            3,157Total Equity
            
            1,526
            
            
            
            2,022Total Liabilities and Stockholders’ Equity
            $
            5,511
            
            
            $
            3,741


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




F-3




---



MECHANICAL TECHNOLOGY, INCORPORATED AND
SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended December 31, 2007, 2008, and 2009




(Dollars in thousands, except per share)
            Years Ended December
  31,2007
            
            2008
            
            2009Product revenue
            $
            9,028
            
            
            $
            6,224
            
            
            $
            6,263Funded research and development revenue
            
            1,556
            
            
            
            1,154
            
            
            
            2,043Total revenue
            
            10,584
            
            
            
            7,378
            
            
            
            8,306Operating costs and expenses:Cost of product revenue
            
            3,430
            
            
            
            3,181
            
            
            
            2,665Research and product
      development expenses:Funded research and product development
            
            1,891
            
            
            
            2,409
            
            
            
            4,095Unfunded research and product development
            
            9,874
            
            
            
            5,855
            
            
            
            1,349Total research and product development expenses
            
            11,765
            
            
            
            8,264
            
            
            
            5,444Selling, general and
      administrative expenses
            
            8,738
            
            
            
            8,369
            
            
            
            3,284Operating loss
            
            (13,349
            )
            
            
            (12,436
            )
            
            
            (3,087
            )Interest expense
            
            —
            
            
            
            (44
            )
            
            
            (222
            )Loss on extinguishment of debt
            
            —
            
            
            
            —
            
            
            
            (232
            )Gain (loss) on derivatives
            
            2,967
            
            
            
            655
            
            
            
            (29
            )Gain on sale of securities available for
      sale
            
            2,549
            
            
            
            1,018
            
            
            
            —Other (expense) income, net
            
            224
            
            
            
            47
            
            
            
            (2
            )Loss before income taxes and
      non-controlling interest
            
            (7,609
            )
            
            
            (10,760
            )
            
            
            (3,572
            )Income tax benefit (expense)
            
            (2,548
            )
            
            
            (2,004
            )
            
            
            208Net
      loss, net of tax
            
            (10,157
            )
            
            
            (12,764
            )
            
            
            (3,364
            )Plus: Net loss attributed to noncontrolling interest
            
            582
            
            
            
            260
            
            
            
            265Net
      loss attributed to MTI
            
            (9,575
            )
            
            
            (12,504
            )
            
            
            (3,099
            )Loss per Share (Basic and Diluted):Loss per share (basic and
    diluted)
            $
            (2.01
            )
            
            $
            (2.62
            )
            
            $
            (0.65
            )


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




F-4




---



MECHANICAL TECHNOLOGY, INCORPORATED AND
SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’
EQUITY AND COMPREHENSIVE LOSS For the Years Ended December 31, 2007, 2008, and 2009




(Dollars in thousands)
            Years Ended December
  31,2007
            
            2008
            
            2009Common StockBalance, beginning
            $
            58
            
            
            $
            58
            
            
            $
            58Balance, ending
            $
            58
            
            
            $
            58
            
            
            $
            58Paid-In CapitalBalance, beginning
            $
            130,968
            
            
            $
            132,065
            
            
            $
            132,781Issuance of shares – stock
      options
            
            60
            
            
            
            —
            
            
            
            —Stock-based compensation
            
            1,558
            
            
            
            844
            
            
            
            505MTI MicroFuel Cell
      Investment
            
            (521
            )
            
            
            (128
            )
            
            
            —Balance, ending
            $
            132,065
            
            
            $
            132,781
            
            
            $
            133,286Accumulated DeficitBalance, beginning
            $
            (95,385
            )
            
            $
            (105,066
            )
            
            $
            (117,570
            )Cumulative effect of adoption
      of FIN 48
            
            (106
            )
            
            
            —
            
            
            
            —Net
      loss
            
            (9,575
            )
            
            
            (12,504
            )
            
            
            (3,099
            )MTI Micro Warrants
      issued
            
            —
            
            
            
            —
            
            
            
            (56
            )Balance, ending
            $
            (105,066
            )
            
            $
            (117,570
            )
            
            $
            (120,725
            )Accumulated Other Comprehensive Income
      (Loss)Balance, beginning
            $
            984
            
            
            $
            500
            
            
            $
            —Change in unrealized (loss)
      gain on securities available for sale (net of taxesof $0 in 2007, 2008, and 2009)
            
            68
            
            
            
            —
            
            
            
            —Less reclassification adjustment for gains included in net income (net
      oftaxes of $2,518 in 2007, $1,971 in 2008 and $-0- in 2009)
            
            (552
            )
            
            
            (500
            )
            
            
            —Balance, ending
            $
            500
            
            
            $
            —
            
            
            $
            —Treasury StockBalance, beginning
            $
            (13,754
            )
            
            $
            (13,754
            )
            
            $
            (13,754
            )Balance, ending
            $
            (13,754
            )
            
            $
            (13,754
            )
            
            $
            (13,754
            )Noncontrolling Interest
      (NCI)Balance, beginning
            $
            205
            
            
            $
            143
            
            
            $
            11Net loss attributed to
      NCI
            
            (582
            )
            
            
            (260
            )
            
            
            (265
            )Equity contribution
            
            520
            
            
            
            128
            
            
            
            3,411Balance, ending
            $
            143
            
            
            $
            11
            
            
            $
            3,157Total Stockholders’
    EquityBalance, ending
            $
            13,946
            
            
            $
            1,526
            
            
            $
            2,022Total Comprehensive
LossNet Loss
            $
            (9,575
            )
            
            $
            (12,504
            )
            
            $
            (3,099
            )Other comprehensive loss:Reclassification adjustment
      for gains included in net income, net of taxes
            
            (552
            )
            
            
            (500
            )
            
            
            —Change in unrealized (loss) gain on securities available for sale, net of
      taxes
            
            68
            
            
            
            —
            
            
            
            —Total comprehensive
loss
            $
            (10,059
            )
            
            
            (13,004
            )
            
            
            (3,099
            )


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




F-5




---



MECHANICAL TECHNOLOGY, INCORPORATED AND
SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 2007, 2008, and 2009




(Dollars in thousands)
            Years Ended December
  31,2007
            
            2008
            
            2009Operating ActivitiesNet (loss)
            $
            (10,157
            )
            
            $
            (12,764
            )
            
            $
            (3,364
            )Adjustments to reconcile net loss to net cash used by operating
      activities:(Gain) loss on derivatives
            
            (2,967
            )
            
            
            (655
            )
            
            
            29Gain on sale of securities
      available for sale
            
            (2,549
            )
            
            
            (1,018
            )
            
            
            —Depreciation and amortization
            
            1,129
            
            
            
            819
            
            
            
            660Loss (gain) on disposal of
      fixed assets
            
            39
            
            
            
            (7
            )
            
            
            16Deferred income taxes
            
            2,518
            
            
            
            1,971
            
            
            
            —Stock based
    compensation
            
            1,558
            
            
            
            844
            
            
            
            505Loss on extinguishment of debt
            
            —
            
            
            
            —
            
            
            
            232Provision for doubtful
      accounts
            
            —
            
            
            
            —
            
            
            
            92Provision for inventory obsolescence
            
            137
            
            
            
            446
            
            
            
            124Changes in operating assets and liabilities:Accounts receivable, net
            
            244
            
            
            
            829
            
            
            
            (694
            )Inventories, net
            
            (294
            )
            
            
            (582
            )
            
            
            781Prepaid expenses and other current assets
            
            113
            
            
            
            57
            
            
            
            106Accounts payable
            
            (379
            )
            
            
            235
            
            
            
            (186
            )Income taxes payable
            
            23
            
            
            
            17
            
            
            
            (216
            )Deferred revenue
            
            (749
            )
            
            
            (109
            )
            
            
            8Accrued liabilities
            
            (349
            )
            
            
            (429
            )
            
            
            (263
            )Net cash used in operating activities
            
            (11,683
            )
            
            
            (10,346
            )
            
            
            (2,170
            )Investing ActivitiesPurchases of property, plant and
      equipment
            
            (414
            )
            
            
            (181
            )
            
            
            (7
            )Proceeds from sale of property, plant and equipment
            
            12
            
            
            
            —
            
            
            
            —Proceeds from sale of securities
      available for sale
            
            5,130
            
            
            
            3,039
            
            
            
            —Net cash provided by (used in) investing activities
            
            4,728
            
            
            
            2,858
            
            
            
            (7
            )Financing ActivitiesProceeds from short-term debt
            
            —
            
            
            
            1,500
            
            
            
            1,300Proceeds from stock option exercises
            
            60
            
            
            
            —
            
            
            
            —Net cash provided by financing
      activities
            
            60
            
            
            
            1,500
            
            
            
            1,300Decrease in cash and cash equivalents
            
            (6,895
            )
            
            
            (5,988
            )
            
            
            (877
            )Cash and cash equivalents - beginning of
      year
            
            14,545
            
            
            
            7,650
            
            
            
            1,662Cash and cash equivalents - end of year
            $
            7,650
            
            
            $
            1,662
            
            
            $
            785


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




F-6




---



MECHANICAL TECHNOLOGY, INCORPORATED AND
SUBSIDIARIES


NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




1. Nature of Operations




Description of Business




Mechanical
Technology, Incorporated, (“MTI” or the “Company”), a New York corporation, was
incorporated in 1961. MTI operates in two segments, the New Energy segment which
is conducted through MTI MicroFuel Cells Inc. (“MTI Micro”), a majority-owned
subsidiary, and the Test and Measurement Instrumentation segment, which is
conducted through MTI Instruments, Inc. (“MTI Instruments”), a wholly-owned
subsidiary.




MTI Micro was
incorporated in Delaware on March 26, 2001, and is developing Mobion® , a handheld energy-generating device to
replace current lithium-ion and similar rechargeable battery systems in many
handheld electronic devices for the military and consumer markets. Mobion® handheld generators are based on direct
methanol fuel cell (DFMC) technology, which has been recognized as enabling
technology for advanced portable power sources by the scientific community and
industry analysts. As the need for advancements in portable power increases, MTI
Micro is developing Mobion® as a solution for advancing current and future
electronic device power needs and addressing the multi-billion dollar portable
electronics market. As of December 31, 2009, the Company owned approximately
61.81% of MTI Micro’s outstanding common stock.




MTI Instruments was
incorporated in New York on March 8, 2000. MTI Instruments is a worldwide
supplier of precision non-contact physical measurement solutions, condition
based monitoring systems, portable balance equipment and wafer inspection tools.
MTI Instrument’s products use a comprehensive array of technologies to solve
complex, real world applications in numerous industries including manufacturing,
semiconductor, solar, commercial and military aviation, automotive and data
storage. Our products consist of electronic gauging instruments for position,
displacement and vibration application within the design,
manufacturing/production, test and research market; wafer characterization of
semi-insulating and semi-conducting wafers within both the semiconductor and
solar industries; and engine vibration analysis systems for both military and
commercial aircraft.




Reverse Stock Split




Unless otherwise
noted, all capital values, share, and per share amounts in the consolidated
financial statements have been retroactively restated for the effects of the
Company’s reverse split of its issued and outstanding common stock at a rate of
1-for-8 which became effective on May 16, 2008. This action was approved by
stockholders on May 15, 2008.




Liquidity and Going Concern




The Company has
incurred significant losses as it continued to fund the direct methanol fuel
cell product development and commercialization programs of its majority owned
subsidiary, MTI Micro, and had a consolidated accumulated deficit of $120,725
thousand and working capital of $1,233 thousand at December 31, 2009. Because of
these losses, limited current cash and cash equivalents, negative cash flows and
accumulated deficit, there is substantial doubt about the Company’s ability to
continue as a going concern. These financial statements do not include any
adjustments that might result from the outcome of this uncertainty.




At present, the
Company does not expect to continue to fund MTI Micro on a long-term basis. The
Company has projected positive cash flows to meet future cash requirements for
operations and capital expenditures exclusive of MTI Micro, and has cash and
cash equivalents of $785 thousand at December 31, 2009. Management believes that
MTI Instruments will continue to generate positive cash flows and be able to
fund its current operations. However, no assurance can be provided regarding MTI
and MTI Instrument’s ability to continue as a going concern given the level of
uncertainty involved with the parent company’s operations.




Since the Company
will no longer fund MTI Micro, the subsidiary has sought other sources of
funding. In September 2008, MTI Micro closed on $2.2 million of funding in the
form of convertible secured notes (the “Bridge Notes”) to investors (the “Bridge
Investors”), including MTI, Dr. Walter L. Robb, a member of the Company’s and
MTI Micro’s Boards of Directors, and Counter Point Ventures Fund II, LP (Counter
Point). Counter Point is a venture capital fund sponsored and managed by Dr.
Walter L. Robb. General Electric Pension Trust, an employee benefit plan trust,
is a passive limited partner in Counter Point. In February 2009, MTI Micro
issued additional bridge notes to Counter Point in the amount of $500,000. On
April 15, 2009, MTI Micro, Counter Point and an additional investor agreed to
additional bridge notes in the amount $800,000 to be drawn down in increments
not to exceed $165,000 monthly. The final principal draw down occurred on
December 4, 2009. The Bridge Notes carried an annual interest rate of 10%. On
December 9, 2009, these bridge notes with the aggregate principal and accrued
interest amount of $3,910,510 outstanding were converted into an aggregate of
55,864,425 shares of Common Stock of MTI Micro using a conversion price per
share of $0.070 (the “Negotiated Conversion”). See Note 17 for further
discussion of this transaction.




F-7




---



On January 11, 2010,
MTI Micro entered into a Common Stock and Warrant Purchase Agreement (the
“Purchase Agreement”) with Counter Point. Through March 11, 2010 $660 thousand
has been drawn against this agreement. See Note 20 for further discussion of
this transaction.




On April 16, 2009,
MTI Micro was awarded a cost share funding grant of $2.4 million from the United
States Department of Energy (DOE) as part of DOE’s $41.9 million in American
Recovery and Reinvestment Act funding for fuel cell technology. As of February
22, 2010, $2.2 million has been billed and paid by the DOE under this
grant.




In order to continue
full commercialization of its micro fuel cell solution, MTI Micro will need to
do one or more of the following to raise additional resources, or reduce its
cash requirements:


- obtain additional government or
  private funding of the Company’s direct methanol fuel cell research,
  development, manufacturing readiness and commercialization;
- secure additional debt or equity
  financing; or
- further reduce its current
  expenditure run-rate.

There is no guarantee
that resources will be available to MTI Micro on terms acceptable to it, or at
all, or that such resources will be received in a timely manner, if at all, or
that MTI Micro will be able to reduce its capital expenditure run-rate further
without materially and adversely affecting its business. MTI Micro had cash and
cash equivalents as of December 31, 2009 of $163 thousand. Additionally, MTI
Micro has $1,340 thousand of available borrowing capacity through the Agreement,
and the remaining $191 thousand for the DOE contract as work is performed.
However, the funds available through the Agreement are only available to us at
increments of $330 thousand bi-monthly. Our next available draw down is May,
2010. Without other resources, management currently believes it will need to
make significant changes to its operations in the month of April of
2010.




2. Accounting Policies




Principles of Consolidation




The consolidated
financial statements include the accounts of the Company and its majority-owned
subsidiaries. All significant inter-company transactions are eliminated in
consolidation.




Non-controlling
interest in subsidiaries consists of equity securities issued by a subsidiary of
the Company. The Company reflects the impact of the equity securities issuances
in its investment in subsidiary and additional paid-in-capital accounts for the
dilution or anti-dilution of its ownership interest in the subsidiary.




Use of Estimates




The preparation of
the consolidated financial statements is in conformity with accounting
principles generally accepted in the United States of America (“U.S. GAAP”)
which requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.




Fair Value of Financial Instruments




The Company’s
financial instruments consist of cash and cash equivalents, marketable
securities, accounts receivable, unbilled contract costs and fees, derivatives
and accounts payable. The estimated fair values of these financial instruments
approximate their carrying values at December 31, 2008 and 2009. The estimated
fair values have been determined through information obtained from market
sources, where available, or Black-Scholes Option Pricing model valuations.




Accounting for Derivative Instruments




On January 1, 2009,
the Company adopted a newly issued accounting standard regarding disclosure of
derivative instruments. The Company recognizes all derivatives as either assets
or liabilities in the statement of financial position and measures these
instruments at fair value. The fair value of the derivative is recorded in the
“Derivative liability” line on the financial statements, and is valued quarterly
using the Black-Scholes Option Pricing Model. The Company also follows the
accounting provisions for Accounting for Derivative Financial Instruments
Indexed to and Potentially Settled in, a Company’s Own Stock, which requires
freestanding contracts that are settled in a company’s own stock, including
common stock warrants, to be designated as an equity instrument, asset or a
liability. Under these provisions, a contract designated as an asset or a
liability must be carried at fair value, with any changes in fair value recorded
in the results of operations. A contract designated as an equity instrument can
be included in equity, with no fair value adjustments required. Based on the
terms and conditions of the warrant of the Company, the instrument does not
qualify to be designated as an equity instrument and is therefore recorded as a
derivative liability.




F-8




---



The asset/liability
derivatives are valued on a quarterly basis using the Black-Scholes Option
Pricing model. Significant assumptions used in the valuation include exercise
dates, closing market prices for the Company’s common stock, volatility of the
Company’s common stock, and proxy risk-free interest rates. Gains (losses) on
derivatives are included in “Gain (loss) on derivatives” in the Consolidated
Statement of Operations.




Accounts Receivable and Allowance for Doubtful Accounts




Trade accounts
receivable are recorded at the invoiced amount and do not bear interest. An
allowance for doubtful accounts, if necessary, represents the Company’s best
estimate of the amount of probable credit losses in its existing accounts
receivable. The Company determines the allowance based on historical write-off
experience and current exposures identified. The Company reviews its allowance
for doubtful accounts monthly. Past due balances over 90 days and over a
specified amount are reviewed individually for collectability. All other
balances are reviewed on a pooled basis by type of receivable. Account balances
are charged off against the allowance when the Company believes it is probable
the receivable will not be recovered. The Company does not have any
off-balance-sheet credit exposure related to its customers.




Inventories




Inventories are
valued at the lower of cost (first-in, first-out) or market. The Company
provides estimated inventory allowances for excess, slow moving and obsolete
inventory as well as inventory whose carrying value is in excess of net
realizable value.




Property, Plant, and Equipment




Property, plant and
equipment are stated at cost and depreciated using primarily the straight-line
method over their estimated useful lives:




Leasehold improvements
            Lesser of the life of the lease or the
      useful life of the improvementComputers and related software
            3 to 5 yearsMachinery and equipment
            3 to 10 yearsOffice furniture, equipment and
      fixtures
            2 to 10 years


Significant additions
or improvements extending assets’ useful lives are capitalized; normal
maintenance and repair costs are expensed as incurred. The costs of fully
depreciated assets remaining in use are included in the respective asset and
accumulated depreciation accounts. When items are sold or retired, related gains
or losses are included in net (loss) income.




Income Taxes




The Company accounts
for taxes in accordance under the asset and liability method of accounting for
income taxes. Under this method, deferred income taxes are recognized for the
tax consequences of “temporary differences” by applying enacted statutory tax
rates applicable for future years to differences between financial statement and
tax bases of existing assets and liabilities. Under the accounting standard, the
effect of tax rate changes on deferred taxes is recognized in the income tax
provision in the period that includes the enactment date. The provision for
taxes is reduced by investment and other tax credits in the years such credits
become available. A valuation allowance is recorded to reduce the carrying
amounts of deferred tax assets unless it is more likely than not those assets
will be realized.




Effective January 1,
2007, the Company adopted an accounting provision that contains a two-step
approach to recognizing and measuring uncertain tax positions (tax
contingencies). The first step is to evaluate the tax position for recognition
by determining if the weight of available evidence indicates it is more likely
than not that the position will be sustained on audit, including resolution of
related appeals or litigation processes, if any. The second step is to measure
the tax benefit as the largest amount which is more than 50% likely of being
realized upon ultimate settlement. The Company considers many factors when
evaluating and estimating its tax positions and tax benefits, which may require
periodic adjustments and which may not accurately forecast actual
outcomes.




F-9




---



Revenue Recognition




The Company applies
the accounting guidance for revenue recognition in the evaluation of its
contracts to determine when to properly recognize revenue. The following
outlines the various types of revenue and the determination of the recognition
of income for each category:




Product Revenue




Product revenue is
recognized when there is persuasive evidence of an arrangement, the collection
of a fixed fee is probable or determinable, and delivery of the product to the
customer or distributor has occurred, at which time title generally is passed to
the customer or distributor. All of these generally occur upon shipment of the
product. If the product requires installation to be performed by the Company,
all revenue related to the product is deferred and recognized upon the
completion of the installation. If the product requires specific customer
acceptance, revenue is deferred until customer acceptance occurs or the
acceptance provisions lapse, unless the Company can objectively and reliably
demonstrate that the criteria specified in the acceptance provisions is
satisfied.




MTI Instruments
currently has distributor agreements in place for the international sale of
general instrument and semiconductor products in certain global regions. Such
agreements grant a distributor the right of first refusal to act as distributor
for such products in the distributor’s territory. In return, the distributor
agrees to not market other products which are considered by MTI Instruments to
be in direct competition with MTI Instruments’ products. The distributor is
allowed to purchase MTI Instruments’ equipment at a price which is discounted
off the published domestic/international list prices. Such list prices can be
adjusted by MTI Instruments during the term of the distributor agreement, but
MTI Instruments must provide advance notice at least 90 days before the price
adjustment goes into effect. Generally, payment terms with the distributor are
standard net 30 days; however, on occasion, extended payment terms have been
granted. Title and risk of loss of the product passes to the distributor upon
delivery to the independent carrier (standard “free-on-board” factory), and the
distributor is responsible for any required training and/or service with the
end-user. The sale (and subsequent payment) between MTI Instruments and the
distributor is not contingent upon the successful resale of the product by the
distributor. Distributor sales are covered by MTI Instruments’ standard one-year
warranty and there are no special return policies for distributors.




Some of MTI
Instruments’ direct sales, particularly sales of semi-automatic and
fully-automated semiconductor metrology equipment, or rack-mounted vibration
systems, involve on-site customer acceptance and/or installation. In those
instances, revenue recognition does not take place at time of shipment. Instead,
MTI Instruments recognizes the sale after the unit is installed and/or an
on-site acceptance is given by the customer. Agreed-upon acceptance terms and
conditions, if any, are negotiated at the time of purchase.




Funded Research and Development Revenue




The Company performs
funded research and development for government agencies under both cost
reimbursement and fixed-price contracts. Cost reimbursement contracts provide
for the reimbursement of allowable costs. On fixed-price contracts, revenue is
generally recognized on the percentage of completion method based upon the
proportion of costs incurred to the total estimated costs for the contract.
Revenue from reimbursement contracts is recognized as the services are
performed. In each type of contract, the Company generally receives periodic
progress payments or payments upon reaching interim milestones. When the current
estimates of total contract revenue for commercial development contracts
indicate a loss, a provision for the entire loss on the contract is recorded.
Any losses incurred in performing funded research and development projects are
recognized as research and development expense as incurred. When government
agencies are providing funding they do not expect the government to be the only
significant end user of the resulting products. These contracts do not require
delivery of products that meet defined performance specifications, but are best
efforts arrangements to achieve overall research and development objectives.
Included in accounts receivable are billed and unbilled work-in-progress on
contracts. Billings in excess of contract revenues earned are recorded as
deferred revenue. While the Company’s accounting for government contract costs
is subject to audit by the sponsoring entity, in the opinion of management, no
material adjustments are expected as a result of such audits. Adjustments are
recognized in the period made.




Commercial Research and Prototype Agreement
Income




The Company also
applies the proper accounting guidance in the evaluation of commercially funded
fuel cell research and prototype agreements in order to determine when to
properly recognize income. Payments received in connection with commercial
research and prototype agreements are deferred and recognized on a straight-line
basis over the term of the agreement for service-related payments, and for
milestone and prototype delivery payments, if and when achieved, revenue is
deferred and recognized on a straight-line basis over the remaining term of the
agreement. Under this policy, when revenue qualifies for recognition it will be
recorded in the Consolidated Statements of Operations in the line “Funded
research and development revenue.” The costs associated with research and
prototype-producing activities are expensed as incurred. Expenses in an amount
equal to revenues recognized are reclassified from “Unfunded research and
product development” to “Funded research and product development” in the
Consolidated Statements of Operations.




F-10




---



Prototype Evaluation Agreements




The Company
recognizes income derived from its micro fuel cell prototype evaluation
agreements, where the Company receives a lump-sum amount from Original Equipment
Manufacturers (“OEMs”) which are testing the Company’s Mobion prototypes for an
OEM-specific application, upon delivery of the evaluation prototypes. These
prototypes are returned to the Company once the evaluation period expires. There
are no warranties given to any OEM regarding these prototypes, and each
evaluation agreement is considered a customer specific arrangement. The costs
associated with executing these prototype evaluation arrangements are expensed
in research and development expense as they are incurred. Income derived from
these arrangements of $45 thousand in 2009 and $23 thousand in 2008 are recorded
in the Consolidated Statements of Operations in the line titled “Other income
(expense), net.”




Cost of Product Revenue




Cost of product
revenue includes material, labor and overhead. Costs incurred in connection with
funded research and development arrangements are included in funded research and
product development expenses.




Deferred Revenue




Deferred revenue
consists of payments received from customers in advance of services performed,
completed installation or customer acceptance.




Warranty




The Company records a
warranty reserve at the time product revenue is recorded based on a historical
rate. The reserve is reviewed during the year and is adjusted, if appropriate,
to reflect new product offerings or changes in experience. Actual warranty
claims are tracked by product line. Warranty liability was $21 thousand and $31
thousand at December 31, 2009 and 2008, respectively.




Accounting for Impairment or Disposal of Long-Lived Assets




The Company accounts
for impairment or disposal of long-lived assets in accordance with accounting
standards that address the financial accounting and reporting for the impairment
or disposal of long-lived assets, specify how impairment will be measured, and
how impaired assets will be classified in the consolidated financial statements.
On a quarterly basis, the Company analyzes the status of its long-lived assets
at each subsidiary for potential impairment. As of December 31, 2009, the
Company does not believe that any of its long-lived assets have suffered any
type of impairment that would require an adjustment to that asset’s recorded
value.




Cash and Cash Equivalents




Cash and cash
equivalents consist of cash and highly liquid short-term investments with
original maturities of less than three months.




Net Loss per Common Share




The Company reports
net loss per basic and diluted common share in accordance with the accounting
standard, which establishes standards for computing and presenting loss per
share. Basic loss per common share is computed by dividing net loss by the
weighted average number of common shares outstanding during the reporting
period. Diluted loss per share reflects the potential dilution, if any, computed
by dividing loss income by the combination of dilutive common share equivalents,
comprised of shares issuable under outstanding investment rights, warrants and
the Company’s share-based compensation plans, and the weighted average number of
common shares outstanding during the reporting period. Dilutive common share
equivalents include the dilutive effect of in-the-money stock options, which are
calculated based on the average share price for each period using the treasury
stock method. Under the treasury stock method, the exercise price of a stock
option, the amount of compensation cost, if any, for future service that the
Company has not yet recognized, and the amount of windfall tax benefits that
would be recorded in additional paid-in capital, if any, when the stock option
is exercised are assumed to be used to repurchase shares in the current
period.




Share-Based Payments




The Company accounts
for stock based awards exchanged for employee service in accordance with the
stock-based payment accounting guidance. The Company has three share-based
employee compensation plans and MTI Micro has two share-based employee
compensation plans, all of which are described more fully in Note 13, Stock
Based Compensation.




F-11




---



Stock-based
compensation represents the cost related to stock-based awards granted to
employees and directors. The Company measures stock-based compensation cost at
grant date based on the estimated fair value of the award, and recognizes the
cost as expense on a straight-line basis (net of estimated forfeitures) over the
option’s requisite service period. The Company estimates the fair value of
stock-based awards using a Black Scholes valuation model. Stock-based
compensation expense is recorded in “Selling, general and administrative
expenses” and “Unfunded research and product development expenses” in the
Consolidated Statements of Operations based on the employees’ respective
functions.




The Company records
deferred tax assets for awards that potentially can result in deductions on the
Company’s income tax returns based on the amount of compensation cost recognized
and the Company’s statutory tax rate. Differences between the deferred tax
assets recognized for financial reporting purposes and the actual tax deduction
reported on the Company’s income tax return are recorded in Additional Paid-In
Capital (if the tax deduction exceeds the deferred tax asset) or in the
Consolidated Statement of Operations (if the deferred tax asset exceeds the tax
deduction and no historical pool of windfall tax benefits exists). Since the
adoption of revised accounting standard on share-based payments, no tax benefits
have been recognized related to share-based compensation since the Company has
incurred net operating losses and has established a full valuation allowance to
offset all potential tax benefits associated with these deferred tax assets. The
Company continues to record the fair market value of stock options and warrants
granted to non-employees and non-directors in exchange for services in
accordance with the appropriate accounting guidance in the Consolidated
Statements of Operations.




Concentration of Credit Risk




Financial instruments
that subject the Company to concentrations of credit risk principally consist of
cash equivalents, trade accounts receivable and unbilled contract costs. The
Company’s trade accounts receivable and unbilled contract costs and fees are
primarily from sales to commercial customers, the U.S. government and state
agencies. The Company does not require collateral and has not historically
experienced significant credit losses related to receivables or unbilled
contract costs and fees from individual customers or groups of customers in any
particular industry or geographic area.




The Company deposits
its cash in commercial banks. Credit exposure to any one entity is limited by
Company policy.




Research and Development Costs




The Company expenses
research and development costs as incurred.




Comprehensive Loss




Comprehensive loss
includes net loss, as well as changes in stockholders’ equity, other than those
resulting from investments by stockholders.




Effect of Recent Accounting Pronouncements




In December 2007, the
FASB revised the authoritative guidance for business combinations, which
establishes that all business combinations are still required to be accounted
for at fair value under the acquisition method of accounting but it changed the
method of applying the acquisition method in a number of significant aspects.
The guidance is effective on a prospective basis for all business combinations
for which the acquisition date is on or after the beginning of the first annual
period subsequent to December 15, 2008, with the exception of the accounting for
valuation allowances on deferred taxes and acquired tax contingencies.
Adjustments made to valuation allowances on deferred taxes and acquired tax
contingencies associated with acquisitions that closed prior to the effective
date of the policy would also apply the provisions of this policy. The Company’s
adoption of this guidance on January 1, 2009 did not have a material effect on
its financial statements.




In December 2007, the
FASB issued authoritative guidance which establishes reporting standards that
require companies to more clearly identify in the financial statements and
disclose the impact of noncontrolling interests in a consolidated subsidiary on
the consolidated financial statements. Noncontrolling interests are now
classified as equity in the financial statements. The consolidated income
statement is presented by requiring net income to include the net income for
both the parent and the noncontrolling interests, with disclosure of both
amounts on the consolidated statement of income. The calculation of earnings per
share continues to be based on income amounts attributable to the parent. Prior
period amounts related to noncontrolling interests have been reclassified to
conform to the current period presentation. The Company adopted this guidance on
January 1, 2009.




In March 2008, the
FASB issued authoritative guidance regarding disclosures about derivative
instruments and hedging activities, which requires enhanced disclosures about
derivative instruments and is effective for fiscal periods beginning after
November 15, 2008. This was effective for our Company on January 1, 2009. Other
than the required disclosures, the adoption of new guidance had no impact on the
Financial Statements.




F-12




---



In April 2008, the
FASB issued authoritative guidance regarding the determination of the useful
life of intangible assets. This guidance amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset and requires enhanced disclosures
relating to: (a) the entity’s accounting policy on the treatment of costs
incurred to renew or extend the term of a recognized intangible asset; (b) in
the period of acquisition or renewal, the weighted-average period prior to the
next renewal or extension (both explicit and implicit), by major intangible
asset class and (c) for an entity that capitalizes renewal or extension costs,
the total amount of costs incurred in the period to renew or extend the term of
a recognized intangible asset for each period for which a statement of financial
position is presented, by major intangible asset class. The Company’s adoption
of this Standard on January 1, 2009 did not have a material effect on its
financial statements.




In May 2008, the FASB
issued authoritative guidance pertaining to the hierarchy of generally accepted
accounting principles, which identifies the sources of accounting principles and
the framework for selecting principles to be used in the preparation of
financial statements of nongovernmental entities that are presented in
conformity with generally accepted accounting principles in the United States.
The FASB does not expect that this will result in a change in current practice.
However, transition provisions have been provided in the unusual circumstance
that the application of the provisions of this guidance results in a change in
practice and is effective 60 days following the SEC’s approval of the Public
Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of
Present Fairly in Conformity With Generally Accepted Accounting Principles.” The
Company’s adoption of this on January 1, 2009 did not have a material effect on
its financial statements.




In May 2008, the FASB
issued authoritative guidance for the accounting for convertible debt
instruments that may be settled in cash upon conversion including partial cash
settlement. This applies to convertible debt instruments that, by their stated
terms, may be settled in cash (or other assets) upon conversion, including
partial cash settlement, unless the embedded conversion option is required to be
separately accounted for as a derivative. This also requires the issuer to
separately account for the liability and equity components of convertible debt
instruments in a manner that reflects the issuer’s nonconvertible debt borrowing
rate on the instrument’s issuance date when interest cost is recognized. The
Company’s adoption of this Standard on January 1, 2009 did not have a material
effect on its financial statements.




In June 2008, the
FASB issued authoritative guidance to determine whether instruments granted in
share-based payment transactions are participating securities. This guidance
states that unvested share-based payment awards that contain nonforfeitable
rights to dividends or dividend equivalents (whether paid or unpaid) are
participating securities and shall be included in the computation of earnings
per share pursuant to the two-class method. The Company’s adoption of this
Standard on January 1, 2009 did not have a material effect on its financial
statements.




In April 2009, the
FASB issued authoritative guidance which provides instruction for estimating
fair value when the volume and level of activity for an asset or liability have
significantly decreased in relation to normal market activity for the asset or
liability, and for identifying circumstances that may indicate that a
transaction is not orderly. Additionally, the guidance requires disclosure about
fair value measurements in interim and annual reporting periods. The guidance is
effective for interim and annual reporting periods ending after June 15, 2009.
The Company’s adoption of this Standard on January 1, 2009 did not have a
material effect on its financial statements.




In April 2009, the
FASB issued authoritative guidance on the timing of impairment recognition and
greater clarity about the credit and noncredit components of impaired debt
securities that are not expected to be sold. The guidance also requires
additional disclosures about impairments in interim and annual reporting periods
and was effective for interim and annual reporting periods ending after June 15,
2009. The Company’s adoption of this Standard on January 1, 2009 did not have a
material effect on its financial statements.




In June 2009, the
FASB issued the FASB Accounting Standards Codification (Codification). The
Codification became the single source of all authoritative GAAP recognized by
FASB to be applied for financial statements issued for periods ending after
September 15, 2009. The Codification did not change GAAP and did not have a
material affect on our financial position, results of operations or
liquidity.




F-13




---



3. Accounts Receivable and Allowance for
Doubtful Accounts




Receivables consist
of the following at December 31:




2008
            
            2009(dollars in
  thousands)U.S. and State Government:Amount billable
            
            $
            102
            
            $
            
            143Amount billed
            
            
            4
            
            
            
            —Total U.S. and State Government
            
            
            106
            
            
            
            143Commercial
            
            
            434
            
            
            
            1,091Less: Allowance for doubtful accounts
            
            
            —
            
            
            
            (92
            )Total
            
            $
            540
            
            $
            
            1,142


As of December 31,
2008 and 2009, the Company had a reserve for doubtful trade accounts receivable
of $0 and $92 thousand, respectively.




4. Issuance of Stock by Subsidiary




MTI Micro was formed
on March 26, 2001 and as of December 31, 2009 the Company owns approximately
61.81% of MTI Micro’s outstanding common stock. The following table represents
all MTI Micro common stock shares issued.




MTI
            
            NCIAverage
            
            
            
            Ownership
            
            
            
            OwnershipPrice
            
            Shares
            
            %
            
            Shares
            
            %
            
            Total SharesBalance at 1/1/2007
            
            
            
            
            27,236,896
            
            94.0
            
            1,750,345
            
            6.0
            
            28,987.241Stock issued for MTI Options to MFC Employees
            
            $
            0.69
            
            44,960
            
            
            
            
            
            
            
            44,960Transfer of Plug Power securities to MFC
            
            $
            0.69
            
            5,680,827
            
            
            
            
            
            
            
            5,680,827Conversion of Loan Receivable
            
            $
            0.70
            
            13,067,770
            
            
            
            
            
            
            
            13,067,770Balance at 12/31/07
            
            
            
            
            46,030,453
            
            96.3
            
            1,750,345
            
            3.7
            
            47,780,798Stock issued for MTI Options to MFC Employees.
            
            $
            0.45
            
            31,469
            
            
            
            
            
            
            
            31,469Transfer of Plug Power securities to MFC
            
            $
            0.35
            
            7,319,181
            
            
            
            
            
            
            
            7,319,181Conversion of Loan Receivable
            
            $
            0.24
            
            10,416,667
            
            
            
            
            
            
            
            10,416,667Balance at 12/31/08
            
            
            
            
            63,797,770
            
            97.3
            
            1,750,345
            
            2.7
            
            65,548,115Stock issued for MTI Options to MFC Employees
            
            $
            0.14
            
            10,501
            
            
            
            
            
            
            
            10,501Conversion of Bridge Loan
            
            $
            0.07
            
            11,241,666
            
            
            
            44,622,759
            
            
            
            55,864,425Balance at 12/31/09
            
            
            
            
            75,049,937
            
            61.8
            
            46,373,104
            
            38.2
            
            121,423,041


The increase
(decrease) in the Company’s paid-in-capital of $(521), $(128), and $-0- thousand
in 2007, 2008, and 2009, respectively, represents the changes in the Company’s
equity investment in MTI Micro, which resulted from the conversion of the bridge
note and the anti-dilutive impact of the Company’s investments into and
third-party stock transactions in MTI Micro stock.




F-14




---



5. Inventories




Inventories, net
consist of the following at December 31:




2008
            
            2009(dollars in
  thousands)Finished goods
            
            $
            772
            
            $
            465Work in process
            
            
            449
            
            
            193Raw materials, net
            
            
            288
            
            
            131$
            1,509
            
            $
            789


6. Property, Plant and Equipment




Property, plant and
equipment consist of the following at December 31:




2008
            
            2009(dollars in
  thousands)Leasehold improvements
            
            $
            1,213
            
            $
            1,213Computers and related software
            
            
            2,199
            
            
            2,164Machinery and equipment
            
            
            4,018
            
            
            3,820Office furniture and fixtures
            
            
            299
            
            
            4737,729
            
            
            7,670Less accumulated depreciation
            
            
            6,201
            
            
            6,811$
            1,528
            
            $
            859


Depreciation expense
was $1,129, $819, and $660 thousand for 2007, 2008, and 2009, respectively.
Repairs and maintenance expense was $82, $57, and $20 thousand for 2007, 2008,
and 2009, respectively.




7. Income Taxes




Income tax (expense)
benefit for each of the years ended December 31 consists of the
following:




2007
            
            2008
            
            2009(dollars in
  thousands)Federal
            
            $
            —
            
            
            $
            —
            
            
            $
            9State
            
            
            (30
            )
            
            
            (33
            )
            
            
            199Deferred
            
            
            (2,518
            )
            
            
            (1,971
            )
            
            
            —Total
            
            $
            (2,548
            )
            
            $
            (2,004
            )
            
            $
            208


Income tax benefit
(expense) allocated directly to stockholders’ equity for each of the years ended
December 31 is as follows:




2007
            
            2008
            
            2009(dollars in
  thousands)Total change in unrealized (gain) loss
      on securities available for sale:Deferred tax benefit
      (expense)
            
            $
            1,201
            
            
            $
            989
            
            
            
            —Valuation allowance
      (expense)
            
            
            (1,201
            )
            
            
            (989
            )
            
            
            —Tax effect of reclassification adjustment for gains included
      innet income (loss)
            
            
            2,518
            
            
            
            1,971
            
            
            
            —$
            2,518
            
            
            $
            1,971
            
            
            $
            —


F-15




---



The significant
components of deferred income tax (expense) benefit from operations before non
controlling interest for each of the years ended December 31 consists of the
following:




2007
            
            2008
            
            2009(dollars in
  thousands)Deferred tax benefit (expense)
            
            $
            1,181
            
            
            $
            721
            
            
            $
            432Net operating loss carry forward
            
            
            3,069
            
            
            
            3,837
            
            
            
            (1,927
            )Valuation allowance
            
            
            (4,250
            )
            
            
            (4,558
            )
            
            
            1,495Disproportionate tax effect of reclassification adjustment
      forgains included in net
      income (loss)
            
            
            (2,518
            )
            
            
            (1,971
            )
            
            
            0$
            (2,518
            )
            
            $
            (1,971
            )
            
            $
            0


The Company’s
effective income tax rate from operations before minority interest differed from
the Federal statutory rate for each of the years ended December 31 is as
follows:




2007
            
            2008
            
            2009Federal statutory tax rate
            
            34
            %
            
            34
            %
            
            34
            %State taxes, net of federal tax effect
            
            1
            
            
            3
            
            
            —Change in valuation allowance
            
            (56
            )
            
            (42
            )
            
            42Disproportionate tax effect of reclassificationadjustment for gains
      included in net income (loss)
            
            (28
            )
            
            (16
            )
            
            —Permanent tax difference on derivative
      valuation
            
            16
            
            
            2
            
            
            —Loss on extinguishment of debt
            
            —
            
            
            —
            
            
            (2
            )IRC Section 382 Limitation
            
            —
            
            
            —
            
            
            (64
            )Adjustment to opening deferred tax balance
            
            —
            
            
            —
            
            
            (3
            )Other, net
            
            —
            
            
            —
            
            
            (1
            )Tax Rate
            
            (33
            )%
            
            (19
            )%
            
            6
            %


Pre-tax loss before
non controlling interests was $7,609, $10,760, and $3,572 thousand for 2007,
2008, and 2009, respectively. The deferred tax assets and liabilities as of
December 31 consist of the following tax effects relating to temporary
differences and carry forwards:




2008
            
            2009(dollars in
  thousands)Current deferred tax (liabilities)
      assets:Inventory
    valuation
            
            $
            204
            
            
            $
            211Inventory
      capitalization
            
            
            13
            
            
            
            16Bad Debt
Reserve
            
            
            —
            
            
            
            37Vacation pay
            
            
            77
            
            
            
            82Warranty and other sale
      obligations
            
            
            12
            
            
            
            9Other reserves and
      accruals
            
            
            22
            
            
            
            81328
            
            
            
            436Valuation allowance
            
            
            (328
            )
            
            
            (436
            )Net current deferred tax liabilities
            
            $
            —
            
            
            $
            —


F-16




---



Noncurrent deferred tax assets
      (liabilities):Net operating loss
            
            $
            24,874
            
            
            $
            22,947Property, plant and equipment
            
            
            27
            
            
            
            158Stock options
            
            
            2,138
            
            
            
            2,340Research and development tax credit
            
            
            459
            
            
            
            459Alternative minimum tax
      credit
            
            
            54
            
            
            
            4527,552
            
            
            
            25,949Valuation allowance
            
            
            (27,552
            )
            
            
            (25,949
            )Non-current net
      deferred tax assets
            
            $
            —
            
            
            $
            —


The valuation
allowance at December 31, 2008 and 2009 was $27,880 and $26,385 thousand,
respectively. The net change in the valuation allowance was $5,547 thousand in
2008 and $(1,495) thousand in 2009. The valuation allowance at December 31, 2008
and 2009 reflects the estimate that it is more likely than not that the net
deferred tax assets may not be realized.




At December 31, 2009,
the Company has unused Federal net operating loss carry forwards of
approximately $65,384 thousand. Of these carry forwards, $1,325 thousand
represents windfall tax benefits from stock option transactions, the tax effect
of which are not included in the Company’s net deferred tax assets.
Additionally, it is estimated that $6,691 thousand of these carryforwards will
expire prior to utilization due to IRC Section 382 limitation described below.
This net operating loss limited by IRC Section 382 is not reflected in the
Company’s deferred tax asset as of December 31, 2009. The Federal net operating
loss carry forwards, if unused, will begin to expire in 2010.




The Company's and/or
its subsidiaries’ ability to utilize their net operating loss carryforwards may
be significantly limited by Section 382 of the Internal Revenue Code of 1986, as
amended, if the Company or any of its subsidiaries undergoes an “ownership
change” as a result of changes in the ownership of the Company's or its
subsidiaries’ outstanding stock pursuant to the exercise of the warrants or
otherwise. A corporation generally undergoes an “ownership change” when the
ownership of its stock, by value, changes by more than 50 percentage points over
any three-year testing period. In the event of an ownership change, Section 382
imposes an annual limitation on the amount of post-ownership change taxable
income a corporation may offset with pre-ownership change net operating loss
carryforwards and certain recognized built-in losses. As of December 31, 2009,
although no formal Section 382 study has been performed, the Company does not
appear to have had an ownership change for Section 382 purposes. However, as
noted below, it appears that as a result of MTI Micro’s conversion of the Bridge
Notes (combined with the Company’s ownership changes) MTI Micro appears to have
had an ownership change for Section 382 purposes which places limitations on the
utilization of MTI Micro’s separate company net operating loss
carryforwards.




As a result of the
conversion of the Bridge Notes (see Footnote 17 for further discussion of the
transaction), MTI no longer maintains an 80% or greater ownership in MTI Micro.
Thus, MTI Micro will no longer be included in Mechanical Technology, Inc. and
Subsidiaries' consolidated federal and combined New York State tax returns,
effective December 9, 2009. Additionally, as the result of conversion, MTI Micro
may have experienced a Section 382 ownership change which subjects MTI Micro's
separate company net operating losses to an annual Section 382
limitation.




Pursuant to the
Internal Revenue Service's consolidated tax return regulations (IRS Regulation
Section 1.1502-36), upon MTI Micro leaving the Mechanical Technology, Inc. and
Subsidiaries consolidated group, MTI is permitted to elect to reduce a portion
of its stock tax basis in MTI Micro by "reattributing" a portion of MTI Micro's
net operating loss carry forwards to MTI, for an amount equivalent to its built
in loss amount in MTI's investment in MTI Micro's stock.




As the result of MTI
anticipating that it will make this election with its December 31, 2009 tax
return, MTI will reattribute approximately $45,226 thousand of MTI Micro's net
operating losses (reducing its tax basis in MTI Micro's stock by the same
amount), leaving MTI Micro with approximately $13,000 thousand of separate
company net operating loss carry forwards. However, as noted above, as the
result of a Section 382 limitation, caused by the conversion, it is estimated
that $6,691 thousand of these net operating losses will expire prior to
utilization.




As of December 31,
2009, the Company has approximately $459 thousand of research and development
tax credit carry forwards, which begin to expire in 2018, and approximately $45
thousand of alternative minimum tax credit carry forwards, which have no
expiration date. Deferred tax assets and liabilities are determined based on the
temporary differences between the financial statement and tax bases of assets
and liabilities as measured by the enacted tax rates.




F-17




---



The Company adopted
the provisions of ASC 740’s accounting for uncertain tax benefits on January 1,
2007, the first day of its 2007 fiscal year. As a result of this implementation,
the Company recorded a $106 thousand increase in the net liability for uncertain
tax positions, which was recorded as an adjustment to the Company’s opening
balance of retained earnings on January 1, 2007. Additionally, the same tax
position that triggered the Company’s adoption charge caused the Company to
reclassify $80 thousand from current income taxes payable to non-current
liabilities for uncertain tax positions.




A reconciliation of
the beginning and ending amount of unrecognized tax benefits in accordance with
ASC 740 for 2007, 2008 and 2009 is as follows:




2007
            
            2008
            
            2009(dollars in
  thousands)Balance as of January 1,
            
            $
            2,024
            
            $
            2,044
            
            $
            2,049Additions for tax positions of prior years
            
            
            20
            
            
            5
            
            
            —Deductions for settlements
            
            
            —
            
            
            —
            
            
            213Balance as of December
      31,
            
            $
            2,044
            
            $
            2,049
            
            $
            1,836


In future periods, if
$1,836 thousand of these unrecognized benefits become supportable, the Company
may not recognize a change in its effective tax rate as long as it remains in a
full valuation allowance position. Additionally the Company does not have
uncertain tax positions that it expects will increase or decrease within twelve
months of this reporting date. In accordance with the Company’s accounting
policy, it recognizes interest and penalties related to uncertain tax positions
as a component of tax expense. This policy did not change as a result of the
adoption of ASC 704’s accounting for uncertain tax positions. The Company
recognized interest and penalties expense of $5 thousand in 2008 and interest
and penalties income of $47 thousand in 2009 (upon settlement of the NYS audit
discussed below). As of December 31, 2008 and 2009, the Company had $54 thousand
and $0 of accrued interest and penalties related to uncertain tax positions,
respectively.




The Company files
income tax returns, including returns for its subsidiaries, with federal and
state jurisdictions. The Company is no longer subject to IRS or NYS examinations
for its federal and state returns for any periods prior to 2006, although
carryforward attributes that were generated prior to 2006 may still be adjusted
upon examination by the IRS if they either have been or will be used in a future
period. On February 2, 2009, New York State Department of Taxation and Finance
notified the Company that it was no longer going to pursue the issue associated
with potentially not permitting the Company to file combined tax returns for the
period 2002 through 2004. At December 31, 2008 the Company had recorded a $213
thousand long-term liability for this issue. In the settlement of this issue,
the Company paid New York State approximately $19 thousand and recognized the
benefit of the reversal of this liability of $194 thousand in the first quarter
of 2009.




8. Accrued Liabilities




Accrued liabilities
consist of the following at December 31:




2008
            
            2009(dollars in
  thousands)Salaries, wages and related
      expenses
            
            $
            746
            
            $
            525Acquisition and disposition costs
            
            
            363
            
            
            363Legal and professional fees
            
            
            212
            
            
            183Warranty and other sale obligations
            
            
            31
            
            
            20Commissions
            
            
            33
            
            
            13Other
            
            
            307
            
            
            186$
            1,692
            
            $
            1,290




F-18




---






9. Fair Value Measurement




The estimated fair
value of certain financial instruments, including cash, cash equivalents and
short-term debt approximates their carrying value due to their short maturities
and varying interest rates. “Fair value” is the price that would be received to
sell an asset or transfer a liability in an orderly transaction between market
participants at the measurement date. The Company utilizes valuation
techniques that maximize the use of observable inputs and minimize the use
of unobservable inputs. Based on the observability of the inputs used in the
valuation methods, the Company is required to provide the following information
according to the fair value accounting standards. These standards established a
fair value hierarchy as specified that ranks the quality and reliability of the
information used to determine fair values. Financial assets and liabilities are
classified and disclosed in one of the following three
categories:




Level 1:
            
            Quoted market prices in active markets
      for identical assets or liabilities, which includes listed equities.Level 2:
            
            Observable market based inputs or
      unobservable inputs that are corroborated by market data. These items are
      typically priced using models or other valuation techniques. These models
      are primarily financial industry-standard models that consider various
      assumptions, including the time value of money, yield curves, volatility
      factors, as well as other relevant economic measures.Level 3:
            
            These use unobservable inputs that are
      not corroborated by market data. These values are generally estimated
      based upon methodologies utilizing significant inputs that are generally
      less observable from objective
sources.


In determining the
appropriate levels, the Company performs a detailed analysis of financial assets
and liabilities. At each reporting period, all assets and liabilities for which
the fair value measurements are based upon significant unobservable inputs are
classified as Level 3. The derivative liability is valued using the
Black-Scholes Option Pricing Model which is based upon unobservable
inputs.




The following is a
summary of the Company’s fair value instruments categorized by their associated
fair value input level:




(Dollars in thousands)Balance atBalance Sheet
      Classification
            Level
      1
            
            Level
      2
            
            Level
      3
            
            December 31, 2009Financial Liabilities:Derivative liability
            $
            —
            
            $
            —
            
            $
            70
            
            $
            70Total fair value of liabilities
            $
            —
            
            $
            —
            
            $
            70
            
            $
            70


The following is a
rollforward of Level 3 fair value instruments for the year ended December 31,
2008:




(Dollars in thousands)Total (Gains) /Beginning
            
            Losses
            
            Purchases,
            
            Ending Balance asBalance as of
            
            Realized and
            
            Issuances, Sales
            
            of December 31,Instrument
            Jan. 1, 2008
            
            Unrealized
            
            and Settlements
            
            2008Derivative liability
            $
            696
            
            $
            (655
            )
            
            $
            —
            
            $
            41Total Level 3 instruments
            $
            696
            
            $
            (655
            )
            
            $
            —
            
            $
            41


The following is a
rollforward of Level 3 fair value instruments for the year ended December 31,
2009:




(Dollars in thousands)
            
            
            
            Total (Gains) /Beginning
            
            Losses
            
            Purchases,
            
            Ending Balance asBalance as of
            
            Realized and
            
            Issuances, Sales
            
            of December 31,Instrument
            Jan. 1, 2009
            
            Unrealized
            
            and Settlements
            
            2009Derivative liability
            $
            41
            
            $
            29
            
            $
            —
            
            $
            70Total Level 3 instruments
            $
            41
            
            $
            29
            
            $
            —
            
            $
            70


F-19




---



10. Stockholders’ Equity




Common Shares




Changes in common
shares are as follows for the years ended December 31:




2007
            
            2008
            
            2009Balance, beginning
            5,760,585
            
            
            5,777,578
            
            
            5,776,750Fractional shares redeemed during reverse stock split
            —
            
            
            (203
            )
            
            —Issuance of shares for stock option
      exercises
            10,743
            
            
            —
            
            
            —Issuance of shares for restricted and unrestricted stock
      grants
            6,875
            
            
            —
            
            
            —Forfeiture of restricted stock
      grants
            (625
            )
            
            (625
            )
            
            —Balance, ending
            5,777,578
            
            
            5,776,750
            
            
            5,776,750


Treasury Stock




Changes in treasury
stock are as follows for the years ended December 31:




2007
            
            2008
            
            2009Balance, beginning
            1,005,092
            
            1,005,092
            
            1,005,092Balance, ending
            1,005,092
            
            1,005,092
            
            1,005,092


Sale of Common Stock




On December 15, 2006,
the Company entered into agreements with certain investors to sell 756,944
shares of common stock and warrants to purchase 378,472 shares of common stock
for an aggregate purchase price of $10,900 thousand. The common stock and
warrants were sold in units, with each unit consisting of 12.5 shares of common
stock and a warrant to purchase 6.25 shares of common stock, at an exercise
price of $18.16 per share. Each non-certificated unit was sold at a negotiated
price of $180.00. The shares of common stock and warrants were immediately
separable and were issued separately (see Warrants Issued below). The common
stock, the warrants and shares issuable upon exercise of the warrants are
registered with the SEC on the Company’s filed and effective registration
statement.




Warrants Issued




MTI On December 20, 2006, the Company issued
warrants to investors to purchase 378,472 shares of the Company’s common stock
at an exercise price of $18.16 per share. These warrants will be fair valued by
the Company until expiration or exercise of the warrants. The warrants became
exercisable on June 20, 2007 and expire on December 19, 2011. The fair value of
the warrants at December 31, 2008 and 2009 was $41 thousand and $70 thousand,
respectively.




MTI Micro On December 9, 2009, MTI Micro issued warrants
to the current shareholders of MTI Micro, including the Company, without
consideration, to purchase 32,779,310 shares of MTI Micro Stock at an exercise
price of $0.07 per share. The warrants become exercisable on December 9, 2010
and expire on December 8, 2017. The warrants have been accounted for as an
equity distribution of $2,030 thousand, including warrants to the Company with a
value of $1,974 thousand that were eliminated in consolidation.




On December 9, 2009,
MTI Micro issued warrants to the Bridge Investors of MTI Micro, including the
Company, to purchase 5,081,237 shares of MTI Micro Stock at an exercise price of
$0.07 per share. The Warrants became exercisable on December 9, 2009 and will
expire on the earlier of: (i) April 15, 2014; (ii) immediately prior to a change
in control; or (iii) immediately prior to an initial public offering of MTI
Micro. The warrants were issued without consideration and were accounted for as
equity and a loss on extinguishment of debt was recorded in the amount of $289
thousand, including warrants to the Company with a value of $57 thousand that
were eliminated in consolidation.




Refer to Note 17 for
further discussion.




F-20




---



Reservation of Shares




The Company has
reserved common shares for future issuance as follows as of December 31,
2009:




Stock options outstanding
            716,403Stock options available for issuance
            316,216Warrants outstanding
            378,472Number of common shares reserved
            1,411,091


11. Retirement Plan




The Company maintains
a voluntary savings and retirement plan under Internal Revenue Code Section
401(k) covering substantially all employees. Employees must complete six months
of service and have attained the age of twenty-one prior to becoming eligible
for participation in the plan. The Company plan allows eligible employees to
contribute a percentage of their compensation on a pre-tax basis and the Company
matches employee contributions dollar for dollar up to a discretionary amount,
currently 4%, of the employee’s salary, subject to annual tax deduction
limitations. Company matching contributions vest at a rate of 25% annually for
each year of service completed. Company matching contributions were $283, $136,
and $141 thousand for 2007, 2008, and 2009, respectively. The Company may also
make additional discretionary contributions in amounts as determined by
management and the Board of Directors. There were no additional discretionary
contributions by the Company for the years 2007, 2008, or 2009.




12. Loss per Share




The following table
sets forth the reconciliation of the numerators and denominators of the basic
and diluted per share computations for continuing operations for the years ended
December 31:




2007
            
            2008
            
            2009(dollars in thousands, except
      shares)Numerator:Net loss
            $
            (9,575
            )
            
            $
            (12,504
            )
            
            $
            (3,099
            )Denominator:Basic EPS:Common shares outstanding, beginning of
      period
            
            4,755,493
            
            
            
            4,772,486
            
            
            
            4,771,658Weighted average common shares issued during theperiod
            
            9,111
            
            
            
            —
            
            
            
            —Weighted average restricted shares
      forfeited during theperiod
            
            (360
            )
            
            
            (323
            )
            
            
            —Weighted average common shares deemed during theperiod in conjunction with the
      reverse stock split
            
            —
            
            
            
            (127
            )
            
            
            —Effect of non-vested restricted
      stock
            
            (697
            )
            
            
            323
            
            
            
            —Denominator for basic earnings per common shares —Weighted average common
      shares
            
            4,763,547
            
            
            
            4,772,359
            
            
            
            4,771,658Diluted EPS:Common shares outstanding, beginning of period
            
            4,755,493
            
            
            
            4,772,486
            
            
            
            4,771,658Weighted average common shares issued
      during theperiod
            
            9,111
            
            
            
            —
            
            
            
            —Weighted average restricted shares forfeited during theperiod
            
            (360
            )
            
            
            (323
            )
            
            
            —Weighted average common shares deemed
      during theperiod in conjunction with the reverse stock split
            
            —
            
            
            
            (127
            )
            
            
            —Effect of non-vested restricted stock due to
anti-dilutiveeffect
            
            (697
            )
            
            
            323
            
            
            
            —Denominator for diluted earnings per
      commonshares — Weighted average common shares
            
            4,763,547
            
            
            
            4,772,359
            
            
            
            4,771,658


F-21




---



Not
included in the computation of earnings per share-assuming dilution for the year
ended December 31, 2007 were options to purchase 776,696 shares of the Company’s
common stock, warrants to purchase 378,472 shares of the Company’s stock, 625
unvested restricted shares of the Company’s common stock and options to purchase
22,668 shares of MTI Micro’s common stock. These potentially dilutive items were
excluded because the Company incurred a loss for this period and their inclusion
would be anti-dilutive.




Not included in the
computation of earnings per share-assuming dilution for the year ended December
31, 2008 were options to purchase 780,340 shares of the Company’s common stock,
warrants to purchase 378,472 shares of the Company’s stock, and options to
purchase 15,001 shares of MTI Micro’s common stock. These potentially dilutive
items were excluded because the Company incurred a loss for this period and
their inclusion would be anti-dilutive.




Not included in the
computation of earnings per share-assuming dilution for the year ended December
31, 2009 were options to purchase 716,403 shares of the Company’s common stock,
warrants to purchase 378,472 shares of the Company’s stock, and options to
purchase 15,001 shares of MTI Micro’s common stock. These potentially dilutive
items were excluded because the Company incurred a loss for this period and
their inclusion would be anti-dilutive.




13. Stock Based
Compensation




MTI Option Plans




Stock-based incentive
awards are provided to employees and directors under the terms of the Company’s
1996 Stock Incentive Plan (“1996 Plan”), 1999 Employee Stock Incentive Plan
(“1999 Plan”) and 2006 Equity Incentive Plan (“2006 Plan”), which was amended
and restated effective September 16, 2009, (collectively, the “Plans”). Awards
under the Plans have generally included at-the-money options and restricted
stock grants.




The 1996 Plan was
approved by stockholders during December 1996 and expired during October 2006.
The 1996 Plan provided an initial aggregate number of 500,000 shares of common
stock to be awarded or issued. The number of shares available to be awarded
under the 1996 Plan and awards outstanding were adjusted for stock splits and
rights offerings. The total number of shares which may be awarded under the 1996
Plan was 468,352 during 2005. Under the 1996 Plan, the Board of Directors was
authorized to issue stock options, stock appreciation rights, restricted stock,
and other stock-based incentives to officers, employees and others.




The 1999 Plan was
adopted by the Company’s Board of Directors and approved by stockholders on
March 18, 1999. The 1999 Plan provides that an initial aggregate number of
1,000,000 shares of common stock may be awarded or issued. The number of shares
which may be awarded under the 1999 Plan and awards outstanding have been
adjusted for stock splits, and during 2005, 2006, and 2007, the total number of
shares which may be awarded under the 1999 Plan was 562,500 shares. Under the
1999 Plan, the Board of Directors is authorized to issue stock-based awards to
officers, employees and others.




The 2006 Plan was
adopted by the Company’s Board of Directors on March 16, 2006 and approved by
stockholders on May 18, 2006. The plan was amended by the Board of Directors and
restated effective September 16, 2009. The Amended and Restated 2006 Equity
Incentive Plan increased the initial aggregate number of 250,000 shares of
common stock which may be awarded or issued to 600,000. The number of shares
which may be awarded under the 2006 Plan and awards outstanding have been
adjusted for stock splits and other similar events. Under the 2006 Plan, the
Board of Directors is authorized to issue stock options, stock appreciation
rights, restricted stock, and other stock-based incentives to officers,
employees and others.




Stock-based
compensation expense for the year ended December 31, 2009 was generated from
stock options and restricted stock grants. Stock options are awards which allow
holders to purchase shares of the Company’s common stock at a fixed price. Stock
options issued to employees generally vest 25% per year beginning one year after
grant. Options issued to non-employee members of the MTI Board of Directors
generally vest upon grant. Certain options granted may be fully or partially
exercisable immediately, may vest on other than a four year schedule or vest
upon attainment of specific performance criteria. Restricted stock awards
generally vest one year after the date of grant; however, certain awards may
vest immediately or vest upon attainment of specific performance criteria.
Option exercise prices are generally equivalent to the closing market value
price of the Company’s common stock on the date of grant. Unexercised options
generally terminate either seven or ten years after date of grant.




F-22




---



Share-Based Compensation Information under accounting guidance for
share-based payments




The Company estimates
the fair value of stock options using a Black Scholes valuation model consistent
with the accounting standards. Key inputs and assumptions used to estimate the
fair value of stock options include the grant price of the award, the expected
option term, volatility of the Company’s stock, an appropriate risk-free rate,
and the Company’s dividend yield. Estimates of fair value are not intended to
predict actual future events or the value ultimately realized by employees who
receive equity awards, and subsequent events are not indicative of the
reasonableness of the original estimates of fair value made by the
Company.




The fair value of
each stock option grant was estimated at the date of grant using a Black-Scholes
Option Pricing model. The following table presents the weighted-average
assumptions used for options granted:




2008
            
            2009Option term (years)
            
            4.4
            
            
            
            3.34Volatility
            
            81.72
            %
            
            
            115.3 – 117
            %Risk-free interest rate range
            
            1.55-3.36
            %
            
            
            2.28-2.49
            %Dividend yield
            
            0
            %
            
            
            0
            %Weighted-average fair value per option
      granted
            $
            1.71
            
            
            $
            1.02


Share-based
compensation expense recognized in the Consolidated Statements of Operations is
based on awards ultimately expected to vest, therefore, awards are reduced for
estimated forfeitures. The revised accounting standard requires forfeitures to
be estimated at the time of grant and revised, if necessary, in subsequent
periods if actual forfeitures differ from those estimates.




Stock-Based Compensation Expense — All Accounting
Treatments




Total share-based
compensation expense, related to all of the Company’s share-based awards,
recognized for the years ended December 31, was comprised as
follows:




2007
            
            2008
            
            2009(dollars in thousands, except
      eps)Unfunded research and product
      development
            $
            216
            
            
            $
            186
            
            
            $
            92Selling, general and administrative
            
            1,342
            
            
            
            658
            
            
            
            413Share-based compensation
    expense
            $
            1,558
            
            
            $
            844
            
            
            $
            505Impact on basic and diluted EPS
            $
            (0.33
            )
            
            $
            (0.18
            )
            
            $
            (0.11
            )


Total unrecognized
compensation costs related to non-vested awards as of December 31, 2008 and
December 31, 2009 is $744 thousand and $105 thousand, respectively and is
expected to be recognized over a weighted-average vesting period of
approximately .98 years and 1.24 years, respectively.




As a result of the
amendment in 2009 of the 2006 plan, 450,000 additional shares were made
available for granting. Presented below is a summary of the Company’s stock
option plans’ activity for the years ended December 31:




2007
            
            2008
            
            2009Shares under option, beginning
            688,649
            
            
            776,696
            
            
            780,340Granted
            231,719
            
            
            213,039
            
            
            171,750Exercised
            (10,743
            )
            
            —
            
            
            —Canceled/Forfeited
            (65,115
            )
            
            (58,956
            )
            
            (89,799
            )Expired
            (67,814
            )
            
            (150,439
            )
            
            (145,888
            )Shares under option, ending
            776,696
            
            
            780,340
            
            
            716,403Options exercisable
            578,544
            
            
            532,298
            
            
            571,617Remaining shares available for granting of options
            128,105
            
            
            68,641
            
            
            316,216


F-23




---



The weighted average
exercise price is as follows for each of the years ended December
31:




2007
            
            2008
            
            2009Shares under option, beginning
            32.32
            
            25.92
            
            21.56Granted
            10.96
            
            2.80
            
            1.31Exercised
            5.60
            
            —
            
            —Canceled/Forfeited
            28.40
            
            13.10
            
            23.78Expired
            41.04
            
            20.57
            
            25.14Shares under option, ending
            25.92
            
            21.56
            
            15.97Options exercisable, ending
            28.40
            
            28.33
            
            12.10


The following table
summarizes information for options outstanding and exercisable at December 31,
2009:




Outstanding Options
            
            Options ExercisableWeighted Average
            
            
            Weighted
            
            
            
            WeightedExercise
            
            
            
            Remaining
            
            
            Average
            
            
            
            AveragePrice Range
            
            Number
            
            Contractual Life
            
            
            Exercise Price
            
            Number
            
            Exercise Price$0.00 - $1.15
            
            60,000
            
            9.72
            
            $
            1.15
            
            60,000
            
            $
            1.15$1.16 - $3.60
            
            238,625
            
            7.67
            
            $
            1.85
            
            130,523
            
            $
            1.78$3.61 - $14.24
            
            137,505
            
            4.43
            
            $
            11.33
            
            107,316
            
            $
            11.64$14.25 - $22.64
            
            53,386
            
            4.08
            
            $
            19.07
            
            53,251
            
            $
            19.07$22.65 - $33.36
            
            81,189
            
            3.97
            
            $
            29.06
            
            80,680
            
            $
            29.07$33.37 - $50.24
            
            142,260
            
            3.12
            
            $
            40.24
            
            136,409
            
            $
            40.45$50.25 - $103.76
            
            3,438
            
            0.57
            
            $
            79.40
            
            3,438
            
            $
            79.40716,403
            
            5.59
            
            $
            15.97
            
            571,617
            
            $
            18.72


The aggregate
intrinsic value (i.e. the difference between the closing stock price and the
price to be paid by the option holder to exercise the option) is zero for both
the Company’s outstanding and exercisable options as of December 31, 2009. The
amounts are based on the Company’s closing stock price of $1.16 as of December
31, 2009.




The total intrinsic
value of options exercised during the years ended December 31, 2007, 2008, and
2009 was $44, zero, and zero, respectively. There were no options exercised for
the year ended December 31, 2009. The Company settles employee stock option
exercises with newly issued shares of Company common stock.




There were no
unvested restricted stock options for the period ended December 31, 2009. The
aggregate intrinsic value of restricted stock vested during the year ended
December 31, 2009 was zero.




MTI Micro Option Plans




MTI Micro has two
plans for issuing MTI Micro stock-based incentive awards; the MTI MicroFuel
Cells Inc. 2001 Employee, Director and Consultant Stock Option Plan (“2001 MTI
Micro Plan”) and the MTI MicroFuel Cells Inc. 2009 Stock Plan (“2009 Micro
Plan”).




The 2001 MTI Micro
Plan was approved by MTI Micro’s stockholders in 2001 and provided an initial
aggregate number of 1,766,000 shares of MTI Micro common stock to be awarded.
The number of shares which may be awarded under the 2001 MTI Micro Plan and
awards outstanding have been adjusted for a 2004 reverse stock split, and during
2005, 2006, and 2007, the total number of shares which may be awarded under the
2001 MTI Micro Plan were 3,416,667 shares. Under the 2001 MTI Micro Plan, the
MTI Micro Board of Directors was authorized to award stock options to officers,
directors, employees and consultants. During 2005, MTI Micro ceased making
grants under the 2001 MTI Micro Plan and determined that it would make no new
awards under this plan in the future.




The Board approved
the MTI MicroFuel Cells Inc. 2009 Stock Plan on December 8, 2009. This plan
provided an initial aggregate number of 38,000,000 shares of MTI Micro’s common
stock to be awarded. Under the 2009 MTI Micro Plan, the Board is authorized to
award stock options to directors, employees, consultants and advisors of MTI
Micro. As of December 31, 2009, no awards have been granted under the 2009 Micro
Plan.




Options issued to
employees generally vested 25% per year beginning one year after grant. Option
exercise prices were determined by MTI Micro’s Board of Directors. Unexercised
options generally terminate ten years after date of grant. Up until January 1,
2006, MTI Micro followed accounting guidance in accounting for employee
stock-based compensation, and provided the disclosures required under the
revised accounting standard. This required no recognition of compensation
expense for most of the stock-based compensation arrangements provided by MTI
Micro, namely, broad-based employee stock purchase plans and option grants where
the exercise price is equal to or not less than the market value at the date of
grant. However, the accounting treatment requires recognition of compensation
expense for variable award plans over the vesting periods of such plans, based
upon the then-current market values of the underlying stock. As of January 1,
2006, MTI Micro is accounting for employee stock-based compensation under the
revised accounting standard for share-based payments.




F-24





---



Presented below is a
summary of compensation expense, which is included in the summary of the
Company’s compensation expense under all share-based awards above, for the MTI
Micro plans:




2007
            
            2008
            
            2009(dollars in
  thousands)Stock options
            $
            12
            
            $
            2
            
            $
            —Total stock-based compensation expense
            $
            12
            
            $
            2
            
            $
            —


Presented below is a
summary of the MTI Micro stock option plans activity for the years ended
December 31:




2007
            
            2008
            
            2009Shares under option, beginning
            33,668
            
            
            22,668
            
            
            15,001Granted
            —
            
            
            —
            
            
            —Exercised
            —
            
            
            —
            
            
            —Canceled/Forfeited
            (11,000
            )
            
            (7,667
            )
            
            —Shares under option, ending
            22,668
            
            
            15,001
            
            
            15,001Options exercisable
            18,626
            
            
            15,001
            
            
            15,001Remaining shares available for granting
      of options
            3,336,196
            
            
            3,343,863
            
            
            38,000,00


The weighted average
exercise price for MTI Micro options is as follows for each of the years ended
December 31:




2007
            
            2008
            
            2009Shares under option, beginning
            $
            3.61
            
            $
            3.70
            
            $
            3.89Granted
            
            —
            
            
            —
            
            
            —Exercised
            
            —
            
            
            —
            
            
            —Canceled/Forfeited
            
            3.42
            
            
            3.33
            
            
            —Shares under option, ending
            
            3.70
            
            
            3.89
            
            
            3.89Options exercisable, ending
            
            3.63
            
            
            3.89
            
            
            3.89


In accordance with
the accounting guidance, the weighted average fair value of stock options
granted is required to be based on a theoretical statistical model using the
preceding Black-Scholes Option Pricing model assumptions.




Outstanding Options
            
            Options ExercisableWeighted AverageExercise
            
            
            
            Remaining
            
            Weighted Average
            
            
            
            Weighted AveragePrice Range
            
            Number
            
            Contractual Life
            
            Exercise Price
            
            Number
            
            Exercise Price$2.55 - $2.75
            
            2,000
            
            3.25
            
            $
            2.55
            
            2,000
            
            $
            2.55$2.76 - $3.79
            
            3,334
            
            3.95
            
            $
            2.76
            
            3,334
            
            $
            2.76$3.80 - $4.65
            
            1,167
            
            2.86
            
            $
            3.80
            
            1,167
            
            $
            3.80$4.66 - $4.66
            
            8,500
            
            4.25
            
            $
            4.66
            
            8,500
            
            $
            4.6615,001
            
            3.94
            
            $
            3.89
            
            15,001
            
            $
            3.89


Based upon an
estimated common stock price of $0.07 at December 31, 2009, the intrinsic value
of all MTI Micro’s outstanding and exercisable options are zero, since all
exercise prices are above the estimated common stock fair value
price.




14. Cash Flows — Supplemental
Information




Years Ended December
  31,2007
            
            
            2008
            
            2009(dollars in
  thousands)Non-Cash Investing and Financing
      Activities:Change in investment and paid-in capital resulting from
    otherinvestors’ activity in MTI
      Micro stock
            $
            (521
            )
            
            $
            (128
            )
            
            $
            3,411


F-25




---



15. Derivatives




The Company held or
has outstanding as of December 31, the following derivative financial
instruments:




2008
            
            2009
            
            ExpirationDerivatives issued:Warrants, exercisable beginning June 20,
      2007, to purchase theCompany’s common stock issued to three investors at a purchaseprice of $18.16 per share
            378,472
            
            378,472
            
            12/19/2011


Warrant Derivative to Purchase MTI Common
Stock: The warrants issued
during the Company’s December 2006 capital raise were legally freestanding,
detachable and transferable by the holders. The features of the warrant allowed
both straight cash exercises as well as cashless exercises. Due primarily to a
stipulation in the warrant agreement which allowed a potential cash settlement
with the holders if the Company was acquired by, or merged with a private
company, these warrants were classified as an asset/liability derivative in
accordance with the accounting guidance (paragraph 11) and EITF
00-19.




The estimated fair
value of this warrant at the date issued was $10.16 per share, using a
Black-Scholes Option Pricing model and assumptions similar to those used for
valuing the Company’s employee share-based compensation. The fair value of the
derivative is recorded in the “Derivative Liability” line on its financial
statements, and is valued quarterly using the Black-Scholes Option Pricing
Model. The assumptions used for the valuations as of December 31 were as
follows:




2008
            
            2009Expected life of option (days)
            1,084
            
            
            730Risk-free interest rate
            1.55
            %
            
            1.14
            %Expected volatility of stock
            93.45
            %
            
            162.7
            %Expected dividend yield
            None
            
            
            None


The Company
recognizes changes in fair value in its Consolidated Statements of Operations in
the line titled “Gain (loss) on derivatives.”




16. Commitments and
Contingencies




Lawrence Litigation




On September 9, 1998,
Barbara Lawrence, the Lawrence Group, Inc. (“Lawrence”) and certain other
Lawrence-related entities (“Plaintiffs”) initially filed suit in the United
States Bankruptcy Court for the Northern District of New York (“Bankruptcy
Court”) and the United States District Court for the Northern District of New
York (“District Court”), which were subsequently consolidated in the District
Court, against First Albany Corporation, now known as Broadpoint Capital, Inc.
(“BCI”), the Company, Dale Church, Edward Dohring, Beno Sternlicht, Alan
Goldberg and George McNamee (Church, Dohring, Sternlicht, Goldberg and McNamee
are former Directors of the Company), Marty Mastroianni (former President and
Chief Operating Officer of the Company) and 33 other individuals (“Defendants”)
who purchased a total of 820,909 shares (307,841 post-split) of the Company’s
stock from the Plaintiffs. The case concerns the Defendants’ 1997 purchase of
the Company’s common stock from the Plaintiffs at the price of $2.25 per share
($6.00 per share post split). BCI acted as Placement Agent in connection with
the negotiation and sale of the shares, including in proceedings before the
Bankruptcy Court, which approved the sale in September 1997.




Plaintiffs claim that
the Defendants failed to disclose material inside information to the Plaintiffs
in connection with the sale and that the $2.25 per share ($6.00 per share post
split) purchase price was unfair. Plaintiffs are seeking damages of $5 million
plus punitive damages and costs. In April 1999, Defendants filed a motion to
dismiss the amended complaint, which was denied by the Bankruptcy Court. On
appeal in October 2000, Plaintiffs’ claims were dismissed by the District Court.
In November 2000, Plaintiffs filed an appeal of that dismissal with the United
States Court of Appeals for the Second Circuit. In June 2002, the Second Circuit
Court of Appeals reversed the District Court decision in part and remanded the
case for further consideration of the Plaintiffs’ claims as motions to modify
the Bankruptcy Court sale order. The Plaintiffs’ claims have now been referred
back to Bankruptcy Court for such consideration. By order and decision dated
September 30, 2003, the Bankruptcy Court allowed certain limited discovery to
proceed, and this process is still underway. During late 2008 and early 2009,
the Bankruptcy Court conducted an eleven day hearing on Plaintiffs' claims. On
February 27, 2009, the Bankruptcy Court issued a decision in which it held that
Plaintiffs' claims had no merit and denied the motions to modify the Bankruptcy
Court sale order. Subsequently, the parties entered into an agreement pursuant
to which the Plaintiffs, inter alia , gave
general releases to the Defendants (including MTI) in exchange for a payment of
$100,000 by BCI; MTI made no payment in connection with that agreement, which
was approved by the Bankruptcy Court and became final in September,
2009.




F-26




---



Leases




The Company and its
subsidiaries lease certain manufacturing, laboratory and office facilities. The
leases generally provide for the Company to pay either an increase over a base
year level for taxes, maintenance, insurance and other costs of the leased
properties or the Company’s allocated share of insurance, taxes, maintenance and
other costs of leased properties. The leases contain renewal provisions.




Future minimum rental
payments required under non-cancelable operating leases are (dollars in
thousands): $440 in 2010, $272 in 2011, $273 in 2012 and $553 in 2013. Rent
expense under all leases was $685, $645, and $564 thousand for 2007, 2008, and
2009, respectively.




Licenses




On January 24, 2008,
the Company cancelled its non-exclusive licensing agreement with Los Alamos
National Laboratory (“LANL”) covering certain direct methanol fuel cell
technology. This agreement, which was last amended on May 17, 2006, prescribed
annual license fees ranging from $35,000 in 2008 to $100,000 in 2019. The
Company paid a one-time fee of $50,000 to cancel the agreement, and no future
royalties will be paid. The Company cancelled this agreement because it no
longer considers the direct methanol fuel cell technology licensed from LANL to
be applicable to its future products.




Under a 2002 NYSERDA
contract, MTI Micro agreed to pay NYSERDA a royalty of 5.0% of the sales price
of any product sold incorporating IP developed pursuant to the NYSERDA contract.
If the product is manufactured by a New York State manufacturer, this royalty is
reduced to 1.5%. Total royalties are subject to a cap equal to two times the
total contract funds paid by NYSERDA to MTI Micro, and may be reduced to reflect
any New York State jobs created by MTI Micro.




Employment Agreements




The Company has
employment agreements with certain employees that provide severance payments,
certain other payments, accelerated vesting and exercise extension periods of
certain options upon termination of employment under certain circumstances, as
defined in the applicable agreements. As of December 31, 2009, the Company’s
potential minimum obligation to these employees was approximately $672 thousand.




17. Secured Convertible Notes and Related
Instruments – related party




On September 18,
2008, MTI Micro executed a Convertible Note and Warrant Purchase Agreement (the
“Purchase Agreement”), Secured Convertible Promissory Note Agreements (the
“Bridge Notes”), Security Agreement (the “Security Agreement’) and Warrant
Agreements (the “Warrants”). The investors (the “Bridge Investors”), included
MTI, in the form of conversion of existing debt of $700,000, Dr. Walter L. Robb,
a member of the Company’s and MTI Micro’s Boards of Directors, and Counter Point
Ventures Fund II, LP (Counter Point). Counter Point is a venture capital fund
sponsored and managed by Dr. Walter L. Robb. General Electric Pension Trust, an
employee benefit plan trust, is a passive limited partner in Counter Point. The
Bridge Notes allowed MTI Micro to borrow up to an aggregate of $2,200 thousand,
including conversion of the outstanding debt totaling $700 thousand owed to the
Company. Under this agreement, MTI Micro closed on $1,500 thousand of funding
from Other Investors on September 18, 2008.




On February 20, 2009,
MTI Micro and the Investors agreed to, among other things, amend the Bridge
Notes (“Amendment No. 1”) to permit MTI Micro to sell additional Bridge Notes
with an additional principal amount of up to $500 thousand to additional
investors, and to extend the maturity date from March 31, 2009 to May 31, 2009
(the “Maturity Date”). No other terms of the Bridge Notes were amended.
Following the effectiveness of the Amendment No. 1, MTI Micro borrowed an
additional $500 thousand from Counter Point, a fund managed by Dr. Walter L.
Robb, a member of the Company’s Board of Directors, bringing the aggregate
outstanding principal amount borrowed under the Bridge Notes, as amended, to
$2,700 thousand, including conversion of outstanding debt totaling $700 thousand
owed to the Company.




On April 15, 2009,
MTI Micro and the Investors agreed to amend the Bridge Notes (“Amendment No. 2”)
to permit MTI Micro to sell additional Bridge Notes with an additional principal
amount of up to $800,000 to an additional investor and Counter Point, and to
extend the maturity date from May 31, 2009 to March 31, 2010 (the “Maturity
Date”). Effective December 4, 2009, MTI Micro had sold all additional Bridge
Notes. The Bridge Notes had an interest rate of 10%, compounded annually.




On December 9, 2009,
MTI Micro entered into a Secured Convertible Promissory Note Negotiated
Conversion Agreement (the “Conversion Agreement”) with the Company and the other
Bridge Investors. The parties agreed to, among other things, convert the
aggregate principal and accrued interest amount of $3,910,510 outstanding under
the Bridge Notes into an aggregate of 55,864,425 shares of Common Stock of MTI
Micro using a conversion price per share of $0.070 (the “Negotiated
Conversion”). Warrants to purchase MTI Micro common stock at $0.07 per share
were issued to Bridge Investors for an aggregate of 5,081,237 shares. As an
incentive for MTI Micro to agree to the terms of the Negotiated Conversion, MTI
Micro, the Company and the Bridge Investors also agreed that immediately prior
to the consummation of the Negotiated Conversion, MTI Micro would issue to each
current MTI Micro stockholder (including the Company), without consideration, a
warrant (“Micro Warrant”) exercisable after one (1) year for up to 50% of the
aggregate number of shares of Common Stock each such MTI Micro stockholder
currently holds in MTI Micro, at $0.070 per share and with a term of seven (7)
years. Accordingly, immediately prior to the consummation of the Negotiated
Conversion on December 9, 2009, MTI Micro issued Micro Warrants exercisable for
an aggregate of 32,779,310 shares of MTI Micro Common Stock.




F-27




---



As a result of the
Negotiated Conversion, the Company converted an aggregate principal and accrued
interest amount of $786,917 outstanding under the Bridge Notes into an aggregate
of 11,241,666 shares of Common Stock of MTI Micro, and the Company’s ownership
interest in MTI Micro decreased from approximately 97.3% to approximately 61.8%,
or 67.8% on a fully-diluted basis including the Micro Warrants issued to all
current MTI Micro stockholders and the Bridge Warrants. The balance of the
Bridge Note payable was $-0- as of December 31, 2009.




18. Geographic and Segment
Information




The Company sells its
products on a worldwide basis with its principal markets listed in the table
below where information on product revenue and funded research and development
revenue is summarized by geographic area for the Company as a whole for each of
the years ended December 31:




2007
            
            2008
            
            2009(dollars in
  thousands)Product revenue:United States
            $
            5,453
            
            $
            3,309
            
            $
            3,908Japan
            
            2,516
            
            
            904
            
            
            612Singapore
            
            287
            
            
            112
            
            
            23Hong Kong
            
            163
            
            
            502
            
            
            251Korea
            
            34
            
            
            46
            
            
            103Other Pacific Rim
            
            109
            
            
            169
            
            
            55Germany
            
            104
            
            
            162
            
            
            12United Kingdom
            
            20
            
            
            189
            
            
            149Netherlands
            
            —
            
            
            29
            
            
            147Other Europe
            
            37
            
            
            131
            
            
            56Canada
            
            112
            
            
            212
            
            
            59Middle East
            
            —
            
            
            315
            
            
            202Turkey
            
            80
            
            
            4
            
            
            463Rest of World
            
            113
            
            
            140
            
            
            223Total product revenue
            $
            9,028
            
            $
            6,224
            
            $
            6,263Funded research and development
      revenue:South Korea
            $
            448
            
            $
            —
            
            $
            —United States
            
            1,108
            
            
            1,154
            
            
            2,043Total funded research and development
      revenue
            $
            1,556
            
            $
            1,154
            
            $
            2,043Total revenue
            $
            10,584
            
            $
            7,378
            
            $
            8,306


Revenues are
attributed to regions based on the location of customers.




The Company operates
in two business segments , New Energy and
Test and Measurement Instrumentation. The New Energy segment is focused on
commercializing DMFCs. The Test and Measurement Instrumentation segment designs,
manufactures, markets and services computer-based balancing systems for aircraft
engines, high performance test and measurement instruments and systems, and
wafer characterization tools for the semiconductor industry. The Company’s
principal operations are located in North America.




The accounting
policies of the New Energy and Test and Measurement Instrumentation segments are
similar to those described in the summary of significant accounting policies
(See Note 2). The Company evaluates performance based on profit or loss from
operations before income taxes, accounting changes, items management does not
deem relevant to segment performance, and interest income and expense.
Inter-segment sales are not significant.




F-28




---



Total product
revenues contributed by the Test and Measurement Instrumentation products
segment and their percentage of total product revenues for each of the years
ended December 31 are shown below:




2007
            
            
            2008
            
            
            2009Sales
            
            %
            
            
            Sales
            
            %
            
            
            Sales
            
            %(dollars in thousands)Aviation
            $
            3,664
            
            40.58
            %
            
            $
            1,977
            
            31.76
            %
            
            $
            2,768
            
            44.19
            %General Gauging
            
            4,490
            
            49.73
            
            
            
            2,983
            
            47.93
            
            
            
            2,619
            
            41.81Semiconductor
            
            874
            
            9.69
            
            
            
            1,264
            
            20.31
            
            
            
            876
            
            14.00Total
            $
            9,028
            
            100.00
            %
            
            $
            6,224
            
            100.00
            %
            
            $
            6,263
            
            100.00
            %


In the Test and
Measurement Instrumentation segment, the U.S. Air Force accounted for $2,375
thousand or 26.3% of total revenue in 2007, $974 thousand or 15.65% of total
product revenue in 2008, and $1,188 thousand or 18.97% of total product revenue
in 2009. Sales to a Japanese distributor accounted for $2,501 thousand or 27.7%
of total product revenue in 2007, $864 thousand or 13.88% of total product
revenue in 2008, and $541 thousand or 8.64% of total product revenue in 2009.
The largest commercial customer in 2009 was a domestic US defense contractor,
who accounted for $618 thousand or 9.86% of total product revenue in 2009, $24
thousand or 0.39% in 2008 and $15 thousand or 0.17% in 2007.




In the New Energy
segment, the DOE accounted for $675 thousand or 43.4% of total funded research
and development revenue in 2007, $1,154 thousand or 100% of total funded
research and development revenue in 2008, and $2,043 thousand or 100% of total
funded research and development revenue in 2009. Samsung accounted for $448
thousand or 28.9% of total funded research and development revenue in
2007.




Summarized financial
information concerning the Company’s reportable segments is shown in the
following table. The “Other” column includes corporate related items and items
such as income taxes or unusual items, which are not allocated to reportable
segments. The “Reconciling Items” column includes non controlling interests in a
consolidated subsidiary. In addition, segments’ non-cash items include any
depreciation and amortization in reported profit or loss. The New Energy segment
figures include the Company’s direct micro fuel cell operations, equity
securities of Plug Power, gains on the sale of these securities, and (losses)
gains related to the embedded derivative for the purchase of Plug Power common
stock.




Test andNew
            
            
            Measurement
            
            
            
            
            Reconciling
            
            Consolidated(Dollars in thousands)
            
            Energy
            
            
            Instrumentation
            
            Other
            
            Items
            
            TotalsYear Ended December 31,
      2007Product revenue
            $
            —
            
            
            $
            9,028
            
            $
            —
            
            $
            —
            
            $
            9,028Funded research and development revenue
            
            1,556
            
            
            
            —
            
            
            —
            
            
            —
            
            
            1,556Research and product development
      expenses
            
            10,115
            
            
            
            1,650
            
            
            —
            
            
            —
            
            
            11,765Selling, general and administrative expenses
            
            1,921
            
            
            
            2,650
            
            
            4,167
            
            
            —
            
            
            8,738Gain on securities available for
      sale
            
            2,549
            
            
            
            —
            
            
            —
            
            
            —
            
            
            2,549Segment (loss) profit from continuing operationsbefore income taxes, equity in
      holdings’losses and non controlling
      interests
            
            (11,189
            )
            
            
            789
            
            
            2,791
            
            
            —
            
            
            (7,609
            )Segment (loss) profit
            
            (11,189
            )
            
            
            789
            
            
            243
            
            
            582
            
            
            (9,575
            )Total assets
            
            8,128
            
            
            
            3,018
            
            
            7,570
            
            
            —
            
            
            18,716Securities available for sale
            
            4,492
            
            
            
            —
            
            
            —
            
            
            —
            
            
            4,492Capital expenditures
            
            212
            
            
            
            177
            
            
            25
            
            
            —
            
            
            414Depreciation and amortization
            
            715
            
            
            
            117
            
            
            297
            
            
            —
            
            
            1,129


F-29









Test andNew
            
            Measurement
            
            
            
            
            
            Reconciling
            
            Consolidated(Dollars in thousands)
            Energy
            
            Instrumentation
            
            Other
            
            Items
            
            TotalsYear Ended December 31,
      2008Product revenue
            $
            —
            
            
            $
            6,224
            
            
            $
            —
            
            
            $
            —
            
            $
            6,224Funded research and development revenue
            
            1,154
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            1,154Research and product development
      expenses
            
            6,614
            
            
            
            1,650
            
            
            
            —
            
            
            
            —
            
            
            8,264Selling, general and administrative expenses
            
            2,463
            
            
            
            2,331
            
            
            
            3,575
            
            
            
            —
            
            
            8,369Gain on securities available for
      sale
            
            1,214
            
            
            
            —
            
            
            
            (196
            )
            
            
            —
            
            
            1,018Segment (loss) profit from continuing operationsbefore income taxes, equity in
      holdings’losses and non controlling
      interests
            
            (8,961
            )
            
            
            (1,415
            )
            
            
            (384
            )
            
            
            —
            
            
            (10,760
            )Segment (loss) profit
            
            (8,961
            )
            
            
            (1,415
            )
            
            
            (2,388
            )
            
            
            260
            
            
            (12,504
            )Total assets
            
            2,093
            
            
            
            2,132
            
            
            
            1,286
            
            
            
            —
            
            
            5,511Capital expenditures
            
            105
            
            
            
            60
            
            
            
            16
            
            
            
            —
            
            
            181Depreciation and amortization
            
            621
            
            
            
            128
            
            
            
            70
            
            
            
            —
            
            
            819Test andNew
            
            Measurement
            
            
            
            
            
            Reconciling
            
            Consolidated(Dollars in thousands)
            Energy
            
            Instrumentation
            
            Other
            
            Items
            
            TotalsYear Ended December 31,
      2009Product revenue
            $
            —
            
            
            
            6,263
            
            
            
            —
            
            
            
            —
            
            
            6,263Funded research and development revenue
            
            2,043
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            2,043Research and product development
      expenses
            
            4,479
            
            
            
            965
            
            
            
            —
            
            
            
            —
            
            
            5,444Selling, general and administrative expenses
            
            105
            
            
            
            1,822
            
            
            
            1,357
            
            
            
            —
            
            
            3,284Segment (loss) profit from continuing
      operationsbefore income taxes, equity in holdings’losses and non controlling interests
            
            (3,171
            )
            
            
            381
            
            
            
            (839
            )
            
            
            57
            
            
            (3,572
            )Segment (loss) profit
            
            (3,171
            )
            
            
            381
            
            
            
            (631
            )
            
            
            322
            
            
            (3,099
            )Total assets
            
            1,061
            
            
            
            1,949
            
            
            
            731
            
            
            
            —
            
            
            3,741Capital expenditures
            
            7
            
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            7Depreciation and amortization
            
            496
            
            
            
            103
            
            
            
            61
            
            
            
            —
            
            
            660


The following table
presents the details of “Other” segment (loss) profit for each of the years
ended December 31:




2007
            
            2008
            
            2009(dollars in
  thousands)Corporate and other (expenses)
      income:Depreciation and
      amortization
            $
            (297
            )
            
            $
            (70
            )
            
            $
            (61
            )Interest income (expense)
            
            413
            
            
            
            (106
            )
            
            
            68Gain (loss) on
      derivatives
            
            2,967
            
            
            
            655
            
            
            
            (29
            )Income tax (expense) benefit
            
            (2,548
            )
            
            
            (2,004
            )
            
            
            (208
            )Other expense, net
            
            (292
            )
            
            
            (863
            )
            
            
            (401
            )Total (expense) income
            $
            243
            
            
            $
            (2,388
            )
            
            $
            (631
            )


19. Restructuring




In March 2007, the
Company announced the suspension of MTI Micro’s high power direct methanol fuel
cell program in response to decreased funding and sales opportunities in the
military market. In connection with this action, the Company accrued
restructuring charges of $344 thousand pre-tax, consisting primarily of
cash-based employee severance and benefit costs related to the reduction of 23
positions within its New Energy segment and Corporate staff. Restructuring
expenses were classified as selling, general and administrative expenses within
the Company’s Consolidated Statements of Operations for the period. All amounts
under this plan were paid by March 31, 2008.




In August 2008, the
Board of Directors approved a restructuring plan (the “Restructuring”), which
was designed to help the Company reduce expenses and preserve cash. As part of
the Restructuring, a total of 29 positions across the Company and its
subsidiaries were eliminated. The Company accrued $342 thousand in connection
with this plan, consisting primarily of cash-based employee severance and
benefit costs. Restructuring expenses were classified as selling, general and
administrative expenses within the Company’s Consolidated Statements of
Operations for the period. All cash expenditures related to this restructuring
were paid as of June 30, 2009.




F-30




---



20. Subsequent Events




On January 11, 2010,
MTI Micro entered into a Common Stock and Warrant Purchase Agreement (the
“Purchase Agreement”) with Counter Point Ventures Fund II, L.P. (“Counter
Point”). Counter Point is managed by Dr. Walter L. Robb, a member of the Board
of Directors of the Company and MTI Micro, and is a current stockholder of MTI
Micro. Dr. Robb and Counter Point beneficially held approximately 29.5% of the
fully-diluted capital stock of MTI Micro of December 31, 2009, and as of March
15, 2010 hold an aggregate of approximately 34.2% of the fully-diluted capital
stock of MTI Micro.




Pursuant to the
Purchase Agreement, MTI Micro may issue and sell to Counter Point up to
28,571,429 shares of common stock, par value $0.01 per share (the “Micro Common
Stock”), at a purchase price per share of $0.070, over a period of twelve (12)
months, and warrants (“Warrants”) to purchase shares of Micro Common Stock equal
to 20% of the shares of Micro Common Stock purchased under the Purchase
Agreement at an exercise price of $0.070 per share. The sale and issuance of the
Micro Common Stock and Warrants shall occur over multiple closings (each, a
“Closing”) occurring over two (2) one month closing periods and five (5)
two-month closing periods (each, a “Closing Period”). Three Closings have
occurred through March 15, 2010, with MTI Micro raising $660,000 from the sale
of 9,428,571 shares of Micro Common Stock and Warrants to purchase 1,885,714
shares of Micro Common Stock to Counter Point. Subsequent Closings may occur
thereafter at MTI Micro’s sole discretion during the Closing Periods upon
delivery of written notice by MTI Micro to Counter Point of its desire to
consummate a Closing, and Counter Point’s acceptance of such offer under the
Purchase Agreement on the terms agreed upon with MTI Micro. In the event the
terms and conditions of the Purchase Agreement no longer reflect current market
conditions or otherwise, either party may elect not to participate in a
Subsequent Closing(s) or the parties may amend the Purchase Agreement on
mutually agreeable terms with respect to such Subsequent Closing(s). If MTI
Micro were to issue and sell the remainder of the 28,571,429 shares under the
Purchase Agreement, the Company would continue to hold an aggregate of 55.8% of
the fully-diluted capital stock of MTI Micro. For additional information
regarding the Purchase Agreement, please see the Company’s Form 8-K filed
January 14, 2010.




On January 28, 2010,
MTI Instruments entered into an Asset Purchase and Sale Agreement with Ernest F.
Fullam, Inc., Peter Fullam and Diane Fullam to acquire the tensile stage line of
products from Ernest F. Fullam, Inc, a pioneering microscopy accessories company
from Clifton Park, NY. As part of the acquisition, Mr. Peter Fullam will join
MTI Instruments as a Product Sales Engineer and MTI Instruments purchased
machinery, inventory and the rights to use the Fullam/MTI Instruments product
name. Additionally, commencing with the calendar quarter ending March 31, 2010
and ending at the close of the calendar quarter ending December 31, 2012, MTI
Instruments will pay Ernest F. Fullam, Inc. a royalty equal to 5% of the Gross
Sales achieved on specific Fullam products.




F-31




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