Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

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

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. Yesx No¨

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 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.¨

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

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of June 30, 20052007 (based on the last sale price of $3.56$1.26 per share for such stock reported by NASDAQ for that date) was approximately $101,988,058.$43,748,142. Such value excludes common stock held by executive officers, directors, and 10% or greater stockholders as of June 30, 2007. The identification of 10% or greater stockholders as of June 30, 2007 is based upon 13G and amended 13G reports publicly filed before June 30, 2007. This calculation does not reflect a determination that such parties are affiliates for any other purposes.

As of March 9, 2006,20, 2008, the Registrant had 30, 972,32538,179,888 shares of common stock outstanding.

Documents incorporated by reference: Portions of the registrant'sregistrant’s Proxy Statement for its 20062008 Annual Meeting of ShareholdersStockholders are incorporated by reference into Part III of this Form 10-K.

PART I

Item 1: Business

Overview

Unless the context requires otherwise in this Annual Report, the terms “we”, “us” and “our” refer to Mechanical Technology, Incorporated, ("MTI" or the "Company")a New York corporation, “MTI Micro” refers to MTI MicroFuel Cells, Inc., a Delaware corporation and our majority owned subsidiary, and “MTI Instruments” refers to MTI Instruments, Inc., 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"), aour wholly owned subsidiary. 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.

At its MTI Micro subsidiary, the Company is primarily focused on the development

We are developing and commercialization of advanced cord-freecommercializing off-the-grid rechargeable power pack technologysources for portable electronics. MTI Micro hasWe have developed a patented, proprietary direct methanol fuel cell ("DMFC") technology platform called Mobion,^®, which generates electrical power using up to 100% methanol as fuel. MTI Micro'sOur 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 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 intendedfully biodegradable. We believe we are the only micro fuel cell developer to replacehave demonstrated power density of over 50 mW/cm² with high energy efficiencies of 1.4 Wh/cc of methanol for handheld consumer electronic applications. For these reasons, we believe our technology offers a compelling alternative to current Lithium-Ionlithium-ion and similar rechargeable battery systems currently used by original equipment manufacturers (OEMs)and branded partners, or OEMs, in many hand heldhandheld electronic devices, such as personalmobile phones (including smart phones) and mobile phone accessories, digital assistants ("PDAs"), Smartphonescameras, portable media players, PDAs, and other accessories. The Company formed MTI MicroGPS devices. We believe our platform will facilitate the development of numerous product advantages, including small size, environmental friendliness, and simplicity of design, all critical for commercialization in the consumer market, and can be implemented as three different product options: a compact external charging device, a snap-on or attached power accessory, or an embedded fuel cell power solution. We have strategic arrangements with Samsung Electronics and the Duracell division of the Gillette Company. Our goal is to become a leading provider of portable power for handheld electronic devices and we intend to commercialize Mobion products beginning in 2009.

Our Mobion technology eliminates the need for active water recirculation pumps or the inclusion of water as a subsidiaryfuel dilutant. The water required for the electrochemical process is transferred internally within the Mobion Chip from the site of water generation on March 26, 2001 and currently owns approximately 90%the air-side of the outstanding common stockcell. This internal flow of MTI Micro. The remaining 10%water takes place without the need for any pumps, complicated re-circulation loops or other micro-plumbing tools. Our Mobion technology is ownedprotected by strategic partners, other investors,a patent portfolio that includes over 90 U.S. patent applications covering five key technologies and MTI Micro employeesmanufacturing areas.

We also design, manufacture, and board members. In addition, directors and employees of MTI Micro also hold options to purchase shares of MTI Micro common stock representing approximately .45% of MTI Micro's outstanding common stock on a fully diluted basis as of December 31, 2005. Such options are vested or will vest within the next four years.

At its MTI Instruments subsidiary, the Company designs, manufactures, and sellssell high-performance test and measurement instruments and systems. MTI Instruments was incorporated as a subsidiary on March 8, 2000 and hassystems serving three product groups:markets: general dimensional gaging,gauging, semiconductor, and aviation. These products consist ofof: electronic, computerized gaginggauging instruments for position, displacement and vibration applications for the design, manufacturing and test markets; semiconductor products for wafer characterization of semi-insulating and semi-conducting wafers for the semiconductor market;characterization; and engine balancing and vibration analysis systems for both military and commercial aircraft.

MTI also co-founded

The Portable Power Source Industry

Industry Background

Consumers demand portable electronics that offer an enhanced experience through expanded memory, improved display technologies, constant connectivity, robust software, and retains a minority interestreduced form factor. In addition, technological advances in Plug Power Inc. ("Plug Power") (Nasdaq: PLUG),semiconductor manufacturing, LED displays, memory costs and availability, wireless technologies, and software applications have resulted in a developerdramatic increase in the number of clean, reliable, on-site energy products.

New Energy Segment

Trendsportable electronic devices, their usage, and power requirements. As a result of these consumer demands and technological advances, there are a number of handheld electronic devices, such as mobile phones (including smart phones) and mobile phone accessories, digital cameras, portable media players, PDAs, and GPS devices, that have been introduced into the market. Many of these devices provide consumers and mobile professionals with the ability to communicate any time, anywhere and have effectively enabled the creation of an “always-on” environment independent of the end user’s location. This trend towards increased functionality in portable electronicselectronic 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 are creatingnot being met. This power gap leads to a growing need for longer-lastingthe end user to plug-in their devices to the electrical grid on a regular basis, which limits their ability to use these electronic devices where and when the need arises.

The Power Source Bottleneck

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 power. Consumers want increased intelligence and functionality for their portable devices. They want more memory, color screens, and convergence of several devices into a multi-purpose one (i.e. cell phones that are also digital cameras and MP3 players). More and more devices are being connected to some kind of network and increasingly used by consumers who want them on and leave them on. All these trends require more energy than current technologies - like battery technologies -

electronics will be incremental at best, as any achievable benefits may be ableoutweighed by the decreasing stability, availability, integrity, and relative safety of these higher energy output batteries. In addition to provide.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.

MTI Micro expects

According to Frost and Sullivan, an independent research firm, the global battery market was approximately $14.3 billion in 2006 and is projected to increase to roughly $21.4 billion by 2012. The market for batteries can be divided into three segments: consumer, industrial, and military. Consumer battery sales represented approximately 81% of this market and are projected to represent an overwhelming majority of sales through at least 2012. The same study estimates that its proprietary technology should provide therechargeable batteries accounted for approximately $5.4 billion of this market in 2006.

OEMs are actively seeking improved power necessarysources to operate presentreplace existing rechargeable lithium-ion batteries and future generationsto power additional improvements to their mobile electronic devices. The development of new products using technologies that already exist, such as radio frequency technologies and 4G wireless capabilities, but cannot be effectively commercialized on mobile devices, will result from the availability of portable, electronicscompact, economical, rechargeable/replaceable higher energy density power sources, 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 their accessories. MTI Micro's Mobion^® technology should last longer becausecost of its highfuel cell construction, which results in a reliable, manufacturable, and affordable power solution that we believe provides improved energy density and it may eliminateportability over competing rechargeable battery technologies. Our proprietary fuel cell power solution consists of two primary components integrated in an easily manufactured device: the need for a lengthy recharge because it can be instantly refueled (recharged) by inserting a new fuel refill of methanol or refueling with a canister.

Mobion^® Technology: MTI Micro's Mobion^® direct methanol fuel cellscell 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 mobile phones (including smart phones) and mobile phone accessories, digital cameras, portable media players, PDAs, and GPS devices.

For handheld consumer electronic applications, we believe we are electrochemical devices that convert high energy density fuel (methanol) directly into electricity. The heart of a Mobion^® fuel cell is a membrane between two catalyst layers. Thethe only micro fuel cell produces electrical current when thedeveloper to have demonstrated power density of over 50 mW/cm² with energy efficiencies of 1.4 Wh/cc of fuel, is introduced to the anode catalyst layer. At the anode catalyst the fuel reacts to produce protons, electrons, and carbon dioxide. The membrane allows protons to pass through to the cathode catalyst layer. Electrons are forced to take an alternative path, and flow through current collectors providing power. At the cathode catalyst layer, the protons and electrons recombine and react with oxygen to form water.

Direct methanol fuel cells operate relatively silently, and at low temperatures and MTI Micro's Mobion^® technology is being designed to reduce parts count and the need for complex components. The Mobion^® technology platform can be customized to provide portable power for a number of applications depending on the power level, required run time and size requirements.

MTI Micro's Mobion^® technology uses methanol as fuel. Methanol - a simple alcohol commonly used in windshield wiper fluid -is biodegradable and because itwhich is a liquid, it is easily storeddirect result of our Mobion platform’s ability to use 100% methanol – a widely available, environmentally friendly, inexpensive, and transported. In addition, methanol is inexpensive, readily available andbiodegradable fuel. These advantages result in its natural state has high energy density (about 4800 Wh/L). Methanol is increasingly seen as a fuel of choice in the industry

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for micro fuel cells and it is being adopted by many in the industry because of its high energy density, packaging advantages, environmental and safety considerations and low cost.

The Company believes that when commercialized, Mobion^® could eventually have higher energy density and therefore provide multiple times the benefitsreduced size, cost, and complexity of existing Lithium-Ion batteries. When sold into the mass-commercial markets, Mobion^®fuel cells should be able toour power a wireless electronic device for longer periods of time than Lithium Ion batteries without recharging/refueling,solution offering consumers portable on-demand power, independence from power outlets, and be instantly refueled withoutfreedom from the need to constantly recharge their devices.

Our Strategy

Our goal is to become a leading provider of portable power for a power outlet or a lengthy recharge.

MTI Micro has built a numberhandheld electronic devices. Key elements of system prototypes that demonstrate technology capabilities, operation in any orientation and operation at a range of voltages. MTI Micro also uses laboratory systems to demonstrate and test advanced concepts and technology. MTI Micro has demonstrated laboratory systems operating on 100% methanol and another laboratory system has achieved an energy density of 250 Watt hours per liter ("Wh/l"), which is comparable to that of a typical prismatic Lithium Ion battery. This lab system also achieved an energy density of 200 Watt hours per kilogram ("Wh/kg") on a weight basis. In addition, in lab systems MTI Micro extracted 1 Wh/cc from methanol and 1.25 Watt hours per gram ("Wh/g") on a weight basis. In addition, in 2005 MTI Micro demonstrated in the laboratory, a low power test unit that ran continuously on one integrated fuel tankour strategy designed to achieve greater than 380 Wh of energy inthis objective include the same size and shape as the BA5590 battery - one of the most used ba tteries in the military.following:

MTI Micro currently plans to use contract manufacturers to manufacture its Mobion^®fuel cell products and has established contracts and relationships with key suppliers and contract manufacturers. MTI Micro also works with third-party suppliers to design, develop and manufacture subsystems and components of its Mobion^®fuel cell products.

The commercialization of MTI Micro's Mobion^® fuel cell products depends upon MTI Micro's ability to significantly reduce the costs of these systems and products, since they are currently substantially more expensive than systems and products based on existing technologies, such as rechargeable batteries. In addition to cost, MTI Micro continues to work on improving reliability, energy density, power density, life, and the overall performance of its Mobion^® systems as well as reducing its size - critical components for successful penetration into the marketplace. We cannot assure that MTI Micro will be able to sufficiently reduce the cost of these systems and products without reducing their performance, reliability and longevity.

Although it is difficult to predict the development timetable and challenges of our Mobion^®technology - a disruptive technology that may be able to provide multiple times the benefits of existing technologies, the Company expects to have units available for testing in the military markets by the end of 2006.

Business Strategy and Commercialization: The market for rechargeable batteries or power packs is large, well established and growing, experiencing sales of several hundred million units per year. MTI Micro's business strategy is to develop a robust, reliable, manufacturable, cost-effective Mobion^® technology platforms suitable for the consumer markets and to first target military

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and industrial markets. Potential military markets include extended life power sources for a number of applications including communication devices, sensors, soldier on-body power and other mission critical devices for the war on terror. Potential industrial markets include portable communications devices, wireless scanners, hand-held inventory control devices and electronic healthcare products. The potential consumer markets span a broad range of mass-market portable electronic devices such as PDAs, cell phones, global positioning systems and digital cameras. Initial applications in the consumer markets will be high value-added devices such as portable navigation systems, digital cameras, game players, camcorders and accessories for them. The Company then plans to penetrate into the even larger market for products such as cell phones and laptops.

As a result of discussions with its partners, government agencies, OEMs and others, MTI Micro has developed a commercialization strategy that consists of two overlapping phases (military/industrial and consumer) for market introduction of its Mobion^®fuel cells. This tiered approach is intended to enable MTI Micro to gradually penetrate each of its selected markets.

To move the Company forward in 2006, the Company has set the following milestones for MTI Micro:

1. Increase system efficiency by 30 percent to 1.3 Wh per cc of fuel in the second quarter;
2. Customer demonstration of a product-intent military portable power system in the third quarter;
3. Develop a prototype for the consumer market that exceeds the energy density of Lithium Ion batteries in the third quarter;
4. Operationally robust units available to sell for field testing in the military market by the end of 2006;
5. Enter into an agreement with a lead consumer OEM by the end of 2006 - a year later than originally projected.

During 2005, MTI Micro's management met important milestones, including:

1. The development of an engineering prototype with a replaceable fuel refill for the consumer market in the second quarter;
2. Delivery of five sensor power pack prototypes in the third quarter;
3. Delivery of a soldier/radio power pack prototype in the third quarter;
4. Doubled the energy density of the military's BA5590 battery in a laboratory unit during the fourth quarter;
5. Entered into an agreement with a lead customer/partner for the development of a military product during the fourth quarter.

Business Focus.

Strategic Partnerships: MTI Micro intends to sell to multiple industries and enable OEMs to enhance existing product offerings. MTI Micro's strategy is to team with appropriate players in each of its targeted markets. In parallel with its product introduction strategy, MTI Micro plans to leverage joint development activities and other formal partnerships with key component and subsystems suppliers. MTI Micro also intends to rely heavily on OEMs as distribution channels for early military and industrial product introductions. MTI Micro anticipates that the nature of these relationships will vary, and as MTI Micro continues to mature and move forward with its product commercialization, such relationships will become increasingly important.

Strategic Agreements: The Gillette Company("Gillette"):On September 19, 2003, MTI Micro entered into a strategic alliance agreement with Gillette whereby MTI Micro, Gillette and Gillette's Duracell business unit agreed to jointly develop and commercialize complementary micro fuel cell products to power future mass market, high volume and portable consumer devices.

The agreement provides for a multi-year exclusive partnership for the design, development and commercialization of a low power direct methanol micro fuel cell power system and a compatible fuel refill system. The strategic alliance agreement has three main components. First, Gillette and MTI Micro shall work together from a technical and marketing perspective to help create a market for micro fuel cells. Second, for a period of time, MTI Micro will receive a percentage of net revenues related to Gillette's sale of fuel refills for micro fuel cells. Third, Gillette has made, and may make in the future equity investments in MTI Micro. On September 19, 2003, Gillette made an initial $1 million investment in MTI Micro common stock and may make additional investments of up to $4 million subject to agreed milestones related to technical and marketing progress. As part of the agreement, MTI agreed to provide enough funding to MTI Micro to co ver all operational costs for the first two years of the agreement and MTI satisfied this obligation in April 2004.

MTI Micro has not yet achieved the milestone necessary for the investment of the next $1 million in additional funds by Gillette. We do not expect this to occur, if at all, until late 2006 or 2007. Basedare focusing our efforts on the current rate of progress with Gillette, we anticipate that Gillette will not invest the remaining $3 million until the end of 2008, if at all.

As part of the strategic alliance, MTI Micro transferred patents and other intellectual property related to fuel refill systems to Gillette, and Gillette transferred patents and other intellectual property related to DMFCs for hand held devices to MTI Micro. The patents and other intellectual property transferred to Gillette and any other intellectual property related to fuel refill systems for fuel cells for handheld devices, will be held in a licensing pool, which either party may license upon payment of a royalty fee. Both MTI Micro and Gillette will share in royalties related to the license of any intellectual property from the licensing pool.

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The strategic alliance agreement is terminable by either party for cause at any time. In addition, either party may terminate the agreement without cause after the completion of tasks and acceptance of all deliverables relating to the OEM marketing calls and concept product development milestone and the engineering product design milestone, as defined in the agreement and the work plan, as amended.

On August 18, 2004, MTI Micro entered into an amendment to the multi-year strategic alliance agreement. The amendment clarified the nature of the deliverables for the third and fourth milestones in the work plan; added an additional milestone; and changed the due dates for the third and fourth milestones. MTI Micro also granted a non-exclusive license to Gillette to any improvements made by MTI Micro to intellectual property developed by Gillette.

In May 2005, MTI Micro worked collaboratively with Gillette and completed milestone No. 3- the development of an engineering prototype with a replaceable fuel refill.

On June 20, 2005, MTI Micro entered into the second amendment to the multi-year strategic alliance agreement. The amendment added an additional milestone relating to product identification, suitability and OEM validation. The amendment also added an additional termination right, exercisable by either party, relating to such milestone.

E.I. du Pont de Nemours and Company ("DuPont") : MTI Micro entered into an agreement with DuPont in August 2001 for the development and commercialization of DMFCsour portable power source products. We believe this business provides a higher potential, higher growth opportunity than our test and measurement instrumentation business. We will continue to evaluate our test and measurement instrumentation business, which contributes positive operating results and cash flows, but may consider its eventual sale or other disposition.

Design for Mass Manufacturing.Our portable electronics.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 injection molded and is being designed for mass manufacturing. In addition, we have continued integrating more functionality into our Mobion Chip while reducing its part count to one molded piece. Our current Mobion Chip is 9ccs in size, which is small enough to fit in the palm of a hand.

Outsource Manufacturing.We plan to outsource manufacturing to expand rapidly and diversify our production capacity. This agreement expiredstrategy will allow us to maintain a variable cost model in Julywhich we do not incur most of 2004 and was subsequently extended effective July 23, 2004 for an additional two years and may be renewed annually thereafter. The parties agreed to work together to jointly optimize DuPont's Nafion^®membrane technology for MTI Mobion^®our manufacturing costs until our proprietary fuel cell systems.

MTI Micro is also partypower solution has been shipped and billed to a supply agreement with DuPont providing that MTI Micro must purchase a majorityour customers. We intend to concentrate on our core competencies of any membrane it purchases for its fuel cell from DuPont for a period of five years, commencing with the first commercial sale of fuel cells in volume by MTI Micro, if DuPont can meet best price and best quality in the industry. DuPont owns a minority equity interest in MTI Micro.

Flextronics International USA, Inc. ("Flextronics"): In November 2004, MTI Micro entered into a Design Services Agreement with Flextronics for designresearch and development pre-productionand 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 customer’s industrial design manufacturing engineering, prototypingalternatives and first article manufacturing of MTI Micro's Mobion^®fuel cell systems.device functionality through innovative product development based on our existing capabilities and technological advances.

Military Contractor:In December 2005, MTI Micro signed an Early Adopter Alliance Agreement with a leading provider of intelligence, secure communications systems, government services and homeland security. As part of this agreement, the parties will work together

Capitalize on Growth Markets.We intend to determine and evaluate the use and integration of MTI Micro's Mobion^® technology into the contractor's unattended ground sensor products. The two companies will cooperatecapitalize on the demonstration of unattended ground sensor prototypes, identify military qualifications processes for any resulting products, and develop a market entry strategy for those products.

SES Americom Inc. ("SES Americom"):In December 2005, MTI Micro signed a Market Development Agreement with SES Americom, a world leader in satellite services and satellite-centric networks. As partgrowth of the agreement, the parties will determine and evaluate the use and integration of MTI Micro's Mobion^® technology into SES Americomelectronic device markets, including new products that may benefitbe 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 these power solutions to OEM customers to enable them to offer products that have 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 alternative energy sources such as fuel cells. The two companiesthose 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 jointly oncontinually to improve our portable power source products, to reduce costs, and to speed the delivery of our products. 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

Portable Power Source Products

We are 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 disposable methanol cartridges that will be used to fuel our portable power source products. Through our alliance with Duracell, we are developing fuel cartridges that will be designed and branded for mass market identification,commercialization. Duracell has experience in the sale and distribution of portable power through its battery products, as well as in the development, distribution, and deliverysale of prototypes, qualification processesliquid products with similar safety and packaging requirements as the 100% methanol cartridges.

External Power Charger:Our design for any resulting products and the development of a market entry strategy for those products.

Recent Grants , Contracts and Developments:During 2005, Saft America Inc. ("Saft"), received a $1million contract from the US Army Communications Electronic Command ("CECOM") to develop an advanced soliderexternal power system ("HASP") for military applications. MTI Microcharger is a subcontractor understandalone 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. Our current prototype external power charger provides up to one month of power for the typical mobile phone. It can be designed to enable a professional photographer to take over 5,000 pictures using a high end digital camera from a single fuel tank. Our device is designed to provide 2.5 watts of power from its USB interface and also offer fast charge, ultra-long run time and self-charging modes.

Mobion external power charger prototypes

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 agreementcategory, we envision a number of product applications, including attachments for digital cameras, portable media players, GPS devices, and has receivedother consumer and electronic products. Our initial design is a purchase order for $470,000. As part of the contract, both Saftdirect methanol fuel cell camera-grip (see photo below) that replaces comparable rechargeable lithium-ion battery-pack grips and MTI Micro are working togetheris designed to build, test and demonstrate a system that combinesprovide 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 bothextended 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 and Lithium Ion battery technology. This contract is ongoing.

In January 2006, MTI Micro was notified by the U.S. Department of Energy ("DOE") that due to a reduction in funding levels to the Hydrogen, Fuel Cells & Infrastructure Technologies Program, MTI Micro will not receive its proportion of funding in 2006 for the $6.14 million, three-year, cost-shared development contract awarded to MTI Micro on August 1, 2004. Under this contract with MTI Micro, DOE authorized $2.35 million of spending on a cost-shared basis which ultimately will result in $1.17 million of contract revenue.  Since the U.S. Congress has not appropriated funding for FY2007, we cannot determine at this time if funding for FY2007 willcan be committed to this contract. 

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During 2004, the New York State Energy and Research Development Authority ("NYSERDA") modified its original contract dated March 2002 twice to reflect the addition of Phase III for $348 thousand (Enhanced Energy Conversion Efficiency of Direct Methanol Fuel Cells - Validation and Testing) and Phase IV for $202 thousand (DMFCs for traffic sensors). The project supports DMFC technology development and commercialization efforts. This contract is ongoing.

In October 2004, MTI Micro received two contracts to demonstrate energy density advantages and to quantify potential logistical advantages of its Mobion^®fuel cells for the U.S. Armed Forces.

• The first award was administered by the U.S. Army Research, Development and Engineering Command and totaled approximately $250 thousand. The program included the delivery of five integrated, hybrid DMFC systems to Special Operations Forces ("SOF"). These systems are targeted to provide continuous power to devices used by SOF and to deliver more than two times the energy of the battery currently used while fitting the same form factor. On September 29^th, 2005 MTI Micro fulfilled the contract and delivered five prototypes for sensor applications to the U.S. Special Operations Command ("SOCOM") to evaluate new technologies for field readiness.

• The second award, a Phase I Small Business Innovative Research contract from U.S. Marine Corps System Command, provided $70 thousand during 2005 to analyze and report on current regulations and requirements necessary to field DMFCs and fuel refill systems. This contract was completed in 2005.

In April 2004, MTI Micro enteredembedded into a $200 thousand contract with Cabot Superior Micro Powders ("CSMP") to evaluate the performance of CSMP's membrane electrode assembly ("MEA") for portable fuel cell application. During 2005, this contract was amended to increase the contract amount to $210 thousand. This contract was completed in 2005.

In November 2003, the Company entered into a $250 thousand contract with the Harris Corporation ("Harris") to build two prototype units of a DMFC hybrid power supply in a similar form factor of a military battery. The original agreement entered into in October 2003 for $200 thousand was modified in May 2004 increasing the contract to $250 thousand, and was again modified in 2005 to decrease the contract to $150 thousand. This contract was completed during 2005.

Competition:We anticipate that the primary competitive considerations in MTI Micro's markets will be compatibility of DMFC power sources with portable electronic devices requirementsin 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 concept model (see photo below) designed for a smart phone and believe that this concept model highlights the anticipated future product direction for our portable power pack size, energy content, reliability and price. We also believe the first company to successfully introduce a DMFC productsource products in the commercial markets will have significant advantages over its competitors. Many of MTI Micro's competitors have much greater access to capital, resources, component supplies, manufacturing capacity and distribution channels than MTI Micro. As such, because of the nature of product development, we cannot accurately determine our competitors' progress in developing DMFCs and whether such competitors' development efforts exceed MTI Micro's development efforts to date.consumer market.

We analyze MTI Micro's competition based, in part, on two separate components of the DFMC market: (1) companies developing and providing DMFCs producing greater than three watts of energy, particularly companies focused on providing power devices for lap top computers; and (2) companies developing DMFCs producing less than three watts of energy. Within both of these categories, we have witnessed substantial changes during the last five years. Significant new competitors have emerged in Asia, Europe and in the United States. In addition, companies based in Japan, Korea, Germany and the United States have made patent filings in the United States for DMFC technologies.

Our primary focus in consumer markets is for hand held (less than 3 watt energy range) devices. Based on certain publicly available information, we believe MTI Micro's major competitors in the less than three watt energy range are large Asian companies, such as,

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Hitachi Ltd. ("Hitachi"), Fujitsu Limited ("Fujitsu"), Samsung Electronics Co., Ltd. ("Samsung"), and Toshiba. These competitors have extensive patent portfolios and according to published reports, dedicated operations working on DMFCs and have publicly introduced prototypes. Hitachi demonstrated DMFCs in PDAs, Toshiba demonstrated DMFCs in Bluetooth headsets and in MP3 players, and Samsung has demonstrated an MP3 player. In addition, Samsung has publicly stated consumer market entry dates. We also compete with a number of smaller companies, such as, Medis Technologies Ltd., which announced a distribution and prototyping agreement with General Dynamics for military customers and a contract with Celestica in Ireland for the production of its power packs starting as early as the first quarter of 2007.

Based on certain publicly available information, we believe MTI Micro also faces significant competition in the greater than three watt energy range, and in particular from companies focused on providing power for lap top computers. In this segment, we believe our major competitors are large Japanese, Chinese, Korean and American companies, including but not limited to Canon Inc., Casio Computer Company Ltd., Nanfu Battery, Fujitsu Laboratories, UltraCell, Hitachi, Matsushita Electric Works (Panasonic), NEC, Samsung, Sanyo, and Toshiba. Each of these companies has greater access to resources than we do and, as the result of vertical integration, may have significant advantages in bringing product to market. We also consider Smart Fuel Cells AG ("Smart Fuel Cells"), based in Germany to be a significant competitor. Smart Fuel Cells has had product available in the market for three years. Other competitors include Protonex, a developer of fuel cell systems based on hydrogen PEM (proton exchan ge membrane) technology, and Millennium Cell, a developer of hydrogen battery technology for portable devices.

Intellectual Property and Proprietary Rights:MTI Micro relies on a combination of patent (both national and international), trade secret, trademark and copyright protection to protect its intellectual property ("IP"). MTI Micro's strategy is to apply for patent protection for all necessary design requirements. Additionally, MTI Micro systematically analyzes the existing IP landscape for DMFCs to determine where the greatest opportunities for developing IP exist.

In addition, MTI Micro enters into standard confidentiality agreements with its employees and consultants and seeks to control access to and distribution of its 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/copyright, and trade secret protection may be unavailable or limited in certain foreign countries.

As of December 31, 2005, MTI Micro has filed 76 U.S. patent applications, 21 of which have been awarded. Internationally, MTI Micro has filed 20 Patent Cooperation Treaty Applications, and 10 National Phase Patent Applications. MTI Micro has developed an extensive portfolio of patent applications in areas including fuel cell systems, components, controls, manufacturing processes and system packaging. 

MTI Micro believes

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 patents are material to its business and that all of its patents may be significant to its future business activities.advantages:

In December 2000, MTI Micro licensed, on a non-exclusive basis, ten patent applications (eight issued and two abandoned) from Los Alamos National Laboratory ("LANL"). MTI Micro based its early DMFC systems work on these patents. MTI Micro has also licensed from LANL, on an exclusive basis, rights to European and Japanese counterpart applications for one LANL patent. In January 2005, MTI Micro and LANL modified the existing license such that it included in its entirety a total of nine issued U.S.

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patents. No changes were made to the license fees or royalties due under such license. MTI Micro also has licensing rights and obligations with respect to IP developed under agreements with Gillette, DuPont and other vendors.

Codes and Standards: MTI Micro is a leader in the development of codes and standards associated with direct methanol fuel cells. Standards

In 2004, MTI Microwe became the world'sworld’s first company to obtain micro fuel cell safety compliance certifications for a fuel cell product from Underwriter'sUnderwriter’s Laboratory ("UL") and from CSA International ("CSA"). MTI MicroInternational. In addition, we received United Nations ("UN") packaging certification and wasour methanol cartridges were deemed compliant by the U.S. Department of Transportation for worldwide cargo shipment ofshipment. Certification is required for every commercial product prior to its methanol fuel cartridges. The methanol cartridges were manufactured by MTI Micro's manufacturing partner Flextronics, in San Jose, California.

In addition to being the first company to receive ULshipment. Based upon our previous experiences with these regulatory agencies, we do not anticipate delays associated with seeking Underwriter’s Laboratory and CSA certification, MTI Micro workedInternational product certifications for our commercial products, which are anticipated to helpbegin shipping in 2009.

Also, we helped to develop thea proposal adopted by the UN which givesUnited Nations to provide methanol fuel cartridges their owna separate classification a significant step forward for usand we worked with other micro fuel cell companies, and the industry. MTI Micro and others worked withappropriate regulatory bodies, to create agenerate the first draft of the international standards for methanol safety and use including those related to transport on commercial airplanes. At the same time, a number of presentations were made to various UN bodies in an effort to increase the understanding and acceptance of micro fuel cells and fuel cartridges.

As a result during 2005of our industry coalition efforts, the International Civil Aviation Organization's ("ICAO") safety panel recommended approval ofOrganization technical instructions and the transportationInternational Air Transport Association Dangerous Goods Regulations now permit airline passengers and crew to carry on and use of methanol fuel cells to power portable electronics in airplane passenger cabins. The action of this panel still needs to be submitted for comment to all ICAO members and then considered for final adoption by the 36-member ICAO Counc il, which could happen as early as the second quarter of 2006. If formally adopted, the regulation will go into effect on January 1, 2007. This is a key event in an on-going effort to develop regulatory acceptance ofcertain fuel cell power systems.systems and fuel cell cartridges containing methanol. The U.S. Department of Transportation is currently reviewing the International Civil Aviation Organization and International Air Transport Association air transport regulations and issued a notice of proposed rulemaking on September 20, 2007 to adopt the International Civil Aviation Organization passenger allowance and harmonize the U.S. requirements with the international standard. The public comment period on these proposed rules closed on November 19, 2007. We expect the U.S. Department of Transportation to adopt its proposed rules during 2008.

As part of the vote from ICAO's safety panel in 2005, butane and formic acid fuels were also approved but other fuels - such as hydrogen and sodium borohydride - were not approved outlining a possible barrier of entry into the business/leisure travel consumer market for those companies developing technologies with such fuels.

Test and Measurement Instrumentation SegmentProducts

MTI Instruments is

We are a world wideglobal supplier of computerized gauging instruments, metrology portable balancing equipment and inspection systems for semiconductor wafers. MTI Instruments products use state-of-the-art technology to solve complex real world applications in numerous industries including automotive, semiconductor, commercialwafers, and military aviation and data storage. MTI Instruments is currently investing in extending their sales reach and developing new product offerings. These investments include more automated and sophisticated sales and marketing management systems, expanded sales coverage in both Europe and the Far East and a concentrated focus on internet marketing. Product investments share a common theme: incorporation of our product technology into larger value added systems that enable MTI Instruments to offer the complete solutions that customers demand. MTI Instruments has industry recognized customer service and has worked with over 200 companies worldwide.

Products and Services: MTI Instruments has three product groups: General dimensional gaging, semiconductor and aviation. Our products consist of electronic, computerized gaging instruments for position, displacement and vibration applications for the design, manufacturing and test markets; semiconductor products for wafer characterization of semi-insulating and semi-conducting wafers for the semiconductor market; andjet engine balancing and vibration analysis systems for both military and commercial aircraft.systems.

General Dimensional Gaging:MTI Instruments' sensing systemsGauging:Our gauging instruments employ fiber optic, laser, and capacitance technologies to make nano-accurateprecision measurements in product design, production, and quality related processes.Gagingprocesses. Our gauging instruments include capacitance gauging systems offering ultra-high precision measurement, a fiber-optic based vibration sensor system with extremely high frequency response, a high-speed laser sensor system utilizing the latest complementary metal-oxide semiconductor/charge-coupled device technology, and a stand-alone data acquisition system that incorporates multiple sensor technologies. These products include laser, fiber-opticare targeted towards the data storage, semiconductor, and capacitance systems that measure a variety of parameters including displacement, position, vibration and dimension.automotive industries.

Listed below are selected MTI Instruments product offerings:

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Semiconductor: MTI Instruments'Our family of wafer metrology systems range from manually operated units to fully automated systems, which test key wafer characteristics critical to producing high qualityhigh-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. Our wafer metrology systems include an automated wafer characterization system, a semi-automated, full wafer surface scanning system, and a device that provides for manual, non-contact measurements.

The semiconductor product line includes the following products:

Aviation:MTI Instruments' computer-based PBSOur portable and test cell balance systems automatically collect and record aircraft engine vibration data, identify vibration or balance troubleissues 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.

MTI Instruments' aviation 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:

Technology

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MarketingA 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 Sales:Inan oxidant, such as oxygen. Fuel cells are different from batteries in that they consume a reactant, which must be replenished, while batteries store electrical energy chemically in a closed system. Generally, the Testreactants flow in and Measurement Instrumentation segment, MTI Instruments markets itsreaction products flow out of the fuel cell. While the electrodes within a battery react and services using channelschange as a battery is charged or discharged, a fuel cell’s electrodes are catalytic and relatively stable.

The direct methanol fuel cell relies upon the reaction of distribution specificwater with methanol at the catalytic anode layer to each of its product groupsrelease protons and customer base.electrons, and form carbon dioxide. The general dimensional gaging product group markets it productselectrons pass through a combinationcircuit 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 manufacturer representativesa direct methanol fuel cell are usually made of platinum particles and platinum ruthenium 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 United States and distributors overseas. The semiconductor product group markets its products exclusively through domestic distributors and international sales representatives, whilemethanol fuel, which limits the aviation group primarily sells direct to the end user.

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

Comparisons of sales by class of products, which account for over 10 percentenergy content of the Company's consolidated sales, are shown belowdiluted fuel (see Chart B).

Direct Methanol Fuel Cell with Active Water Transport (Chart A)

Methanol Fuel Cell With Water As A Fuel Dilutant (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 re-circulation loops or other micro-plumbing tools (see Chart C).

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

Our Mobion solution contains a passive water recirculation sub-system that allows for the years endedconsumption 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 May 16, 2006, we entered into an alliance with Samsung Electronics Co., Ltd., or Samsung, to develop next-generation fuel cell prototypes for Samsung’s mobile phone business. We developed, and together with Samsung we jointly tested and evaluated, our Mobion technology for several Samsung mobile phone applications. We are continuing to work with Samsung on a non-exclusive collaboration under which we continue to refine our Mobion baseline product design. We will share development updates with Samsung and loan them prototypes for evaluation. Samsung may also request changes to product specifications until December 31:2008 and may purchase commercial samples as soon as they become available.

Product DevelopmentOn September 19, 2003, we entered into a strategic alliance agreement with the Duracell division of The Gillette Company, or Duracell, under which we agreed to work with Duracell to develop and Manufacturing:MTI Instruments is working on expanding its range of capacitancecommercialize complementary methanol fuel cell products to increase penetrationpower mass market, high-volume portable consumer devices. The agreement provides for a multi-year partnership for the design, development, and commercialization of a low power direct methanol fuel cell power system and a compatible fuel refill system. The arrangement provides for us to receive a percentage of net revenues related to Duracell’s sale of fuel refills for methanol fuel cells. The agreement gives Duracell the ability to make equity investments in MTI Micro. Duracell has made an initial $1.0 million investment in MTI Micro common stock and may make additional investments of up to $4.0 million, subject to agreed upon milestones related to technical and marketing progress. Any further investment by Duracell in MTI Micro will effectively dilute our ownership interest in MTI Micro, although we do not believe that such dilution will be substantial.

On August 1, 2004, we entered into new market segments and management believes thata $6.1 million cost-shared development contract with the successU.S. Department of Energy, or the enterprise depends to a large extent upon innovation, technological expertise and new product development.Initiatives are underway to bring new products to market during 2006. MTI Instruments also plans to continueDOE, for the development of advanced PBS systemsmanufacturing techniques and the optimization of our Mobion product solutions. Through February 2008, the DOE has authorized $5.5 million of spending on a cost-shared basis.

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 use inmilitary 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. 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 militarybasic design, function, and commercial markets.performance of our in-house engineering capabilities to foster the successful commercialization of our products.

MTI Instruments' latest

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, including our injection molded Mobion Chip, design to ensure its manufacturability (including engineering, verification and product offerings include: In the general gaging area,testing), design for 2004, MTI Instruments introduced the MTI-2100 Fotonic™ Sensor - a "next generation" fiber-optic sensorassembly, design for high-resolution, non-contacttestability, and design for serviceability, all of which are critical to successful high-volume production.

We assemble and test our test and instrumentation 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 line. It is designed to meet the stringent requirements of brake rotor measurement applications in the automotive industry. In Semiconductors, for 2004, MTI Instruments introduced the Proforma™ 300SA - a semi-automated tool for measuring thickness, total thickness variation, bow, warp, stress and flatness of 300mm wafers. In aviation, for 2004, MTI Instruments introduced the PBS-3300 - a compact balancing and vibration diagnostics system for use in mobile test cells and distributed test stands. The PBS-3300 is currently being used to balance the AGT 1500 gas turbine engine in the U.S. Army's M1A1 tank.

MTI Instruments assembles and tests its products at itsour facilities located in Albany, New York. MTI Instruments believesWe believe that itsour existing assembly and test capacity is sufficient to meet itsour current needs and short termshort-term future requirements. Also, management believesWe believe that most of the raw materials used in our test and measurement products are readily available from a variety of vendors.

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 through them. We plan to generate sales to OEM customers through direct sales employees as well as outside sales representatives and distributors. We have recently established sales representatives in South Korea and Japan.

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 monitor developments in the portable power industry through subscriptions with well known firms such as Frost and Sullivan, a wide array of publications, active public relations, updates with industry analysts and the investment community, and speaking engagements.

We market our test and measurement instrumentation products through a combination of direct sales personnel and domestic and international distributors. We expect this business to continue to achieve double digit year over year growth.

Customers

We expect that our customers for our portable power source products will include a number of the world’s largest electronic device OEMs.

Sales of our test and measurement instrumentation products to Koyo, our Japanese distributor, and the U.S. Air Force accounted for 27.8% and 26.4%, respectively, of product revenue in 2007. In 2006, sales to the U.S. Air Force and Koyo accounted for 23.1% and 22.9%, respectively, of product revenue. No other customer accounted for more than 10% of our product revenue in either 2006 or 2007.

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 and some of our potential OEM customers.

Competition in the sale of our measurement and instrumentation products is based on product quality, performance, price, and timely delivery. Our competitors for test and measurement instrumentation products include National Instruments, KLA-Tencor, Capacitec, Sigma Tech, Corning Tropel, Chadwick-Helmuth, ACES Systems, Micro-Epsilon, and Keyence.

Product Development

Over the past two 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 three 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.

We have improved the capabilities of our Mobion Chip technology during the last two 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 and should be able to power wireless electronic devices for longer periods of time than rechargeable lithium-ion batteries.

Intellectual Property and Proprietary Rights: MTI Instruments reliesRights

We rely on a combination of patent (both national and international), trade secret, lawstrademark, and patentscopyright protection to establish and protect our intellectual property. Our strategy is to apply for patent protection for all significant design requirements. Additionally, we systematically analyze the proprietary rights of its products. In addition, MTI Instruments entersexisting 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 itsour employees, consultants, vendors, partners and consultantspotential customers and seeksseek to control access to and distribution of itsour proprietary information. Even

As of December 31, 2007, we had filed over 90 U.S. patent applications, 43 of which have been awarded. Of the awarded patents, 34 are assigned to us and 9 are assigned to Duracell as part of our strategic alliance agreement with these precautions, it may be possiblethem. We have filed 22 Patent Cooperation Treaty Applications and have filed for National Phase Patent Protection for 12 pieces of intellectual property in multiple countries, including Japan, the European Union, and South Korea. We have developed a third partyportfolio of patent applications in areas including fuel cell systems, components, controls, manufacturing processes, and system packaging.

Research and Development

Our 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 copy or otherwise obtain and useadvance the development of our direct methanol fuel cell technology to enhance the commercial value of our products orand technology, without authorization oras well as to develop similar technology independently. In addition, effective patentnext generation fuel cell products.

We have incurred research and trade secret protection may be unavailable or limiteddevelopment costs of approximately $9.7 million, $12.9 million and $11.8 million for the years ended December 31, 2005, 2006, and 2007, respectively. We expect to continue to invest in certain foreign countries. MTI Instruments has one patent issued supporting its semiconductor product line.

Significant Customers: MTI Instruments' largest customers include the U.S. Air Forceresearch and companiesdevelopment in the computer, electronic, semiconductor, automotive, aerospace, aircraftfuture.

Employees

As of December 31, 2007, we had 107 employees compared with 132 as of December 31, 2006. Of these employees, 46 were involved in our portable power source business (including 25 scientists and bioengineering fields. Inengineers, of whom 18 had advanced degrees) and 46 were involved in our test and measurement instrumentation business. Fifteen of our employees are involved in corporate functions.

Properties

We presently lease two premises, one located at 325 Washington Avenue Extension, Albany, New York and the Testother at 431 New Karner Road, Albany, New York. Both leases expire at the end of 2009. The 325 Washington Avenue Extension premise consists of approximately 20,700 useable square feet of space, and Measurement Instrumentation Segment,the 431 New Karner Road consists of approximately 23,500 useable square feet of space. Together, the premises are adequate for our current and foreseeable needs.

Legal Proceedings

We are not currently involved in 2005, the U.S. Air Force accounted for $2.385 million or 39.7% of product revenues; in 2004, the U.S. Air Force accounted for $3.508 million or 46.6% of product revenues; in 2003, the U.S. Air Force accounted for $2.261 million or 40.8% of product revenues. A loss of the U.S. Air Force as a customerany legal proceeding that we believe would have a material adverse effect on this segment.

Recent Contracts: In 2002, MTI Instruments was awarded a multi-year U.S. Air Force contract to service and retrofit existing PBS-4100 jet engine balancing systems with the latest diagnostic and balancing technology could potentially generate up to a total of $8.8 million in sales for the Company between the years 2002 and 2007. As of December 31, 2005, MTI Instruments had recorded $5.3 million in orders for approximately 59% of the five-year contract's total value.

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Competition: MTI Instruments is subject to competition from several companies, many of which are larger than MTI Instruments and have greaterour business or financial resources. MTI Instruments' competitors include ADE Corporation, Sigma Tech Corporation, Corning Tropel Corporation, Chadwick-Helmuth, ACES Systems 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 and 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.

Employees

The total number of employees of MTI and its subsidiaries was 125 as of December 31, 2005, as compared to 128 as of December 31, 2004. Fiscal 2005 employees include corporate operations and the Company's two subsidiaries, MTI Micro and MTI Instruments. Executives and staff were chosen for their acumen, ability and experience in areas critical to the execution of the Company's core business strategy.

Financing Arrangements

Private Placement:The Company entered into a financing transaction with Fletcher International, Ltd. ("Fletcher"), on January 29, 2004 and amended the terms of such transaction on May 4, 2004. To date, Fletcher has purchased 2,680,671 shares of our common stock pursuant to such financing transaction. In addition, Fletcher has the right to purchase an additional $20 million of MTI's common stock, on one or more occasions, at a price of $6.023 (adjusted from $6.34) per share at any time prior to December 31, 2006. Fletcher also has the right to receive Company shares without payment upon the occurrence of certain events, including but not limited to, failing to register for resale with the SEC shares purchased by Fletcher on the agreed upon time table, a restatement of the Company's financial statements, change of control of the Company and issuance of securities at a price below Fletcher's purchase price. We have filed registration statements covering all of the shares purc hased by Fletcher to date and in the event of any additional purchases we are similarly obligated to file one or more registration statements covering the resale of such shares. In connection with the late effective date for the registration statement filed on January 6, 2005, the Company issued and registered 66,413 shares of common stock to Fletcher without any additional payment. At December 31, 2005, Fletcher owned 393,515 shares or 1.3% of the Company's common stock.

Gillette Company ("Gillette"):Gillette entered into a strategic alliance agreement with MTI Micro on September 19, 2003, whereby MTI Micro, Gillette and Gillette's Duracell business unit will seek to jointly develop and commercialize micro fuel cell products to power high-volume, low-power, hand-held and mass market portable consumer devices. This agreement was amended on June 20, 2005 and August 18, 2004. Pursuant to the agreement, Gillette purchased 1,088,278 shares of MTI Micro common stock (362,760 post 2004 1-for-3 reverse split) at a price of $.92 ($2.76 post 2004 1-for-3 reverse split) per share for $1 million. In connection with this agreement, Gillette may make additional investments of up to $4 million subject to agreed milestones.

Operations Sold or Discontinued

Ling Electronics, Inc. and Ling Electronics Limited (collectively, "Ling") were sold on October 21, 1999 to SatCon in exchange for 770,000 shares of SatCon common stock (which stock had a market value of approximately $6.7 million on the transaction date). At the time of the sale, Ling designed, manufactured, and marketed electro-dynamic vibration test systems, high-intensity-sound transducers, power conversion equipment and power amplifiers used to perform reliability testing and stress screening during product development and quality control.

The sale of the Company's Technology Division, the sole component of the Technology segment, to NYFM, Incorporated (a wholly-owned subsidiary of Foster-Miller, Inc., a Waltham, Massachusetts-based technology company) was completed on March 31, 1998. Accordingly, the Company no longer includes such Technology Division among its reportable business segments. The Technology Division has been reported as a discontinued operation since December 26, 1997. See Note 18 of the Notes to Consolidated Financial Statements referred to in Item 8 below.

Backlog

The backlog of orders believed to be firm is as follows:

The backlog relates to contracts and purchase orders received from commercial customers and government agencies.condition.

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Segment Information

Segment information is set forth in Note 19 - Geographic and Segment Information - of the Notes to Consolidated Financial Statements referred to in Item 8 below and incorporated herein by reference.

Subsequent Events

Sales of Securities available for Sale:From January 1 through March 13, 2006, the Company sold securities available for sale as follows:

Lease Termination:MTI Micro entered into a Lease Termination Agreement in connection with certain premises at 750 University Avenue, Suite 270, Los Gatos, CA with 750 University, LLC. The Lease Termination Agreement was fully executed on February 9, 2006 with a lease termination effective date of January 31, 2006. The Company accrued $25 thousand in connection with this lease termination obligation.

Contracts: In January 2006, MTI Micro was notified by the DOE that due to a reduction in funding levels to the Hydrogen, Fuel Cells & Infrastructure Technologies Program, MTI Micro will not receive its proportion of funding in 2006 for the $6.14 million, three-year, cost-shared development contract awarded to MTI Micro on August 1, 2004. Under this contract with MTI Micro, the DOE has only authorized $2.35 million of spending on a cost-shared basis which will ultimately result in $1.17 million of contract revenue.  Since the U.S. Congress has not appropriated funding for FY2007, the Company cannot determine at this time if funding for 2007 will be committed to this contract. 

Availability of Information

The Company makesWe 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 the Company's website'sour website’s Investor Relations page.

The public may read and copy any materials the Company fileswe file with the SEC at the SEC'sSEC 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. The Company filesWe 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.

Item 1A: Risk Factors

Factors Affecting Future Results

This Annual Report on Form 10-K and the documents we have filed with the Securities and Exchange CommissionSEC 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 "anticipates," "plans," "expects," "believes," "should," "could," "may," "will"“anticipate,” “estimate,” “plans,” “projects,” “continuing,” “ongoing,” “expects,” “management believes,” “we believe,” “we intend,” “should,” “could,” “may,” “will” and similar expressions,words or phrases, we are identifying forward-looking statements. Forward-looking statements involve risks, uncertainties, estimates and uncertainties,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;
• risks related to developing Mobion^®direct methanol micro fuel cells and whether we will ever successfully develop commercially viable Mobion^® fuel cell systems;
• the potential for early termination of our agreement with Gillette and its Duracell division;
• our inability, or Gillette's inability, to develop Mobion^® fuel cell systems or fuel refills on our planned schedule;

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• market acceptance of Mobion^® fuel cell systems;
• risks related to our first Mobion^® fuel cell product delivered in December 2004, including reliability, run time, customer acceptance and safety;
• our dependence on OEMs integrating Mobion^®fuel cell systems into their devices;
• the need for current regulations to change to permit methanol to be carried onto airplanes for Mobion^®fuel cell systems to achieve mass market commercialization;
• Fletcher's decision whether to exercise its additional investment rights and the price at which Fletcher purchases shares;
• risks related to the flammable nature of methanol as a fuel source;
• our history of losses;
• intense competition in the DMFC and instrumentation businesses;
• risks related to protection and infringement of intellectual property;
• the historical volatility of our stock price;
• general market conditions; and
• other factors referred to under the caption "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, youassumptions should not assumebe 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.

We have incurred recurring net losses, including net losses of $15.1 million in 2005, $13.7 million in 2006, and $9.6 million in 2007, which includes a net gain of $2.5 million from the sale of securities available for sale and a net gain of $3.0 million on derivatives in 2007. As a result of ongoing operating losses, we had an accumulated deficit of approximately $105.1 million as of December 31, 2007. 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 continued 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 sources of funding, 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.

We have received a going concern report from our independent auditors.

Our auditors have included an explanatory paragraph in their opinion that accompanies our audited consolidated financial statements as of December 31, 2007, indicating that our recurring losses from operations, net capital deficiency, and current liquidity position raise additionalsubstantial doubt about our ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Our common stock may be delisted from The Nasdaq Global Market, which may adversely affect our ability to raise capital and stockholders’ ability to completesell their shares.

Nasdaq notified us on January 9, 2008 that our common stock could be delisted from The Nasdaq Global Market for failure to maintain a minimum bid price of $1.00 and that we had until July 7, 2008 to regain compliance with the listing standards of such market. To regain compliance, the closing bid price of our common stock must meet or exceed $1.00 per share for a minimum of 10 consecutive business days. If compliance is not regained, Nasdaq will notify us of its determination to delist our common stock, which we may appeal to its listings qualification panel. We may alternatively apply to transfer our common stock to The Nasdaq Capital Market if we satisfy all of its requirements, other than the minimum bid price, for initial inclusion on such market. If we elect to apply for such a transfer and if such application is approved, we will be afforded the remainder of a second 180 calendar day-period to regain compliance with the minimum bid price rule while listed on The Nasdaq Capital Market. A delisting from The Nasdaq Global Market may result in a decline of the price of our common stock and adversely affect our ability to raise capital through the sale of common stock.

We currently derive all of our product revenue from our test and measurement instrumentation business, but our principal focus is the development and commercialization plansof our portable power source business.

We currently derive all of our product revenue from our test and measurement instrumentation business, but our principal focus is the failure to complete such development and commercialization plans will materially adversely affect our business plans, prospects, results of operations and financial condition:Our cash requirements depend on numerous factors, including completion of our product development activities, our success in commercializing our Mobion^®fuel cell systemsportable power source business. Our test and market acceptance of Mobion^®fuel cells. Before we can successfully commercialize Mobion^®fuel cells, we must completemeasurement instrumentation business is subject to a number of critical activities, and certain events must occur, including further product development; manufacturing process development; development of large-scale production capabilities; completion, refinement and management of our supply chain; completion, refinement, and management of our distribution channel; and further work on codes and standards critical to consumer acceptance,risks, including the existencefollowing:

In addition, our commercialization plans. We can raise funds in four ways: sale of certain of our Plug Power shares, sale of our Company's stock, sale of MTI Micro stocktest and sale of other assets. Pursuant to our amended agreement with Fletcher, they have the right to invest up to an additional $20 million in our common stock. However, theremeasurement instrumentation products can be no assurances that Fletcher will exercise such right. If Fletcher does not exercise its additional investment rights we may be forcedsold in quantity to increase thea relatively few number of P lug Power shares sold to fund operations, or reduce spending on micro fuel cell development. If additional funds are raised through the issuance of equity securities, the percentage ownership of our then current shareholders will be reduced. If adequate funds are not available to satisfy either short or long-term capital requirements, we may be required to limit operationscustomers, resulting in a manner inconsistent with our development and commercialization plans, which would materially adversely affect our business plans, prospects, results of operations and financial condition in future periods.

We are dependent on continued government funding for new energy research and development and MTI Instruments product sales.customer concentration risk. The loss of any significant portion of such contracts andcustomers or a material adverse change in the inability to obtain additional contracts mayfinancial condition of any one of these customers could have a material adverse effect on our business.

We have not generated any product revenue from our portable power source business plans, prospects, resultsand 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 operations, cash flowsour portable power source products will depend on a number of factors, including the following:

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:A large portioncondition. If adequate funds are not available, we may have to delay development or commercialization of revenues at MTI Instrumentsour 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 MTI Micro forfinancial condition.

Any revenue derived in the next several years may comerelatively near relating to our portable power source business likely will result from government contracts.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 and the inability to obtain additionaladditionally contracts could materially adversely affectharm our business plans, prospects, results of operations, cash flows and financial condition.business.

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

We may not successfully developwill need additional funding to commercialize our new technologyportable power source business. If we are unable to secure the necessary additional funding or to raise funds from the sale of our test and the failuremeasurement instrumentation business should we determine to do so, we may need to delay further commercialization plans. 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 materially adversely affect our business plans, prospects, results of operationsbe sufficient, that the financing will be available on terms favorable to us or to existing stockholders and financial condition:DMFCs are a new technology with many technical and engineering challenges still to be resolved. We cannot assureat such times as required, or that we will be able to successfully resolveobtain the technicaladditional financing required for the continued operation and engineering challenges

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growth of DMFCs, or if we are successful, that such solutions will be commercially viable. Resolution of these technical and engineering issues requires substantial resources including financial, managerial and technical resources. We cannot assure that all the necessary resources will be available to the degree, and at the times, they are needed.our business. If we are unable to successfully develop Mobion^®fuel cells,raise additional funds by issuing equity securities, our business plans, prospects, results of operations and financial condition would be materially adversely affected.

Current commitments for joint development, distribution, marketing and investment by The Gillette Company (Gillette) and its Duracell divisionstockholders will experience dilution. Debt financing, if available, may be subject to early termination and any such early termination will have material adverse consequences on MTI Micro's and the Company's business plans, prospects, results of operations and financial condition:Gillette and its Duracell division's commitments in the strategic alliance agreement and the other agreements entered into as a part of the strategic alliance transaction (including those commitments relating to joint development, distribution, marketing and investment) with MTI Micro are subject to early termination. Either MTI Microinvolve restrictive covenants.  Any debt financing or Gilletteadditional equity financing may terminate the strategic alliance agreement for cause at any time and at certain pre-defined periods of time, if technical milestonescontain terms that are not completedfavorable to the satisfaction of the other party. Gillette may also terminate the strategic alliance agreement prior to mass market commercializa tion if it decides not to establish fuel refill manufacturing capability.

The investment agreement with Gillette may be terminated if the strategic alliance agreement is terminated. In addition, any future investment by Gillette is conditioned upon MTI Micro reaffirming that the representations and warranties in the investment agreement are true as of the date of such investment. These representations and warranties include statements concerning ownership of intellectual property, and affirmations that MTI Micro is not infringing on the intellectual property of others and others are not infringing on MTI Micro's intellectual property. At this time we cannot determine whether MTI Micro will be able to make these statements as of the date of any potential future investments by Gillette, and the inability to make such statements could result in Gillette terminating the investment agreement.

Termination of MTI Micro's agreements with Gillette and its Duracell division would have material adverse consequences on MTI Micro's and the Company's business plans, prospects, results of operations and financial condition.

MTI Micro may never complete the development of commercially acceptable Mobion^® fuel cell products and may not be able to achieve profitable commercialization of its products in the military/industrial and consumer market on the timetable it anticipates,us or at all, and any such delay or failure would have material adverse consequences on MTI Micro's and the Company's business plans, prospects, results of operations and financial condition:We cannot guarantee that MTI Micro will be able to develop commercially viable Mobion^® fuel cell products in the military/industrial and consumer market on the timetable it anticipates, or at all. The commercialization of Mobion^® fuel cell products requires substantial technological advances to improve the efficiency, functionality, reliability, cost, performance and environmental operating latitude of these systems and products and to develop commercial volume manufacturing processes for these systems a nd products. We cannot guarantee that MTI Micro will be able to develop the technology necessary for commercialization of Mobion^® fuel cell products, or acquire or license the required technology from third parties. MTI Micro's failure to develop the technology necessary for high-volume commercialization of Mobion^® fuel cells that are reliable, cost effective and present a value proposition to the customer will, in each case, have a material adverse effect on MTI Micro's and the Company's business plans, prospects, results of operations and financial condition.

A mass market for fuel cells may never develop or may take longer to develop than we anticipate.

Fuel cell systems represent emerging technologies, and we do not know whether consumers will adopt these technologies on a large scale or whether OEMs will incorporate these technologies into their products. In particular, if a mass market fails to develop, or develops more slowly than anticipated, for methanol portable power applications, we may be unable to recover our expenditures to develop our fuel systems and may be unable to achieve or maintain profitability, any of which could negatively impact our business. Estimates for the development of a mass market for fuel cell products and systems have lengthened in recent years. Many factors that are beyond our control may have a negative effect on the development of a mass market for fuel cells and our fuel systems for methanol applications. These factors include the following:

• cost competitiveness and physical size of fuel cell systems and components;
• availability, future costs and safety of methanol, natural gas and other potential fuel cell fuels;
• consumer acceptance of methanol or alternative fuel products;
• government funding and support for the development of methanol fuel cells for portable applications;
• the willingness of OEMs to replace current technology;
• consumer perceptions of methanol systems;
• regulatory requirements; and
• emergence of newer, breakthrough power technologies and products.

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Our cost to produce our current Mobion^®fuel cell product exceeds the amount for which we can currently sell such product. If we are unable to reduce the costs of our Mobion^®fuel cells, it will have a material adverse effect on MTI Micro's and the Company's

business plans, prospects, results of operations and financial condition:The commercialization of MTI Micro's Mobion^® fuel cell products depends upon MTI Micro's ability to significantly reduce the costs of these systems and products, since they are currently substantially more expensive than systems and products based on existing technologies, such as rechargeable batteries.

The price of our fuel cell products is dependent largely on material and other manufacturing costs. We are unable to offer any assurance that either we or a contract manufacturer will be able to reduce costs to a level which will allow production of a competitive product that the consumer finds attractive or that any product produced using lower cost materials and manufacturing processes will not suffer from a reduction in performance, reliability and longevity.

The production costs of our initial industrial product were higher than its sales price. We recognize that successfully implementing our strategy and obtaining a significant share of the military, industrial and consumer markets requires that we offer our direct methanol fuel cell products at competitive prices, which can only be accomplished when production costs are cut substantially from current levels. If we are unable to produce direct methanol fuel cell products at competitive prices relative to alternative technologies and products, our target market customers will be unlikely to buy our fuel cell products.

The failure to achieve cost reductions may materially adversely affect MTI Micro's and the Company's business plans, prospects, results of operations and financial condition.

Gillette may not be able to achieve commercialization of fuel refills on the timetable we anticipate, or at all, and the delay or failure to achieve such commercialization would have material adverse consequences on MTI Micro's and the Company's business plans, prospects, results of operations and financial condition:We cannot guarantee that Gillette will be able to, or will choose to, develop, acquire or license commercially viable fuel refills for Mobion^® fuel cell products on the timetable we anticipate, or at all. The commercialization of fuel refills for Mobion^® fuel cell products requires substantial technological advances to improve the efficiency, functionality, reliability, cost and performance of these systems and products and to develop commercial volume manufacturing processes for these systems and products. Gillette's failure to supply fuel refills would have a material adverse effect on MTI Micro's and the Company's business plans, prospects, results of operations and financial condition.

A viable market for micro fuel cell systems may never develop or may take longer to develop than we anticipate. If a market for fuel cells does not develop or is delayed, it will have a material adverse effect on our business plans, prospects, results of operations and financial condition:Micro fuel cell systems for portable electronic devices represent an emerging market, and we do not know the extent to which our targeted distributors and resellers will want to purchase them and whether end-users will want to use them. The development of a viable market for our systems may be impacted by many factors that are out of our control, including:

• the cost competitiveness of other micro fuel cell systems;
• the future costs of materials used to build our systems;
• consumer reluctance to try a new product;
• consumer perceptions of our systems' safety;
• regulatory requirements;
• improvements in existing rechargeable battery technology; and
• the emergence of newer, more competitive technologies and products.

If a viable market fails to develop or develops more slowly than we anticipate, we may be unable to recover the losses we will have incurred to develop our product and we may be unable to achieve profitability, each of which would have a material adverse effect on our business plans, prospects, results of operations and financial condition.

Our first field test ready military application Mobion^®fuel cell product could fail due to technical, customer acceptance, safety or other reasons. Any such failure could have a material adverse effect on MTI Micro's and the Company's business plans and prospects:We anticipate having field test ready military application Mobion^®fuel cell products available for sale by the end of 2006. We may experience problems with the fuel cells, including reliability issues, run time, customer acceptance or safety. If the fuel cells experience failures, it could result in a material adverse effect on MTI Micro's and the Company's business plans and prospects.

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Alternatives to our technology could render our systems obsolete prior to commercialization, which would have a material adverse effect on our business plans, prospects, results of operations and financial condition:Our Mobion^® fuel cells are one of a number of alternative portable power energy solutions being developed as replacements for batteries, including thin film batteries, extended life lithium batteries and other types of fuel cell technologies. Technological advances in existing battery technologies or other fuel cell technologies may render our micro fuel cell systems obsolete and this would materially adversely affect our business plans, prospects, results of operations and financial condition.

MTI Micro is dependent upon external OEMs to purchase certain of its products and integrate Mobion^® fuel cells into their products. If external OEMs do not purchase and integrate Mobion^® fuel cells into their products, our market will be very limited, which could have a material adverse effect on MTI Micro's and the Company's business plans, prospects, results of operations and financial condition: To be commercially useful, certain of our Mobion^®fuel cells must be integrated into products manufactured by OEMs. We cannot guarantee that OEMs will manufacture appropriate products or, if they do manufacture such products, that they will choose to use Mobion^®fuel cells. Any integration, design, manufacturing or marketing problems encountered by OEMs could adversely affect the market for Mobion^® fuel cells, which could have a material adverse effect on MTI Micro's and the Company's business plans, prospects, results of operations and financial condition.

In order to achieve mass commercialization of Mobion^® fuel cells, customers must be able to carry methanol fuel inside the passenger compartment of commercial airlines. If current airline, Federal Aviation Administration ("FAA") and certain international regulations do not change, passengers will be unable to carry non-dilute methanol in the passenger compartments of airplanes, which will have a material adverse effect on MTI Micro's and the Company's business plans, prospects, results of operations and financial condition: Current airline and FAA regulations and certain international laws, regulations and treaties limit the amount and concentration of methanol that any passenger can carry aboard passenger planes. We believe that these regulations must change for mass commercialization of Mobion^® fuel cell products to be possible. If pending regulatory changes are approved by ICAO, this will permit direct methanol micro fuel cells and refill cartridg es to be carried in the passenger compartment of airplanes. If these regulations do not change, it would materially adversely affect MTI Micro's ability to achieve mass commercialization of Mobion^® fuel cell products and have a material adverse effect on MTI Micro's and the Company's business plans, prospects, results of operations and financial condition.

In connection with the 2004 private placement, we may have to (1) sell shares of our common stock at prices which result in substantial dilution to our shareholders, and (2) issue additional shares of our common stock to Fletcher at prices that may be substantially below market value at the time of issuance without any payment required by Fletcher, which would cause our shareholders to suffer additional dilution: After giving effect to the 1,261,829 shares of common stock we issued to Fletcher on December 22, 2004 (as well as all shares issued or to be potentially issued to Fletcher in connection with our failure to satisfy the registration requirement as discussed in Note 11, Shareholders' Equity), the 2004 private placement provided Fletcher additional investment rights to purchase up to an additional $20 million of our common stock at a price equal to $6.34 per share (subject to adjustment). This price has been reduced to $6.023 per share due to our failure to satisfy the registratio n requirement, and may be further reduced due to, among other things, continuing failure to satisfy such registration requirement. Any exercise of the additional investment rights could result in sales of our common stock at prices that are below the market price for our common stock at the time the investment right is exercised and could result in substantial dilution to our shareholders.

Our agreement with Fletcher also provides that Fletcher will receive additional shares of our common stock with respect to shares it already owns, and the exercise price and term relating to unexercised additional investment rights will be adjusted to the benefit of Fletcher, each upon the occurrence of certain events or circumstances, some of which are beyond our control, including:

• issuances of our equity securities at a price below $7.048 per share (which is the price Fletcher paid in connection with its initial $10 million investment) or issuances of our equity securities at a price below $6.34 per share (which was the original exercise price relating to the additional investment rights);
• our failure to satisfy certain requirements relating to registering the resale of shares issued or issuable to Fletcher pursuant to the securities laws;
• a change in control of our Company; and
• a restatement of our financial results.
  

In any event, 8,330,411 shares is the maximum number of shares of our common stock we may be required to issue to Fletcher, which amount includes the 1,418,842 shares issued on January 29, 2004, the 1,261,829 shares issued on December 22, 2004 and the 66,413 registration penalty shares issued on April 20, 2005.

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In connection with the 2004 private placement, we are responsible for having the resale of shares purchased by Fletcher registered with the SEC within defined time periods and subject to penalties if the shares are not registered with the SEC within those defined time periods: Pursuant to our agreement with Fletcher, we are obligated, within ten business days after the closing of the purchase of

any additional shares by Fletcher pursuant to rights issued in connection with the 2004 Private Placement, to file a registration statement with the SEC covering the resale of all such shares. We are also obligated to cause each of those registration statements to be declared effective not more than sixty (60) days after the closing of the purchase of such shares, or if the registration statement is reviewed by the SEC, not more than ninety (90) days after the closing of the purchase of such shares. If we fail to file the registration statements or become effective as set forth above, we must issue to Fletcher a number of additional shares to reflect the number of shares it would have acquired if its purchase price was based on the actual exercise price reduced by five percent for each month in which we fail to satisfy our obligations and adjust the exercise price for the additional investment rights to such lower price. In addition, such failure may result in an extension of the investment term for ea ch day we fail to satisfy our registration obligations. The Company initially filed a Registration Statement on January 6, 2005 which was within ten business days after the closing of the purchase of additional shares by Fletcher on December 22, 2004. The 90-day deadline for this Registration Statement to be declared effective was March 22, 2005. Since the Registration Statement was declared effective on April 21, 2005, we failed to meet the March 22, 2005 deadline and therefore were required to issue 66,413 additional shares of common stock to Fletcher without any payment required on its part.

The sale of a substantial amount of our common stock in the public market could materially decrease the market price of our common stock: The Company agreed as part of the 2004 Private Placement with Fletcher to register for resale shares of our common stock owned by Fletcher. If Fletcher exercised its remaining investment right and a substantial amount of our common stock were sold in the public market, or even targeted for sale, it could have a material adverse effect on the market price of our common stock and our ability to sell common stock in the future.

Current shareholders may be diluted as a result of additional financings:stockholders. If we raise additional funds through the sale of equity or convertible debt securities in either the Company or MTI Micro, current shareholders' percentage ownership willcollaboration and licensing arrangements with third parties, it may be reduced. In addition, these transactions may dilute the value of common stock outstanding. Moreover, we may havenecessary to issue securities that may haverelinquish some rights preferences and privileges senior to our common stock. We cannot assure that we will be able to raise additional fundstechnologies or our products, or grant licenses on terms acceptable to us, if at all. If future financing is not available or is not available on acceptable terms, we may not be able to fund our future needs, which would have a material adverse effect on our business plans, prospects, results of operations and financial condition.

We may be involved in intellectual property litigation that causes us to incur significant expenses or prevents us from selling our products, which could have a material adverse effect on MTI Micro's and the Company's business plans, prospects, results of operations and financial condition:In recent years, hundreds of fuel cell patents have been issued worldwide. Many of these patents are broadly written and encompass basic and fundamental theories of how fuel cells should or could work. As we continue to develop our technology, our designs may infringe the patent or intellectual property rights of others. Whether our technology infringes or not, MTI Micro and our Company may become subject to lawsuits in which it is alleged that we have infringed the intellectual property rights of others. We may also commence lawsuits against others who we believe are infringing upon MTI Micro's rights. Involvement in intellectual property litigation could result in significant expense to MTI Micro and our Com pany, adversely affecting the development of sales of the challenged product or intellectual property and diverting the efforts of our technical and management personnel, whether or not such litigation is resolved in our favor. In the event of an adverse outcome as a defendant or plaintiff in any such litigation, MTI Micro and the Company may, among other things, be required to:

• pay substantial damages;
• cease the development, manufacture, use, sale or importation of products that infringe upon other patented intellectual property;
• expend significant resources to develop or acquire non-infringing intellectual property;
• discontinue processes incorporating infringing technology; or
• obtain licenses to the infringing intellectual property.

We cannot guarantee that MTI Micro or the Company would be successful in such development or acquisition or that such license would be available upon reasonable terms. Any such development, acquisition or license could require the expenditure of substantial time and other resources and could have a material adverse effect on MTI Micro's and the Company'sbusiness plans, prospects, results of operations and financial condition.

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MTI Micro's products use potentially dangerous, flammable fuels, which could subject its business and the Company to product liability claims. Any such lawsuits or claims could have a material adverse effect on MTI Micro's and the Company's business

plans, prospects, results of operations and financial condition: The sale of Mobion^® fuel cells exposes MTI Micro and the Company to potential product liability claims that are inherent in the methanol and products that use methanol industry. Methanol is flammable and therefore potentially dangerous. Any accidents involving MTI Micro's products or other methanol-based products could materially impede widespread market acceptance and demand for DMFCs which could have a material adverse effect on MTI Micro's and the Company's business plans and prospects. In addition, MTI Micro may be held responsible for damages beyond the scope of its insurance coverage. We also cannot predict whether MTI Micro will be ablenot favorable to maintain its insurance coverage on acceptable terms. Damages beyond the scope of MTI Micro's insurance coverage or the inability to maintain insurance coverage on acceptable terms would have a material adverse impact on MTI Micro's and the Company's business plans, prospect s, results of operations and financial condition.

We have incurred losses and anticipate continued losses. If we do not become profitable and sustain profitability, it will have a material adverse effect on our business plans, prospects, results of operations and financial condition: As of December 31, 2005, we had an accumulated deficit of $81.718 million. For the year ended December 31, 2005, our net loss was $15.094 million, which includes a net gain of $10.125 million from sales of securities available for sale and a loss of $10.407 million from derivative valuations and an operating loss of $15.098 million. We expect to continue incurring net losses from operations until we can produce sufficient revenues to cover costs. In order to achieve profitability, we must successfully achieve all or some combination of the following:

• develop new products for existing markets;
• sell these products to existing and new customers;
• increase gross margins through higher volumes and manufacturing efficiencies;
• control operating expenses; and
• develop and manage distribution capability.

Furthermore, we anticipate that we will continue to incur losses until we can produce and sell our fuel cell systems on a large-scale and cost-effective basis. Even if we do achieve profitability, we may be unable to sustain or increase our profitability in the future. Failure to do so will have a material adverse effect on our business plans, prospects, results of operations and financial condition.

Our competitors may develop a more cost effective, better product and bring that product to market faster than we can. If we do not create a competitive DMFC product or we are late to market, it will have a material adverse effect on our business plans, prospects, results of operations and financial condition: There are a number of other companies developing DMFCs. Some of our competitors may have better access to resources and capital than we do. Some of our competitors are much larger and have better access to manufacturing capacity, supply chains and distribution channels than we do. Some of our competitors may resolve technical or engineering issues before we do. Accordingly, one or more of our competitors may bring a mass commercial product to market before we do. In addition, one or more of our competitors may make a better or more cost effective product than we can make. Failure to get to market with the best and most cost competitive DMFC product before our competitors would have a material adverse effect on our business plans, prospects, results of operations and financial condition.

We have limited experience manufacturing fuel cell systems on a commercial basis. If we do not achieve the necessary manufacturing capabilities, it will have a material adverse effect on our business plans, prospects, results of operations and financial condition: To date, we have focused primarily on research and development and have limited experience manufacturing micro fuel cell systems on a commercial basis. We plan to manufacture our fuel cell products through third-party contract manufacturers. We can offer no assurance that either we, our contract manufacturers or any other party we partner with to volume-produce our products will develop efficient, automated, low-cost manufacturing capabilities and processes to meet the quality, price, engineering, design and production standards or production volumes required to successfully mass market our fuel cell products. Even if we or our contract manufacturers are successful in developing such manufacturing capability and processes, we do not know whether we or they will be timely in meeting our product commercialization schedule or the production and delivery requirements of potential customers. Failure to develop or procure such manufacturing capabilities will have a material adverse effect on the Company's business plans, prospects, results of operations and financial condition.

We may not be able to establish additional strategic relationships that we will need to complete our product development and commercialization plans.us. If we are unable to develop necessary strategic relationships on terms that are acceptable to us, it will have a material adverse effect on our business plans, prospects, results of operations and financial condition: We believe that we will need to enter into additional strategic relationships in order to complete our current product development and commercialization plans on schedule. If we are unable to identify or enter into a satisfactory agreement with potential partners,raise adequate funds, we may not be ablehave to

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complete liquidate some or all of our product development and commercialization plans on scheduleassets or at all, which would have a material adverse effect on our business plans, prospects, results of operations and financial condition. We may also need to scale back these plans in the

absence of a partner, which would materially adversely affect our future business plans, prospects, results of operations and financial condition. In addition, any arrangement with a strategic partner may require us to issue a material amount of equity securities to the partner or commit significant financial resources to fund our product development efforts in exchange for their assistance or the contribution to us of intellectual property. Any such issuance of equity securities woulddelay, reduce the percentage ownershipscope of or eliminate some or all of our then current shareholders, which would have a material adverse effect on our business plans, prospects, results of operationsresearch and financial condition.

We will rely on our partners to develop and provide components for our Mobion^® fuel cell systems. If our partners do not meet our quality, quantity, reliability or schedule requirements, it will have a material adverse effect on our business plans, prospects, results of operations and financial condition: We depend on third parties to supply many of the components of our Mobion^® fuel cell systems. A supplier's failure to develop and supply components in a timely manner, or to develop or supply components that meet our quality, quantity or cost requirements, or our inability to obtain substitute sources of these components on a timely basis or on terms acceptable to us, would harm our ability to manufacture our fuel cell systems. In addition, to the extent that our supply partners use technology or manufacturing processes that are proprietary, we may be unable to obtain comparable components fr om alternative sources. Failure to do so will have a material adverse effect on our business plan, prospects, results of operations and financial condition.development programs.

In addition, platinum is a key material in our micro fuel cells. Platinum is a scarce natural resource and we are depending upon a sufficient supply of this commodity. While we do not anticipate significant near or long-term shortages in the supply of platinum, any such shortages would adversely affect our ability to produce commercially viable fuel cell systems or significantly raise our cost of producing our fuel cell systems.

Our inability to deliver a commercially viable Mobion^®fuel cell on time, or at all, will have a material adverse effect on our business plans, prospects, results of operations and financial condition: We anticipate having field test ready military application Mobion^®fuel cell product available for sale by the end of 2006. There may be technical or engineering challenges we have not anticipated, issues of reliability for our device, an inability for our device to be integrated into existing electronic devices, difficulties in obtaining materials or components, or problems with manufacturing or distribution, and many other problems that we have not, and perhaps could not anticipate. All of these issues could delay or prohibit further releases of additional Mobion^®fuel cell products, which would have a material adverse effect on our business plans, prospects, results of operations and financial condition.

Failure to achieve future product development and the timing associated with entry into the military, industrial or consumer market or commercialization milestones will have a material adverse effect on our business plans, prospects, results of operations and financial condition: We have established aggressive product development and commercialization milestones and dates for achieving development goals related to technology and design improvements. We use these milestones to assess our progress toward developing commercially viable fuel cell systems. Delays in our product development will likely have a material impact on our commercialization schedule. If we experience delays in meeting our development goals or if our micro fuel cell systems exhibit technical defects or if we are unable to meet cost, performance or manufacturing goals, including power output, useful life and reliability, our commercialization schedule will be delayed. In this event, potential purchasers of our initial comme rcial systems may choose alternative technologies and any delays could allow potential competitors to gain market advantages. We cannot assure that we will successfully achieve our milestones in the future and the failure to achieve such milestones would have a material adverse effect on our business plans, prospects, results of operations and financial condition.

Our resources available to fund operations may fluctuate as the value of Plug Power's share price fluctuates. Such price fluctuations could result in our requiring additional funding sooner than anticipated: A primary asset of the Companyour company is the Plug Power common stock we own. As of December 31, 2007, we owned 1,137,166 shares of Plug Power common stock it owns. As of December 31, 2005, the Company owned 3,693,436 shares ofstock. Plug Power common stock in Plug Power, which is a publicly traded company.on The Nasdaq Global Market. The market price of the Plug Power common stock may fluctuate due toas a result of market conditions and other conditionsfactors over which the Company haswe have no control. Fluctuations in the market price of Plug Power'sPower’s common stock may result in a reduction of resources available to fund operations, which could result in our requiring additional funding sooner than anticipated.

If wecurrent U.S. Department of Transportation, Federal Aviation Administration, and certain international regulations do not change, passengers will be unable to carry methanol in the passenger compartments of airplanes, which would adversely affect our sales and results of operations.

Current airline and Federal Aviation Administration regulations and certain international laws, regulations, and treaties limit the amount and concentration of methanol that any passenger can carry onboard passenger planes. We believe that these regulations must change for mass commercialization of Mobion technology products to be possible. The implementation by the U.S. Department of Transportation, the Federal Aviation Administration, and other similar international bodies of regulatory changes approved by the International Civil Aviation Organization will permit direct methanol fuel cell systems and refill cartridges to be carried in the passenger compartment of airplanes. If these regulations are not successful in protecting our patents and intellectual property, it will have a material adverse effect on our business plans, prospects, results of operations and financial condition: Patent and trade secret rights are of material importance to us. No assurance can be given as to the issuance of patents or, if so issued, as to their scope. Patents granted may not provide meaningful protection from competitors. Even if a competitor's products were to infringe patents owned by usimplemented, it would be costlymaterially and adversely affect our ability to pursue an enforcement actionachieve mass commercialization of Mobion technology products and would divert funds and resources which otherwise could be used in operations. Furthermore, there can be no assurance that an enforcement action would be successful.

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In addition to our patent rights, we also rely on treatment of our technology as trade secrets and upon confidentiality agreements. These agreements may be breached, and we may not have adequate remedies for any breach. Our inability to obtain patents, as well as to protect and enforce any patents that are issued as well as trade secrets, could have a material adverse effect on our business plans, prospects, results of operations, and financial condition.

Our inability orportable 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:

Target markets for our proposed portable power source products, such as those for smart phones, digital cameras, and portable media players, 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.

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 currently do not anticipate selling our portable power source products directly to end users. Instead, 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 smart phones, digital cameras, and portable media players. 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 effectivelytheir 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 operations problems. The loss of our 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.

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 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 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 competitive 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.

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 plans, prospects, results of operations and financial condition: We continue to undergo rapid change incondition. In the scope and breadthevent of an adverse judgment, a court could hold that some or all of our operations as we advanceasserted intellectual property rights are not infringed, or are invalid or unenforceable, and could award attorneys’ fees to the development of our micro fuel cell products. Such rapid change is likely to place a significant strain on our senior management team and other resources. party.

We will be required to make significant investments in our engineering, logistics, financial and management information systems and to motivate and effectively manage our employees. Our business plans, prospects, results of operations and financial condition could be harmed if we encounter difficulties in effectively managing the budgeting, forecasting and other process control issues presented by such a rapid change.

Our share price could bemay become subject to extreme price fluctuations,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 shareholders could have difficulty trading shares: The markets for high technology companiessubject 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 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 particular have been volatile, and the market price of our common stock, which is traded on the Nasdaq National Market under the symbol MKTY, has been and may continue to be subject to significant fluctuations. Fluctuations could be in response to operating results, announcements of technological innovations or new products by us, or by our competitors, patent or proprietary rights developments, and market conditions for high technology stocks in general. In addition, the stock market in recent years has experienced extreme price and volume fluctuationsissued patents that sometimes have been unrelated or disproportionate to the operating performance of individual companies. These market fluctuations, as well as general economic conditions, may adversely affect the market price of our common stock and the ability of shareholders to dispose of o ur common stock.

General economic conditions may affect investors' expectations regarding our financial performancematerially and adversely affect our stock price, which maybusiness. 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 a material adverse effect onsignificant costs, substantial damages, and our business plans, prospects, results of operations and financial condition: Certain industries in which weinability to manufacture, market, or sell and intend to sell products, such as the energy and semiconductor industries are highly cyclical. In the future, our results may be subject to substantial period-to-period fluctuations as a consequence of the industry patternsany of our customers, generalproduct 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 regional economic conditions, and other factors. These factors may also have a material adverse effect onif we independently discovered, that our business plans, prospects, results of operations and financial condition.

The loss of key employees may have a material adverse effect on our business plans, prospects, results of operations and financial condition: Our success will depend, in large part, upon our ability to attract, motivate and retain highly qualified scientists and engineers, as well as highly skilled and experienced management, sales and technical personnel. Competition for these personnel is intense, andproduct offerings violated third-party proprietary rights, there can be no assurance that we willwould be successfulable 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 attracting, motivatingaddition treble the compensatory damages and award attorneys’ fees. These damages could materially and adversely affect our business and financial condition.

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 retaining key personnel. 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, dependswhich 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 significant extent uponparticular technology, our customers may decide not to introduce or may terminate products utilizing the technology for a numbervariety of key employees,reasons, including membersthe following:

The lossnature of the services ofour business will require us to make continuing investments for new technologies. Significant expenses relating to one or more of these senior executives or key employees, or the inabilitynew technologies that ultimately prove to continue to attract qualified personnel, could delay product development cycles or otherwise harm our business andbe 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 plans,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 depends on various factors, including the following:

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.

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

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 or customers do so more effectively than we do.

New technologically 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 electronics industry is 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 consumers, 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:

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

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 plan to transact our portable power source business predominantly in U.S. dollars and bill and collect our sales in U.S. dollars. 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. 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.

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 electronic devices. Softening demand in these markets caused by ongoing economic uncertainty may result in decreased revenue or earnings levels or growth rates. 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, and stock price.

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.

Our prospectus depends to a significant extent on our strategic allowances with Samsung and Gillette. In addition, 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 these alliances may impede our ability to introduce new products and enter new markets.

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 injuries 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, condition.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

Item 1B: Unresolved Staff Comments

respond to customer requirements more quickly than we can. Our competitive position could suffer if one or more of our customers determine not to utilize our portable power source products and instead decide to contract with our competitors or to use alternative technologies.

None.Our ability to compete successfully will depend on a number of factors, both within and outside our control. These factors include the following:

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 noncompetition and nondisclosure 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 and 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.

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:

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.

Item 2: Properties

The Company leases

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

*The Company closed the California office as of December 31, 2005 and vacated this facility. Effective as of January 31, 2006, we have terminated this lease.

In management's opinion, theWe 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.

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Item 3: Legal Proceedings

At any point in time, the Company and its subsidiarieswe 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. The Company doesWe do not believe there are any such proceedings presently pending which could have a material adverse effect on the Company'sour financial condition.

Lawrence

On September 9, 1998, Barbara Lawrence, the Lawrence Group, Inc. ("Lawrence") and certain other Lawrence-related entities ("Plaintiffs") initially filed suit in the Bankruptcy Court and the United States District Court for the Northern District of New York which were subsequently consolidated in the District Court, against First Albany Corporation ("FAC"), MTI, Dale Church, Edward Dohring, Beno Sternlicht, Alan Goldberg and George McNamee (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 (2,462,727 shares post split) shares of the Company's stock from the Plaintiffs. The case concerns the Defendants' 1997 purchase of MTI shares from the Plaintiffs at the price of $2.25 per share ($0.75 per share post split). FAC acted as Placement Agent for the Defendants in the negotiation and sale of th e shares and in proceedings before the Bankruptcy Court for the Northern District of New York, which approved the sale in September 1997.

Plaintiffs claim that the Defendants failed to disclose material inside information concerning Plug Power, LLC to the Plaintiffs and therefore the $2.25 per share ($0.75 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' cause of action was dismissed by the United States District Court for the Northern District of New York. 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 and remanded the case for further consideration of the Plaintiff's claims as motions to modify the Bankruptcy Court sale order. The Plaintiff's claims have now been referred back to Bankruptcy Court for such consideration. In September 2003, th e Bankruptcy Court issued an order permitting Plaintiffs to conduct limited discovery concerning how First Albany formed an opinion about the Company's stock up until the date the Stock Purchase Agreement was executed. Discovery has commenced.

The Company believes the claims have no merit and intends to defend them vigorously.The Company cannot predict theoutcome of the claims nor reasonably estimate a range of possible loss given the current status of the litigation. Accordingly, no amounts have been reserved for this matter.

Item 4: Submission of Matters to a Vote of Security Holders

There were no matters submitted to a vote of the registrant'sour security holders during the fourth quarter of fiscal 2005.

2007.

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PART II

Price Range of Common Stock

MTIOur common stock is traded on theThe Nasdaq NationalGlobal Market under the symbol MKTY.“MKTY”. The following table sets forth the high and low last reported sale prices forof our common stock as reported by the Nasdaq National Market for the periods indicated:

Number of Equity Security Holders

As of February 28, 2006, the Company had approximately 555 holders of our common stock. However, management believes that a significant number of shares are held by brokers under a "nominee name" and that the number of beneficial shareholders of our common stock is approximately 15,000.

Dividends

The payment of dividends is within the discretion of the Company's Board of Directors and will depend, among other factors, on earnings, capital requirements, and the operating and financial condition of the Company. The Company has never paid and does not anticipate paying dividends in the foreseeable future.

Recent Sales of Unregistered Securities

None.

Issuer Purchases of Equity Securities

None.

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Item 6: Selected Financial Data

The following tablestable sets forth our summary consolidated financial data for the fiscal years ended December 31, 2005, 2006, and 2007, 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, 2003 and 2004 set forth selectedin the following table from our audited consolidated financial statement not included in this report. You should read the following summary consolidated financial data and other operating information of the Company. The selected statement of operations and balance sheet data for 2005, 2004, 2003, 2002 and 2001 as set for below are derived from the audited financial statements of the Company. The information is only a summary and you should read it in conjunctiontogether with the Company's audited financial statements and related notes and other financial information included herein and "Management'sunder “Management’s Discussion and Analysis of Financial Condition and Results of Operations."Operations” and our consolidated financial statements, including the related notes thereto.

22

Item 7: Management'sManagement’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 accompanyingConsolidated Financial Statements and Notes theretothe related notes included withinelsewhere in this Annual Report on Form 10-K. In addition to historical information, this Annual Report on Form 10-K and the followingReport. This discussion contain statements that are not historical facts and are considered forward-looking within the meaning of the Private Securities Litigation Act of 1995. Certain statements made in this document that state Management's intentions, hopes, goals, beliefs, expectations, projections, plans, anticipation, outlook or predictions of the future are forward looking statements. Such statements include, among others, estimates of cash needs and sources; our ability to meet cash needs in the future; MTI Micro's plans under its strategic alliance agreement with its fuel refill partner; future prospects and applications for fuel cell systems; MTI's, MTI Micro's and MTI Instruments' future business prospects, technology and performance; the market po tential for and progress MTI Micro is making in developing its Mobion fuel cells; the significance of any contracts, grants, awards, or other recognition that MTI Micro may receive; the timing or success of market entry, in either the vertical or horizontal markets, by MTI Micro; MTI Micro's ability to meet its stated milestones on time, if at all; MTI, MTI Micro's and MTI Instruments' ability to increase or maintain sales into military and other governmental markets; the importance of any relationships we may have, and our ability to maintain those relationships going forward; MTI Micro's ability to produce products or prototypes consistent with any announced specifications or customer requirements, if at all; MTI Micro's ability to remain a leader in advancing codes and standards; and the importance of any patents or codes and standards. Allcontains forward-looking statements, are made as of today,which involve risk and MTI disclaims any duty to update such statements. It is important to note that the Company'suncertainties. Our actual results could differ materially from those projectedanticipated in the forward-looking statements. Factors that could cause the anticipated results not to occur include, among others, risks related to financing; uncertainties in development, manufacturing, competition and consumer demand for DMFCs; Gillette's ability to terminate its agreements with MTI Micro prior to commercializationstatements as a result of DMFCs; and the riskcertain factors, listedincluding those discussed in Item 1A: Risk Factors.

“Risk Factors” and elsewhere in this Annual Report.

Overview

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,Overview

We are developing and the Test and Measurement Instrumentation segment, which is conducted through MTI Instruments, Inc. ("MTI Instruments"), a wholly owned subsidiary.

At its MTI Micro subsidiary, the Company is primarily focused on the development and commercialization of advanced cord-freecommercializing off-the-grid rechargeable power pack technologysources for portable electronics. MTI Micro hasWe have developed a patented, proprietary direct methanol fuel cell ("DMFC") technology platform called Mobion,^®, which generates electrical power using up to 100% methanol as fuel. MTI Micro'sOur 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. The methanol used by the technology is intendedfully biodegradable. We are currently the only micro fuel cell developer to replacehave demonstrated power density of over 50 mW/cm² with high energy efficiencies of 1.4 Wh/cc of methanol. For these reasons, we believe our technology offers a compelling alternative to current Lithium-Ionlithium-ion and similar rechargeable battery systems currently used by original equipment manufacturers (OEMs)and branded partners, or OEMs, in many hand heldhandheld electronic devices, such as mobile phones (including smart phones) and mobile phone accessories, digital cameras, portable media players, personal digital assistants, or PDAs, Smartphones and global positioning systems, or GPS devices. We believe our platform will facilitate the development of numerous product advantages, including small size, environmental friendliness, and simplicity of design, all critical for commercialization in the consumer market, and can be implemented as three different accessories.product options: a compact external charging device, a snap-on or attached power accessory, or a lithium-ion battery replacement embedded fuel cell power solution. We intend to commercialize the Mobion platform in 2009.

Our Mobion technology eliminates the need for active water recirculation pumps or the inclusion of water as a fuel dilutant. The Company believes that when commercialized,water required for the electrochemical process is transferred internally within the Mobion^® could eventually have higher energy density and therefore provide multiple times Chip from the benefitssite of existing Lithium-Ion batteries. When and if Mobion^®fuel cells are ready to be sold in mass-commercial markets, they should be able to power a wireless electronic device for lon ger periodswater generation on the air-side of time than Lithium Ion batteries without recharging/refueling, and be instantly refueledthe cell. This internal flow of water takes place without the need for any pumps, complicated re-circulation loops or other micro-plumbing tools. Our Mobion technology is protected by a patent portfolio that includes over 90 U.S. patent applications covering five key technologies and manufacturing areas. Our goal is to become a leading provider of portable power outlet or a lengthy recharge.(See Item 1: Business, New Energy Segment.)for handheld electronic devices.

At its MTI Instruments subsidiary, the Company designs, manufactures,We also design, manufacture, and sellssell high-performance test and measurement instruments and systems. MTI Instruments was incorporated as a subsidiary on March 8, 2000 and operatessystems serving three product groups:markets: general dimensional gaging,gauging, semiconductor, and aviation. These products consist ofof: electronic, computerized gaginggauging instruments for position, displacement and vibration applications withinfor the design, manufacturing and test markets; semiconductor products for wafer characterization of semi-insulating and semi-conducting wafers within the semiconductor market;characterization; and engine balancing and vibration analysis systems for both military and commercial aircraft.(See Item 1: Business, Test and Measurement Instrumentation Segment)

MTI also co-founded and retains a minority interest in Plug Power Inc. ("Plug Power") (Nasdaq: PLUG), a developer of clean, reliable, on-site energy products.

Our cash requirements depend on numerous factors, including completion of our productportable power source products development activities, our ability to commercialize our systems,portable power source products, market acceptance of our systemsportable power source products, and other factors. We expect to pursue the expansion of our operations through internal growth and strategic partnerships.

23

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

From inception through December 31, 2005, the Company has2007, we have incurred net lossesan accumulated deficit of $81.718$105.1 million and expectswe expect to incur losses for the foreseeable future as it continueswe continue micro fuel cell product development and commercialization programs. The Company expectsWe expect that losses will fluctuate from year to year and that such fluctuations may be substantial as a result of, among other factors, sales of securities available for sale andas well as the operating results of our businesses.

Results of Operations

Results of Operations for the Year Ended December 31, 2007 Compared to December 31, 2006.

Product Revenue:Product revenue in our test and measurement instrumentation business for 2007 increased by $1.4 million, or 17.8%, to $9.0 million for the fiscal year ended December 31, 2007 from $7.7 million for the fiscal year ended December 31, 2006. This performance was primarily the result of a $602,000 increase in activity by the U.S. Air Force, driven by the New PBS-4100 systems contract. Also contributing were increased purchases by our Japanese distributor (particularly OEM capacitance), as well as increased volume in semiconductor product shipments. Total product revenue for general dimensional gauging products increased by $298,000, or 7.2%, to $4.5 million, while total product revenue for semiconductor products increased by $364,000, or 71.2%, to $875,000.

In our test and measurement instrumentation business during 2007, the U.S. Air Force accounted for $2.4 million, or 26.3%, of product revenue while during 2006, the U.S. Air Force accounted for $1.8 million, or 23.1%, of product revenue. Additionally, during 2007, Koyo Precision, our Japanese distributor, represented $2.5 million, or 27.7%, of product revenue while during 2006, Koyo Precision represented $1.8 million, or 22.9%, of product revenue.

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

^{__________________________________________________________________________________________}

Funded Research and Development Revenue:Funded research and development revenue in our new energy business during 2007 increased by $1.1 million, or 218.2%, to $1.6 million for the year ended December 31, 2007 from $489,000 for the year ended December 31, 2006. The increase in revenue was primarily the result of billings under the DOE contract, which had its funding reinstated during May 2007 after it had been suspended during 2006. This DOE funding resumption contributed an additional $613,000 to revenue during 2007. 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 increased by $21,000 during 2007 over 2006.

^{__________________________________________________________________________________________}

Cost of Product Revenue:Cost of product revenue in our test and measurement instrumentation business increased by $530,000, or 18.3%, to $3.4 million during the year ended December 31, 2007 from $2.9 million during the year ended December 31, 2006. As a percentage of product revenue, the annual cost of product revenue remained relatively consistent with 2006, and this increase was consistent with the higher revenue during 2007.

Gross profit as a percentage of product revenue decreased by 0.2% to 62.0% for the year ended December 31, 2007, remaining relatively consistent with 2006.

Funded Research and Product Development Expenses:Funded research and development expenses in our new energy business increased $739,000, or 64.1%, to $1.9 million for the year ended December 31, 2007 from $1.2 million for the year ended December 31, 2006. While the active contracts were relatively consistent between periods, costs for the DOE contract increased $1.3 million, reflecting its reinstatement during May 2007, while costs for the Samsung contract increased by $22,000. These increases were partially offset by a decrease in costs for the SAFT contract of $576,000, as that contract was completed during the first quarter of 2007.

Unfunded Research and Product Development Expenses:Unfunded research and product development expenses decreased $1.9 million, or 16.1%, to $9.9 million for the year ended December 31, 2007 from $11.8 million for the year ended December 31, 2006. This decrease reflects a $2.2 million decrease in development costs related to (a) the DOE contract that resumed during May 2007, which related increase is reflected in funded research and product development expenses, and (b) cost savings from the decision to suspend work on our high power program during March 2007. This decrease was partially offset by a $317,000 increase in product development expenses in our test and measurement instrumentation business reflecting increased staffing and external product development costs focused on the development of the division’s new stand-alone measurement and data acquisition solution, stand-alone laser head, as well as other precision measurement solutions.

Selling, General and Administrative Expenses:Selling, general and administrative expenses decreased by $1.3 million, or 13.2%, to $8.7 million for the year ended December 31, 2007 from $10.1 million for the year ended December 31, 2006. This decrease was primarily the result of (a) a $387,000 decrease in non-cash stock-based compensation charges reflecting the difference between sign on and promotion grants during 2006 compared with primarily annual compensation grants during 2007 and the reversal of expense during 2007 related to certain cancelled executive stock-based performance grants where performance goals were not met, (b) a $528,000 decrease in outside services, including audit, legal, and consulting fees, (c) a $345,000 decrease in recruiting and relocation costs, (d) a $178,000 increase in severance costs attributable to employees terminated as a result of our March 2007 restructuring, (e) a $632,000 decrease in wages and benefits, which was also attributable to our March 2007 restructuring, (f) a $227,000 decrease in other operating expenses, primarily insurance and laboratory operating fees, (g) a $647,000 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, and (h) a $40,000 decrease in other expenses, net.

Operating Loss:Operating loss for the year ended December 31, 2007 compared with the operating loss for the year ended December 31, 2006 decreased by $4.4 million to $13.3 million, a 24.7% 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, 2007 was $2.5 million compared with a gain of $4.3 million for the year ended December 31, 2006. During 2007, we sold 1,452,770 shares of Plug Power common stock at a weighted average price of $3.53 per share, with gross proceeds to us of $5.1 million.

Gain (loss) on Derivatives:We recorded a gain on derivative accounting of $3.0 million for the year ended December 31, 2007 and a gain of $182,000 on derivative accounting for the year ended December 31, 2006. Both the 2007 and 2006 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, 2007 was 33%, while the income tax rate for the year ended December 31, 2006 was 15%. 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, 2007 was $22.3 million and at December 31, 2006 was $18.9 million. We determined that it was more likely than not that the ultimate recognition of certain deferred tax assets would not be realized.

Results of Operations for the Year Ended December 31, 2006 Compared to December 31, 2005.

Product Revenue:Product revenue in our test and measurement instrumentation business increased by $1.7 million, or 27.5%, to $7.7 million for the year ended December 31, 2006 from $6.0 million for the year ended December 31, 2005. This performance was primarily the result of (a) an increase of $1.5 million, or 55.0%, in dimensional gauging sales, particularly direct capacitance sales through our Japanese distributor, (b) increases in semiconductor sales of $200,000, as 18 manual, one automatic, and one semi-automated metrology

tool systems were sold during the year, compared to seven manual, one semi-automated, and four OEM systems during 2005, (c) commercial aviation equipment sales increases of $539,000, and (d) lower revenue from the U.S. Air Force of $611,000 as a result of fewer purchases of new equipment and reduced activity under the existing repair contract.

In our test and measurement instrumentation business, the U.S. Air Force accounted for $1.8 million, or 23.1%, of product revenue during the year ended December 31, 2006 compared with $2.4 million, or 39.7%, of product revenue during the year ended December 31, 2005. During 2006, Koyo Precision, our Japanese distributor, represented $1.8 million, or 22.9%, of product revenue.

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

^{__________________________________________________________________________________________}

Funded Research and Development Revenue:Funded research and development revenue in our new energy business decreased $1.3 million, or 73.3%, to $489,000 for the year ended December 31, 2006 from $1.8 million for the year ended December 31, 2005. The decrease in revenue was primarily the result of the suspension of previously approved DOE funding for 2006 and the completion of other programs that were active in 2005, including programs with the New York State Energy Research and Development Authority, the Army Research Labs, the Marine Corps, the Cabot Superior Micro Powders subcontract with the National Institute of Standards and Technology, and Harris. This decrease was partially offset by $427,000 of revenue recognized from the Samsung alliance agreement during 2006.

Information regarding government and private company development contracts included in funded research and development revenue is as follows:

^{__________________________________________________________________________________________}

Cost of Product Revenue:Cost of product revenue in our test and measurement instrumentation business increased by $519,000, or 21.8%, to $2.9 million for the year ended December 31, 2006 from $2.4 million for the year ended December 31, 2005. This increase is consistent with higher product revenue during 2006 compared with 2005.

Gross profit as a percentage of product revenue increased by 1.8% to 62.2% for the year ended December 31, 2006. The improvement in gross margin during 2006 was primarily the result of a five point rise in average margins on capacitance product sales resulting from higher sales volume and improved pricing strategies.

Funded Research and Product Development Expenses:New energy funded research and product development expenses decreased by $2.4 million, or 67.6%, to $1.2 million for the year ended December 31, 2006 from $3.6 million for the year ended December 31, 2005. The decreased costs were attributable to active contracts during 2005, which were no longer active during 2006. During 2006, we had active contracts with Samsung, DOE and SAFT, while during 2005 we had active contracts with DOE, NYSERDA, SAFT, NIST, ARL, and the Marine Corps.

Unfunded Research and Product Development Expenses:Unfunded research and product development expenses increased by $5.7 million, or 92.4%, to $11.8 million for the year ended December 31, 2006 from $6.1 million for the year ended December 31, 2005. This increase reflected a $5.4 million increase in our new energy business related to increased internal costs for the development of micro fuel cell systems and costs in connection with developing prototypes and product intent prototypes, including a $512,000 non-cash charge for share-based compensation resulting from the adoption of SFAS No. 123R, which requires that the fair value of share-based compensation be expensed. This increase also included a $208,000 increase in product development expenses in our test and measurement instrumentation business for projects related to the development of a glass thickness gauge, improvements to the portable engine vibration and balancing system, and updated industrial balancing software.

Selling, General and Administrative Expenses:Selling, general and administrative expenses decreased by $815,000, or 7.5%, to $10.1 million for the year ended December 31, 2006 from $10.9 million for the year ended December 31, 2005. This decrease was primarily the result of (a) an $892,000 increase in non-cash equity compensation charges resulting from the adoption of SFAS No. 123R, which required that the fair value of share-based compensation be expensed, (b) a $1.1 million decrease in salaries and engineering management costs, partially a result of an increase in costs directly charged to research and product development and the elimination of the government systems group during the second quarter of 2005, (c) a $640,000 decrease related to increases in liquidations to unfunded research and development costs, which was a result of having charged more time to internal development projects for low power and high power technology platform developments, the development of prototypes for Samsung, and the development of the Mobion 30M product, (d) a $259,000 decrease in the Los Alamos National Laboratory license fees as a result of an amendment of the license agreement, which resulted in reduced minimum annual license payments, (e) a $152,000 decrease in depreciation costs primarily related to the renewal of the lease on our main office, (f) a $104,000 increase in commission costs at MTI Instruments, (g) a $131,000 increase in incentive compensation primarily related to new executive employment agreements, (h) a $261,000 increase in marketing costs as MTI Micro raised its emphasis on marketing and business development and MTI Micro.Instruments underwent a major rebranding campaign during 2006, and (i) a $39,000 decrease in other expenses, net.

Operating Loss:Operating loss increased by $2.6 million, or 17.5%, to $17.7 million for the year ended December 31, 2006 compared with the year ended December 31, 2005 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, 2006 was $4.3 million compared with $10.1 million for the year ended December 31, 2005. During the year ended December 31, 2006, we sold 1,103,500 shares of Plug Power common stock at a weighted average price of $5.66 per share, with gross proceeds to us of $6.2 million.

On June 24, 2005, Fletcher International Ltd., or Fletcher, notified us of its election to exercise in full its right to purchase from us an amount of common stock of Plug Power. As a result of this election, Fletcher purchased 1,799,791 shares of Plug Power common stock from us at a price of $0.7226 per share, with proceeds to us of $1.3 million. In connection with this exercise, we recognized a loss on this embedded derivative immediately prior to exercise of $7.2 million and a gain on the sale of Plug Power common shares of $9.6 million.

Gain (loss) on Derivatives:We recorded a gain on derivative accounting of $182,000 for the year ended December 31, 2006 and a loss of $10.4 million on derivative accounting for the year ended December 31, 2005. The 2006 gain was the result of derivative treatment of the freestanding warrants issued in conjunction with our December 2006 capital raise, while the 2005 result related to an embedded derivative for the purchase of Plug Power common stock, which was issued as part of the 2004 private placement transaction. The warrant derivative was valued using the Black-Scholes Pricing model, as was the embedded derivative prior to its exercise on June 24, 2005. Upon exercise, the embedded derivative was valued at its intrinsic value.

Income Tax (Expense) Benefit:Our income tax expense rate for the year ended December 31, 2006 was 15%, while the income tax expense rate for the year ended December 31, 2005 was 11%. These tax rates were primarily the result of losses generated by operations, changes in the valuation allowance, 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, 2006 was $18.8 million and at December 31, 2005 was $10.9 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, sales of securities available for sale, 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, 2007, we had an accumulated deficit of $105.1 million. During the year ended December 31, 2007, our results of operations resulted in a net loss of $9.6 million and cash used in operating activities totaling $11.7 million. This cash use in 2007 was funded primarily by cash and cash equivalents on hand as of December 31, 2006 of $14.5 million and proceeds from the sales of securities available for sale of $5.1 million. We expect to continue to incur losses as we seek to develop and commercialize our portable power source products and we expect to continue funding our operations from current cash and cash equivalents, the sales of securities available for sale, proceeds, if any, from equity financings, including warrants issued in connection with the December 2006 capital raise, and government funding. We expect to spend approximately $11.7 million on research and development of Mobion technology and $1.8 million in research and development on MTI Instruments’ products during 2008.

Additional financing during 2008 may not be available to us on acceptable terms, if at all. Cash used to support operations is expected to total approximately $11.8 million and cash used for capital expenditures is expected to total approximately $1.1 million. Capital expenditures will consist of purchases of manufacturing and laboratory equipment, software, computer equipment, and furniture. Proceeds from our sale of securities available for sale are subject to fluctuations in the market value of Plug Power. We may also seek to supplement our resources through additional equity offerings, sales of assets (including MTI Instruments), and additional government revenue could also provide more resources.

As of December 31, 2007, we owned 1,137,166 shares of Plug Power common stock. Potential future sales of Plug Power securities will generate taxable income or loss, which is different from book income or loss, as a result of the tax bases in these assets being significantly different from their book bases. Book and tax bases as of December 31, 2007 are as follows:

Plug Power stock is currently traded on The Nasdaq Global Market and is therefore subject to stock market conditions. When acquired, these securities were unregistered. Our Plug Power securities are considered “restricted securities” as defined in the securities laws and may not be sold in the future without registration under the Securities Act, unless in compliance with an available exemption from registration. While our Plug Power shares remain “restricted securities,” these shares are now freely transferable in accordance with Rule 144(d) under the Securities Act, subject to the limitations associated with such rule.

Working capital was $11.3 million at December 31, 2007, a $9.5 million decrease from $20.8 million at December 31, 2006. This decrease was primarily the result of the use of cash in operations offset by proceeds from sale of securities available for sale.

At December 31, 2007, the Company’s order backlog was $445,000, compared to $220,000 at December 31, 2006.

Our inventory turnover ratios and average accounts receivable days sales outstanding for the years ended December 31, 2006 and 2007 and their changes are as follows:

The decline in inventory turnover stemmed from a 13% higher year-end inventory balance needed to support new product initiatives as these products gain acceptance in their targeted markets, as well as maintenance of higher stock levels to support continued growth at strategic end-use customers.

The increase in average accounts receivable days sales outstanding in 2007 compared with 2006 was primarily attributable to our decision to grant our largest commercial customer 90-day payment terms.

Cash flow used by operating activities was $11.7 million during 2007 compared with $12.7 million during 2006. This cash use decrease of $1.0 million reflected a net decrease of $3.5 million in cash expenditures to fund operations coupled with net balance sheet changes, which increased cash expenditures by $2.5 million, reflecting the timing of cash receipts and payments, particularly recognition of

deferred revenue and payment of certain accrued liabilities.

Capital expenditures were $414,000 during 2007, a decrease of $1.2 million from the prior year. Capital expenditures during 2007 included computer equipment, software, and manufacturing and laboratory equipment. Outstanding commitments for capital expenditures as of December 31, 2007 totaled $35,000 and included expenditures for laboratory and computer equipment. We expect to finance these expenditures and other capital expenditures during 2008 with current cash and cash equivalents, the sale of securities available for sale, equity financing, and other sources, as appropriate and to the extent available.

During 2007, we sold 1,452,770 shares of Plug Power common stock with proceeds totaling $5.1 million and gains totaling $2.5 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, 2007, our remaining net operating loss carry forwards were approximately $54 million.

Off-Balance Sheet Arrangements

Pursuant to a financing transaction between us and certain investors on December 15, 2006, we issued warrants to purchase up to an aggregate 3,027,778 shares of our common stock exercisable at any time until December 19, 2011 at an exercise price per share of $2.27. The shares issuable upon exercise of these warrants would be issued under a shelf registration statement covering the resale of such shares. The terms of the warrant agreement permits a cash settlement with the holders of the warrants if we are acquired by, or merge with, a private company. Because of the possibility of such a settlement, we have classified this agreement as an asset/liability derivative in accordance with SFAS No. 133 and EITF 00-19.

Critical Accounting Policies and Significant Judgments and Estimates

The Company'sfollowing discussion and analysis of its financial condition and results of operations is based upon the Company'sour consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Note 12 to the consolidated financial statements includes a summary of the Company'sour most significant accounting policies. The preparation of these financial statements requires the Companyus to make estimates and judgments that affect the reported amounts of assets, liabilities, revenuesrevenue and expenses, and related disclosure of assets and liabilities. On an on-going basis, the Company evaluates itswe evaluate our estimates and judgments, including those related to revenue recognition, inventories, securities available for sale, income taxes, share-based compensation and derivatives. Management bases itsWe 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 jud gmentsjudgments 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. Management discussed ourWe review critical accounting estimates with the Audit Committee of our Audit Committee.Board of Directors.

The significant accounting policies that management believeswe believe are most critical to aid in fully understanding and evaluating our reported financial results include the following:

Revenue Recognition: The Company recognizesWe 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 DMFCdirect methanol fuel cell technology. Some of these contracts require the Companyus to contribute to the development effort. The customers for these contracts are both commercial customers and various state and federal government agencies. WhenWhile government agencies are providing revenue, we do not expect the government to be a significant end user of the resulting products. Therefore, the Company doeswe 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 the Company iswe are not successful in securing additional funding, the Company recordswe record the estimated additional expense before it is incurred.

We apply the guidance in SAB No. 104,Revenue Recognition, 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. 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 Comp any had no accrual for contract losses for the year ended December 31, 2005.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.

The Company recognizes

We also recognize revenue from product sales in accordance with Staff Accounting Bulletin ("SAB")SAB No. 104,Revenue Recognition.104. Product revenue is recognized 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 the Company haswe 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 the Company,us, all revenue related to the product is deferred and recognized upon the completion of the installation.

Inventory: