Soluna Holdings, Inc - Quarter Report: 2009 March (Form 10-Q)

MECHANICAL TECHNOLOGY, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

On February 20, 2009, MTI Micro and the Investors agreed to, among other things, amend the Bridge Notes (“Amendment No. 1”) to permit MTI Micro to sell additional Bridge Notes with an additional principal amount of up to $500,000, and to extend the maturity date from March 31, 2009 to May 31, 2009 (the “Maturity Date”). No other terms of the Bridge Notes were amended. Following the effectiveness of the Amendment No. 1, MTI Micro borrowed an additional $500,000 from an existing Bridge Investor, a fund managed by Dr. Robb, bringing the aggregate outstanding principal amount borrowed under the Bridge Notes, as amended, to $2.7 million, including conversion of outstanding debt totaling $700,000 thousand owed to the Company.

On April 15, 2009, MTI Micro and the Investors agreed to amend the Bridge Notes (“Amendment No. 2”) to permit MTI Micro to sell additional Bridge Notes with an additional principal amount of up to $800,000 to an additional investor and the fund managed by Dr. Robb, and to extend the maturity date from May 31, 2009 to March 31, 2010 (the “Maturity Date”).

If the Next Equity Financing does not occur on or before the Maturity Date, all principal and (at MTI Micro’s option) accrued interest outstanding under all of the Notes shall be converted into equity securities of MTI Micro based upon a valuation of MTI Micro and on such terms to be agreed upon by MTI Micro and the holders of a majority interest of the Notes within thirty (30) days following the earlier to occur of (i) the Maturity Date or (ii) the date upon which the aggregate principal amount under all the Notes equals or exceeds $3,500,000, which the valuation and terms shall be negotiated in good faith by MTI Micro and a majority interest of the Notes.

The Bridge Notes have an interest rate of 10%, compounded annually. Accrued interest at March 31, 2009 was $87,000. MTI Micro intends to use the proceeds for general corporate purposes, including development and commercialization activities in support of its portable power source products. The Bridge Notes were issued in private placements with accredited investors and were exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.

The bridge note payable has been accounted for as a liability in accordance with FAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, as it represents a financial instrument with an obligation that requires settlement by issuance of a variable number of the issuer’s equity shares that has a value equal to a fixed monetary amount.

Depending on the valuation of MTI Micro at the time of conversion, the Company’s ownership position could be substantially diluted, and the Company may no longer have sufficient equity to control the operations of MTI Micro. If MTI Micro and holders of a majority in interest of the Bridge Notes cannot agree upon the valuation and terms of a negotiated conversion, and do not consummate such negotiated conversion within thirty (30) days following the Maturity Date, then all principal and accrued interest outstanding under the Bridge Notes shall be due and payable upon demand by the holders at any time thereafter.

In the event of a change of control of MTI Micro prior to the consummation of the Next Equity Financing, a negotiated conversion, or the repayment in full of all principal and accrued interest under the Bridge Notes, then all unpaid principal and accrued interest shall become immediately due and payable in an amount equal to 125% of the principal amount of the Bridge Notes and 100% of the accrued interest then outstanding within thirty (30) days following the consummation of a change in control.

The Bridge Notes contain customary negative covenants for loans of this type, including limitations on MTI Micro’s ability to incur indebtedness, issue securities, and dispose of assets. As of March 31, 2009, MTI Micro was not in default. The Bridge Notes are secured by all of MTI Micro’s assets (including intellectual property) and are senior to all other debts and obligations of MTI Micro in accordance with the provisions of a Security Agreement among MTI Micro and the Investors.

The Investors will also receive Warrants to purchase securities issued in the Next Equity Financing or issued in a Negotiated Conversion, as applicable, having an aggregate exercise price equal to 10% of the principal amount of the outstanding Bridge Notes. The per share exercise price of the Warrants shall be the per share price at which securities are sold or issued in the Next Equity Financing or Negotiated Conversion, as applicable. The Warrants will be net-exercisable and will expire on the earlier of: (i) the fifth anniversary of the Warrant issue date; (ii) immediately prior to a change in control; (iii) thirty days following the Maturity Date if no Negotiated Conversion is consummated; or (iv) immediately prior to an initial public offering of MTI Micro.

Because the Next Equity Financing or a Negotiated Conversion has not yet taken place, the warrant’s exercise price and number of shares are not yet determinable. As such, the warrants have not been measured. When the Next Equity Financing or a Negotiated Conversion does occur, the warrants will be measured and recognized at that time.

As of March 31, 2009, the Company owned approximately 97% of MTI Micro. MTI Micro’s financial results are presently consolidated into the Company’s financial information. Conversion of the Bridge Notes and exercise of the Warrants into equity of MTI Micro by the Other Investors besides the Company could result in substantial dilution of the Company’s ownership interest in MTI Micro, and could result in the Company deconsolidating future financial results of MTI Micro.

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MECHANICAL TECHNOLOGY, INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

16. Subsequent Events

On April 15, 2009, MTI Micro and the Investors agreed to amend the Bridge Notes (“Amendment No. 2”) to permit MTI Micro to sell additional Bridge Notes with an additional principal amount of up to $800,000 to additional investors, and to extend the maturity date from May 31, 2009 to March 31, 2010 (the “Maturity Date”). MTI Micro borrowed an additional $215,000 of the $800,000 available additional capacity prior to April 30, and an additional $165,000 on May 1^st, bringing the aggregate outstanding principal amount borrowed under the Purchase Agreement, as amended, to $3,080,000, including conversion of outstanding debt totaling $700,000 owed to the Company. Thereafter, MTI Micro will have the right to borrow an additional $420,000 in increments not to exceed $165,000 per month.

On April 16, 2009, MTI Micro was awarded a cost share funding grant of $2.4 million from the United States Department of Energy (DOE) as part of the DOE’s $41.9 million in American Recovery and Reinvestment Act funding for fuel cell technology. The DOE funding is expected to be made as a cost share contract and will be used to accelerate fuel cell use in consumer markets by demonstrating a one-watt consumer electronics power pack. The project will focus on improving reliability to meet the standards required by the electronics market and will include testing of individual components, subsystems and complete direct methanol fuel cell systems. MTI Micro will also use the funding to develop manufacturing processes to improve product yields and reduce overall costs.

On April 24, 2009, the Company announced it received a Staff Determination Letter dated April 16, 2009, from the Nasdaq Stock Market (“Nasdaq”) on April 23, 2009, stating that the Company’s shares of common stock were subject to delisting from the Nasdaq Capital Market pursuant to Listing Rule 5210(d) for failure to pay all applicable fees as described in the Listing Rule 5900 Series. Since the Company had previously determined to voluntarily delist its common stock from Nasdaq Capital Market prior to receiving the letter and filed a Form 25 with the Securities and Exchange Commission and Nasdaq on April 16, 2009, which resulted in the delisting of its common stock at the close of the trading on April 24, 2009, the Company did not appeal the Staff’s Determination. The Company’s common stock is now quoted on Pink Sheets.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Unless the context requires otherwise, the terms “we,” “us,” and “our” refer to Mechanical Technology, Incorporated, 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 and our wholly owned subsidiary. We have a registered trademark in the United States for “Mobion.” Other trademarks, trade names, and service marks used in this Quarterly Report on Form 10-Q are the property of their respective owners.

The following discussion of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and the notes thereto included in Item 1 of Part I of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and the notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2008 contained in our 2008 Annual Report on Form 10-K.

In addition to historical information, the following discussion contains forward-looking statements, which involve risk and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements, including those discussed in Part II, Item 1A “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q.

Overview

We are developing and commercializing off-the-grid rechargeable power sources for portable electronics. We have developed a patented, proprietary direct methanol fuel cell technology platform called Mobion, which generates electrical power using up to 100% methanol as fuel. Our proprietary fuel cell power solution consists of two primary components integrated in an easily manufactured device: the direct methanol fuel cell power engine, which we refer to as our Mobion Chip, and methanol replacement cartridges. Our Mobion Chip weighs less than one ounce and is small enough to fit in the palm of one’s hand. The methanol used by the technology is fully biodegradable. We believe we are the only micro fuel cell developer to have demonstrated power density of over 62 mW/cm² while producing more than 1,800 Wh/kg of energy from the direct methanol fuel feed. For these reasons, we believe our technology offers a compelling alternative to current lithium-ion and similar rechargeable battery systems currently used by original equipment manufacturers and branded partners, or OEMs, in many handheld electronic devices, such as mobile phones (including smart phones) and mobile phone accessories, digital cameras, portable media players, personal digital assistants (PDAs), and global positioning systems (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 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 have strategic arrangements with Samsung Electronics, an OEM of mobile phone accessories, with a global Japanese consumer electronics company, with a U.S. based developer and marketer of universal chargers, a letter of intent with Duracell, part of the Procter & Gamble Company, and a power tool manufacturer Our goal is to become a leading provider of portable power for handheld electronic devices and, assuming available financing, we intend to commercialize Mobion products in late 2009 or early 2010.

Our Mobion technology eliminates the need for active water recirculation pumps or the inclusion of water as a fuel dilutant. The water required for the electrochemical process is transferred internally within the Mobion Chip from the site of water generation on the air-side of the cell. This internal flow of water takes place without the need for any pumps, complicated re-circulation loops or other micro-plumbing tools. Our Mobion technology is protected by a patent portfolio that includes over 110 U.S. patent applications covering five key technologies and manufacturing areas.

We also design, manufacture, and sell high-performance test and measurement instruments and systems serving three markets: general dimensional gauging, semiconductor, and aviation. These products consist of: electronic, computerized gauging instruments for position, displacement and vibration applications for the design, manufacturing and test markets; products for wafer characterization in the semiconductor and solar markets; and engine balancing and vibration analysis systems for military and commercial aircraft.

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

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

(Dollars in thousands)	Three Months Ended
	March, 31
	2008				2009
Cash and cash equivalents	$	4,560			$	794
Securities available for sale		3,537				—
Working capital		7,634				(922	)
Net loss		(3,187	)			(1,244	)
Net cash used in operating activities		(2,988	)			(1,368	)
Purchase of property, plant and equipment		(102	)			—

From inception through March 31, 2009, we have incurred an accumulated deficit of $118.8 million, and we expect to incur losses for the foreseeable future as we continue micro fuel cell product development and commercialization programs. We expect that losses will fluctuate from year to year and that such fluctuations may be substantial as a result of, among other factors, our operating results, the availability of equity financing, and the ability to attract government funding resources to offset research and development costs.

At present, the Company does not expect to continue to fund MTI Micro’s development and commercialization of its portable power source products. MTI Micro currently has cash and cash equivalents of $290 thousand at March 31, 2009, and the ability to draw down on the $800 thousand bridge loan credit line. The credit line is expected to bridge MTI Micro to the start of the DOE funding, which is expected to commence in June 2009, and may allow MTI Micro to bill for work already completed year to date. As a result of this, management currently believes it should have adequate resources to fund its MTI Micro operations into the fourth quarter of 2009. MTI Micro will be required to raise additional funds through issuance of its equity or debt, government funding and/or explore other strategic alternatives including but not limited to the sale of assets and/or the company. If MTI Micro is unable to raise additional financing, it may be required to discontinue its business operations. Based upon projected cash requirements and current cash and cash equivalents for MTI Instruments, along with cash necessary to operate the public parent company, we believe that we will have adequate resources to fund MTI Instruments and the public parent company at least through December 2009.

Restructuring

In August 2008, the Board of Directors approved a restructuring plan (the “Restructuring”), which was designed to help the Company reduce expenses and preserve cash. As part of the Restructuring, a total of 29 positions across the Company and its subsidiaries were eliminated. The Company incurred total severance and other benefit charges of approximately $342 thousand in connection with this plan. All cash expenditures related to this restructuring have been paid as of March 31, 2009.

Results of Operations

Results of Operations for the Three Months Ended March 31, 2009 Compared to the Three Months Ended March 31, 2008.

Product Revenue. Product revenue in our test and measurement instrumentation business decreased by $431,000, or 21.7%, to $1.55 million for the three months ended March 31, 2009 from $1.98 million for the three months ended March 31, 2008. The revenue decrease was primarily the result of a $503,000 decrease in general dimensional gauging sales due to significantly lower sales to a Japanese and a domestic OEM. Semiconductor / solar sales increased $123,000, and aviation sales remained comparable to that of the first three months of last year.

In our test and measurement instrumentation business, the U.S. Air Force accounted for $351,000, or 22.7%, of product revenue to date in 2009. During the same period in 2008, the U.S. Air Force revenue totaled $362,000, which represented 18.3% of product revenue for that timeframe. Additionally, during the first quarter of 2009, Koyo Precision, our Japanese distributor, represented $172,000, or 11.1%, of product revenue while during the first quarter of 2008, Koyo Precision represented $398,000, or 20.2%, of product revenue.

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

(Dollars in thousands)														Total Contract
											Revenue			Orders
					Revenues for the						Contract			Received
					Three Months Ended March 31,						to Date			to Date
Contract (1)		Expiration			2008			2009			March 31, 2009			March 31, 2009
$2.3 million Air Force New PBS-4100
Systems		07/28/2010	(2)		$	--		$	285		$	1,881		$	1,938
$8.8 million Air Force Retrofit and
Maintenance of PBS-4100
Systems		06/19/2008	(3)		$	338		$	50		$	8,009		$	8,009

____________________
 

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

Funded Research and Development Revenue. Funded research and development revenue in our new energy business decreased to $-0- in the three months ended March 31, 2009 from $173,000 for the three months ended March 31, 2008. This decrease in revenue was the result of the completion of all contracts by December 31, 2008. All revenues for 2008 were a result of reimbursement for research and development costs under the DOE contract with the final billing occurring in December 2008.

Information regarding our prior contract included in funded research and development revenue as of March 31, 2008 is as follows:

(Dollars in thousands)

Revenue

Revenue

Revenue

Three Months

Three Months

Contract to

Ended

% of 2008

Ended

% of 2009

Date

Contract

Expiration (1)

March 31, 2008

Total

March 31, 2009

Total

March 31, 2009

$3.0 million DOE (2)

03/31/09

$

173

100%

$

—

—

$

3,000

____________________

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

Cost of Product Revenue. Cost of product revenue in our test and measurement instrumentation business decreased by $175,000, or 20.8%, to $665,000 for the first three months of 2009 compared to $840,000 for the first three months of 2008. The decrease corresponded to the 21.7% decline in product revenue for the quarter.

Gross profit, as a percentage of product revenue, of 57.1% for the first three months of 2009 decreased by less than one-half of a percentage point from 57.6% for the first three months of 2008. The slight decrease resulted from a change in the current product sales mix, which to date includes a higher concentration of custom products which have yielded lower than expected margins.

Funded Research and Product Development Expenses. Funded research and product development expenses in our new energy business decreased from $356,000 for the three months ended March 31, 2008 to $-0-, for the three months ended March 31, 2009. This change was the result of the end of the DOE contract, as mentioned above in Funded Research and Development Revenue.

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Unfunded Research and Product Development Expense. Unfunded research and product development expenses decreased by $1 million, or 51%, to $980,000 for the three months ended March 31, 2009 from $2.0 million for the three months ended March 31, 2008. This decrease is attributable to continued cost reductions by management due to decreases in funding.

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased by $1.2 million, or 47%, to $1.4 million for the three months ended March 31, 2009 from $2.6 million for the three months ended March 31, 2008. This decrease was primarily the result of (a) a $423,000 decrease in payroll costs due to staff reductions in 2008 (b) $326,000 in corresponding decreases in benefit related costs, bonuses and commissions (c) a $217,000 decrease in stock compensation related expenses and (d) a $714,000 decrease in general operating expenses representing management efforts to reduce expenditures due to decreases in funding sources. These decreases in expenditures were offset by a $600,000 increase related to a decrease in allocations of expense from SG&A to funded and unfunded research and development costs for overhead and other costs allocable to research and development programs.

Operating Loss. Operating loss decreased by $1.8 million or 55%, to $1.5 million for the three months ended March 31, 2009 compared with the three months ended March 31, 2008 as a result of the factors noted above.

Gain (loss) on Derivatives. Our gain on derivative treatment of the freestanding warrants issued in conjunction with our December 2006 capital raise decreased by $315,000, or 94.6%, to $18,000 for the three months ended March 31, 2009 compared with $333,000 for the three months ended March 31, 2008. The decrease in derivative income was attributable to valuation changes of the underlying warrants using the Black-Scholes pricing model.

Income Tax (Expense) Benefit. Our income tax rate for the three months ended March 31, 2009 and 2008 was 13.2% and 0.3%, respectively. These tax rates were primarily the result of the reversal of the UTP due to the settlement with New York State, losses generated by operations, changes in the valuation allowance, state true-ups, permanent deductible differences for derivative valuations, 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 March 31, 2009 was $28.5 million and at December 31, 2008 was $27.8 million. We determined that it was more likely than not that ultimate recognition of certain deferred tax assets would not be realized.

Liquidity and Capital Resources

We have incurred significant losses as we continue to fund the development and commercialization of our portable power source business. We expect that losses will fluctuate from year to year and that such fluctuations may be substantial as a result of, among other factors, our operating results, the availability of equity financing, and the ability to attract government funding resources to offset research and development costs. As of March 31, 2009, we had an accumulated deficit of $118.8 million. During the three months ended March 31, 2009, our results of operations resulted in a net loss of $1.2 million and cash used in operating activities totaling $1.4 million. This cash use in 2009 was funded primarily by cash and cash equivalents on hand as of December 31, 2008 of $1.7 million. We expect to continue to incur losses during this global economic slowdown, and we expect to continue funding our operations from current cash and cash equivalents, proceeds, if any, from debt or equity financings and government funding. We expect to spend approximately $1.2 million on research and development on MTI Instruments’ products and $2 million in MTI Micro during 2009.

In September 2008, MTI Micro issued Bridge Notes to investors, including MTI in the form of conversion of existing debt of $700,000, Dr. Walter L. Robb, a member of the Company’s Board of Directors, and a fund managed by Dr. Robb, totaling $2.2 million.

In February 2009, MTI Micro and the Bridge Investors agreed to, among other things, amend the Bridge Notes (“Amendment No. 1”) to permit MTI Micro to sell additional Bridge Notes with an additional principal amount of up to $500,000, and to extend the maturity date from March 31, 2009 to May 31, 2009 (the “Maturity Date”). No other terms of the Bridge Notes were amended. Following the effectiveness of the Amendment No. 1, MTI Micro borrowed an additional $500,000 from an existing Bridge Investor, a fund managed by Dr. Robb, bringing the aggregate outstanding principal amount borrowed under the Bridge Notes, as amended, to $2.7 million, including conversion of outstanding debt totaling $700,000 owed to the Company.

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On April 15, 2009, MTI Micro, a new investor and the fund managed by Dr. Robb agreed to amend the Bridge Notes (“Amendment No. 2”) to permit MTI Micro to sell additional Bridge Notes with an additional principal amount of up to $800,000 to additional investors, and to extend the maturity date from May 31, 2009 to March 31, 2010 (the “Maturity Date”). As of May 14, 2009, MTI Micro has drawn down $380,000 from this line.

If the Next Equity Financing does not occur on or before the Maturity Date, all principal and (at MTI Micro’s option) accrued interest outstanding under all of the Notes shall be converted into equity securities of MTI Micro based upon a valuation of MTI Micro and on such terms to be agreed upon by MTI Micro and the holders of a majority interest of the Notes within thirty (30) days following the earlier to occur of (i) the Maturity Date or (ii) the date upon which the aggregate principal amount under all the Notes equals or exceeds $3,500,000, which the valuation and terms shall be negotiated in good faith by MTI Micro and a majority interest of the Notes.

The Bridge Notes carry an annual interest rate of 10%. These Bridge Notes are secured by all of the assets of MTI Micro, including intellectual property. Lastly, five-year warrants to purchase additional securities were issued to all investors, having an aggregate exercise price equal to 10% of the outstanding principal amounts under the Bridge Notes. These warrants will be priced in a manner similar to the conversion of the Bridge Notes.

On April 16, 2009, MTI Micro was awarded a cost share funding grant of $2.4 million from the United States Department of Energy (DOE) as part of the DOE’s $41.9 million in American Recovery and Reinvestment Act funding for fuel cell technology. We expect funding from this grant to commence in June 2009.

We have no other commitments for funding future needs of the organization at this time and financing during the remainder of 2009 may not be available to us on acceptable terms, if at all. We may also seek to supplement our resources through additional debt or equity financings, sales of assets (including MTI Micro or MTI Instruments), and additional government funding.

We had a working capital deficit of $900,000 at March 31, 2009, a $1.15 million decrease from a working capital of $250,000 at December 31, 2008. This decrease was primarily the result of the use of cash in operations.

At March 31, 2009, our order backlog was $971 thousand compared to $1.4 million at December 31, 2008.

Our inventory turnover ratios and accounts receivable days outstanding for the trailing twelve month periods and their changes at March 31, 2008 and 2009 are as follows:

	2008		2009		Change
Inventory turnover	2.3		1.5		(0.8	)
Average accounts receivable days outstanding	56		41		(15	)

The decline in inventory turnover is attributed to average inventory levels running 18% higher over the last twelve months as compared to the previous twelve months. Recent increases in inventory levels have occurred as a result of an overall slow down in base business at MTI Instruments combined with a higher level of subassemblies necessary for two existing orders, which are expected to ship during the second and third quarters of 2009.

The decrease in average accounts receivable days outstanding over the last twelve months as compared to the previous twelve months was partially attributable to our decision to grant our largest commercial customer 90-day payment terms during 2007. These extended terms were eliminated in conjunction with the expiration of our formal distribution agreement in September 2008 and the customer is now back to net 30 payment terms. Also contributing to the improvement was the increased concentration in the current product mix of U.S. Air Force revenue, which by contract must be paid in 30 days.

Cash used by operating activities was $1.4 million for the three months ended March 31, 2009 compared with $3.0 million in 2008. This cash use decrease of $1.6 million is a direct result of management’s reorganization efforts and expenditure control.

There were no capital expenditures during the three months ended March 31, 2009, a decrease of $102,000 from the prior year. Capital expenditures in 2008 included manufacturing, laboratory and demonstration equipment. We had no outstanding commitments for capital expenditures as of March 31, 2009.

During 2008, we sold our remaining 1,137,166 shares of Plug Power common stock with proceeds totaling $3.0 million and gains totaling $1.0 million. These proceeds reflect our previously announced strategy to raise additional capital through the sale of Plug Power stock to fund our micro fuel cell operations. The net gains were offset by our operating losses for purposes of computing taxable income. We estimate that as of March 31, 2009, our remaining net operating loss carry forwards were approximately $65 million.

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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 378,472 shares of our common stock exercisable at any time until December 19, 2011 at an exercise price per share of $18.16. 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 permit 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.

Contractual Payment Obligations

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

	Less									More
Contractual Payment Obligations	Than 1			1-3			3-5			Than 5
(in thousands)	Year			Years			Years			Years			Total
Bridge Notes:
Principal (1)	$	2,000		$	—		$	—		$	—		$	2,000
Interest		87			—			—			—			87
Operating Leases (2)		457			47			—			—			504
Total Contractual Payment Obligations	$	2,544		$	47		$	—		$	—		$	2,591

____________________

(1)		Reflects amounts outstanding with respect to the Bridge Notes. In February 2009, MTI Micro issued an additional $500,000 of Bridge Notes due on May 31, 2009.
(2)		Reflects payment obligations under certain manufacturing, laboratory and office facility lease agreements.

Critical Accounting Policies and Significant Judgments and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. Note 2 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2008 includes a summary of our most significant accounting policies. There have been no material changes to the critical accounting policies previously disclosed in our 2008 Annual Report on Form 10-K. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, inventories, securities available for sale, income taxes, stock-based compensation and derivatives. Management bases its estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Periodically, we review our critical accounting estimates with the Audit Committee of our Board of Directors.

New Accounting Pronouncements

In April 2009, the FASB issued FSP No. FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or the Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. FSP No. FAS 157-4 amends SFAS No. 157 to provide additional guidance on (i) estimating fair value when the volume and level of activity for an asset or liability have significantly decreased in relation to normal market activity for the asset or liability, and (ii) circumstances that may indicate that a transaction is not orderly. FSP No. FAS 157-4 also requires additional disclosures about fair value measurements in interim and annual reporting periods. FSP No. FAS 157-4 is effective for interim and annual reporting periods ending after June 15, 2009. It is expected that the adoption of FSP No. FAS 157-4 will not have a material effect on the Company’s financial statements.

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In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP No. FAS 115-2”). FSP No. FAS 115-2 provides additional guidance on the timing of impairment recognition and greater clarity about the credit and noncredit components of impaired debt securities that are not expected to be sold. FSP No. FAS 115-2 also requires additional disclosures about impairments in interim and annual reporting periods. FSP No. FAS 115-2 is effective for interim and annual reporting periods ending after June 15, 2009. It is expected that the adoption of FSP No. FAS 115-2 will not have a material effect on the Company’s financial statements.

In April 2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments. FSP No. FAS 107-1 and APB 28-1 amends SFAS No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments in interim as well as in annual financial statements. This FSP also amends Accounting Principles Board (“APB”) Opinion No. 28, Interim Financial Reporting, to require those disclosures in all interim financial statements. FSP No. FAS 107-1 and APB 28-1 is effective for interim reporting periods ending after June 15, 2009. It is expected that the adoption of FSP No. FAS 107-1 and APB 28-1 will not have a material effect on the Company’s financial statements.

Statement Concerning Forward-Looking Statements

This Quarterly Report on Form 10-Q and the documents we have filed with the Securities and Exchange Commission that are incorporated by reference herein contain forward-looking statements that involve risks and uncertainties within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Any statements contained, or incorporated by reference, in this Form 10-Q that are not statements of historical fact may be forward-looking statements. When we use the words “anticipate,” “estimate,” “plans,” “projects,” “continuing,” “ongoing,” “expects,” “management believes,” “we believe,” “we intend,” “should,” “could,” “may,” “will” and similar words or phrases, we are identifying forward-looking statements. Forward-looking statements involve risks, uncertainties, estimates and assumptions which may cause our actual results, performance or achievements to be materially different from those expressed or implied by forward-looking statements. Important factors that could cause these differences include the following:

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

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• our ability to commercialize our proposed portable power source solutions and develop new product solutions on a timely basis;
• our ability to develop and utilize new technologies that address the needs of our customers;
• intense competition in the direct methanol fuel cell and instrumentation businesses;
• change in policies by U.S. or foreign governments that hinder, disrupt or economically disadvantage international trade;
• the impact of future exchange rate fluctuations;
• uncertainty of the U.S. economy;
• the historical volatility of our stock price;
• the cyclical nature of the electronics industry;
• failure of our strategic alliances to achieve their objectives or perform as contemplated and the risk of cancellation or early termination of such alliance by either party;
• product liability or defects;
• risks related to the flammable nature of methanol as a fuel source;
• the loss of services of one or more of our key employees or the inability to hire, train, and retain key personnel;
• significant periodic and seasonal quarterly fluctuations in our results of operations;
• risks related to the limitation of the use of our net operating losses in the event of certain ownership changes; and
• other factors discussed under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 and in Part II, Item 1A of this Quarterly Report on Form 10-Q.

Forward-looking statements speak only as of the date they are made. You should not put undue reliance on any forward-looking statements. We assume no obligation to update forward-looking statements to reflect actual results, changes in assumptions, or changes in other factors affecting forward-looking information, except to the extent required by applicable securities laws. If we do update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.

Item 4. Controls and Procedures

The certifications of our Chief Executive Officer and Chief Financial Officer attached as Exhibits 31.1 and 31.2 to this Quarterly Report on Form 10-Q include, in paragraph 4 of such certifications, information concerning our disclosure controls and procedures and internal control over financial reporting. Such certifications should be read in conjunction with the information contained in this Item 4 for a more complete understanding of the matters covered by such certifications.

(a) Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer, who is also our acting principal financial officer, evaluated the effectiveness of MTI’s disclosure controls and procedures as of March 31, 2009. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. We recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and we necessarily apply our judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the valuation of our disclosure controls and procedures as of March 31, 2009, our chief executive officer, who is also our acting principal financial officer, concluded that, as of such date, our disclosure controls and procedures were not effective due to staffing turnover and a lack of adequate resources within the accounting and finance department. In August 2008, the Board of Directors approved a restructuring plan (the “August 2008 Restructuring”), which was designed to help the Company reduce expenses and preserve cash. As part of the August 2008 restructuring, the Company’s Chief Financial Officer transitioned out of the Company along with several other accounting and Information Technology personnel. Prior to the August 2008 restructuring, the Company’s Controller left the Company to pursue other opportunities. Additionally, effective December 1, 2008 the Company’s Interim Chief Financial and Director of Financial Reporting resigned from the Company. In response to the turnover, the Company has retained an outside consulting firm to provide controllership and chief financial officer related services.

(b) Changes in Internal Control Over Financial Reporting

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

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

At any point in time, we may be involved in various lawsuits or other legal proceedings. Such lawsuits could arise from the sale of products or services or from other matters relating to its regular business activities, compliance with various governmental regulations and requirements, or other transactions or circumstances. We do not believe there are any such proceedings presently pending that could have a material adverse effect on our financial condition. See Note 12 to our Condensed Consolidated Financial Statements for further information.

Item 1A. Risk Factors

Our Annual Report on Form 10-K for the year ended December 31, 2008 contains a detailed discussion of our risk factors. In addition, information regarding risk factors appears in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Statement Concerning Forward Looking Statements”. These risk factors could cause our actual results to differ materially from those stated in forward-looking statements contained in this document and elsewhere. Pursuant to the instructions to this Quarterly Report on Form 10-Q, we have provided below only those risk factors that are new or that have been materially amended since the time that we filed our 2008 Annual Report on Form 10-K. Accordingly, the information presented below should be read in conjunction with the risk factors and information disclosed in our 2008 Annual Report on Form 10-K.

We have incurred recurring net losses and anticipate continued net losses as we execute our commercialization plan for our portable power source business.

We incurred recurring net losses, including net losses of $1.2 million for the three months ended March 31, 2009 and $3.2 million for the three months ended March 31, 2008, which includes a net gain of $18,000 on derivatives in 2009. As a result of ongoing operating losses, we had an accumulated deficit of $118.8 million as of March 31, 2009. We expect to continue to make significant expenditures and incur substantial expenses as we develop and commercialize our proposed portable power source products; develop our manufacturing, sales, and distribution networks; implement internal systems and infrastructure; and hire additional personnel. As a result, we expect to continue to incur significant losses as we execute our plan to commercialize our portable power source business and may never achieve or maintain profitability. We will be unable to satisfy our current obligations solely from cash generated from operations or become profitable until we successfully commercialize our portable power source business. If we continue to incur substantial losses and are unable to secure additional financing, we could be forced to discontinue or curtail our business operations; sell assets at unfavorable prices; or merge, consolidate, or combine with a company with greater financial resources in a transaction that may be unfavorable to us.

At present, the Company does not expect to fund MTI Micro’s development and commercialization of its portable power source products. MTI Micro currently has cash and cash equivalents of $290,000 at March 31, 2009, and the ability to draw down on the $800,000 bridge loan credit line, of which $420,000 remains available as of May 14, 2009. The credit line is expected to bridge MTI Micro to the start of the DOE funding, which is expected to commence in June 2009, and may allow MTI Micro to bill for work already completed year to date. As a result of this, management currently believes it should have adequate resources to fund its MTI Micro operations into the fourth quarter of 2009. MTI Micro will be required to raise additional funds through issuance of its equity or debt, government funding and/or explore other strategic alternative, including the sale of assets and/or the company. If MTI Micro is unable to raise additional financing, it may be required to discontinue its business operations. Based upon projected cash requirements and current cash and cash equivalents for MTI Instruments, along with cash necessary to operate the public parent company, we believe that we will have adequate resources to fund MTI Instruments and the public parent company at least through December 2009.

Our independent auditors have included a going concern paragraph in their opinion.

Our auditors included an explanatory paragraph in their opinion that accompanies our audited consolidated financial statements as of December 31, 2008, indicating that our recurring losses from operations, net capital deficiency, and current liquidity position raised substantial doubt about our ability to continue as a going concern. The accompanying consolidated financial statements did not include any adjustments that would have resulted from the outcome of this uncertainty.

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

We will need additional funding to commercialize our portable power source business. MTI Micro had cash and cash equivalents of $290,000 at March 31, 2009, has received $380,000 through May 14, 2009 from the April bridge loan, and has the ability to draw down on the remaining $420,000 of the bridge loan credit line. The credit line is expected to bridge MTI Micro to the start of the DOE funding, which is expected to commence in June 2009, and may allow MTI Micro to bill for work already completed year to date. As a result of this, management believes it should have adequate resources to fund its MTI Micro operations into the fourth quarter of 2009. If we are unable to secure the necessary additional funding, we will need to delay further commercialization plans. In order to conserve cash and extend operations while we pursue any additional necessary financing, we will be required to reduce operating expenses and raise additional capital through funding. There is no assurance that funds raised in any such a financing will be sufficient, that the financing will be available on terms favorable to us or to existing stockholders and at such times as required, or that we will be able to obtain the additional financing required for the continued operation and growth of our business. During the last twelve months, we have raised $3.5 million in external debt financing. If we raise additional funds by issuing equity securities, our stockholders will experience dilution. Additional debt financing, if available, may involve restrictive covenants. Any debt financing or additional equity financing may contain terms that are not favorable to us or our stockholders. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish some rights to our technologies or our products, or grant licenses on terms that are not favorable to us. If we are unable to raise adequate funds, we may have to liquidate some or all of our assets or delay, reduce the scope of or eliminate some or all of our research and development programs, or discontinue our portable power source business.

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

We currently own approximately 97% of the outstanding equity in MTI Micro and have control over the operations of this subsidiary. In September 2008 and February 2009, MTI Micro issued $1.5 million and $500,000, respectively, of secured notes to outside investors, which notes are convertible into shares of MTI Micro. On April 15, 2009, MTI Micro amended the notes to permit MTI Micro to sell additional notes with an additional principal amount of up to $800,000 to additional investors, and to extend the maturity date from May 31, 2009 to March 31, 2010. A further amendment provided that if the Next Equity Financing does not occur on or before the Maturity Date, all principal and (at MTI Micro’s option) accrued interest outstanding under all of the Notes shall be converted into equity securities of MTI Micro based upon a valuation of MTI Micro and on such terms to be agreed upon by MTI Micro and the holders of a majority interest of the Notes within thirty (30) days following the earlier to occur of (i) the Maturity Date or (ii) the date upon which the aggregate principal amount under all the Notes equals or exceeds $3,500,000, which the valuation and terms shall be negotiated in good faith by MTI Micro and a majority interest of the Notes. If the notes are converted, our ownership could decrease significantly. In addition, we do not currently expect to advance additional resources to MTI Micro to fund its continued direct methanol fuel cell development and commercialization programs. Instead, MTI Micro will seek additional capital from external sources to fund future development and operations. Depending on the valuation of MTI Micro at the time of future financings, if any, our ownership position could be substantially diluted, and we may no longer have sufficient equity to control the operations of MTI Micro. If MTI Micro is unable to secure the necessary additional external financing, we may be forced to substantially downsize or eliminate its operations.

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

As of March 31, 2009, we had approximately $65 million of net operating loss, or NOL, carryforwards on the Company’s balance sheet. Our ability to utilize these NOL carryforwards, including any future NOL carryforwards that may arise, may be limited by Section 382 of the Internal Revenue Code of 1986, as amended, if we or MTI Micro undergo an “ownership change” as a result of subsequent changes in the ownership of our outstanding common stock pursuant to the exercise of the warrants, the conversion of MTI Micro’s bridge notes, or otherwise. A corporation generally undergoes an “ownership change” when the ownership of its stock, by value, changes by more than 50 percentage points over any three-year testing period. In the event of an ownership change, Section 382 imposes an annual limitation on the amount of post-ownership change taxable income a corporation may offset with pre-ownership change NOL carryforwards and certain recognized built-in losses.

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Item 5. Other Information

None

Item 6. Exhibits

Exhibit No.		Description
31.1		Rule 13a-14(a)/15d-14(a) Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, of Peng K. Lim
32.1		Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of Peng K. Lim

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		Mechanical Technology, Incorporated
May 14, 2009	By:	/S/ PENG K. LIM
		Peng K. Lim
		Chief Executive Officer, Chief Financial Officer

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