Soluna Holdings, Inc - Annual Report: 2011 (Form 10-K)

INDEX TO FORM 10-K

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PART I

Item 1: Business

Unless the context requires otherwise in this Annual Report on Form 10-K, the terms “we”, “us” and “our” refer to Mechanical Technology, Incorporated, “MTI Instruments” refers to MTI Instruments, Inc., and “MTI Micro” refers to MTI MicroFuel Cells, Inc. We have a registered trademark in the United States for “Mobion”. Other trademarks, trade names, and service marks used in this Annual Report on Form 10-K are the property of their respective owners.

Mechanical Technology, Incorporated, (MTI or the Company), a New York corporation, was incorporated in 1961. MTI operates in two segments: the Test and Measurement Instrumentation segment, which is conducted through MTI Instruments, Inc. (MTI Instruments), a wholly-owned subsidiary, and the New Energy segment, which is conducted through MTI MicroFuel Cells, Inc. (MTI Micro), a variable interest entity (VIE) as of December 31, 2011.

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

MTI Micro was incorporated in Delaware on March 26, 2001, and has been developing Mobion^®, a handheld energy-generating device to replace current lithium-ion and similar rechargeable battery systems in many handheld electronic devices for the military and consumer markets. Mobion^® handheld generators are based on direct methanol fuel cell (DMFC) technology, which has been recognized as enabling technology for advanced portable power sources by the scientific community and industry analysts. As the need for advancements in portable power increases, MTI Micro has been developing Mobion^® as a solution for advancing current and future electronic device power needs of the portable electronics market. As of December 31, 2011, the Company owned approximately 47.6% of MTI Micro’s outstanding common stock. Although MTI Micro continues to believe in the potential of its Mobion^® based power solutions, operations have been suspended at MTI Micro until such time as market demand and other deciding factors, including obtaining additional external financing, the successful completion of customer trials, a new development program with a government agency, and/or a customer order, come to fruition. Currently, MTI Micro has no employees and projects to spend between $5 and $10 thousand per month for operating activities including rent, preparing prototypes for customer demonstrations, minimal sales efforts, patent fees to keep its patent portfolio current and minimal consultant costs to perform these initiatives. MTI Micro will continue to seek additional capital from external sources to resume operations and fund future development, if any. If MTI Micro is unable to secure additional financing, a new development program or customer order, the MTI Micro board of directors will assess other options for MTI Micro, including the sale of MTI Micro’s intellectual property portfolio and other assets.

The Test and Measurement Instrumentation Segment

MTI Instruments is a worldwide supplier of metrology, portable balancing equipment and inspection systems. Our products use state-of-the-art technology to solve complex real world applications in numerous industries including automotive, semiconductor, solar cell manufacturing, material testing, commercial and military aviation and data storage. We are continuously working on ways to expand our sales reach, including expanded sales coverage throughout Europe and Asia, as well as a focus on internet marketing.

Products

Our test and measurement segment has three product groups: Precision Instruments, Semiconductor and Solar Metrology Systems and Aviation Balancing Systems. Our products consist of electronic, computerized gauging instruments for position, displacement and vibration applications for the design, manufacturing/production and test and research markets; metrology tools for wafer characterization of semiconductor and solar wafers; tensile stage systems for materials testing in research and industrial settings; and engine balancing and vibration analysis systems for both military and commercial aircraft.

Precision Instruments: The Precision Instruments group employs capacitance, laser and fiber optic technologies to make nano-accurate measurements. These advanced sensing and physical measurement technologies are used to produce products that range from basic sensors to complete, fully integrated measurement systems, and are available as single sensors for integration into existing data acquisition systems or as complete system level solutions that can be further integrated into a facility wide communication backbone.

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

Accumeasure Family:

The Accumeasure family of products is designed to address the needs of product developers, process engineers, researchers, designers, and others who need precise, reliable, non-contact measurements.

Microtrak Family:

MTI Instrument's Microtrak family of laser triangulation sensors offers high speed, high resolution displacement, position and vibration measurements. The Microtrak features state-of-the-art complementary metal oxide semiconductors with charged coupled device (CMOS – CCD) laser triangulation technology, which is ideal for solving tough in-process, production and quality control sensing applications. The large variety of laser triangulation sensors provides operating distances to 300mm, measurement ranges to 200mm and measurement resolution to less than 1 micron. Our Laser triangulation sensors contain a solid-state laser light source and a CMOS detector.

Microtrak II Series:

The Microtrak II comes standard with an interface controller that provides a convenient digital display of the target position, alarm set points and connections for analog and RS-485 outputs.

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Microtrak Pro-2D:

In the summer of 2011, MTII launched its new Microtrak PRO-2D laser triangulation scanners, which provide high speed profile, displacement and dimensional information in real time.

MTI-2100 Fotonic Sensor Series:

MTI Tensile Stages:

Semiconductor and Solar Metrology Systems: Our family of wafer metrology systems includes manual and semi-automated systems which test key wafer characteristics critical to producing integrated circuits. Primarily used in quality control applications, these systems provide highly precise measurements of thickness variation, bow, warp, resistivity, and flatness. These systems can be used on substrates varying widely in size and materials. In addition to MTI Instrument’s push/pull capacitance probe technology, we have expanded our line of products to include offerings for the solar industry, including the measurement of solar wafer thickness.

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The Semiconductor and Solar Metrology Systems include the following products:

Proforma 200SA/300SA:

Proforma 300:

The Proforma 300 is an easy-to-use, manual tool that accepts any wafer size and can measure a number of different materials without recalibrating or electrically grounding the wafers.

PV-1000:

The PV-1000 series brings our 40+ years of precision measurement experience to a line of products specifically designed for the photovoltaic/solar industry.

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

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

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PBS-4100+ /4100R+ Portable Balancing System:

TSC-4800A Tachometer Signal Conditioner:

Targeted for operators of Engine Test cells, where accurate and reliable conditioning of speed signals is essential, MTI Instruments has designed the TSC-4800A Tachometer Signal Conditioner to detect and condition signals for monitoring, measuring, and indicating engine speeds.

1510A Calibrator:

Marketing and Sales

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

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

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Comparisons of sales by class of products of MTI Instrument’s sales are shown below for the years ended December 31:

Product Development and Manufacturing

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

Our most recent product offerings include:

• In aviation balancing systems, we introduced the TSC-4800A Tachometer Signal Conditioner, for the characterization of engine speeds, as well as the PBS-4100+, an advanced and compact portable jet engine balancing and vibration diagnostics system for use by both military and commercial carriers.
• In the precision instruments area, we added the tensile stage and the Microtrak Pro-2D product lines. Tensile stages are tailored to both academia and industry for the characterization and investigation of material properties, and the Microtrak PRO-2D is ideal for welding and process control applications.

We seek to achieve a competitive position by continuously advancing our technology, producing new state of the art precision measurement equipment, expanding our worldwide distribution, and providing intimate customer support and product customization.

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

Intellectual Property and Proprietary Rights

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

Significant Customers

MTI Instruments’ largest customer is the U.S. Air Force. We also have strong relationships with companies in the manufacturing, semiconductor, automotive, aerospace, aircraft and research industries. In 2011, the U.S. Air Force accounted for $2.3 million or 22.4% of product revenues; in 2010, it accounted for $1.6 million or 22.3% of product revenues; and in 2009, it accounted for $1.2 million, or 19.2%, of product revenue. The largest commercial customer in 2011 was a Southeast Asian distributor, who accounted for $1.1 million or 10.7% of total product revenue in 2011. The largest commercial customer in 2010 was a Chinese distributor, who accounted for $560 thousand, or 7.8% of total product revenue in 2010. The largest commercial customer in 2009 was a domestic US defense contractor, who accounted for $618 thousand or 9.9% of total product revenue in 2009.

Recent Contracts

In 2011, MTI Instruments was awarded a $4.1 million multi-year U.S. Air Force contract for the purchase of PBS4100+ portable aircraft engine balancing systems. As of December 31, 2011, MTI Instruments had recorded $684 thousand in orders, approximately 16.7% of the total contract’s total value.

In 2009, MTI Instruments was awarded a multi-year U.S. Air Force contract to service and repair its existing fleet of PBS-4100 jet engine balancing systems with the latest diagnostic and balancing technology, which could potentially generate up to a total of $6.5 million in sales for the Company between 2009 and 2014. As of December 31, 2011, MTI Instruments had recorded $2.9 million in orders, approximately 44.6% of the five-year contract’s total value.

Competition

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

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The primary competitive considerations in MTI Instruments’ markets are product quality, performance, price, timely delivery, and the ability to identify, pursue and obtain new customers. MTI Instruments believes that its employees, product development skills, sales and marketing systems and reputation are competitive advantages.

The New Energy Segment

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

MTI Micro has been developing an off-the-grid power solution for various portable electronic devices to address this power gap. Our patented proprietary DMFC technology platform, called Mobion^®, converts methanol fuel to usable electricity capable of providing continuous power as long as necessary fuel flows are maintained. Our proprietary fuel cell power solution consists of two primary components integrated into an easily manufactured device: the direct methanol fuel cell power engine, which we refer to as our Mobion^® Chip, and methanol fuel cartridges. Our current Mobion^® Chip is small enough to fit in the palm of one’s hand. The methanol used by the technology is fully biodegradable.

Although MTI Micro continues to believe in the potential of its Mobion^® based power solutions, operations have been suspended at MTI Micro until such time as market demand and other deciding factors, including obtaining additional external financing, the successful completion of customer trials, a new development program with a government agency, and/or a customer order, come to fruition. Currently, MTI Micro has no employees and projects to spend between $5 and $10 thousand per month for operating activities including rent, preparing prototypes for customer demonstrations, minimal sales efforts, and patent fees to keep its patent portfolio current and minimal consultant costs to perform these initiatives. MTI Micro will continue to seek additional capital from external sources to resume operations and fund future development, if any. If MTI Micro is unable to secure additional financing, a new development program or customer order, the MTI Micro board of directors will assess other options for MTI Micro, including the sale of MTI Micro’s intellectual property portfolio and other assets.

MTI Micro’s Solution

At the core of MTI Micro’s solution is its proprietary Mobion^® Chip engine, a design architecture that embodies a reduction in the size, complexity, and cost of fuel cell construction, which results in a reliable, manufacturable, and affordable power solution that we believe provides higher energy density and portability over competing portable power technologies. MTI Micro’s proprietary fuel cell power solution consists of two primary components integrated in an easily manufactured device: the direct methanol fuel cell power engine, which MTI Micro refers to as the Mobion^® Chip, and methanol replacement cartridges. The Mobion^® Chip is small enough to fit in the palm of one’s hand. For these reasons, MTI Micro believes that its Mobion^® platform is ideally suited to provide a replacement or go along with rechargeable batteries. Based upon MTI Micro’s ability to provide a compact, efficient, clean, safe, and long-lasting power source, MTI Micro intends to initially target power solutions for applications such as universal handheld chargers, military equipment, power tools, remote sensors, mobile phones, digital cameras, portable gaming devices, e-readers and other portable devices.

MTI Micro’s Strategy

Although MTI Micro has suspended its operations, if/when those operations are able to resume, its goals remain the same, to become a leading provider of portable power for various electronic devices. Key elements of MTI Micro’s strategy would include:

• MTI Micro’s portable power source products can be manufactured using standard processes, such as injection molding and automated test and assembly. In preparing Mobion^® for commercialization, the current Mobion^® Chip is designed for mass manufacturing.
• MTI Micro plans to outsource manufacturing of its products to allow MTI Micro to expand rapidly and diversify its production capacity. This strategy should allow MTI Micro to maintain a variable cost model in which MTI Micro does not incur most of their manufacturing costs until their proprietary fuel cell power solution has been shipped and billed to their customers. MTI Micro intends to concentrate on their core competencies of research and development and product design. This approach should reduce MTI Micro’s fixed capital expenditures and allow them to efficiently scale production.

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• MTI Micro plans to utilize its intellectual property portfolio and technological expertise to develop and offer portable power source products across multiple electronic device markets. MTI Micro intends to employ its 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.

Additionally, MTI Micro’s board of directors will assess other options for MTI Micro including the sale of MTI Micro’s intellectual property portfolio and other assets.

Products

Technology

A fuel cell is an electrochemical energy conversion device, which is similar to a battery that produces electricity from a liquid or gaseous fuel, such as methanol, and an oxidant, such as oxygen. Fuel cells are different from batteries in that they consume a reactant that can be replenished, while batteries store electrical energy chemically in a closed system.

Generally, the reactants flow in and reaction products flow out of the fuel cell. While the electrodes within a battery react and change as a battery is charged or discharged, a fuel cell’s electrodes are catalytic and relatively stable.

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

Strategic Agreements

On October 26, 2010, MTI Micro was awarded a $100 thousand firm fixed contract from a United States Department of Defense (DOD) agency for the development of proof of concept fuel cells for technical testing and subsequent demonstration in a capabilities based experiment. The total contract was billed and paid as of December 31, 2011.

On July 28, 2010, MTI Micro was awarded a cost share funding grant of $296 thousand from the New York State Energy Research and Development Authority (NYSERDA). The total contract was billed and paid as of December 31, 2011.

On April 16, 2009, we entered into a $4.8 million cost-shared development contract with the Department of Energy (DOE), for the commercialization of our Mobion^® product solutions, with $2.4 million in funds available under this program. On April 30, 2010, MTI Micro was approved for an extension of this grant with additional funds available of $594 thousand. As of April 25, 2011, all amounts awarded have been billed and paid by the DOE under this grant. During the first quarter of 2011, we completed the work required under this DOE grant. The objective of the grant was to demonstrate and field test a commercially viable one watt DMFC charger for consumer electronic devices. As part of this objective, MTI Micro field tested 75 units to various users, including 17 OEM’s, 33 individuals, 21 military agencies and four governmental agencies. We have achieved all technical performance targets required by the DOE under this grant; this field testing has concluded and the final report to the DOE may be found at http://www.mtimicrofuelcells.com/news/events.asp. Additional experimental testing was conducted at the DOD since the fourth quarter of 2010 that resulted in product improvements in the third quarter of 2011. Further testing by the DOD of our Mobion^® fuel cell charger commenced in October 2011. If approval is granted, this may result in the signing of a commercialization contract or purchase orders for final production. To date, no approval has been granted and there is no clear indication as to when MTI Micro will be notified.

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Intellectual Property and Proprietary Rights

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

As of December 31, 2011, MTI Micro’s Mobion^® Technology had filed over 106 U.S. patent applications, 54 of which have been awarded. Of the awarded patents, 44 are assigned to us and 10 are assigned to Duracell. We have filed 33 Patent Cooperation Treaty Applications in multiple countries, 5 of which have been issued. We have developed a portfolio of patent applications in areas including fuel cell systems, fuel refill and packaging, fuel, components, manufacturing processes, and system packaging.

Research and Development

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

MTI, through MTI Instruments and MTI Micro, has incurred research and development costs of approximately $1.5 million, $3.9 million and $5.4 million for the years ended December 31, 2011, 2010, and 2009, respectively. We expect to continue to invest in research and development in the future in our MTI Instruments segment.

Employees

As of December 31, 2011, we had 43 employees including 42 full-time employees.

Availability of Information

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

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

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Item 1A: Risk Factors

Factors Affecting Future Results

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

• sales revenue growth of our test and measurement instrumentation business may not be achieved or maintained;
• the dependence of our test and measurement instrumentation business on a small number of customers and potential loss of government contracts;
• our inability to build and maintain relationships with our customers;
• 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 inability to develop and utilize new technologies that address the needs of our customers;
• intense competition in the instrumentation business;
• our history of recurring net losses and the risk of continued net losses;
• the impact of future exchange rate fluctuations;
• the uncertainty of the U.S. economy;
• the historical volatility of our stock price;
• the cyclical nature of the electronics industry;
• failure of our strategic alliances to achieve their objectives or perform as contemplated and the risk of cancellation or early termination of such alliance by either party;
• product liability or defects;
• the loss of services of one or more of our key employees or the inability to hire, train, and retain key personnel;
• significant periodic and seasonal quarterly fluctuations in our results of operations;
• our dependence on sole suppliers or a limited group of suppliers for both business segments;
• our ability to generate income to realize our net operating losses
• risks related to the limitation of the use of our net operating losses in the event of certain ownership changes; and
• MTI Micro’s need to raise additional financing;
• our ownership position in MTI Micro may be reduced further as a result of our need to seek external financing for MTI Micro’s operations;
• risks related to developing Mobion^® direct methanol fuel cells and whether MTI Micro will ever successfully develop reliable and commercially viable Mobion^® fuel cell solutions;
• MTI Micro’s dependence on OEMs integrating Mobion^® fuel cell systems into their devices; and
• other factors discussed under the heading “Risk Factors” below.

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

Risk Factors

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

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

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

• cancellation of sales from the military as a result of a potential redeployment of governmental funding;
• the company may not be able to maintain, improve, or expand its direct and indirect channels of distribution;

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• a failure to expand or maintain the business as a result of competition, a lack of brand awareness, or market saturation; and
• an inability to launch new products as a result of intensive competition, uncertainty of new technology development, and developmental timelines.

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

Since we have suspended operations for MTI Micro due to lack of funding, all of our corporate costs must be funded by the test and measurement instrumentation business.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Our inability to 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.

The electronic, semiconductor, solar, automotive and general instrumentation industries are subject to constant technological change. Our future success will depend on our ability to respond appropriately to changing technologies and changes in product function and quality. If we rely on products and technologies that are not attractive to end users, we may not be successful in capturing or retaining significant market share. 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 products obsolete, and we may not be able to respond effectively to the technological requirements of evolving markets. As a result, we will be required to expend substantial funds for and commit significant resources to:

• continue research and development activities on all product lines;
• hire additional engineering and other technical personnel; and
• purchase advanced design tools and test equipment.

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

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International sales risks could adversely affect our operating results.

Having a worldwide distribution network for our products exposes us to various economic, political, and other risks that could adversely affect our operations and operating results, including the following:

• unexpected changes in regulatory requirements;
• tariffs and duties and other trade barrier restrictions;
• greater difficulty in collecting accounts receivable;
• the burdens and costs of compliance with a variety of foreign laws;
• potentially reduced protection for intellectual property rights; and
• political or economic instability in certain parts of the world.

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

Historically, we have incurred net losses as a result of MTI Micro. Despite the suspension of MTI Micro’s operations in late 2011, there can be no assurance that there will be adequate resources to fund our future operations.

Prior to 2011, when we generated net income of $2.4 million primarily attributable to the reversal of a portion of the deferred tax asset’s valuation reserve of $1.5 million, representing the portion of the Company’s deferred tax asset that management has estimated is more likely than not to be realized and MTI Instrument’s strong performance, we had incurred recurring net losses, including net losses of $1.8 million in 2010, and $3.1 million in 2009. As a result of historic operating losses, we had an accumulated deficit of approximately $120.1 million as of December 31, 2011. MTI Micro suspended its operations at the end of 2011 and, therefore, expects to incur minimal ongoing operating expenses unless additional funding becomes available to fund its operations in the future. If MTI Micro is unable to secure additional financing, MTI Micro could be forced to 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.

Since the Company no longer expects to fund MTI Micro, MTI Micro has sought and will continue to seek other sources of funding, but there is no assurance that such funding will be available on acceptable terms, if at all.

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

We transact our business in U.S. dollars and bill and collect our sales in U.S. dollars. In 2011, approximately 33.3% of our revenue was from customers outside of the United States. A weakening of the dollar could cause our overseas vendors to require renegotiation of either the prices or currency we pay for their goods and services. Similarly, a strengthening of the dollar could cause our products to be more expensive for our international customers, which could cause the demand for our products and our revenue to decline.

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

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

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

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

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

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.

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

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

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

Our operating results may experience significant fluctuations.

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

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

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

We have experienced an ownership change in MTI Micro that has resulted in a limitation of the use of their net operating losses, and we may experience further ownership changes in both MTI and MTI Micro which would result in a further limitation of the use of our net operating losses.

As of December 31, 2011, it is estimated that MTI has net operating loss (NOL) carryforwards of approximately $50.4 million and MTI Micro has NOL carryforwards of approximately $16.5 million. As a result of the conversion of the bridge notes in December 2009, MTI no longer maintained an 80% or greater ownership in MTI Micro. Thus, MTI Micro is no longer included in Mechanical Technology, Incorporated and Subsidiaries' consolidated federal and combined New York State tax returns, effective December 9, 2009. Pursuant to the Internal Revenue Service's consolidated tax return regulations (IRS Regulation Section 1.1502-36), upon MTI Micro leaving the Mechanical Technology, Incorporated and Subsidiaries’ consolidated group, MTI elected to reduce a portion of its stock tax basis in MTI Micro by "reattributing" a portion of MTI Micro's NOL carryforwards to MTI, for an amount equivalent to its built-in loss amount in MTI's investment in MTI Micro's stock. As the result of MTI making this election with its December 31, 2009 tax return, MTI reattributed approximately $45.2 million of MTI Micro's NOLs (reducing its tax basis in MTI Micro's stock by the same amount), leaving MTI Micro with approximately $13 million of separate company NOL carryforwards at the time of conversion of the Bridge Notes.

The Company and its subsidiaries have undergone a formal Section 382 study. 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 of the Internal Revenue Code of 1986 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. As a result of MTI Micro’s issuance of stock between 2009 and 2011, MTI Micro has experienced a Section 382 ownership change, which has reduced their NOLs by an estimated $14.6 million.

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Our ability to utilize the MTI and remaining MTI Micro NOL carryforwards, including any future NOL carryforwards that may arise, may be limited by Section 382, if we or MTI Micro undergo any further “ownership changes” as a result of subsequent changes in the ownership of our outstanding common stock pursuant to the exercise of the MTI Micro warrants, MTI or MTI Micro options outstanding, additional financings obtained, or otherwise.

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

As of December 31, 2011, we owned approximately 47.6% of MTI Micro’s Common Stock issued. Between September 2008 and September 2011, MTI Micro entered into numerous debt and equity financings with third parties, primarily, Dr. Walter L. Robb, a member of the Company’s and MTI Micro’s boards of directors, and Counter Point Ventures Fund II, LP (Counter Point). Counter Point is a venture capital fund sponsored and managed by Dr. Robb. After these series of transactions, MTI now holds an aggregate of approximately 47.6% of the outstanding common stock of MTI Micro or 53.3% of the outstanding common stock and warrants issued of MTI Micro, and Dr. Robb and Counter Point hold approximately 5.1% and 45.2%, respectively of the outstanding common stock of MTI Micro or 4.3% and 40.3%, respectively of the outstanding common stock and warrants issued of MTI Micro. Since no entity of the related parties has power but, as a group, the Company and its related parties have the power, then the party within the related party group that is most closely associated with the VIE, MTI Micro, is the primary beneficiary. Even though Dr. Robb and Counterpoint combined control a majority of the outstanding common stock, and they have the ability to elect the directors of MTI Micro and decide whether to continue to seek business opportunities for MTI Micro or instead seek opportunities to sell the intellectual property, they have not elected to do so. The Company continues to oversee the day to day operations, exercise management decision making, seek opportunities to sell intellectual properties, and have a vested interest in the commercialization of MTI Micro’s fuel cell technology. Since inception in 2001, the Company has made the largest investment and been the principal funder of MTI Micro. The Company has also been exposed to losses and has the ability to benefit from MTI Micro. Considering the facts and circumstances, management believes the Company is most closely associated with the VIE, MTI Micro, and therefore, it is the primary beneficiary of MTI Micro. Should there be a change in the facts and circumstances (such as a change in governance or a change to the related party group) management will reassess whether they act as the primary beneficiary and should continue to include MTI Micro in the Company’s consolidated results of operations.

MTI Micro currently does not have sufficient funds to commercialize its portable power source products.

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

• obtain additional government grants or private funding of its direct methanol fuel cell research, development, manufacturing readiness and commercialization;
• receive a purchase order from government agencies or OEM’s MTI Micro is currently with; or
• secure additional debt or equity financing.

There is no guarantee that resources will be available to MTI Micro on terms acceptable to it, or at all, or that such resources will be received in a timely manner, if at all, or that MTI Micro will be able to resume operations or reduce its expenditure run-rate further. MTI Micro had cash and cash equivalents of $110 thousand as of December 31, 2011. Since 2008, MTI Micro has raised $5.4 million in external debt and equity financing. At the end of 2011, MTI Micro suspended its operations while additional necessary funding is being pursued. If MTI Micro raises additional funds by issuing equity securities, MTI Micro’s stockholders, including MTI, will experience further dilution. Additional debt financing, if available, may involve restrictive covenants. There is no assurance that funds raised in any future debt financing or additional equity financing arrangements will be sufficient, that the financing will be available on terms favorable to MTI Micro or to existing stockholders and at such times as required, or that MTI Micro will be able to obtain the additional financing required to resume the operation of its business. If MTI Micro raises additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish some rights to MTI Micro’s technologies or its products, or grant licenses on terms that are not favorable to MTI Micro. If MTI Micro is unable to secure additional financing, MTI Micro could be forced to 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.

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MTI Micro’s portable power source products may not be accepted by the market.

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

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

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

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

If MTI Micro’s proposed portable power source products do not achieve market acceptance, it could materially and adversely affect MTI Micro’s business and financial condition.

Item 1B: Unresolved Staff Comments

None.

Item 2: Properties

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

We believe our facilities are generally well maintained and adequate for our current needs and for expansion, if required. The New Energy lease has been extended until April 2012, at which time the Company intends to vacate the premises.

Item 3: Legal Proceedings

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

Item 4: Mine Safety Disclosure

Not applicable.

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PART II

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

Price Range of Common Stock

Our common stock is traded on the over the counter (OTC) Markets at PinkSheets.com under the symbol “MKTY.PK”. The following table sets forth the high and low sale prices of our common stock as reported by Pink Sheets for the periods indicated:

Dividend Policy

We have never declared or paid dividends on our common stock and do not anticipate or contemplate paying cash dividends on our common stock in the foreseeable future. We currently intend to use all available funds to develop our business. We can give no assurances that we will ever have excess funds available to pay dividends. Any future determination as to the payment of dividends will depend upon critical requirements and limitations imposed by our credit agreements, if any, and such other factors as our board of directors may consider.

Equity Compensation Plan Information

See also Part III Item 12 in this Annual Report on Form 10-K for additional detail related to security ownership and related stockholder matters, and for additional detail on equity compensation plan matters.

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Item 6: Selected Financial Data

The following table sets forth our summary consolidated financial data for the fiscal years ended December 31, 2011, 2010 and 2009 which was derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. We derived our summary consolidated financial data for the years ended December 31, 2008 and 2007 set forth in the following table from our audited consolidated financial statements not included in this report. You should read the following summary consolidated financial data together with the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements, including the related notes thereto.

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

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

Overview

MTI operates in two segments: the Test and Measurement Instrumentation segment, which is conducted through MTI Instruments, Inc. (MTI Instruments), a wholly-owned subsidiary, and the New Energy segment, which is conducted through MTI MicroFuel Cells, Inc. (MTI Micro), a variable interest entity (VIE) as of December 31, 2011. MTI and MTI Micro currently share the same board of directors, while MTI also continues to oversee the day to day operations, exercise management decision making, seek opportunities to sell intellectual properties, and have a vested interest in the commercialization of MTI Micro’s fuel cell technology. Since inception in 2001, MTI has made the largest investment and been the principal funder of MTI Micro. MTI has also been exposed to losses and has the ability to benefit from MTI Micro. Considering the facts and circumstances, management believes MTI is most closely associated with the VIE, MTI Micro, and therefore, it is the primary beneficiary. Should there be a change in the facts and circumstances (such as a change in governance or a change to the related party group) management will reassess whether they act as the primary beneficiary and should continue to include MTI Micro in MTI’s consolidated results of operations.

Test and Measurement Segment – MTI Instruments is a worldwide supplier of metrology, portable balancing equipment and inspection systems. Our products use state-of-the-art technology to solve complex real world applications in numerous industries including automotive, semiconductor, solar cell manufacturing, material testing, commercial and military aviation and data storage. We are continuously working on ways to expand our sales reach, including expanded sales coverage throughout Europe and Asia, as well as a focus on internet marketing.

Our test and measurement segment has three product groups: Precision Instruments, Semiconductor and Solar Metrology Systems, and Aviation Balancing Systems. Our products consist of electronic, computerized gauging instruments for position, displacement and vibration applications for the design, manufacturing/production and test and research markets; metrology tools for wafer characterization of semiconductor and solar wafers; tensile stage systems for materials testing in research and industrial settings; and engine balancing and vibration analysis systems for both military and commercial aircraft.

In 2011, MTI Instruments was awarded a $4.1 million multi-year U.S. Air Force contract for the purchase of PBS4100+ portable aircraft engine balancing systems. As of December 31, 2011, MTI Instruments had recorded $684 thousand in orders, approximately 16.7% of the total contract’s total value. MTI Instruments also has a multi-year U.S. Air Force contract to service and repair its existing fleet of PBS-4100/+ jet engine balancing systems with the latest diagnostic and balancing technology, which could potentially generate up to a total of $6.5 million in sales for the Company between 2009 and 2014. As of December 31, 2011, MTI Instruments had recorded $2.9 million in orders, approximately 44.6% of the contract’s total value.

New Energy Segment - MTI Micro has been developing an off-the-grid power solutions for various portable electronic devices. Our patented proprietary direct methanol fuel cell (DMFC) technology platform, called Mobion^®, converts methanol fuel to usable electricity capable of providing continuous power as long as necessary fuel flows are maintained. Our proprietary fuel cell power solution consists of two primary components integrated into an easily manufactured device: the direct methanol fuel cell power engine, which we refer to as our Mobion^® Chip, and methanol fuel cartridges. The methanol used by the technology is fully biodegradable.

Although MTI Micro continues to believe in the potential of its Mobion^® based power solutions, operations have been suspended at MTI Micro until such time as market demand and other deciding factors, including obtaining additional external financing, the successful completion of customer trials, a new development program with a government agency, and/or a customer order come to fruition. Currently, MTI Micro has no employees and projects to spend between $5 and $10 thousand per month for operating activities including rent, preparing prototypes for customer demonstrations, minimal sales efforts, and patent fees to keep its patent portfolio current and minimal consultant costs to perform these initiatives. MTI Micro will continue to seek additional capital from external sources to resume operations and fund future development, if any. If MTI Micro is unable to secure additional financing, a new development program or customer order, the MTI Micro board of directors will assess other options for MTI Micro including the sale of MTI Micro’s intellectual property portfolio and other assets.

In the second half of 2010, we entered into a firm fixed price contract for the development of proof of concept fuel cells for technical testing with a United States Department of Defense (DOD) agency. Additionally, during the first quarter of 2011, we completed the work required under the United States Department of Energy (DOE) grant awarded for the period January 8, 2009 through March 30, 2011. The objective of the grant was to demonstrate and field test a commercially viable one watt DMFC charger for consumer electronic devices. As part of this objective, MTI Micro field tested 75 units to various users, including 17 OEM’s, 33 individuals, 21 military agencies and four governmental agencies. We have achieved all technical performance targets required by the DOE under this grant; this field testing has concluded and the final report to the DOE may be found at http://www.mtimicrofuelcells.com/news/events.asp. Additional experimental testing was conducted at the DOD since the fourth quarter of 2010 that resulted in product improvements in the third quarter of 2011. Further testing by the DOD of our Mobion^® fuel cell charger commenced in October 2011. If approval is granted, this may result in the signing of a commercialization contract or purchase orders for final production. To date, no such approval has been granted and there is no clear indication as to when MTI Micro will be notified.

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Recent Developments

Material Agreements – On February 9, 2011, Amendment No. 1 to the Common Stock and Warrant Purchase Agreement (the Purchase Agreement) was entered into between MTI Micro and Counter Point. The total $450 thousand of Amendment No. 1 was drawn down as of September 30, 2011. In exchange, Counter Point received 6,428,574 shares of MTI Micro Common Stock and 1,285,715 MTI Micro Warrants. See Note 10 in the consolidated financial statements for further discussion of this transaction.

On September 23, 2011, Amendment No. 2 to the Purchase Agreement was entered into between MTI Micro and Counter Point. The total $84 thousand of Amendment No. 2 has been drawn down as of December 31, 2011. In exchange, Counter Point received 1,200,000 shares of MTI Micro Common Stock and 240,000 MTI Micro Warrants. See Note 10 in the consolidated financial statements for further discussion of this transaction.

Line of Credit – On September 20, 2011, MTI Instruments entered into a working capital line of credit with First Niagara Bank, N.A. Pursuant to the Demand Grid Note, MTI Instruments may borrow from time to time up to $400 thousand to support its working capital needs. The note is payable upon demand, and the interest rate on the note is equal to the prime rate with a floor of 4.0% per annum. The note is secured by a lien on all of the assets of MTI Instruments and is guaranteed by the Company. The line of credit is subject to a review date of June 30, 2012. Under the line of credit, MTI Instruments is required to hold a line balance of $0 for 30 consecutive days out during each consecutive year. As of December 31, 2011, there were no amounts outstanding under the line of credit.

Results of Operations

Results of Operations for the Year Ended December 31, 2011 Compared to December 31, 2010.

Test and Measurement Instrumentation Segment

Product Revenue: Product revenue in our test and measurement instrumentation segment for the year ended December 31, 2011 increased by $3.1 million, or 43.2%, to $10.3 million in 2011 from $7.2 million in 2010. This increase in product revenue was due to a $2.6 million rise in new aviation balancing equipment sales and higher capacitance product sales. These product revenue increases were partially offset by a decline in wafer metrology tool shipments. As with the prior year, the US Air Force was the largest customer for the segment; accounting for $2.3 million, or 22.4%, of the total year product revenue, as compared to $1.6 million, or 22.3%, of the total product revenue in 2010. The segment’s largest commercial customer in 2011 was a Southeast Asian distributor, who accounted for $1.1 million, or 10.7%, of the total product revenue, as compared to the largest commercial customer in the prior year who was a Chinese distributor, who accounted for $560 thousand, or 7.8%, of the total product revenue in 2010.

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

Cost of Product Revenue: Cost of product revenue in our test and measurement instrumentation segment for the year ended December 31, 2011 increased by $851 thousand, or 29.1%, to $3.8 million in 2011 from $2.9 million in 2010 in conjunction with the aforementioned 43.2% increase in product revenue. Gross profit, as a percentage of product revenue, increased to 63.2%, compared to 59.2% for the same period in 2010 due to reductions in material component costs and warranty repairs.

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Unfunded Research and Product Development Expenses: Unfunded research and product development expenses in our test and measurement instrumentation segment for the year ended December 31, 2011 increased by $284 thousand, or 29.6%, to $1.2 million in 2011 from $959 thousand in 2010. This increase is attributable to higher material spending on current development projects throughout the year, along with additional personnel costs in the segment’s engineering department.

Selling, General and Administrative Expenses: Selling, general and administrative expenses in our test and measurement instrumentation segment for the year ended December 31, 2011 increased by $322 thousand, or 16.2%, to $2.3 million in 2011 from $2.0 million in 2010. This increase is the result of additional staffing in the segment’s sales and business development departments along with higher consultant costs.

New Energy Segment

Funded Research and Development Revenue: Funded research and development revenue in our new energy segment for the year ended December 31, 2011 decreased $1.2 million, or 99.0%, to $13 thousand in 2011 from $1.2 million in 2010. The decrease in funded research and development revenue was primarily the result of the work performed under the DOE and NYSERDA contracts being substantially completed in 2010 for the commercialization of our fuel cell product. Final billings for these grants occurred in the first quarter of 2011, and no further grants have been received.

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

Funded Research and Product Development Expenses: Funded research and product development expenses in our new energy segment for the year ended December 31, 2011 decreased by $2.5 million, or 99.0%, to $25 thousand in 2011 from $2.5 million in 2010. This decrease is a result of the majority of the work being performed in 2010 for the DOE and NYSERDA contracts, whose contracts concluded in the first quarter of 2011, as discussed in funded research and development revenue above.

Unfunded Research and Product Development Expenses: Unfunded research and product development in our new energy segment for the year ended December 31, 2011 decreased by $160 thousand, or 44.7%, to $199 thousand in 2011 from $358 thousand in 2010. This decrease from the prior year was due to staff reductions and substantial cut backs in external development spending throughout 2011.

Selling, General and Administrative Expenses: Selling, general and administrative expenses in our new energy segment for the year ended December 31, 2011 decreased by $957 thousand, or 49.1%, to $993 thousand in 2011 from $1.9 million in 2010. This decrease was primarily the result of a significant decrease in personnel costs and benefits of $2.1 million, a reduction in rent and other facility costs of $256 thousand, travel expense reductions of $28 thousand, depreciation expense reductions of $174 thousand and a reduction in China operations of $81 thousand for the year. These reductions in expense were offset by a reduction in the allocation of costs to research and development of $1.7 million.

Results of Consolidated Operations

Operating Income (Loss): Operating income for the year ended December 31, 2011 was $52 thousand compared to an operating loss of $3.4 million for the year ended December 31, 2010. This decrease in operating loss was a result of the factors noted above.

Gain (loss) on Derivatives: We recorded a gain on derivative accounting of $73 thousand for the year ended December 31, 2011 and a loss of $3 thousand on derivative accounting for the year ended December 31, 2010. Both the 2011 gain and 2010 loss are the result of derivative treatment of the freestanding warrants issued to investors in conjunction with our December 2006 capital raise. These warrants expired on December 19, 2011.

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Income Tax Benefit (Expense): Income tax benefit for the year ended December 3, 2011 was $1.5 million compared to income tax expense of $4 thousand for the same period in 2010. Our income tax rate for the years ended December 31, 2011 and 2010 was 1,548% and 0%, respectively. The 2011 tax rate was primarily the result of the reversal of a portion of the valuation allowance to reflect the portion of the Company’s deferred tax asset that management has estimated is more likely than not to be realized. The 2010 tax rate was primarily the result of losses generated by operations, changes in the valuation allowance, state true-ups upon tax return filings, and permanent deductible differences for the derivative valuation. The valuation allowance against our deferred tax assets at December 31, 2011 and at December 31, 2010 was $19.8 million and $27.8 million, respectively.

Net Losses Attributed to Non-Controlling Interests (of MTI Micro): The net loss attributed to non-controlling interests for the year ended December 31, 2011 decreased by $900 thousand, or 55.0%, to $738 thousand in 2011 from $1.6 million in 2010. This is the result of a decrease in the net loss of MTI Micro from $3.6 million in 2010 to $1.5 million in 2011, offset in part, by an increase in the percentage of ownership of the non-controlling interest of MTI Micro in 2011.

Net Income (Loss): Net income for the year ended December 31, 2011 was $2.4 million compared to a net loss of $1.8 million for the same period in 2010. The increase in net income of $4.1 million for the year ended December 31, 2011 as compared to the same period in 2010 is primarily attributed to the reversal of a portion of the deferred tax asset’s valuation reserve of $1.5 million, representing the portion of the Company’s deferred tax asset that management has estimated is more likely than not to be realized, an increase of MTI Instruments yearly net income of $1.6 million, a reduction of the yearly net loss of MTI Micro of $2.2 million, and a reduction in the net loss attributed to non-controlling interests of $900 thousand. These are a result of the factors discussed above.

Results of Operations for the Year Ended December 31, 2010 Compared to December 31, 2009.

Test and Measurement Instrumentation Segment

Product Revenue: Product revenue in our test and measurement instrumentation segment for the year ended December 31, 2010 increased by $915 thousand, or 14.6%, in comparison to 2009, to $7.2 million. As with the prior year, the US Air Force was the top customer for the segment; accounting for $1.6 million, or 22.0%, of the total year revenue, as compared to $1.2 million, or 19.0%, of the total revenue in 2009. The segment’s top commercial customer in 2010 accounted for $560 thousand, or 7.8%, of the annual revenue, as compared to the top commercial customer last year accounting for $618 thousand, or 9.9%, of the total 2009 revenue.

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

Cost of Product Revenue: Cost of product revenue in our test and measurement instrumentation segment for the year ended December 31, 2010 increased in comparison to 2009 by $265 thousand, or 9.9%, to $2.9 million in conjunction with the aforementioned 14.6% increase in product revenue. Gross profit, as a percentage of product revenue, rose two points to 59% in 2010 due to a reduction in expense for potentially obsolete and slow-moving inventory.

Unfunded Research and Product Development Expenses: Unfunded research and product development expenses in our test and measurement segment for the year ended December 31, 2010 decreased by $6 thousand, or 0.6%, to $959 thousand from $965 thousand in 2009. This decrease is attributable to lower personnel costs in the segment’s engineering department during the year, which were partially offset by increases in material spending for new product development and existing product support.

Selling, General and Administrative Expenses: Selling, general and administrative expenses in our test and measurement segment increased for the year ended December 31, 2010 by $162 thousand, or 8.2%, to $1.98 million from $1.82 million for 2009. This increase is primarily the result of additional staffing in the segment’s sales and business development departments.

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New Energy Segment

Funded Research and Development Revenue: Funded research and development revenue in our new energy segment decreased by $810 thousand, or 40%, to $1.23 million for the year ended December 31, 2010 from $2.04 million for the year ended December 31, 2009. The decrease in revenue was primarily the result of the research and development performed under the DOE contract in 2009 for the commercialization of our fuel cell product, while billing in 2010 has been substantially less as we entered into the market test phase of the commercialization.

Information regarding our contracts included in funded research and development revenue is as follows:

Funded Research and Product Development Expenses: Funded research and product development expenses in our new energy segment for the year ended December 31, 2010 decreased by $1.56 million or 38% to $2.54 million from $4.1 million in 2009. This is a result of the majority of the work being performed in 2009 for the DOE contract, as discussed in funded research and development revenue above.

Unfunded Research and Product Development Expenses: Unfunded research and product development in our new energy segment decreased by $26 thousand, or 7%, to $358 thousand for the year ended December 31, 2010 compared to 2009. This decrease from the prior year was due to staff reductions and substantial cut backs in external development spending.

Selling, General and Administrative Expenses: Selling, general and administrative expenses in our new energy segment for the year ended December 31, 2010 increased by $1.85 million, or 1,758%, to $1.95 million in 2010 from $105 thousand in 2009. This increase was primarily the result of stock option expense on MTI and MTI Micro Options awarded to employees increasing from $428 thousand in 2009 to $1.4 million in 2010 and a decrease in the allocation of costs to research and development.

Results of Consolidated Operations

Operating Loss: Operating loss for the year ended December 31, 2010 compared with the operating loss for the year ended December 31, 2009 increased by $305 thousand to $3.4 million, a 10% increase, as a result of the factors noted above.

Gain (loss) on Derivatives: We recorded a loss on derivative accounting of $3 thousand for the year ended December 31, 2010 and a loss of $29 thousand on derivative accounting for the year ended December 31, 2009. Both the 2010 loss and 2009 loss 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: Income tax benefit went from a benefit of $208 thousand in 2009 to an expense of $4 thousand for 2010. This is primarily the result of a reversal of an uncertain tax position in 2009 of $194 thousand that was recorded in 2008 and settled in 2009. Our income tax rate for the year ended December 31, 2010 was 0%, while the income tax rate for the year ended December 31, 2009 was 6%. These tax rates were primarily the result of losses generated by operations, changes in the valuation allowance, state true-ups upon tax return filings, and permanent deductible differences for the derivative valuation.

The valuation allowance against our deferred tax assets at December 31, 2010 was $27.8 million and at December 31, 2009 was $26.4 million. We determined that it was more likely than not that the ultimate recognition of certain deferred tax assets would not be realized.

Net Losses Attributed to Non-Controlling Interests (of MTI Micro): The net loss attributed to non-controlling interests increased from $265 thousand for 2009 to $1.6 million in 2010. This is a result of the increase in the percentage of ownership of the non-controlling interest of MTI Micro in 2010 due to additional equity contributions of $1.9 million. In addition, the equity contributions of $3.4 million in 2009 occurred in September 2009; thus 2010 includes a full year of losses for these additions.

Net Income (Loss): Net loss for the year ended December 31, 2010 was $1.8 million compared to a net loss of $3.1 million for 2009. This reduction in losses is a result of the factors discussed above.

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Liquidity and Capital Resources

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

The Company has historically incurred significant losses, the majority stemming from the direct methanol fuel cell product development and commercialization programs of MTI Micro, and had a consolidated accumulated deficit of $120.1 million as of December 31, 2011. During 2011, the Company generated net income attributed to MTI of $2.4 million and had working capital at December 31, 2011 of $3.1 million, a $1.6 million increase from $1.5 million at December 31, 2010. This increase was primarily attributed to the reversal of a portion of the deferred tax asset’s valuation reserve of $1.5 million, representing the portion of the Company’s deferred tax asset that management has estimated is more likely than not to be realized, the improved result of operations for MTI Instruments, a continued hold on expenses, and capital raised through the issuance of MTI Micro stock. The Company had an operating cash surplus of $67 thousand in 2011 and currently has no debt. While it cannot be assured, management believes that MTI Instruments will continue to generate positive cash flows and be able to fund the Company’s operations for at least the next twelve months.

Although MTI Micro continues to believe in the potential of its Mobion^® based power solutions, operations have been suspended at MTI Micro until such time as market demand and other deciding factors, including obtaining additional external financing, the successful completion of customer trials, a new development program with a government agency, and/or a customer order, come to fruition. MTI Micro had cash and cash equivalents as of December 31, 2011 of $110 thousand. Currently, MTI Micro has no employees and projects to spend between $5 and $10 thousand per month for operating activities including rent, preparing prototypes for customer demonstrations, minimal sales efforts, patent fees to keep its patent portfolio current and minimal consultant costs to perform these initiatives. MTI Micro will continue to seek additional capital from external sources to resume operations and fund future development, if any. If MTI Micro is unable to secure additional financing, a new development program or customer order, the MTI Micro board of directors will assess other options for MTI Micro, including the sale of MTI Micro’s intellectual property portfolio and other assets.

During the year ended December 31, 2011, cash provided by operating activities was $67 thousand, consisting of net income of $1.6 million, non-cash expenses of $(617) thousand (primarily including $307 thousand for depreciation, $661 thousand for stock based compensation, and a $(1.5) million income tax benefit), and other changes in operating assets and liabilities of $(964) thousand (primarily due to the increase in accounts receivable at year end). Cash used by investing activities for the year ended December 31, 2011 was $163 thousand, comprised primarily of purchases of property, plant and equipment primarily for MTI Instruments related to computers and laboratory and demo equipment. We had no outstanding commitments for capital expenditures as of December 31, 2011. Cash provided by financing activities for the year ended December 31, 2011 was $647 thousand consisting of capital raised through the issuance of MTI Micro common stock.

As of December 31, 2011, we had approximately $1.7 million of cash and cash equivalents to fund our future operations. During the year ended December 31, 2011, our results of operations resulted in net income after the non-controlling interest allocation of $2.4 million and cash provided by operating activities totaling $67 thousand. We expect to spend approximately $1.4 million in research and development on MTI Instruments’ products during 2012. We expect to continue funding our operations from current cash and cash equivalents, proceeds, if any, from additional debt or equity financings and government funding. We may also seek to supplement our resources through the sales of assets (including our investment in MTI Micro). Besides the line of credit at MTI Instruments, we have no other commitments for funding future needs of the organization at this time and such additional financing during 2012 may not be available to us on acceptable terms, if at all.

Line of Credit

On September 20, 2011, MTI Instruments entered into a working capital line of credit with First Niagara Bank, N.A. Pursuant to the Demand Grid Note, MTI Instruments may borrow from time to time up to $400 thousand to support its working capital needs. The note is payable upon demand, and the interest rate on the note is equal to the prime rate with a floor of 4.0% per annum. The note is secured by a lien on all of the assets of MTI Instruments and is guaranteed by the Company. The line of credit is subject to a review date of June 30, 2012. Under the line of credit, MTI Instruments is required to hold a line balance of $0 for 30 consecutive days out during each consecutive year. As of December 31, 2011, there were no amounts outstanding under the line of credit.

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Backlog, Inventory and Accounts Receivable

At December 31, 2011, the Company’s order backlog was $861 thousand, compared to $2.1 million at December 31, 2010. The backlog at December 31, 2010 was elevated by record high fourth quarter order activity that year.

Our inventory turnover ratios and average accounts receivable days sales outstanding for the years ended December 31, 2011 and 2010 and their changes are as follows:

The positive increase in inventory turnover is driven by average inventory balances increasing 27% on a 43% higher annual sales volume in 2011 as well as better managed production quantities and inventory purchases over the last twelve months.

The average accounts receivable days sales outstanding remained consistent in 2011 compared with 2010.

Off-Balance Sheet Arrangements

There are no off balance sheet arrangements of the Company.

Contractual Obligations

We have entered into various agreements with non-cancelable terms that result in contractual payment obligations in future years. These contracts include manufacturing, laboratory and office facility lease agreements as well as purchase commitments for general operations of the Company. The following table summarizes cash payments that we are committed to make under the existing terms of contracts to which we are a party as of December 31, 2011. This table does not include contingencies.

Market Risk

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

Interest Rate Risk. Interest rate risk is the risk that changes in interest rates could adversely affect earnings or cashflows. The Company’s cash equivalents are sensitive to changes in interest rates. Interest rate changes would result in a change in interest income due to the difference between the current interest rates on cash. Interest rate risk sensitivity analysis is used to measure interest rate risk by computing estimated changes in cashflow as a result of assumed changes in market interest rates. A 10% decrease in 2011 interest rates would be immaterial to the Company’s consolidated financial statements.

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

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

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

Critical Accounting Policies and Significant Judgments and Estimates

The following discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Note 2 of the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K includes a summary of our most significant accounting policies. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, 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, income taxes, share-based compensation and derivatives. We base our estimates on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Periodically, we review our critical accounting estimates with the Audit Committee of our Board of Directors.

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

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

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

We apply accounting guidance on revenue recognition in the evaluation of commercially funded fuel cell research and prototype agreements to determine when to properly recognize income. Payments received in connection with commercial research and prototype agreements are deferred and recognized on a straight-line basis over the term of the agreement for service-related payments. For milestone and prototype delivery payments, if and when achieved, revenue is deferred and recognized on a straight-line basis over the remaining term of the agreement. When revenue qualifies for recognition it will be recorded as funded research and development revenue. The costs associated with research and prototype-producing activities are expensed as incurred. Expenses in an amount equal to revenue recognized are reclassified from unfunded research and product development to funded research and product development.

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

Share-Based Payments. We grant options to purchase our common stock and award restricted stock to our employees and directors under our equity incentive plans. The benefits provided under these plans are share-based payments subject to the appropriate accounting provisions regarding Share-Based Payments. Effective January 1, 2006, we use the fair value method of accounting with the modified prospective application, which provides for certain changes to the method for valuing share-based compensation. The valuation provisions apply to new awards and to awards that are outstanding on the effective date and subsequently modified. Under the modified prospective application, prior periods are not revised for comparative purposes. Share-based compensation expense recognized under these accounting methods for the year ended December 31, 2011 was $661 thousand. At December 31, 2011, total unrecognized estimated compensation expense related to non-vested awards granted prior to that date was $104 thousand, which is expected to be recognized over a weighted average period of .87 years.

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We estimate the fair value of share-based awards on the date of grant using a Black-Scholes option-pricing model. The determination of the fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rate, and expected dividends.

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

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

For purposes of estimating the fair value of stock options granted during the twelve months ended December 31, 2011 using the Black-Scholes model, we used the historical volatility of our stock for the expected volatility assumption input to the Black-Scholes model, consistent with the accounting guidance. The risk-free interest rate is based on the risk-free zero-coupon rate for a period consistent with the expected option term at the time of grant. We do not currently pay nor do we anticipate paying dividends, but we are required to assume a dividend yield as an input to the Black-Scholes model. As such, we use a zero dividend rate. The expected option term is estimated using both historical term measures and projected termination estimates.

Income Taxes. As part of the process of preparing our consolidated financial statements, we calculate income taxes for each of the jurisdictions in which we operate. This involves estimating actual current taxes due together with assessing temporary differences resulting from differing treatment for tax and accounting purposes that are recorded as deferred tax assets and liabilities. We periodically evaluate deferred tax assets, net operating loss carryforwards and tax credit carryforwards to determine their recoverability based primarily on our ability to generate future taxable income.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance recorded against our net deferred tax assets. We considered all available evidence, both positive and negative, such as historical levels of income and future forecasts of taxable income amongst other items in determining whether a full or partial release of our valuation allowance is required. In addition, our assessment requires us to schedule future taxable income in accordance with accounting standards that address income taxes to assess the appropriateness of a valuation allowance, which further requires the exercise of significant management judgment.

As a result of our analyses in 2011, we released a portion of our valuation allowance against our deferred tax assets. The partial release of the valuation allowance caused an incremental tax benefit of $1.5 million to be recognized in the fourth quarter of 2011. For our analysis, we projected our pre-tax earnings utilizing a combination of historical and projected results, taking into consideration existing levels of permanent differences, non-deductible expense and the reversal of significant temporary differences. We need to generate approximately $225 thousand of taxable income in each year over the next twenty years to ensure the realizability of the $1.5 million of deferred tax assets recorded on our balance sheet at December 31, 2011. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to adjust the recorded valuation allowance, which could materially impact our financial position and results of operations. The remaining valuation allowance at December 31, 2011 is $19.8 million and relates primarily to net operating losses and stock based compensation. We will continue to evaluate the ability to realize our deferred tax assets and related valuation allowance on a quarterly basis.

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Our Federal net operating loss carryforwards as of December 31, 2011 were $66.9 million. Of these, $50.4 are MTI’s and $16.5 are MTI MicroFuel Cells. However, approximately $14.6 million of MFC’s NOLs have been reduced due to limitations caused by Section 382 ownership changes. Of the remaining NOL’s, $4.1 million expire in 2020, with the remainder expiring through 2031.

We account for taxes in accordance with the asset and liability method of accounting for income taxes. Under this method, we must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. The impact of our reassessment of our tax positions for these standards did not have a material impact on our results of operations, financial condition, or liquidity.

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

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

Recent Accounting Pronouncements

A discussion of recently adopted and new accounting pronouncements is included in Note 2 of the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

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

Item 8: Financial Statements and Supplementary Data

The Company’s Consolidated Financial Statements filed herewith beginning at page F-1 are incorporated in this Item 8 by reference.

Selected Quarterly Financial Data

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Selected Quarterly Financial Data

As a result of rounding and quarterly calculations, the sum of the quarters may not agree to the year to date results.

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

None.

Item 9A: Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of MTI’s disclosure controls and procedures as of December 31, 2011. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. We recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and we necessarily apply our judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the valuation of our disclosure controls and procedures as of December 31, 2011, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

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

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

Under the supervision and with the participation of our management, including the principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting using the criteria set forth in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation using the criteria set forth in Internal Control—Integrated Framework, Management has concluded that our internal control over financial reporting was effective as of December 31, 2011.

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

(c) Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(1) under the Exchange Act, during our fiscal quarter ended December 31, 2011 that have materially affected, or are reasonable likely to materially affect our internal control over financial reporting.

Item 9B: Other Information

No information was required to be disclosed in a current Report on Form 8-K during the fourth quarter of the fiscal year covered by this Annual Report on Form 10-K which has not been reported.

PART III

Item 10: Directors, Executive Officers and Corporate Governance

(a) Directors
Incorporated herein by reference is the information appearing under the captions “Information about our Directors” and “Compliance with Section 16(a) of the Securities Exchange Act of 1934” in our definitive Proxy Statement for our 2012 Annual Meeting of Stockholders to be filed with the SEC on or before April 29, 2012.

(b) Executive Officers
Incorporated herein by reference is the information appearing under the captions “Executive Officers” and “Compliance with Section 16(a) of the Securities Exchange Act of 1934” in our definitive Proxy Statement for our 2012 Annual Meeting of Stockholders to be filed with the SEC on or before April 29, 2012.

Incorporated herein by reference is the information appearing under the caption “Board of Director Meetings and Committees – Audit Committee” in our definitive Proxy Statement for our 2012 Annual Meeting of Stockholders to be filed with the SEC on or before April 29, 2012.

Code of Ethics: We have adopted a Code of Ethics for employees, officers and directors. The Code of Ethics is intended to comply with Item 406 of Regulation S-K of the Securities Exchange Act of 1934. A copy may be obtained at no charge by written request to the attention of our Secretary at 325 Washington Avenue Extension, Albany, New York 12205. A copy of the Code of Ethics is also available on our website at http://www.mechtech.com under Investor Relations, Corporate Governance.

Item 11: Executive Compensation

Incorporated herein by reference is the information appearing under the caption “Executive Compensation” in the Company’s definitive Proxy Statement for our 2012 Annual Meeting of Stockholders to be filed with the SEC on or before April 29, 2012.

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

Incorporated herein by reference is the information appearing under the caption “Principal Stockholders” in our definitive Proxy Statement for our 2012 Annual Meeting of Stockholders to be filed with the SEC on or before April 29, 2012.

Equity Compensation Plans
As of December 31, 2011, we have three equity compensation plans, each of which was originally approved by our stockholders; the Mechanical Technology, Incorporated 1996 Stock Incentive Plan (the 1996 Plan), 1999 Employee Stock Incentive Plan (the 1999 Plan) and 2006 Equity Incentive Plan (the 2006 Plan). The 2006 Plan was amended and restated and approved by our Board of Directors in 2011 and 2009. We refer collectively to these as the Plans. See Note 13 of the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for a description of these Plans.

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The following table presents information regarding these plans as of December 31, 2011:

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

Incorporated herein by reference is the information appearing under the caption “Certain Relationships and Related Transactions” in our definitive Proxy Statement for the 2012 Annual Meeting of Stockholders to be filed with the SEC on or before April 29, 2012.

Item 14: Principal Accounting Fees and Services

Incorporated herein by reference is the information appearing under the caption “Independent Accountants” in our definitive Proxy Statement for the 2012 Annual Meeting of Stockholders to be filed with the SEC on or before April 29, 2012.

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PART IV

Item 15: Exhibits, Financial Statement Schedules

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

15(a) (2) Financial Statement Schedules: The following Consolidated Financial Statement Schedule for the years ended December 31, 2011, 2010, and 2009 is included pursuant to Item 15(d):

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

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

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

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35

All other exhibits for which no other filing information is given are filed herewith.
____________________

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Signatures

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

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

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Report of Independent Registered Public Accounting Firm on
Financial Statement Schedule

To the Board of Directors
of Mechanical Technology, Incorporated:

Our audits of the consolidated financial statements referred to in our report dated March 27, 2012 appearing on page F-2 of this Form 10-K of Mechanical Technology, Incorporated also included an audit of the financial statement schedule listed in Item 15(a)(2) of this Form 10-K. In our opinion, this financial statement schedule present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.

/s/PricewaterhouseCoopers LLP

Albany, New York
March 27, 2012

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

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MECHANICAL TECHNOLOGY, INCORPORATED AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

F-1

Report of Independent Registered Public Accounting Firm

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

We have audited the accompanying consolidated balance sheets and the related consolidated statements of operations, consolidated statements of stockholder's equity and comprehensive (loss) income, and consolidated statements of cash flows of Mechanical Technology, Incorporated and its subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Mechanical Technology Incorporated at December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2011 in conformity with accounting principles generally accepted in the United States of America.
 

F-2

MECHANICAL TECHNOLOGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2011 and 2010

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

F-3

MECHANICAL TECHNOLOGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, 2011, 2010, and 2009

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

F-4

MECHANICAL TECHNOLOGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE (LOSS) INCOME
For the Years Ended December 31, 2011, 2010, and 2009

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

F-5

MECHANICAL TECHNOLOGY, INCORPORATED AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2011, 2010, and 2009