Unless the context requires otherwise, the terms "we," "us," and "our" refer to Mechanical Technology, Incorporated, a New York Corporation, "MTI Micro" refers to MTI MicroFuel Cells Inc., a Delaware corporation and our majority owned subsidiary, and "MTI Instruments" refers to MTI Instruments, Inc., a New York corporation and our wholly owned subsidiary. We have a registered trademark in the United States for "Mobion." Other trademarks, trade names, and service marks used in this Quarterly Report on Form 10-Q are the property of their respective owners.

The following discussion of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and the notes thereto included in Item 1 of Part I of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and the notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2007 contained in our 2007 Annual Report on Form 10-K.

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

Overview

We are developing and commercializing off-the-grid rechargeable power sources for portable electronics. We have developed a patented, proprietary direct methanol fuel cell technology platform called Mobion, which generates electrical power using up to 100% methanol as fuel. Our proprietary fuel cell power solution consists of two primary components integrated in an easily manufactured device: the direct methanol fuel cell power engine, which we refer to as our Mobion Chip, and methanol replacement cartridges. Our Mobion Chip weighs less than one ounce and is small enough to fit in the palm of one's hand. The methanol used by the technology is fully biodegradable. We believe we are the only micro fuel cell developer to have demonstrated power density of over 62 mW/cm2 while producing more than 1,800 Wh/kg of energy from the direct methanol fuel feed. For these reasons, we believe our technology offers a compelling alternative to current lithium-ion and similar rechargeable battery systems currently used by original equipment manufacturers and branded partners, or OEMs, in many handheld electronic devices, such as mobile phones (including smart phones) and mobile phone accessories, digital cameras, portable media players, personal digital assistants, or PDAs, and global positioning systems, or GPS devices. We believe our platform will facilitate the development of numerous product advantages, including small size, environmental friendliness, and simplicity of design, all critical for commercialization in the consumer market, and can be implemented as three different product options: a compact external charging device, a snap-on or attached power accessory, or a lithium-ion battery replacement embedded fuel cell power solution. With adequate funding, we intend to commercialize the Mobion platform in 2009.

Our Mobion technology eliminates the need for active water recirculation pumps or the inclusion of water as a fuel dilutant. The water required for the electrochemical process is transferred internally within the Mobion Chip from the site of water generation on the air-side of the cell. This internal flow of water takes place without the need for any pumps, complicated re-circulation loops or other micro-plumbing tools. Our Mobion technology is protected by a patent portfolio that includes over 101 U.S. patent applications covering five key technologies and manufacturing areas.

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

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

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

(Dollars in thousands)                         Nine Months Ended
                                                 September 30,
                                              2007        2008
Cash and cash equivalents                   $  11,493   $   3,350
Securities available for sale                       -          98
Working capital                                11,375       1,708
Net loss                                       (8,124 )   (10,481 )
Net cash used in operating activities         (10,760 )    (8,542 )
Purchase of property, plant and equipment        (281 )      (190 )

From inception through September 30, 2008, we have incurred an accumulated deficit of $115.5 million and we expect to incur losses for the foreseeable future as we continue micro fuel cell product development and commercialization programs. We expect that losses will fluctuate from year to year and that such fluctuations may be substantial as a result of, among other factors, sales of securities available for sale as well as the operating results of our businesses.

Restructuring

In August 2008, the Board of Directors approved a restructuring plan (the "Restructuring"), which was designed to help the Company reduce expenses and preserve cash. As part of the Restructuring, a total of 29 positions across the Company and its subsidiaries were eliminated. The Company accrued and at present expects to incur total severance and other benefit charges of approximately $342,000 in connection with this plan. Through September 30, 2008, the Company has incurred cash expenditures to implement this plan of $107,000, and we expect to incur a majority of our remaining cash expenditures under this plan by March 31, 2009.

MTI Micro Bridge Notes

In September 2008, MTI Micro closed on $1.5 million of funding in the form of convertible secured notes (the "Bridge Notes") from an investor group that included Dr. Walter L. Robb, a member of our Board of Directors. We agreed to convert $700,000 of our prior advances to MTI Micro into these Bridge Notes. The Bridge Notes carry an annual interest rate of 10%, compounded annually, and mature on March 31, 2009. If a qualified financing event (expected to be Series A Preferred Stock) occurs prior to the maturity of the Bridge Notes, all note holders will exchange their principal and interest amounts for MTI Micro securities issued during the qualified financing event (at then-issued prices). If no such qualifying financing event occurs prior to March 31, 2009, the Bridge Notes will either be repaid or converted into securities of MTI Micro at a mutually agreeable price among all note holders. These Bridge Notes are secured by all of the assets of MTI Micro, including intellectual property. Lastly, five-year warrants to purchase additional securities were issued to all investors, having an aggregate exercise price equal to 10% of the outstanding principal amounts under the Bridge Notes. These warrants will be priced in a manner similar to the conversion of the Bridge Notes.

Results of Operations

Results of Operations for the Three and Nine Months Ended September 30, 2008 Compared to the Three and Nine Months Ended September 30, 2007.

Product Revenue. Product revenue in our test and measurement instrumentation business for the three months ended September 30, 2008 decreased in comparison to the same period in 2007 by $796,000, or 36.2%, to $1.4 million. The revenue decrease was primarily the result of a $634,000 decrease in general dimensional gauging sales, on significantly lower sales to a Japanese OEM. Aviation sales also decreased $358,000 due to lower sales to the U.S. Air Force. These declines were partially offset by an increase in semiconductor sales of $196,000, driven by the sale of a fully automated tool during the quarter.

Product revenue in our test and measurement instrumentation business for the nine months ended September 30, 2008 decreased in comparison to the same period in 2007 by $1.1 million, or 17.4%, to $5.1 million. The revenue decrease was chiefly attributable to a $1.2 million decrease in general dimensional gauging sales, driven by significantly lower sales to a Japanese OEM. This decline was partially offset by an increase of $509,000 in semiconductor products due to sales expansion in international markets and the sale of a fully automated tool in the third quarter. Aviation sales declined by $396,000 between periods due to declining activity with the U.S. Air Force.

As a result of general global economic conditions, including weaker than expected demand in Japan for photolithography equipment, slower than expected dimensional gauging sales, reduced sales demand within the commercial aviation industry, and the deferral of certain orders under our existing U.S. Air Force contract, our test and measurement instrumentation business is no longer expected to generate double-digit sales growth in 2008. Based upon current global market conditions, we estimate that the test and measurement instrumentation business will experience a sales decrease of between 25% to 30% for 2008 compared to 2007.

                      MECHANICAL TECHNOLOGY, INCORPORATED

        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)



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



(Dollars in thousands)                                                            Revenue        Total Contract
                                                     Revenues for the           Contract to    Orders Received to
                                                Nine Months Ended Sept. 30,         Date              Date
       Contract (1)            Expiration         2007              2008         Sept. 30,       Sept. 30, 2008
                                                                                    2008

$2.3 million Air Force New
PBS-4100 Systems             07/28/2010 (2)     $       570       $         -      $   1,596             $    1,596
$8.8 million Air Force
Retrofit and Maintenance
of PBS-4100 Systems          06/19/2008 (3)     $       682       $       594      $   7,959             $    7,959

(2) Date represents expiration of contract, including all three potential option extensions.

(3) Expiration date was extended during May 2008 from May 19, 2008 to June 19, 2008.

Funded Research and Development Revenue. Funded research and development revenue in our new energy business for the three months ended September 30, 2008 increased in comparison to the same period in 2007 by $42,000, or 11.8%, to $399,000. The increase in revenue was primarily the result of revenue recognized from our contract with the U.S. Department of Energy, or the DOE, increased by $101,000. This increase was partially offset by a $59,000 decline in revenue recognized under the alliance agreement with Samsung Electronics, Ltd., or Samsung.

Funded research and development revenue in our new energy business for the nine months ended September 30, 2008 decreased in comparison to the same period in 2007 by $444,000, or 33.5%, to $881,000. The decrease in revenue was primarily the result of the completion of our contract with SAFT America, Inc., or SAFT, during the first quarter of 2007, which accounted for $418,000 of revenue in 2007. Revenue during 2008 for the DOE contract, which had its funding reinstated during May 2007, increased by $437,000, while revenue recognized under the alliance agreement with Samsung, decreased by $448,000 during 2008 compared to 2007 due to the contract's completion in 2007, while revenue for the NCMS, decreased by $15,000 during 2008 compared to 2007 due to the contract's completion in 2007.

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

(Dollars in
thousands)
 Contract                                                                                           Revenue
                                  Revenue                           Revenue                        Contract
                                Nine Months                       Nine Months                       to Date
                                   Ended        % of 2007            Ended        % of 2008        Sept. 30,
              Expiration (1)   Sept. 30, 2007     Total          Sept. 30, 2008     Total            2008

$3.0
million DOE
(2)              03/31/09    $            444        33.5 %    $            881       100.0 %    $     2,728
$1.0
million
Samsung (3)      07/31/07                 448        33.8                     -           -              875
$418,000
SAFT (4)         12/31/06                 418        31.6                     -           -              418
$15,000
NCMS(5)          06/30/07                  15         1.1                     -           -               15
Total
funded
research
and
development
revenue                      $          1,325       100.0 %    $            881       100.0 %    $     4,036

(2) The DOE contract is a cost share contract. DOE funding for this contract was suspended during January 2006 and reinstated during May 2007. During 2007, we received notifications from the DOE of funding releases totaling $1.0 million and an extension of the termination date for the contract from July 31, 2007 to September 30, 2008. To date in 2008, we received notifications of funding releases totaling $825,000 and an extension of the termination date for the contract from September 30, 2008 to March 31, 2009.

(3) The Samsung contract is a research and prototype contract. This contract included one up-front payment of $750,000 and two milestone payments of $125,000 each for the delivery of prototypes. The contract was amended on October 22, 2007 as we agreed to issue a credit in the amount of the last invoice in recognition of our continuing collaboration with Samsung. Therefore, revenue under this contract totaled $875,000.

(4) The SAFT contract is a fixed price contract. This is a subcontract with SAFT under the U.S. Army CECOM contract. The purchase order received in connection with this subcontract was revised on November 14, 2006 eliminating one milestone. As a result, the contract value was reduced from $470,000 to $418,000 and the expiration date was extended from September 30, 2006 to December 31, 2006.

(5) The NCMS contract is a cost plus catalyst research contract.

Cost of Product Revenue. Cost of product revenue in our test and measurement instrumentation business for the three months ended September 30, 2008 decreased in comparison to the same period in 2007 by $13,000, or 1.5%, to $835,000. As a percentage of product revenue, the quarterly cost of product revenue increased by 21%, compared to the same period in the prior year, due to increased reserves for potentially obsolete inventory as a significant decline in sales, combined with increased stock on hand, decreased item turnover estimates.

Gross profit as a percentage of product revenue decreased by 21.0% for the three months ended September 30, 2008 to 40.4% from 61.6% in the same period in the prior year.

Cost of product revenue in our test and measurement instrumentation business for the nine months ended September 30, 2008 increased in comparison to the same period in 2007 by $99,000, or 4.1%, to $2.5 million. As a percentage of product revenue, the year to date cost of product revenue has increased by 10%, compared to the same period in the prior year, due to a less favorable product sales mix, an increase in manufacturing overhead, and higher inventory reserves for potentially obsolete inventory.

Gross profit as a percentage of product revenue decreased by 10.1% for the nine months ended September 30, 2008 to 51.0% from 61.1% in the same period in the prior year.

Funded Research and Product Development Expenses. Funded research and product development expenses in our new energy business increased by $128,000, or 18.5%, to $819,000 for the three months ended September 30, 2008 in comparison to the same period in 2007. This change was primarily the result of costs for the DOE contract increasing by $188,000, while costs for the Samsung contract decreased by $60,000, as that contract was completed during July 2007.

Funded research and product development expenses in our new energy business increased by $390,000, or 27.5%, to $1.8 million for the nine months ended September 30, 2008 in comparison to the same period in 2007. This change was primarily the result of costs for the DOE contract increasing by $877,000, reflecting the impact of its reinstatement during May 2007, while costs for the Samsung contract decreased by $449,000, as that contract was completed during July 2007. The research expenses for SAFT and NCMS, the only other active research contracts during 2007, decreased by a combined $39,000.

Unfunded Research and Product Development Expenses. Unfunded research and product development expenses decreased by $859,000, or 43.3%, to $1.1 million for the three months ended September 30, 2008 from $2.0 million for the three months ended September 30, 2007. This decrease reflects an $829,000 decrease in development costs in our new energy business primarily related to the DOE contract that resumed during May 2007, which increased funded research and product development expenses. This decrease also reflects a $30,000 decrease in product development expenses for our test and measurement instrumentation business.

Unfunded research and product development expenses decreased by $2.5 million, or 31.9%, to $5.3 million for the nine months ended September 30, 2008 from $7.8 million for the nine months ended September 30, 2007. This decrease reflects a $2.6 million decrease in development costs in our new energy business related to
(a) cost savings from the decision to suspend work on our high power program during March 2007, and (b) the DOE contract that resumed during May 2007, which increased funded research and product development expense, which were partially offset by (c) the effects of the completion of work under the Samsung alliance agreement, which increased unfunded research and product development. This decrease was also partially offset by an $86,000 increase in product development expenses for our test and measurement instrumentation business reflecting increased staffing and external product development costs focused on the development of our photovoltaic thickness module and redesigns of certain aviation products.

Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by $631,000, or 36.8%, to $2.3 million for the three months ended September 30, 2008 from $1.7 million for the three months ended September 30, 2007. This increase was primarily the result of (a) a $478,000 increase in legal, audit, printing, and other miscellaneous fees primarily attributable to the withdrawal of the Company's registration statement, as these fees were expected to be netted against the proceeds, (b) a $423,000 increase related to decreases in liquidations to unfunded research and development costs, which was primarily due to the elimination of our high power program, partially offset by increased liquidations in connection with the DOE program, (c) $284,000 in severance costs, which was attributable to executive and staff reductions in August 2008, (d) a $163,000 decrease in non-cash equity compensation primarily related to lower grant activity, (e) a $77,000 decrease in bonus and sales incentive compensation, (f) an $82,000 decrease in depreciation costs, (g) a $154,000 savings in wages and benefits for positions eliminated through attrition, (h) a $30,000 decrease in travel and entertainment costs, and (i) a $48,000 decrease in other expenses, net.

Selling, general and administrative expenses increased by $405,000, or 6.1%, to $7.0 million for the nine months ended September 30, 2008 from $6.6 million for the nine months ended September 30, 2007. This increase was primarily the result of (a) a $1.5 million increase related to decreases in liquidations to unfunded research and development costs, which was primarily due to the elimination of our high power program, partially offset by increased liquidations in connection with the

DOE program, (b) a $579,000 decrease in non-cash equity compensation primarily related to lower grants, lower fair values for new grants issued and the forfeiture of several executive performance grants in 2008, (c) a $423,000 increase in legal, audit, printing, and other miscellaneous fees primarily attributable to the withdrawal of the Company's registration statement, as these fees were expected to be netted against the proceeds, (d) a $678,000 decrease in administrative salaries and benefits as a result of our headcount reduction efforts in March 2007 and August 2008, (e) a $238,000 decrease in depreciation costs, (f) a $128,000 increase in professional and other outsourcing fees, (g) a $58,000 decrease in employee recruiting and relocation costs, (h) a $70,000 decrease in business travel and entertainment, on fewer overseas business development trips, and (i) a $40,000 decrease in other expenses, net.

Operating Loss. Operating loss increased by $641,000, or 23.8%, to $3.3 million for the three months ended September 30, 2008 compared with the three months ended September 30, 2007 as a result of the factors noted above.

Operating loss decreased by $60,000, or 0.6%, to $10.6 million for the nine months ended September 30, 2008 compared with the nine months ended September 30, 2007 as a result of the factors noted above.

Gain/Loss on Derivatives. Our gain/loss on derivative treatment of the freestanding warrants issued in conjunction with our December 2006 capital raise decreased by $427,000, or 117.6%, to a loss of $65,000 for the three months ended September 30, 2008 compared with a $363,000 gain for the three months ended September 30, 2007. The decrease in derivative income was attributable to valuation changes of the underlying warrants using the Black-Scholes Pricing model.

Our gain on derivative treatment of the freestanding warrants issued in conjunction with our December 2006 capital raise decreased by $1.5 million, or 71.2%, to $601,000 for the nine months ended September 30, 2008 compared with $2.1 million for the nine months ended September 30, 2007. The decrease in derivative income was attributable to valuation changes of the underlying warrants using the Black-Scholes Pricing model.

Income Tax (Expense) Benefit. Our income tax rate for the three months ended September 30, 2008 was (35.22)% and our income tax rate for the three months ended September 30, 2007 was (36.04)%. These tax rates were primarily the result of losses generated by operations, changes in the valuation allowance, state true-ups, permanent deductible differences for derivative valuations, and disproportionate effects of reclassification of gains on Plug Power, Inc., or Plug Power, security sales included in operating loss.

Our income tax rate for the nine months ended September 30, 2008 was (20.41)% and our income tax rate for the nine months ended September 30, 2007 was
(8.99)%. These tax rates were primarily the result of losses generated by operations, changes in the valuation allowance, state true-ups, permanent deductible differences for derivative valuations and disproportionate effects of reclassification of gains on Plug Power security sales included in operating loss.

The valuation allowance against our deferred tax assets at September 30, 2008 was $27.0 million and at December 31, 2007 was $22.3 million. We determined that it was more likely than not that ultimate recognition of certain deferred tax assets would not be realized.

Liquidity and Capital Resources

We have incurred significant losses as we continue to fund the development and commercialization of our portable power source business. We expect that losses will fluctuate from year to year and that such fluctuations may be substantial as a result of, among other factors, sales of securities available for sale, our operating results, the availability of debt or equity financing, including warrants issued in connection with the December 2006 capital raise, and the ability to attract government funding resources to offset research and development costs.

As of September 30, 2008, we had an accumulated deficit of $115.5 million. During the nine months ended September 30, 2008, our results of operations resulted in a net loss of $10.5 million and cash used in operating activities totaling $8.5 million. This cash use in 2008 was funded primarily by cash and cash equivalents on hand as of December 31, 2007 of $7.7 million.

At present, the Company does not currently expect to advance future resources to fund MTI Micro's development and commercialization of its portable power source products. MTI Micro expects to continue funding its operations from current cash and cash equivalents, proceeds from any other debt or equity financings or the exercise of outstanding convertible securities, and government funding. During September 2008, MTI Micro received $1.5 million in funding from certain external investors in the form of convertible secured notes. Subject to the availability of financing, we expect to spend approximately $6.8 million on research and development of Mobion technology during 2008, of which $5.8 million has been spent for the first nine months of 2008.

Based on MTI Micro's project cash requirements for 2008 and their current cash and cash equivalents of $2.0 million at September 30, 2008, we believe MTI Micro will have adequate resources to fund operations through the end of January 2009

based on current cash and cash equivalents, current cash flow requirements, and revenue and expense projections.

. . .