UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the Quarterly Period Ended September 30, 2007

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from to

Commission file number 000-49890

MTC TECHNOLOGIES, INC.

(Exact name of registrant as specified in its charter)

Delaware

02-0593816

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)


4032 Linden Avenue, Dayton, Ohio		45432
(Address of principal executive offices)		(Zip Code)

(937) 252-9199

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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

¨ Large Accelerated Filer x Accelerated Filer ¨ Non-Accelerated Filer

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

The number of shares of Common Stock, $0.001 par value, of the registrant outstanding as of October 31, 2007 was 15,147,906.

MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

Index:


PART I. FINANCIAL INFORMATION

	ITEM 1.	Financial Statements	1

	ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11

	ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	21

	ITEM 4.	Controls and Procedures	22

PART II. OTHER INFORMATION

	ITEM 1.	Legal Proceedings	22

	ITEM 6.	Exhibits	22

SIGNATURES			24

EXHIBIT INDEX			25

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

ITEM 1.

Financial Statements

Consolidated Balance Sheets

(Dollar amounts in thousands, except per share amounts)


	(unaudited) September 30, 2007			December 31, 2006
Assets
Current assets:
Cash and cash equivalents	$	—		$	3,342
Restricted cash		3,654			—
Accounts receivable, net		85,330			90,630
Costs and estimated earnings in excess of amounts billed on uncompleted contracts		18,809			11,671
Inventories		14,082			11,767
Prepaid expenses and other current assets		4,184			4,543

Total current assets		126,059			121,953
Property and equipment, net		26,605			20,559
Goodwill, net		155,373			162,770
Intangible assets, net		23,350			27,627
Other assets		1,634			1,400

Total assets	$	333,021		$	334,309


Liabilities and stockholders’ equity
Current liabilities:
Current maturities of long-term debt	$	10,985		$	8,500
Accounts payable		28,519			35,504
Compensation and related items		18,227			18,592
Billings in excess of costs and estimated earnings on uncompleted contracts		3,999			2,951
Income taxes payable and other current liabilities		4,344			3,509

Total current liabilities		66,074			69,056

Long-term debt		73,540			80,300
Deferred income taxes and other long-term liabilities		6,133			6,070

Stockholders’ equity:
Common stock, $0.001 par value; 50,000,000 shares authorized; 15,145,406 and 15,219,231 shares issued and outstanding at September 30, 2007 and December 31, 2006, respectively		16			16
Paid-in capital		122,223			121,752
Retained earnings		80,233			70,486
Other comprehensive (loss) income		(269	)		16
Treasury stock		(14,929	)		(13,387	)

Total stockholders’ equity		187,274			178,883

Total liabilities and stockholders’ equity	$	333,021		$	334,309

See accompanying Notes to Consolidated Financial Statements.

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

ITEM 1.

Financial Statements

Consolidated Statements of Income (Unaudited)

(Dollar amounts in thousands, except per share amounts)


	Three months ended September 30,						Nine months ended September 30,
	2007			2006			2007			2006
Revenue	$	114,621		$	105,194		$	321,681		$	304,845
Cost of revenue		98,198			87,873			272,968			254,575

Gross profit		16,423			17,321			48,713			50,270
General and administrative expenses		7,177			6,375			22,654			17,445
Restructuring charge		—			—			1,452			—
Intangible asset amortization		1,537			1,536			4,609			4,375

Operating income		7,709			9,410			19,998			28,450
Interest income		242			72			281			306
Interest expense		(1,535	)		(1,500	)		(4,529	)		(3,934	)

Interest expense, net		(1,293	)		(1,428	)		(4,248	)		(3,628	)

Other income, net		593			—			593			—

Income before income tax expense		7,009			7,982			16,343			24,822
Income tax expense		2,782			3,145			6,341			9,780

Net income	$	4,227		$	4,837		$	10,002		$	15,042

Basic and diluted earnings per common share	$	0.28		$	0.31		$	0.66		$	0.96

Weighted average common shares outstanding:
Basic		15,145,406			15,605,610			15,165,574			15,713,958
Diluted		15,187,215			15,625,304			15,202,363			15,746,258

See accompanying Notes to Consolidated Financial Statements.

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

ITEM 1.

Financial Statements

Consolidated Statement of Cash Flows (Unaudited)

(Dollar amounts in thousands)


	Nine months ended September 30,
	2007			2006
Cash flows from operating activities:
Net income	$	10,002		$	15,042
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		7,835			6,883
Stock compensation expense		765			561
Deferred income taxes		(219	)		(470	)
Loss (gain) on sale of fixed assets		3			(126	)
Changes in operating assets and liabilities (net of acquisitions):
Accounts receivable		4,173			9,264
Costs and estimated earnings in excess of amounts billed on uncompleted contracts		(7,138	)		(4,681	)
Inventories		(2,315	)		(442	)
Prepaid expenses and other assets		68			(181	)
Accounts payable		(6,985	)		(6,416	)
Compensation and related items		(365	)		1,820
Billings in excess of costs and estimated earnings on uncompleted contracts		1,048			1,702
Income taxes payable and other current liabilities		657			943

Net cash provided by operating activities		7,529			23,899

Cash flows from investing activities:
Net proceeds from (payments for) acquired businesses		8,149			(47,833	)
Purchase of property and equipment		(9,281	)		(5,129	)
Proceeds from sale of property and equipment		5			963

Net cash used in investing activities		(1,127	)		(51,999	)

Cash flows from financing activities:
Issuance of common stock		—			43
Gross borrowings on the revolving credit facility		127,800			95,550
Gross repayments on the revolving credit facility		(135,700	)		(63,550	)
Payments on long-term borrowing		(6,375	)		(4,500	)
Net proceeds from issuance of bonds, net of restricted cash of $3,654		6,073			—
Excess tax benefits from share-based payments		—			11
Repurchase of common stock		(1,542	)		(8,463	)

Net cash (used in) provided by financing activities		(9,744	)		19,091

Net decrease in cash		(3,342	)		(9,009	)
Cash and cash equivalents at beginning of period		3,342			13,755

Cash and cash equivalents at end of period	$	—		$	4,746

See accompanying Notes to Consolidated Financial Statements.

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

A. SUMMARY OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES

Interim Financial Information—The consolidated financial statements as of September 30, 2007 and for the three- and nine-month periods ended September 30, 2007 and 2006 are unaudited and have been prepared on the same basis as our audited consolidated financial statements. MTC Technologies, Inc. (we, us, MTC or the Company) has continued to follow the accounting principles set forth in the consolidated financial statements included in its 2006 Annual Report on Form 10-K filed with the Securities and Exchange Commission. In the opinion of management, the unaudited consolidated financial statements include all adjustments, consisting only of normal recurring items, necessary to present fairly the periods indicated. Results of operations for the interim periods ended September 30, 2007 and 2006 are not necessarily indicative of the results for the full year.

Business Segment—We operate as one segment, delivering a broad array of services primarily to the federal government in the areas of modernization and sustainment; professional services; command, control, communications, computers, intelligence, surveillance and reconnaissance (C4ISR); and logistics solutions. We offer these services separately or in combination across our customer base. Accordingly, revenue and profit are internally reviewed by our management primarily on a contract basis, making it impracticable to determine revenue and profit by services offered.

Earnings per Common Share—Basic earnings per common share were computed by dividing net income available to common stockholders by the weighted average number of shares of common stock outstanding during each period. Shares issued and shares reacquired, if any, during the period are weighted for the portion of the period during which they were outstanding. The weighted average shares for the three- and nine-month periods ended September 30, 2007 and 2006 are as follows:


	Three months ended September 30,		Nine months ended September 30,
	2007	2006	2007	2006
Basic weighted average common shares outstanding	15,145,406	15,605,610	15,165,574	15,713,958
Effect of potential exercise of stock options	41,809	19,694	36,789	32,300

Diluted weighted average common shares outstanding	15,187,215	15,625,304	15,202,363	15,746,258

Comprehensive Income—The components of comprehensive income are as follows (in thousands):


	Three months ended September 30,						Nine months ended September 30,
	2007			2006			2007			2006
Net income	$	4,227		$	4,837		$	10,002		$	15,042
Change in fair value of interest rate swap, net of tax (benefit) expense of ($56) and $184, respectively, for the quarter and ($19) and $21, respectively, for the year to date		(443	)		(284	)		(285	)		32

Comprehensive income	$	3,784		$	4,553		$	9,717		$	15,074

Recent Accounting Pronouncements—In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), which clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We adopted the provisions of FIN 48 during the first quarter of 2007. As a result of the implementation of FIN 48, we recognized a $0.3 million increase in liability for

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings. See Note F for further information related to the impact of adopting FIN 48 on our consolidated financial statements.

Stock-Based Compensation—Effective January 1, 2006, we adopted the fair value recognition provisions of FASB Statement No. 123(R), Share-Based Payments (SFAS No. 123 (R)), using the modified prospective transition method. As a result, in 2006, our operating income and income before taxes were reduced by $0.5 million, our net income was reduced by $0.3 million, and our basic and diluted earnings per share were reduced by $0.02. For the nine months ended September 30, 2007, our operating income and income before taxes were reduced by $0.5 million, and our basic and diluted earnings per share were reduced by $0.02. For the nine months ended September 30, 2007 and the year ended December 31, 2006, we recognized financing cash inflows of $0 and $11,000, respectively, for tax benefits related to stock option transactions, which benefits would previously have been recorded as cash flows from operations. The above amounts approximate the incremental impact of adopting SFAS No. 123(R) as compared to the application of the original provisions of SFAS No. 123.

Options. Stock options outstanding as of December 31, 2006 and September 30, 2007, and changes during the nine-month period ended September 30, 2007, were as follows:


	Shares		Weighted Average Exercise Price
Outstanding at December 31, 2006	258,568		$	25.69
Granted	122,842		$	21.42
Exercised	—			—
Forfeited or expired	(1,000	)	$	17.00

Outstanding at September 30, 2007	380,410		$	24.33

Vested and unvested expected to vest at September 30, 2007	374,335		$	24.36

Exercisable at September 30, 2007	239,071		$	26.03

The aggregate intrinsic value of vested and unvested expected to vest options at September 30, 2007 was $0.1 million, with a weighted average remaining contractual life of 7.7 years.

The following table summarizes certain information for options currently outstanding and exercisable at September 30, 2007:


	Options Outstanding						Options Exercisable
Option Price	Shares	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life	Intrinsic Value		Shares	Weighted Average Exercise Price		Weighted Average Remaining Contractual Life	Intrinsic Value
$16 - $21	178,282	$	19.33	7.9 years	$	135,219	73,717	$	17.61	5.6 years	$	135,219
$23 - $27	121,628	$	25.74	7.5 years		—	84,854	$	26.47	6.9 years		—
$29 - $34	80,500	$	33.29	7.5 years		—	80,500	$	33.29	7.5 years		—
Total	380,410	$	24.33	7.7 years	$	135,219	239,071	$	26.03	6.7 years	$	135,219

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

We estimate the fair value for stock options at the date of grant using the Black-Scholes option pricing model, which requires us to make certain assumptions. We selected the assumptions used in the Black-Scholes pricing model using the following criteria:

Risk-free interest rate. We base the risk-free interest rate on implied yields available on a U.S. Treasury note with a maturity term equal to or approximating the expected term of the underlying award.

Dividend yield. We do not intend to pay dividends on our common stock for the foreseeable future and, accordingly, use a dividend yield of zero.

Volatility. The expected volatility of our common stock was estimated based upon the historical volatility of our common stock share price.

Expected life. The expected life of the option grants represents the period of time options are expected to be outstanding and is based on the contractual term of the grant, vesting schedules, and past exercise behavior.

We used the following weighted average assumptions in the Black-Scholes option pricing model to determine the fair values of stock-based compensation awards granted during the nine months ended September 30, 2007 and the year ended December 31, 2006:


	2007		2006
Expected life of options	7.8 years		7.4 years
Risk-free interest rate	4.6% - 4.7	%	4.6% - 5.0	%
Expected stock price volatility	39.3	%	39.6	%
Expected dividend yield	0.0	%	0.0	%

The fair value of options outstanding was $4.7 million at September 30, 2007 and $3.4 million at December 31, 2006. The fair value of the shares vested during the nine months ended September 30, 2007 was $0.7 million and $0.8 million during the year ended December 31, 2006. No stock options were exercised in the nine months ended September 30, 2007. The total intrinsic value of stock options exercised during the year ended December 31, 2006 was $29,000. The weighted average per share fair value of stock options granted during the nine months ended September 30, 2007 was $11.18 and during the year ended December 31, 2006 was $11.89. As of September 30, 2007, we had unrecognized compensation cost related to non-vested stock options of $1.3 million, which we expect to be recognized over a weighted average period of approximately 3.6 years.

Restricted Share Units. The following outlines the unrecognized compensation cost associated with the outstanding restricted share unit awards for the nine months ended September 30, 2007 (dollar amounts in thousands, except per share amounts):


	Restricted Share Units	Weighted Average Grant Date Fair Value per Share		Unamortized Grant Date Fair Value
Non-vested at December 31, 2006	60,142	$	26.81	$	1,135
Granted	30,991	$	20.57		637
Vested	—		—		—
Forfeited	—		—		—
Expense recognized	—		—		(295	)

Unamortized balance at September 30, 2007	91,133	$	24.69	$	1,477

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

As of September 30, 2007, we had unrecognized compensation cost related to outstanding restricted share units of $1.5 million, which we expect to be recognized over the remaining weighted vesting period of approximately 3.4 years. Vesting is dependent on continuous service by our directors throughout the award period for a period of five years from date of grant. Upon vesting, all restrictions initially placed upon the common shares lapse.

The weighted average per share grant-date fair value of restricted share units granted during 2007 and 2006 was $20.57 and $25.58, respectively.

B. RELATED-PARTY TRANSACTIONS

We subcontract to, purchase services from, rent a portion of our facilities from, and utilize aircraft from various entities that are controlled by Mr. Rajesh K. Soin, a significant stockholder, Chief Executive Officer, and Chairman of the Board of Directors of MTC. The following is a summary of transactions with related parties (in thousands) for the three- and nine-month periods ending September 30, 2007 and 2006:


	Three months ended September 30,				Nine months ended September 30,
	2007		2006		2007		2006
Included in general and administrative expenses:
Aircraft usage and transportation charges paid to Soin International, LLC	$	—	$	2	$	11	$	4
Rent and maintenance costs paid to related parties		17		89		49		91

	$	17	$	91	$	60	$	95

Sub-contracting services paid to related parties:
Corbus, LLC	$	—	$	15	$	45	$	1,396

Revenues from related parties:
Corbus, LLC	$	411	$	411	$	1,233	$	1,233

Aerospace Integration Corporation ⁽¹⁾	$	—	$	—	$	—	$	29

⁽¹⁾	Revenues from Aerospace Integration Corporation (AIC) in 2006 were prior to our acquisition of AIC.

We believe that our subcontracting, lease and other agreements with each of the related parties identified above reflect prevailing market conditions at the time they were entered into and contain substantially similar terms to those that might be negotiated by independent parties on an arm’s-length basis.

At September 30, 2007 and December 31, 2006, there were no amounts due from or payable to related parties.

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

C. INVENTORY

Inventories are valued at the lower of cost or market using the first-in, first-out method. The components of inventories as of September 30, 2007 and December 31, 2006 are as follows (in thousands):


	September 30, 2007		December 31, 2006
Raw materials	$	115	$	—
Work-in-process		13,742		11,767
Finished goods		225		—

	$	14,082	$	11,767

D. LONG-TERM DEBT

In April 2005, we entered into a five-year Credit and Security Agreement, dated as of April 21, 2005 (the Credit Agreement), with National City Bank, Branch Banking and Trust Company, KeyBank National Association, Fifth Third Bank, JPMorgan Chase Bank, N.A., Comerica Bank, and PNC Bank, N.A. The Credit Agreement, which is scheduled to expire on March 31, 2010, allows us to borrow up to $145.0 million in the form of an $85.0 million revolving loan and a $60.0 million term loan. The interest rates on borrowings under the term loan range from the prime rate to the prime rate plus 25 basis points, or the London Interbank Offered Rate (LIBOR) rate plus 125 to 225 basis points, and under the revolving loan are the prime rate, or the LIBOR rate plus 100 to 200 basis points, depending in most instances on the ratio of our consolidated funded debt to consolidated pro forma earnings before interest, taxes, depreciation, and amortization (EBITDA).

The borrowing availability at September 30, 2007 under the revolving loan portion of our Credit Agreement was $55.1 million. Borrowings under our Credit Agreement are secured by a general lien on our consolidated assets. In addition, we are subject to certain restrictions, and we are required to meet certain financial covenants. These covenants require that we, among other things, maintain certain financial ratios and minimum net worth levels. As of September 30, 2007, we were in compliance with these covenants.


	September 30, 2007 (in thousands)
Credit Agreement, due March 31, 2010
Term loan	$	44,625
Revolving loan		29,900
Bonds payable, due March 1, 2018		10,000

Total debt		84,525
Less—current maturities		(10,985	)

	$	73,540

In October 2005, we entered into an interest rate swap agreement with National City Bank under which we exchange floating-rate interest payments for fixed-rate interest payments on our term loan. The amount of the interest rate swap is equal to 50% of the outstanding balance of our term loan, or $22.3 million as of September 30, 2007, and is reduced as the loan amortizes. The swap provides for payments over approximately a four-year period that began in December 2005 and is settled on a quarterly basis. The fixed interest rate provided by the agreement is 4.87 % plus our spread at September 30, 2007 of 200 basis points, or 6.87%. At September 30, 2007, the interest rate on the

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

portion of the term loan that was not subject to the interest rate swap agreement was 5.25% plus our spread at September 30, 2007 of 200 basis points, or 7.25%.

Effective April 5, 2006, we entered into an interest rate swap agreement with National City Bank under which we exchange floating-rate interest payments for fixed-rate interest payments. The agreement covers a combined notional amount of debt equal to $20.0 million and the agreement ends March 31, 2008. The swap provides for payments over a two-year period that began in June 2006, and is settled on a quarterly basis. The fixed interest rate provided by the agreement was 5.44% plus our spread at September 30, 2007 of 175 basis points, or 7.19%. The weighted average interest rate for the portion of the revolving loan that is not subject to the interest rate swap, as of September 30, 2007, was 7.49 %, including our spread at September 30, 2007 of 175 basis points.

On March 30, 2007, MTC Technologies, Inc., an Ohio corporation and our wholly owned subsidiary, entered into a guaranty in connection with the issuance of $10 million in principal amount of Variable Rate Industrial Development Bonds (Bonds) by the Industrial Development Board of the City of Albertville, Alabama (IDB) on behalf of AIC. The Bonds were issued to finance the construction by AIC of an aircraft completion center at the Albertville, Alabama airport. AIC received $2.2 million in proceeds from the Bonds at the closing and paid transaction costs of $0.2 million. AIC has received an additional $4.1 million, in proceeds as project reimbursements during the second and third quarters of 2007. The remaining $3.7 million of proceeds is held in escrow and will be paid to AIC as additional capital expenditures are made on the aircraft completion center in Albertville, Alabama. The parcel of land on which such construction is occurring, has been leased to AIC by the City of Albertville.

Concurrently with the issuance of the Bonds, AIC entered into a lease agreement (Lease Agreement) with the IDB whereby AIC will complete the construction of and furnish the equipment for the aircraft completion center located at the airport. The Lease Agreement provides that AIC will make lease payments sufficient to pay the principal of and interest on the Bonds. The Bonds are secured by a direct pay letter of credit (Letter of Credit) issued by National City Bank (Bank), which expires on March 16, 2010 subject to extensions as agreed to by AIC and the Bank. In consideration for the issuance of the Letter of Credit, AIC has entered into a reimbursement agreement (Reimbursement Agreement) obligating AIC to pay the Bank for all drawings made on the Letter of Credit. In addition, the Company has entered into a guaranty with the Bank guaranteeing the payment and performance of AIC under the Reimbursement Agreement. AIC’s obligations under the Reimbursement Agreement are secured by a mortgage of its leasehold interest in the ground lease and a security interest in its personal property. The Company’s obligations under the guaranty are secured by a security interest in its personal property.

The Bonds are scheduled to mature on March 1, 2018. AIC will pay only the interest on the Bonds for a period of one year, followed by ten years of quarterly principal and interest payments beginning on March 1, 2008. The interest rate on the Bonds is determined on a weekly basis by the remarketing agent for the Bonds, NatCity Investments, Inc. AIC has the right to convert the variable weekly interest rates to a fixed interest rate upon written notice to the trustee for the Bonds, the Bank and NatCity Investments, Inc. Principal payments will be made on the Bonds beginning March 2008 and will continue through the maturity date (or such earlier date on which the Bonds may be redeemed). The Bonds may be redeemed at the option of AIC and are subject to mandatory redemption in the event that the interest on the Bonds is determined to be subject to income taxation under the Internal Revenue Code.

The Reimbursement Agreement contains customary events of default, including failure to make required payments when due, failure to comply with certain covenants, breaches of certain representations and warranties, certain events of bankruptcy and insolvency, amendments to the Lease Agreement without the prior consent of the Bank, and an “event of default” under the Credit Agreement. Upon any such event of default, the maturity of the Bonds can be accelerated, causing payment by the

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

Bank under the Letter of Credit and an immediate reimbursement obligation of AIC for the amount of accelerated Bonds pursuant to the Reimbursement Agreement.

Effective March 30, 2007, AIC entered into an interest rate swap agreement with the Bank under which it exchanged floating-rate interest payments for fixed-rate interest payments. The amount of the interest rate swap is equal to the full amount of the Bonds and ends March 1, 2017. The swap provides for payments over ten years and is settled on a quarterly basis commencing June 1, 2007. The fixed interest rate provided by the agreement is 3.91%.

We account for our interest rate swap agreements under the provisions of SFAS No. 133 and have determined that the swap agreements qualify as effective hedges. Accordingly, the fair value of the swap agreements, net of income tax benefits, will be reported in other assets or other long-term liabilities, and the effective portion of the change in fair value, net of income tax benefit, will be reported as other comprehensive income or loss on the consolidated balance sheet.

E. STOCK REPURCHASE PROGRAM

In October 2006, our Board of Directors authorized the repurchase of up to $10 million of outstanding shares of MTC common stock in the open market, including, without limitation, pursuant to a Rule 10b5-1 trading plan, or in privately negotiated transactions.

As of September 30, 2007, the Company had repurchased a total of 159,193 shares at an aggregate cost of $3.5 million and was authorized to repurchase up to an additional $6.5 million of shares under the program.

F. ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES (FIN 48)

We adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, we recognized a $0.3 million increase in the liability for unrecognized tax benefits, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings. We recognize interest and penalties accrued related to unrecognized tax benefits in income tax expense. The total amount of net unrecognized tax benefits that, if recognized, would affect income tax expense is $0.3 million.

We file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. With few exceptions, we are no longer subject to U.S. federal examinations by tax authorities for years before 2002 and state and local examinations by tax authorities for years before 2002.

As of September 30, 2007, the liability for unrecognized tax benefits was $0.3 million. This balance was recorded in other current liabilities as prescribed by FIN 48. We do not currently anticipate that the total amount of unrecognized tax benefits will significantly increase or decrease by the end of 2007.

G. RESTRUCTURING ACTIVITIES

In June 2007, management approved a restructuring plan to consolidate the Company’s organizational structure to improve customer focus and operational effectiveness. The measure, which consists of workforce reductions, is intended to improve efficiency and reduce expenses. As a result of this action, the Company recorded a pre-tax restructuring charge as a component of operating income in the income statement totaling approximately $1.5 million to cover costs associated with staff reductions, which are expected to be completed in 2007, with payments extending into the first quarter of 2008. Annual cost savings resulting from the restructuring plan, upon completion, are anticipated to be approximately $6 million.

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

A rollforward of the restructuring reserve in association with this initiative follows (in thousands):


Accrued restructuring charge as of December 31, 2006	$	—
Restructuring charge in June 2007		1,452
Cash payments		(870	)

Accrued restructuring charge as of September 30, 2007	$	582

H. GOODWILL AND INTANGIBLE ASSETS

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets (SFAS No. 142), we performed an impairment test of goodwill during the fourth quarter of 2006 and determined that no impairment of the recorded goodwill existed. We based our assessment of possible impairment on the discounted present value of the operating cash flows of our consolidated reporting unit. In accordance with SFAS No. 142, goodwill will be tested for impairment at least annually and more frequently if an event occurs which indicates the goodwill may be impaired. On an annual basis, our impairment testing will be performed during the fourth quarter.

The changes in the carrying amount of goodwill for the nine months ended September 30, 2007 are as follows (in thousands):


Balance as of December 31, 2006	$	162,770
Reduction in goodwill arising from our Manufacturing Technology, Inc. (MTI) acquisition		(6,604	)
Reduction in goodwill arising from our AIC acquisition		(793	)

Balance as of September 30, 2007	$	155,373

The reduction in goodwill of our previously completed acquisition of MTI in 2006 relates to a negotiated purchase price adjustment determination in the third quarter of 2007, net of expenses. The reduction in goodwill of our AIC acquisition is primarily due to a $1.9 million release from escrow, which reduced goodwill, partially offset by other purchase price adjustments.

ITEM 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

GENERAL OVERVIEW

The following discussion summarizes the significant factors affecting the consolidated operating results of MTC Technologies, Inc. and its subsidiaries (we, us, MTC or the Company) for the three- and nine-month periods ended September 30, 2007 compared to the three- and nine-month periods ended September 30, 2006 and the financial condition of MTC at September 30, 2007 compared to December 31, 2006. This discussion should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements included elsewhere in this Quarterly Report.

We provide modernization and sustainment; professional services; command, control, communications, computers, intelligence, surveillance and reconnaissance (C4ISR); and logistics solutions, focusing primarily on U.S. federal government agencies such as the Department of Defense, various intelligence agencies and other companies that serve these same markets. Our services encompass the full system life cycle from requirements definition, design, development and integration, to upgrade, sustainment and support for mission critical information and weapons systems. For the nine months ended September 30, 2007 and 2006, approximately 98% and 97%, respectively, of our revenue was derived ultimately from our customers in the Department of Defense and the intelligence community, including the U.S. Air Force, U.S. Army and joint military commands.

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

In July 2001, we were one of six awardees of the Federal Acquisition and Sustainment Tool (FAST) contract with a ceiling of $7.4 billion and with a period of performance, including option years, that extends to 2008. Our revenue under the FAST contract was approximately 27% and 21% of total revenue for the three- and nine-month periods ended September 30, 2007, respectively, and 19% and 21% of total revenue for the three- and nine-month periods ended September 30, 2006, respectively. FAST revenue was comprised of approximately 59 separate task orders, the largest of which amounted to approximately 6% and 3% of total revenue, for the three- and nine-month periods ended September 30, 2007, respectively. In prior years, we performed some of the work we are now performing on the FAST contract on other contract vehicles. While the FAST contract represents a significant percentage of our total revenue, we believe that the broad array of engineering, technical and management services we provide to the federal government through various contract vehicles allows for diversified business growth. No other task order, including individual contracts under our General Services Administration (GSA) vehicles, accounted for more than 6% and 3%, respectively, of revenue for the three- and nine-month periods ended September 30, 2007.

Under the FAST contract, we have the potential to compete for millions of dollars in task orders over the FAST contract’s approximately one-year remaining life as the U.S. Air Force maintains and modernizes aircraft and defense systems. In addition, a few of our FAST task orders have a period of performance extending into 2011. As of September 30, 2007, we have been awarded multiple individual task orders under the FAST contract with a remaining potential award value of approximately $323 million if all options are exercised. Although we believe the FAST contract presents an opportunity for additional growth and expansion of our services, we expect that many of the task orders we may be awarded under the FAST contract will be for lead system integrator and program management services, which historically have been less profitable than our other activities because these activities typically involve a significantly greater use of subcontractors. Margins on subcontractor-based revenue are typically lower than the margins on our direct work. Since the FAST contract is expected to remain a significant part of our business, it is possible that our operating income, as a percentage of total revenue, could diminish, while growing in absolute dollars.

Our federal government contracts are subject to government audits of our direct and indirect costs. The incurred cost audits have been completed through December 31, 2005, and the rates have been agreed to. We do not anticipate any material adjustment to our consolidated financial statements in subsequent periods for audits not yet completed.

For the nine months ended September 30, 2007 and 2006, approximately 65% and 74%, respectively, of our revenue came from work provided to our customers as a prime contractor, and the balance came from work provided as a subcontractor. Approximately 75% and 74% of our revenue for the nine months ended September 30, 2007 and 2006, respectively, consisted of the work of our employees, and the balance was provided by the work of subcontractors. Our work as a prime contractor on the FAST contract has resulted, and is expected to continue to result, in a significant use of subcontractors. The increased use of subcontractors on the FAST contract has been partially offset by the business model of our recent acquisitions, which typically have not used subcontractors to a great extent.

Our federal government contracts are subject to funding availability and current market conditions, such as the ongoing war on terror and other factors. These conditions are causing delays in the bidding/award process, are affecting funding availability and the availability of assets to be repaired or upgraded.

We typically provide our services under contracts with a base term, often of three years, and option terms, typically two to four additional one-year terms or more, which the customer can exercise on an annual basis. We also have contracts with fixed terms, some extending as long as five or six

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

years. Although we occasionally obtain government contracts for which the contracting agency obligates funding for the full term of the contract, most of our government contracts receive incremental funding, which subjects us to the risks associated with the government’s annual appropriations process.

Contract Types. When contracting with our government customers, we enter into one of three basic types of contracts: time-and-materials, fixed-price and cost-plus:

•

Time-and-materials contracts. Under a time-and-materials contract, we receive a fixed hourly rate for each direct labor hour worked, plus reimbursement for our allowable direct costs. To the extent that our actual labor costs vary significantly from the negotiated rates under a time-and-materials contact, we can either make more or less money than we originally anticipated.

•

Fixed-price contracts. Under fixed-price contracts, we agree to perform specified work for a firm fixed price. If our actual costs exceed our estimate of the costs to perform the contract, we may generate less profit or incur a loss. A portion of our fixed-price contract work is under a fixed-price level-of-effort contract, which represents a similar level of risk to our time-and-materials contracts, under which we agree to perform certain units of work for a fixed price per unit. We generally attempt to avoid undertaking high-risk work, such as software development or research and development efforts, under fixed-price contracts.

•

Cost-plus contracts. Under cost-plus contracts, we are reimbursed for allowable costs and receive a supplemental fee, which represents our profit. Cost-plus fixed fee contracts specify the contract fee in dollars or as a percentage of anticipated costs. Cost-plus incentive fee and cost-plus award fee contracts provide for increases or decreases in the contract fee, within specified limits, based upon actual results as compared to contractual targets for factors such as cost, quality, schedule and performance.

The following table provides information about the revenue and percentage of revenue attributable to each of these types of contracts for the periods indicated:


	Three months ended September 30,				Nine months ended September 30,
	2007		2006		2007		2006
Time-and-materials	43	%	53	%	48	%	53	%
Fixed-price	46	%	33	%	39	%	33	%
Cost-plus	11	%	14	%	13	%	14	%

Total	100	%	100	%	100	%	100	%

Funded Backlog. We define funded backlog as the portion of total backlog (our estimate of the total potential value of all orders for services under existing signed contracts and task orders, assuming, where appropriate, the exercise of all options and add-ons relating to those contracts and task orders, subject to available ceiling remaining on those contracts and task orders) for which funding currently is appropriated and obligated to us under a contract or other authorization for payment signed by an authorized purchasing authority, less the amount of revenue we have previously recognized. Funded backlog excludes options and add-ons to existing contracts for which we have not yet received funding. Our funded backlog does not include the full potential value of our contracts because funds for a particular program or contract are regularly funded on a yearly or even shorter basis, even though the contract may call for performance over a number of years.

The primary source of our backlog is contracts to perform work for the federal government. Our estimated funded backlog at September 30, 2007 was approximately $312 million as compared to

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

approximately $273 million at September 30, 2006. The approximate $39 million increase in funded backlog resulted primarily from the Santa Rosa underground cable installation contract and additional funding of the FAST contract.

Our funded backlog at September 30, 2007 was approximately 72% of our trailing twelve-month revenue, which is higher than the range of typical industry averages for funded backlog of 40% to 60% of trailing twelve-month revenue.

Restructuring Charge. In June 2007, management approved a restructuring plan to consolidate our organizational structure to improve customer focus and operational effectiveness. The measure, which consists of workforce reductions, is intended to improve efficiency and reduce expenses. As a result of this action, we recorded pre-tax restructuring provisions in our income statement totaling approximately $1.5 million to cover costs associated with staff reductions, which are expected to be completed by the end of 2007, with payments extending into the first quarter of 2008. Annual cost savings resulting from the restructuring plan, upon completion, are anticipated to be approximately $6 million.

CRITICAL ACCOUNTING POLICIES

Revenue Recognition. Our critical accounting policies primarily concern revenue recognition and related cost estimation. We recognize revenue under our government contracts when a contract has been executed, the contract price is fixed and determinable, delivery of services or products has occurred, and collection of the contract price is considered probable and can be reasonably estimated. Revenue is earned under time-and-materials, fixed-price and cost-plus contracts.

We recognize revenue on time-and-materials contracts to the extent of billable rates times hours delivered, plus expenses incurred. For fixed-price contracts within the scope of Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts (SOP 81-1), revenue is recognized on the percentage of completion method using costs incurred in relation to total estimated costs or upon delivery of specific products or services, as appropriate. For fixed-price-completion contracts that are not within the scope of SOP 81-1, revenue is generally recognized as earned according to contract terms as the service is provided. We will provide our customer with a number of different services that are generally documented through separate negotiated task orders that detail the services to be provided and our compensation for these services. Services rendered under each task order represent an independent earnings process and are not dependent on any other service or product sold. We recognize revenue on cost-plus contracts to the extent of allowable costs incurred plus a proportionate amount of the fee earned, which may be fixed or performance-based. We consider fixed fees under cost-plus contracts to be earned in proportion to the allowable costs incurred in performance of the contract, which generally corresponds to the timing of contractual billings. We record provisions for estimated losses on uncompleted contracts in the period in which we identify those losses. We consider performance-based fees, including award fees, under any contract type to be earned only when we can demonstrate satisfaction of a specific performance goal or we receive contractual notification from a customer that the fee has been earned.

Contract revenue recognition inherently involves estimation. From time to time, facts develop that require us to revise the total estimated costs or revenues expected. In most cases, these changes relate to changes in the contractual scope of the work and do not significantly impact the expected profit rate on a contract. We record the cumulative effects of any revisions to the estimated total costs and revenues in the period in which the facts become known.

Our work-in-process inventory relates to costs accumulated under fixed-price-type contracts accounted for under certain output measures, such as units delivered, of the percentage-of-completion method. Inventories are stated at the lower of cost or market, computed on an average cost basis.

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

Goodwill and Intangible Assets. Goodwill represents the excess of cost over the fair value of net tangible and identifiable intangible assets of acquired companies. Purchase price allocated to intangible assets is amortized using the straight-line method over the estimated terms of the contracts, which range from three to eight years. We perform impairment reviews on an annual basis. We have elected to conduct our annual impairment reviews as of the fourth quarter of each year. We base our assessment of possible impairment on the discounted present value of the operating cash flows of our consolidated operating unit. We determined that no impairment charge was required in 2006.

Income Taxes. We calculate our income tax provision using the asset and liability method. Under the asset and liability method, deferred income taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred taxes of a change in tax rates would be recognized in income in the period that includes the enactment date.

Beginning January 1, 2007, the Company adopted FIN 48, “Accounting for Uncertainty in Income Taxes.” Refer to Notes A and F in the Notes to Consolidated Financial Statements for details related to the adoption of FIN 48. The adoption of FIN 48 resulted in recording a $0.3 million adjustment to our beginning retained earnings and did not have any impact on our Consolidated Statements of Income.

FORWARD-LOOKING STATEMENTS

Portions of this Quarterly Report that are not statements of historical or current fact are forward-looking statements. The forward-looking statements in this Quarterly Report involve risk and uncertainties, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this document should be read as applying to all related forward-looking statements wherever they appear. Our actual results could differ materially from those anticipated in the forward-looking statements. Factors that could cause our actual results to differ materially from those anticipated include, but are not limited to, the following: strains on resources and decreases in operating margins; federal government audits and cost adjustments; differences between authorized amounts and amounts received by us under government contracts; government customers’ failure to exercise options under contracts; changes in federal government (or other applicable) procurement laws, regulations, policies and budgets; delays in the bidding/award process; our ability to attract and retain qualified personnel; our ability to retain contracts during re-bidding processes; pricing pressures; undertaking acquisitions, including the acquisition of AIC, that might increase our costs or liabilities or be disruptive; integration of acquisitions; and changes in general economic and business conditions.

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

RESULTS OF OPERATIONS

The following table sets forth, for each period indicated, the revenue (in millions) and percentage of items in the statement of income in relation to revenue:


	Three months ended September 30,								Nine months ended September 30,
	2007				2006				2007				2006
Revenue	$	114.6	100.0	%	$	105.2	100.0	%	$	321.7	100.0	%	$	304.8	100.0	%
Cost of revenue		98.2	85.7			87.9	83.5			273.0	84.9			254.6	83.5

Gross profit		16.4	14.3			17.3	16.5			48.7	15.1			50.2	16.5
General and administrative expenses		7.2	6.3			6.4	6.0			22.6	7.0			17.4	5.7
Restructuring charge		—	—			—	—			1.5	0.5			—	—
Intangible asset amortization		1.5	1.3			1.5	1.5			4.6	1.4			4.4	1.5

Operating income		7.7	6.7			9.4	9.0			20.0	6.2			28.4	9.3
Net interest expense		1.3	1.1			1.4	1.4			4.3	1.3			3.6	1.2
Other income, net		0.6	0.5			—	—			0.6	0.2			—	—

Net income before income taxes		7.0	6.1			8.0	7.6			16.3	5.1			24.8	8.1
Income tax expense		2.8	2.4			3.2	3.0			6.3	2.0			9.8	3.2

Net income	$	4.2	3.7	%	$	4.8	4.6	%	$	10.0	3.1	%	$	15.0	4.9	%

THREE MONTHS ENDED SEPTEMBER 30, 2007

COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2006

Revenue. Revenue for the three months ended September 30, 2007 increased 8.9%, or $9.4 million, as compared to the same period in 2006, due primarily to an increase of $11.5 million in revenue under our Flexible Acquisition and Sustainment Tool (FAST) contract, as well as the Santa Rosa underground cable installation program and PM Soldier Systems Project, which contributed additional revenue of $5.8 million and $2.9 million, respectively, in the quarter. These increases were partially offset by a net decrease in revenue from the former Aeronautical Systems Center Blanket Purchase Agreement (ASC/BPA) contract and a decrease of $10.0 million in revenue from our wholly-owned subsidiary Aerospace Integration Corporation (AIC).

Gross profit. Gross profit for the three months ended September 30, 2007 decreased 5.2%, or $0.9 million, as compared to the same period in 2006. This change primarily relates to increased cost of revenue. Gross profit as a percentage of revenue was 14.3% for the three months ended September 30, 2007, compared to 16.5% for the same period in 2006, primarily due to decreased margins caused by a higher volume of FAST subcontracting revenue, decreased gross margins realized by AIC and additional costs involved for the TIER II Unmanned Aircraft System flight testing. Partially offsetting these reductions in gross profit were savings resulting from the restructuring initiated in the second quarter of 2007.

General and administrative expenses. General and administrative expenses for the three months ended September 30, 2007 increased 12.6%, or $0.8 million, as compared to the same period in 2006. The change was due primarily to $1.2 million in additional bid and proposal costs due to increased bid activity. General and administrative expenses as a percentage of revenue were 6.0% of revenue for the three months ended September 30, 2006 compared to 6.3% for the three months ended September 30, 2007.

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

Operating income. Operating income for the three months ended September 30, 2007 decreased 18.1%, or $1.7 million, as compared to the three months ended September 30, 2006. This change in operating income primarily reflects the decreased gross profit combined with the increase in general and administrative expenses. Operating income as a percentage of revenue was 9.0% of revenue for the three months ended September 30, 2006 compared to 6.7% for the three months ended September 30, 2007, primarily for the reasons addressed above.

Other income. Other income for the three months ended September 30, 2007 increased by $0.6 million due primarily to the negotiated purchase price adjustment determination for a previously completed acquisition.

Income tax expense. Income tax expense for the three months ended September 30, 2007 decreased approximately 11.5%, or $0.4 million, as compared to the same period in 2006. Our effective income tax rates for the quarters ended September 30, 2007 and 2006 were 39.7% and 39.4%, respectively.

Net income. Net income for the three months ended September 30, 2007 decreased 12.6%, or approximately $0.6 million, as compared to the three months ended September 30, 2006. This change in net income was primarily the result of the lower operating income, partially offset by the increase in other income and the decreased income tax expense.

NINE MONTHS ENDED SEPTEMBER 30, 2007

COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2006

Revenue. Revenue for the nine months ended September 30, 2007 increased 5.5%, or $16.8 million, as compared to the same period in 2006. Revenue growth resulted primarily from revenue increases for the FAST, PEO Soldier Systems and the Santa Rosa underground cable installation contracts.

Gross profit. Gross profit for the nine months ended September 30, 2007 decreased 3.0%, or $1.5 million, as compared to the same period in 2006. Gross profit as a percentage of revenue was 15.1% for the nine months ended September 30, 2007 compared to 16.5% in the same period in 2006. This change resulted primarily from lower margins due to higher volume of FAST subcontracting revenue, decreased gross margins realized by AIC and additional costs involved for the TIER II Unmanned Aircraft System flight testing. Partially offsetting these reductions in gross profit were savings resulting from the restructuring initiated in the second quarter of 2007.

General and administrative expenses. General and administrative expenses for the nine months ended September 30, 2007 increased 29.9%, or $5.2 million, as compared to the same period in 2006. Included in general and administrative expenses for the nine months ended September 30, 2007 is approximately $1.2 million of additional general and administrative expenses from AIC, which was acquired in the second quarter of 2006, additional bid and proposal costs and increased salary and benefit expenses resulting from the addition of personnel. General and administrative expenses as a percentage of revenue were 5.7% of revenue for the nine months ended September 30, 2006 compared to 7.0% for the nine months ended September 30, 2007.

Restructuring charge. A plan to consolidate our organizational structure was initiated in June 2007. We recorded pre-tax restructuring expense totaling approximately $1.5 million in the second quarter of 2007 to cover costs associated with staff reductions.

Operating income. Operating income for the nine months ended September 30, 2007 decreased 29.7%, or $8.4 million, as compared to the nine months ended September 30, 2006. This change in operating income primarily reflects the lower gross profit, increased general and administrative

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

expenses, and a $1.5 million restructuring charge recorded in the second quarter of 2007. Operating income as a percentage of revenue was 9.3% of revenue for the nine months ended September 30, 2006 compared to 6.2% for the nine months ended September 30, 2007.

Net interest expense. The $0.6 million increase in net interest expense related to the increased borrowings made under our credit facility in 2006, which were used primarily to fund the acquisition of AIC made in the second quarter of 2006.

Other income. Other income for the nine months ended September 30, 2007 increased by $0.6 million due primarily to the negotiated purchase price adjustment determination for a previously completed acquisition.

Income tax expense. Income tax expense for the nine months ended September 30, 2007 decreased approximately 35.2%, or $3.4 million, as compared to the same period in 2006. Our effective income tax rates for the nine months ended September 30, 2007 and 2006 were 38.8% and 39.4%, respectively.

Net income. Net income for the nine months ended September 30, 2007 decreased 33.5%, or $5.0 million, as compared to the nine months ended September 30, 2006. This change in net income was primarily the result of the change in operating income and net interest expense, partially offset by the increased other income and decreased income tax expense.

QUARTERLY FLUCTUATIONS

Our results of operations, particularly our revenue, gross profit and cash flow, may vary significantly from quarter-to-quarter depending on a number of factors, including the progress of contract performance, revenue earned on contracts, the number of billable days in a quarter, the timing of customer orders or deliveries, changes in the scope of contracts and billing of other direct and subcontract costs, timing of funding of task orders, the commencement and completion of contracts we have been awarded, general economic conditions and timing of government awards. Because a significant portion of our expenses, such as personnel and facilities costs, are fixed in the short term, successful contract performance and variation in the volume of activity, as well as in the number of contracts or task orders commenced or completed during any quarter, may cause significant variations in operating results from quarter-to-quarter.

The federal government’s fiscal year ends September 30. If a federal budget for the next fiscal year has not been approved by that date in each year, our customers may have to suspend engagements that we are working on until a budget has been approved. Any suspensions may cause us to realize lower revenue in the fourth quarter of the year and possibly ensuing quarters of the following year. In addition, a change in Presidential administration, in Congressional majority or in other senior federal government officials may negatively affect the rate at which the federal government purchases technology and engineering services. The federal government’s fiscal year end can also trigger increased purchase requests from customers for equipment and materials. Any increased purchase requests we receive as a result of the federal government’s fiscal year end would serve to increase our fourth quarter revenues, but will generally decrease profit margins for that quarter, as these activities typically are not as profitable as our normal service offerings. As a result of the above factors, period-to-period comparisons of our revenue and operating results may not be meaningful. Potential investors should not rely on these comparisons as indicators of future performance as no assurances can be given that quarterly results will not fluctuate, causing a material adverse effect on our operating results and financial condition.

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

LIQUIDITY AND CAPITAL RESOURCES

Historically, our positive cash flow from operations, proceeds from stock offerings, and borrowings under our credit facilities have provided us adequate liquidity and working capital to fund our operational needs and support our acquisition activities.

Our cash and cash equivalents balance was $0 and $3.3 million on September 30, 2007 and December 31, 2006, respectively. Our working capital was approximately $60.0 million at September 30, 2007 and approximately $52.9 million at December 31, 2006. Our working capital increased $7.1 million in the first nine months of 2007 primarily due to:

•

a $3.7 million increase in restricted cash held in escrow from the issuance of $10 million in industrial development bonds (discussed below);

•

a $2.3 million increase in inventories;

•

a $7.1 million net increase in cost and estimated earnings in excess of amounts billed on uncompleted contracts; and

•

a $7.0 million decrease in accounts payable; but was

•

partially offset by a $5.3 million decrease in net accounts receivable, primarily in unbilled receivables, a $2.5 million increase in current maturities of long term debt and a $3.3 million decrease in cash.

Our operating activities provided net cash of approximately $7.5 million for the nine months ended September 30, 2007. The cash used in operations primarily represented net income of $10.0 million adjusted for depreciation and amortization of $7.8 million and changes in working capital as discussed above. For the nine months ended September 30, 2006, our operating activities provided net cash of approximately $23.9 million, primarily represented by net income of $15.0 million adjusted for depreciation and amortization of $6.9 million, and a $2.0 million decrease in working capital.

Our investing activities used net cash of approximately $1.1 million for the nine months ended September 30, 2007 as a result of approximately $9.3 million of capital expenditures, $5.7 million of which related to construction of the aircraft completion center described below. We currently anticipate 2007 aggregate capital expenditures to range between $12 and $15 million for additional facilities, software tools and computer equipment to support our growth, including the $10 million to be used for the construction of the aircraft completion center. Net proceeds for businesses purchased for the nine months ended September 30, 2007 were related to purchase price adjustments on two previously completed acquisitions. Net cash used by investing activities for the nine months ended September 30, 2006 of $52.0 million consisted primarily of approximately $47.8 million of payments made primarily in connection with our acquisition of AIC and other strategic investments, as well as $5.1 million of capital expenditures.

Our financing activities used net cash of approximately $9.7 million for the nine months ended September 30, 2007, which primarily consisted of $14.3 million in net repayments of debt under our credit facility and repurchase of outstanding MTC common stock during the period for $1.5 million, offset by $6.1 million of proceeds from the issuance of bonds to finance construction of the aircraft completion center discussed below. Our financing activities provided net cash of approximately $19.1 million for the nine months ended September 30, 2006, which primarily consisted of $27.5 million in net borrowings under our credit facility for the acquisition of AIC, offset by the Company’s repurchase of outstanding MTC common stock during the period for $8.5 million.

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

$145.0 million in the form of an $85.0 million revolving loan and a $60.0 million term loan. The interest rates on borrowings under the term loan range from the prime rate to the prime rate plus 25 basis points, or the London Interbank Offered Rate (LIBOR) rate plus 125 to 225 basis points, and under the revolving loan are the prime rate, or the LIBOR rate plus 100 to 200 basis points, depending in most instances on the ratio of our consolidated funded debt to consolidated pro forma earnings before interest, taxes, depreciation, and amortization (EBITDA).

As of September 30, 2007, we had $74.5 million outstanding under the Credit Agreement, compared to $88.8 million outstanding as of December 31, 2006.

Borrowings under the Credit Agreement are secured by a general lien on our consolidated assets. We are also subject to certain restrictions, and are required to meet certain financial covenants. These covenants require that we, among other things, maintain certain financial ratios and minimum net worth levels. As of September 30, 2007, we were in compliance with these covenants.

On March 30, 2007, MTC Technologies, Inc., an Ohio corporation and our wholly owned subsidiary, entered into a guaranty in connection with the issuance of $10 million in principal amount of Variable Rate Industrial Development Bonds (Bonds) by the Industrial Development Board of the City of Albertville, Alabama (IDB) on behalf of AIC. The Bonds were issued to finance the construction by AIC of an aircraft completion center at the Albertville, Alabama airport. AIC received $2.2 million in proceeds from the Bonds at the closing and paid transaction costs of $0.2 million. AIC has received an additional $4.1 million, in proceeds as project reimbursements during the second and third quarters of 2007. The remaining $3.7 million is being held in escrow and will be paid to AIC as additional capital expenditures are made on the aircraft completion center in Albertville, Alabama. The parcel of land on which such construction is occurring has been leased to AIC by the City of Albertville.

The Reimbursement Agreement contains customary events of default, including failure to make required payments when due, failure to comply with certain covenants, breaches of certain

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

representations and warranties, certain events of bankruptcy and insolvency, amendments to the Lease Agreement without the prior consent of the Bank, and an “event of default” under the Credit Agreement. Upon any such event of default, the maturity of the Bonds can be accelerated, causing payment by the Bank under the Letter of Credit and an immediate reimbursement obligation of AIC for the amount of accelerated Bonds pursuant to the Reimbursement Agreement.

We have made acquisitions in the past and may pursue selective acquisitions in the future. Historically we have financed our acquisitions with the proceeds from our public stock offerings, cash on hand, borrowings under credit facilities, and shares of our common stock. We expect to finance any future acquisitions with proceeds from cash generated by operations, borrowings under our Credit Agreement or a combination of the foregoing.

Management believes that the cash generated by operations and amounts available under our Credit Agreement will be sufficient to fund our working capital requirements, debt service obligations, purchase price commitments for completed acquisitions and capital expenditures for the next twelve months and through March 2010, when our Credit Agreement matures.

Our ability to generate cash from operations depends to a significant extent on winning new and re-competed contracts and/or task orders from our customers in competitive bidding processes. If a significant portion of our government contracts were terminated or if our win rate on new or re-competed contracts and task orders were to decline significantly, our operating cash flow would decrease, which would adversely affect our liquidity and capital resources.

ITEM 3.

Quantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk relates to changes in interest rates for borrowings under our Credit Agreement and Bonds payable. As of September 30, 2007, we had $74.5 million of borrowings outstanding under the Credit Agreement and $10 million in Bonds payable. We have offset a portion of our interest rate risk by entering into interest rate swap agreements.

In October 2005, we entered into an interest rate swap agreement with the Bank under which we exchange floating-rate interest payments for fixed-rate interest payments on our term loan. The amount of the interest rate swap is equal to 50% of the outstanding balance of our term loan, or $22.3 million as of September 30, 2007, and is reduced as the loan amortizes. The swap provides for payments over an approximately four-year period that began in December 2005 and is settled on a quarterly basis. The fixed interest rate provided by the agreement is 4.87% plus our spread at September 30, 2007 of 200 basis points, or 6.87%. At September 30, 2007, the interest rate on the portion of the term loan that was not subject to the interest rate swap agreement was 5.25% plus our spread at September 30, 2007 of 200 basis points, or 7.25%.

Effective April 5, 2006, we entered into an interest rate swap agreement with the Bank under which we exchange floating-rate interest payments for fixed-rate interest payments. The agreement covers a combined notional amount of debt equal to $20.0 million, and the agreement ends March 31, 2008. The swap provides for payments over a two-year period that began in June 2006 and is settled on a quarterly basis. The fixed interest rate provided by the agreement was 5.44% plus our spread at September 30, 2007 of 175 basis points, or 7.19%. The weighted average interest rate for the portion of the revolving loan that is not subject to the interest rate swap, as of September 30, 2007, was 7.49%, including our spread at September 30, 2007 of 175 basis points.

On March 30, 2007, MTC Technologies, Inc., an Ohio corporation and our wholly owned subsidiary, entered into a guaranty in connection with the issuance of $10 million in principal amount of Bonds by the IDB on behalf of AIC. The Bonds are being issued to finance the construction by AIC of an aircraft completion center at the Albertville, Alabama airport. AIC entered into a ten year interest

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES

rate hedge on the full amount of the Bonds at a fixed rate of 3.91%. The all-in interest rate is approximately 5.4%, including amortization of issuance costs. The Bonds are interest only for the first year with quarterly principal payments beginning in March 2008 and ending in March 2018. The September 30, 2007 balance sheet reflects the $10 million of bonds payable as well as $3.7 million of restricted cash that will be released as AIC makes additional capital expenditures on the aircraft completion center.

Although the Company’s financial results are affected by changes in short-term interest rates on its borrowings, the effects of interest rate changes are limited by the use of interest rate swaps. A hypothetical 100 basis point increase in interest rates, for example, would have resulted in an increase in interest expense of approximately $0.3 million on borrowings not subject to the interest rate swaps for the nine months ended September 30, 2007.

ITEM 4.

Controls and Procedures

Our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), together with other members of senior management, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of September 30, 2007. Based on this review, our CEO and CFO have concluded that, as of September 30, 2007, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure and were effective to ensure that such information is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

There were no changes in our internal control over financial reporting during the three months ended September 30, 2007 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1.

Legal Proceedings

From time to time, we are involved in legal proceedings arising in the ordinary course of business. We do not believe that any pending litigation will have a material adverse effect on our financial condition, results of operations or cash flows.

ITEM 6.

Exhibits


Exhibit No.		Description
10.1		Letter Agreement and Release, effective as of July 20, 2007, by and between MTC Technologies, Inc., a Delaware corporation, and John Longhouser (incorporated by reference to Exhibit 10.1 to MTC Technologies, Inc.’s Current Report on Form 8-K (Commission No. 000-49890), filed on July 26, 2007).

10.2		Letter Agreement and Release, effective as of September 25, 2007, by and between MTC Technologies, Inc., a Delaware corporation, and James Clark (incorporated by reference to Exhibit 10.1 to MTC Technologies, Inc.’s Current Report on Form 8-K (Commission No. 000-49890), filed on September 28, 2007).

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MTC TECHNOLOGIES, INC. AND SUBSIDIARIES


31.1		Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.

31.2		Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.

32.1		Certification of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

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


	MTC TECHNOLOGIES, INC.

Date: November 6, 2007

	By:	/s/ Michael I. Gearhardt
		(Signature)
		Michael I. Gearhardt
		Chief Financial Officer
		(Duly authorized officer and principal financial officer)

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EXHIBIT INDEX


Exhibit No.		Description
10.1		Letter Agreement and Release, effective as of July 20, 2007, by and between MTC Technologies, Inc., a Delaware corporation, and John Longhouser (incorporated by reference to Exhibit 10.1 to MTC Technologies, Inc.’s Current Report on Form 8-K (Commission No. 000-49890), filed on July 26, 2007).

10.2		Letter Agreement and Release, effective as of September 25, 2007, by and between MTC Technologies, Inc., a Delaware corporation, and James Clark (incorporated by reference to Exhibit 10.1 to MTC Technologies, Inc.’s Current Report on Form 8-K (Commission No. 000-49890), filed on September 28, 2007).

31.1		Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.

31.2		Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.

32.1		Certification of the Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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