---

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---



FORM 10-Q



---



|x | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ---------------------------------------------------------------------------------------



For the Quarterly Period Ended March 31, 2004,



or



| ̈ | 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: 0-13829



---



PEMCO AVIATION GROUP, INC.

(Exact name of registrant as specified in its charter)



---



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 84-0985295                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                           |  |           
|------------------------------------------ |  | ----------
|1943 North 50thStreet, Birmingham,
Alabama |  | 35212     
|(Address of principal executive offices)   |  | (Zip Code)



205-592-0011

(Registrants telephone number, including area code)



---



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.    x  Yes ̈No



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). ̈Yes    x  No



Indicate the number of shares outstanding of each of the registrants classes of common stock, as of the latest practicable date.



|                               |  |                            
|------------------------------ |  | ---------------------------
|Class                          |  | Outstanding at May 11, 2004
|Common Stock, $.0001 par value |  | 4,045,402                  



---



---

PART I. FINANCIAL INFORMATION



Item 1. Financial Statements



PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS



ASSETS

(In Thousands)



|                                               |  |                        |         |   |                  |   |         |  
|---------------------------------------------- |  | ---------------------- | ------- | - | ---------------- | - | ------- | -
|                                               |  | March 31,2004Unaudited |         |   | December 31,2003 |  
|Current assets:                                |  |                        |         |   |                  |   |         |  
|Cash                                           |  | $                      | 158     |   |                  | $ | 3,156   |  
|Accounts receivable, net                       |  |                        | 32,431  |   |                  |   | 35,042  |  
|Inventories, net                               |  |                        | 34,008  |   |                  |   | 25,504  |  
|Deferred income taxes                          |  |                        | 6,574   |   |                  |   | 7,223   |  
|Prepaid expenses and other                     |  |                        | 1,267   |   |                  |   | 1,561   |  
|                                               |  |                        |         |   |                  |   |         |  
|Total current assets                           |  |                        | 74,438  |   |                  |   | 72,486  |  
|                                               |  |                        |         |   |                  |   |         |  
|Machinery, equipment and improvements at cost: |  |                        |         |   |                  |   |         |  
|Machinery and equipment                        |  |                        | 31,565  |   |                  |   | 31,536  |  
|Leasehold improvements                         |  |                        | 27,435  |   |                  |   | 27,281  |  
|Construction-in-process                        |  |                        | 1,350   |   |                  |   | 988     |  
|                                               |  |                        |         |   |                  |   |         |  
|                                               |  |                        | 60,350  |   |                  |   | 59,805  |  
|Less accumulated depreciation and amortization |  |                        | (34,425 | ) |                  |   | (33,864 | )
|                                               |  |                        |         |   |                  |   |         |  
|Net machinery, equipment and improvements      |  |                        | 25,925  |   |                  |   | 25,941  |  
|                                               |  |                        |         |   |                  |   |         |  
|Other non-current assets:                      |  |                        |         |   |                  |   |         |  
|Deposits and other                             |  |                        | 1,776   |   |                  |   | 1,779   |  
|Related party receivable                       |  |                        | 466     |   |                  |   | 460     |  
|Intangible pension asset                       |  |                        | 4,539   |   |                  |   | 4,539   |  
|Intangible assets, net                         |  |                        | 178     |   |                  |   | 217     |  
|                                               |  |                        |         |   |                  |   |         |  
|                                               |  |                        | 6,959   |   |                  |   | 6,995   |  
|                                               |  |                        |         |   |                  |   |         |  
|Total assets                                   |  | $                      | 107,322 |   |                  | $ | 105,422 |  
|                                               |  |                        |         |   |                  |   |         |  



The accompanying notes
are an integral part

of these consolidated statements.



-1-



---

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS



LIABILITIES AND STOCKHOLDERS EQUITY

(In Thousands, Except Common Share Information)



|                                                                                                                                                    |  |                        |         |   |                  |   |         |  
|--------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                    |  | March 31,2004Unaudited |         |   | December 31,2003 |  
|Current liabilities:                                                                                                                                |  |                        |         |   |                  |   |         |  
|Current portion of long-term debt                                                                                                                   |  | $                      | 1,234   |   |                  | $ | 1,255   |  
|Current portion of pension liability                                                                                                                |  |                        | 8,460   |   |                  |   | 8,612   |  
|Accounts payable                                                                                                                                    |  |                        | 3,052   |   |                  |   | 1,849   |  
|Accounts payable - accrued                                                                                                                          |  |                        | 5,007   |   |                  |   | 6,696   |  
|Accrued health and dental                                                                                                                           |  |                        | 1,227   |   |                  |   | 1,141   |  
|Accrued liabilities - payroll related                                                                                                               |  |                        | 9,574   |   |                  |   | 7,951   |  
|Accrued liabilities - other                                                                                                                         |  |                        | 10,750  |   |                  |   | 9,210   |  
|Customer deposits in excess of cost                                                                                                                 |  |                        | 7,684   |   |                  |   | 7,679   |  
|                                                                                                                                                    |  |                        |         |   |                  |   |         |  
|Total current liabilities                                                                                                                           |  |                        | 46,988  |   |                  |   | 44,393  |  
|                                                                                                                                                    |  |                        |         |   |                  |   |         |  
|Long-term debt, less current portion                                                                                                                |  |                        | 19,639  |   |                  |   | 20,299  |  
|Long-term pension benefit liability                                                                                                                 |  |                        | 14,679  |   |                  |   | 15,575  |  
|Other long-term liabilities                                                                                                                         |  |                        | 1,982   |   |                  |   | 2,180   |  
|                                                                                                                                                    |  |                        |         |   |                  |   |         |  
|Total liabilities                                                                                                                                   |  |                        | 83,288  |   |                  |   | 82,447  |  
|                                                                                                                                                    |  |                        |         |   |                  |   |         |  
|Stockholders equity:                                                                                                                               |  |                        |         |   |                  |   |         |  
|Preferred Stock, $0.0001 par value, 5,000,000 shares authorized, none outstanding                                                                   |  |                        |         |   |                  |   |         |  
|Common stock, $0.0001 par value, 12,000,000 shares authorized, 4,045,402 and 4,044,164 issued at March 31, 2004 and December 31, 2003,
respectively |  |                        | 1       |   |                  |   | 1       |  
|Additional paid-in capital                                                                                                                          |  |                        | 10,100  |   |                  |   | 10,077  |  
|Retained earnings                                                                                                                                   |  |                        | 39,540  |   |                  |   | 38,504  |  
|Treasury stock, at cost  359,723 shares at March 31, 2004 and December 31, 2003, respectively                                                      |  |                        | (7,043  | ) |                  |   | (7,043  | )
|Accumulated other comprehensive income (loss)                                                                                                       |  |                        |         |   |                  |   |         |  
|Net unrealized gain on investments                                                                                                                  |  |                        | 140     |   |                  |   | 140     |  
|Minimum pension liability                                                                                                                           |  |                        | (18,704 | ) |                  |   | (18,704 | )
|                                                                                                                                                    |  |                        |         |   |                  |   |         |  
|Total stockholders equity                                                                                                                          |  |                        | 24,034  |   |                  |   | 22,975  |  
|                                                                                                                                                    |  |                        |         |   |                  |   |         |  
|Total liabilities and stockholders equity                                                                                                          |  | $                      | 107,322 |   |                  | $ | 105,422 |  
|                                                                                                                                                    |  |                        |         |   |                  |   |         |  



The accompanying notes
are an integral part

of these consolidated statements.



-2-



---

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME

(In Thousands, Except Net Income per
Common Share Information)



|                                              |  |                                |        |                                |   |       
|--------------------------------------------- |  | ------------------------------ | ------ | ------------------------------ | - | ------
|                                              |  | ThreeMonths EndedMarch 31,2004 |        | ThreeMonths EndedMarch 31,2003
|Net sales                                     |  | $                              | 43,247 |                                | $ | 35,669
|Cost of sales                                 |  |                                | 34,312 |                                |   | 29,164
|                                              |  |                                |        |                                |   |       
|Gross profit                                  |  |                                | 8,935  |                                |   | 6,505 
|                                              |  |                               
|Selling, general, and administrative expenses |  |                                | 7,025  |                                |   | 5,170 
|                                              |  |                                |        |                                |   |       
|Income from operations                        |  |                                | 1,910  |                                |   | 1,335 
|                                              |  |                               
|Interest                                      |  |                                | 225    |                                |   | 219   
|                                              |  |                                |        |                                |   |       
|Income before income taxes                    |  |                                | 1,685  |                                |   | 1,116 
|Income tax expense                            |  |                                | 649    |                                |   | 423   
|                                              |  |                                |        |                                |   |       
|Net income                                    |  | $                              | 1,036  |                                | $ | 693   
|                                              |  |                                |        |                                |   |       
|Net income per common share:                  |  |                                |        |                                |   |       
|Basic                                         |  | $                              | 0.26   |                                | $ | 0.17  
|Diluted                                       |  | $                              | 0.23   |                                | $ | 0.16  
|                                              |  |                               
|Weighted average common shares outstanding:   |  |                                |        |                                |   |       
|Basic                                         |  |                                | 4,045  |                                |   | 4,036 
|Diluted                                       |  |                                | 4,544  |                                |   | 4,384 



The accompanying notes
are an integral part

of these consolidated statements.



-3-



---

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)



|                                                                                            |  |                                |        |   |                                |   |        |  
|------------------------------------------------------------------------------------------- |  | ------------------------------ | ------ | - | ------------------------------ | - | ------ | -
|                                                                                            |  | ThreeMonths EndedMarch 31,2004 |        |   | ThreeMonths EndedMarch 31,2003 |  
|Cash flows from operating activities:                                                       |  |                                |        |   |                                |   |        |  
|Net income                                                                                  |  | $                              | 1,036  |   |                                | $ | 693    |  
|                                                                                            |  |                                |        |   |                                |   |        |  
|Adjustments to reconcile net income to net cash (used in) provided by operating activities: |  |                                |        |   |                                |   |        |  
|Depreciation and amortization                                                               |  |                                | 915    |   |                                |   | 740    |  
|Provision for deferred income taxes                                                         |  |                                | 649    |   |                                |   | 423    |  
|Funding over pension cost                                                                   |  |                                | (1,048 | ) |                                |   | (398   | )
|Provision for losses on receivables                                                         |  |                                |       |   |                                |   | 36     |  
|Provision for inventory valuation                                                           |  |                                | 3      |   |                                |   |       |  
|Provision for losses on contracts-in-process                                                |  |                                | 711    |   |                                |   |       |  
|Income tax benefit from exercise of non-qualified stock options                             |  |                                | 11     |   |                                |   | 74     |  
|Changes in assets and liabilities:                                                          |  |                                |        |   |                                |   |        |  
|Related party receivable                                                                    |  |                                | (6     | ) |                                |   | (19    | )
|Accounts receivable, net                                                                    |  |                                | 2,611  |   |                                |   | 1,296  |  
|Inventories                                                                                 |  |                                | (8,507 | ) |                                |   | (4,981 | )
|Prepaid expenses and other                                                                  |  |                                | 294    |   |                                |   | 796    |  
|Deposits and other                                                                          |  |                                | 3      |   |                                |   | (76    | )
|Customer deposits in excess of cost                                                         |  |                                | 5      |   |                                |   |       |  
|Accounts payable and accrued liabilities                                                    |  |                                | 1,854  |   |                                |   | 2,200  |  
|                                                                                            |  |                                |        |   |                                |   |        |  
|Total adjustments                                                                           |  |                                | (2,505 | ) |                                |   | 91     |  
|                                                                                            |  |                                |        |   |                                |   |        |  
|Net cash (used in) provided by operating activities                                         |  |                                | (1,469 | ) |                                |   | 784    |  
|                                                                                            |  |                                |        |   |                                |   |        |  
|Cash flows from investing activities:                                                       |  |                                |        |   |                                |   |        |  
|Capital expenditures                                                                        |  |                                | (860   | ) |                                |   | (2,369 | )
|                                                                                            |  |                                |        |   |                                |   |        |  
|Net cash used in investing activities                                                       |  |                                | (860   | ) |                                |   | (2,369 | )
|                                                                                            |  |                                |        |   |                                |   |        |  
|Cash flows from financing activities:                                                       |  |                                |        |   |                                |   |        |  
|Proceeds from exercise of stock options                                                     |  |                                | 12     |   |                                |   | 175    |  
|Net change under revolving credit facility                                                  |  |                                | (399   | ) |                                |   | 1,393  |  
|Principal payments under long-term debt                                                     |  |                                | (282   | ) |                                |   | (408   | )
|                                                                                            |  |                                |        |   |                                |   |        |  
|Net cash (used in) provided by financing activities                                         |  |                                | (669   | ) |                                |   | 1,160  |  
|                                                                                            |  |                                |        |   |                                |   |        |  
|Net decrease in cash                                                                        |  |                                | (2,998 | ) |                                |   | (425   | )
|                                                                                            |  |                                |        |   |                                |   |        |  
|Cash, beginning of period                                                                   |  |                                | 3,156  |   |                                |   | 2,795  |  
|                                                                                            |  |                                |        |   |                                |   |        |  
|Cash, end of period                                                                         |  | $                              | 158    |   |                                | $ | 2,370  |  
|                                                                                            |  |                                |        |   |                                |   |        |  
|Supplemental disclosure of cash flow information:                                           |  |                                |        |   |                                |   |        |  
|Cash paid during the period for:                                                            |  |                                |        |   |                                |   |        |  
|Interest                                                                                    |  | $                              | 189    |   |                                | $ | 178    |  
|                                                                                            |  |                                |        |   |                                |   |        |  
|Taxes                                                                                       |  | $                              | 50     |   |                                | $ |       |  
|                                                                                            |  |                                |        |   |                                |   |        |  



The accompanying notes
are an integral part

of these consolidated statements



-4-



---

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of and for the Quarters Ended

March 31, 2004 and 2003



1. CONSOLIDATED FINANCIAL STATEMENTS



The interim consolidated financial statements have been prepared by Pemco Aviation Group, Inc. (the company) following the requirements of the
Securities and Exchange Commission for interim reporting, and are unaudited. In the opinion of management, all adjustments necessary for a fair presentation are reflected in the interim financial statements. Such adjustments are of a normal and
recurring nature. The results of operations for the period ended March 31, 2004 are not necessarily indicative of the operating results expected for the full year. The interim financial statements should be read in conjunction with the audited
financial statements and notes thereto included in the companys 2003 Annual Report on Form 10-K.



2. STOCK OPTIONS



The
company uses the fair value method for stock options granted for services rendered by non-employees in accordance with SFAS No. 123 Accounting for Stock Based Compensation.



The company uses the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 Accounting for
Stock Issued to Employees, for stock option grants to individuals defined as employees. Accordingly, no compensation expense is recognized for options granted at or above the fair market value of the underlying stock on the grant date. The
following table illustrates what the effect on net income and earnings per share would have been if the company had applied the fair value recognition provisions of FASB Statement No. 123 to stock options granted to employees.



(In thousands except per share information)



|                                                                    |  |                                |       |   |                                |   |       |  
|------------------------------------------------------------------- |  | ------------------------------ | ----- | - | ------------------------------ | - | ----- | -
|                                                                    |  | ThreeMonths EndedMarch 31,2004 |       |   | ThreeMonths EndedMarch 31,2003 |  
|Net Income  as reported                                            |  | $                              | 1,036 |   |                                | $ | 693   |  
|Stock based compensation under fair value method, net of tax effect |  |                                | (155  | ) |                                |   | (969  | )
|                                                                    |  |                                |       |   |                                |   |       |  
|Net income (loss)  pro forma                                       |  | $                              | 881   |   |                                | $ | (276  | )
|                                                                    |  |                                |       |   |                                |   |       |  
|Net income per share, basic  as reported                           |  | $                              | 0.26  |   |                                | $ | 0.17  |  
|                                                                    |  |                                |       |   |                                |   |       |  
|Net income per share, diluted  as reported                         |  | $                              | 0.23  |   |                                | $ | 0.16  |  
|                                                                    |  |                                |       |   |                                |   |       |  
|Net income (loss) per share, basic  pro forma                      |  | $                              | 0.22  |   |                                | $ | (0.07 | )
|                                                                    |  |                                |       |   |                                |   |       |  
|Net income (loss) per share, diluted  pro forma                    |  | $                              | 0.19  |   |                                | $ | (0.06 | )
|                                                                    |  |                                |       |   |                                |   |       |  



-5-



---

3. INVENTORIES



Inventories as of March 31, 2004 and December 31, 2003 consist of the following:



(In Thousands)



|                                              |  |               |         |   |                  |   |         |  
|--------------------------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                              |  | March 31,2004 |         |   | December 31,2003 |  
|Work in process                               |  | $             | 38,720  |   |                  | $ | 31,679  |  
|Finished goods                                |  |               | 2,005   |   |                  |   | 2,058   |  
|Raw materials and supplies                    |  |               | 10,286  |   |                  |   | 9,677   |  
|                                              |  |               |         |   |                  |   |         |  
|Total                                         |  |               | 51,011  |   |                  |   | 43,414  |  
|Less reserves                                 |  |               | (2,427  | ) |                  |   | (2,473  | )
|Less milestone payments and customer deposits |  |               | (14,576 | ) |                  |   | (15,437 | )
|                                              |  |               |         |   |                  |   |         |  
|                                              |  | $             | 34,008  |   |                  | $ | 25,504  |  
|                                              |  |               |         |   |                  |   |         |  



A substantial portion
of the above inventories relate to U.S. Government contracts or sub-contracts. The company receives milestone payments on the majority of its government contracts. The title to all inventories on which the company receives milestone payments is
vested in the customer to the extent of the deposit balance.



4. NET INCOME
PER SHARE



Basic net income per share was computed by
dividing net income by the weighted average number of shares of common stock outstanding during the periods. Diluted net income per share was computed by dividing net income by the weighted average number of shares of common stock and the dilutive
effects of the shares awarded under the companys Non-Qualified Stock Option Plan, based on the treasury stock method using an average fair market value of the stock during the respective periods.



-6-



---

The following table represents the net income per share calculations for the three-month periods ended
March 31, 2004 and 2003:



(All numbers In Thousands, except
Income Per Share)



|                                |  |                                |       |                                |   |      
|------------------------------- |  | ------------------------------ | ----- | ------------------------------ | - | -----
|                                |  | ThreeMonths EndedMarch 31,2004 |       | ThreeMonths EndedMarch 31,2003
|Net income                      |  | $                              | 1,036 |                                | $ | 693  
|Weighted average shares         |  |                                | 4,045 |                                |   | 4,036
|Basic net income per share      |  | $                              | 0.26  |                                | $ | 0.17 
|Dilutive securities: options    |  |                                | 499   |                                |   | 348  
|Diluted weighted average shares |  |                                | 4,544 |                                |   | 4,384
|Diluted net income per share    |  | $                              | 0.23  |                                | $ | 0.16 



Options to purchase
-0- and approximately 209,000 shares of common stock related to March 31, 2004 and 2003, respectively, were excluded from the computation of diluted net income per share because the option exercise price was greater than the average market price of
the shares.



5. DEBT



Debt as of March 31, 2004 and December 31, 2003 consists of the following:



(In Thousands)



|                                                                                                                 |  |               |        |   |                  |   |        |  
|---------------------------------------------------------------------------------------------------------------- |  | ------------- | ------ | - | ---------------- | - | ------ | -
|                                                                                                                 |  | March 31,2004 |        |   | December 31,2003 |  
|Revolving credit facility; Interest at LIBOR plus 2.50% (3.62% at March 31, 2004)                                |  | $             | 14,567 |   |                  | $ | 14,966 |  
|Bank Term Loan; Interest at LIBOR plus 2.75% (3.87% at March 31, 2004)                                           |  |               | 3,750  |   |                  |   | 4,000  |  
|Airport Authority Term Loan; Interest at BMA plus 0.36% (1.27% at March 31, 2004)                                |  |               | 2,500  |   |                  |   | 2,500  |  
|Capital Lease Obligations; Interest from 8.4% to 11.0%, collateralized by security interest in certain equipment |  |               | 56     |   |                  |   | 88     |  
|                                                                                                                 |  |               |        |   |                  |   |        |  
|Total long-term debt                                                                                             |  |               | 20,873 |   |                  |   | 21,554 |  
|Less portion reflected as current                                                                                |  |               | (1,234 | ) |                  |   | (1,255 | )
|                                                                                                                 |  |               |        |   |                  |   |        |  
|Long term-debt, net of current portion                                                                           |  | $             | 19,639 |   |                  | $ | 20,299 |  
|                                                                                                                 |  |               |        |   |                  |   |        |  



On December 16, 2002,
the company executed a Credit Agreement that provides for a revolving credit facility and a term loan (the Revolving Credit Facility and Bank Term Loan, respectively). The Revolving Credit Facility had an original term of two
years. The company amended the Credit Agreement on December 16, 2003, which increased borrowing capacity under the Revolving Credit Facility from $20.0 million to $25.0 million and extended the maturity date from December 16, 2004 to December 16,
2005. The Revolving Credit Facility bears interest at LIBOR plus 2.00% to 2.75%, determined based on the ratio of adjusted funded debt to earnings before interest, taxes, depreciation and amortization, each as defined in the Credit Agreement.



-7-



---

The Bank Term Loan has a term of 5 years and bears interest at LIBOR plus 2.25% to 3.00%, determined
based on the ratio of adjusted funded debt to earnings before interest, taxes, depreciation and amortization, each as defined in the Credit Agreement. The original principal amount of $5.0 million is payable in 60 monthly installments of $83,333
plus interest, which began January 31, 2003.



On May 22, 2003,
the company amended the Credit Agreement to create a line of credit for the repurchase of the companys common stock (Treasury Stock Term Loan). The company may draw upon the Treasury Stock Term Loan up to $5.0 million through May
22, 2004, and the borrowings may be used to make purchases of the companys common stock from any person who is not or has never been an affiliate of the company. The Treasury Stock Term Loan can be drawn in increments of $0.5 million and bears
interest at LIBOR plus 3.00%. The company had no outstanding balance under the Treasury Stock Term Loan at March 31, 2004 or December 31, 2003. The loan will be repaid, if drawn, in equal monthly installments over 43 months commencing on May 22,
2004.



The Airport Authority Term Loan was originated on
November 26, 2002, has a term of 15 years, and bears interest at BMA plus 0.36%. The amount outstanding under the Airport Authority Term Loan at March 31, 2004 was $2.5 million and will be repaid over 14 annual installments of approximately $180,000
commencing on September 30, 2004. A Letter of Credit supports the Airport Authority Term Loan and has a fee of 1.0% per year with a 5-year term.



Borrowing availability under the Revolving Credit Facility is tied to percentages of eligible accounts receivable and inventories. The company had
borrowings of approximately $14.6 million outstanding under the Revolving Credit Facility at March 31, 2004. Remaining borrowing capacity available under the facility at March 31, 2004, based upon the calculation that defines the borrowing base,
totaled approximately $10.4 million. All of the facilities have provisions for increases in the interest rate during any period when an event of default exists.



As of March 31, 2004, principal maturities of debt were as follows:



(In Thousands)



|           |  |   |       
|---------- |  | - | ------
|Current    |  | $ | 1,234 
|1-3 years  |  |   | 16,929
|3-5 years  |  |   | 1,110 
|Thereafter |  |   | 1,600 
|           |  |   |       
|           |  | $ | 20,873
|           |  |   |       



A significant portion
of the debt maturing during the 1-3 year period listed above relates to the expiration of the 2-year term of the Revolving Credit Facility, as amended. The company expects that it will renew the agreement for an additional 2-year term on December
16, 2004, and continue to do so each year, although there can be no assurances in that regard. Notwithstanding this



-8-



---

intended continuous renewal of the Revolving Credit Facility, the company may elect to pay down the
facility out of proceeds from the results of operations, or other potential financing sources, prior to the scheduled maturity.



The above loans are collateralized by substantially all of the assets of the company and have various covenants which limit or prohibit the company from
incurring additional indebtedness, disposing of assets, merging with other entities, declaring dividends, or making capital expenditures in excess of certain amounts in any fiscal year. Additionally, the company is required to maintain various
financial ratios and minimum net worth amounts.



Notwithstanding the covenants mentioned above which limit or prohibit the company from incurring additional indebtedness, the company does have certain assets that are not covered by these limitations or prohibitions that could possibly be
used to secure additional financing.



6. STOCKHOLDERS EQUITY



Holders of Stock Options under the companys
Non-Qualified Stock Option Plan exercised options for approximately 1,200 and 16,000 shares, respectively, of the companys common stock during the three months ended March 31, 2004 and 2003. The company recorded both the exercise price and a
tax benefit totaling approximately $23,000 and $250,000, respectively, to Additional Paid In Capital during the first quarter of 2004 and 2003.



7. EMPLOYEE BENEFIT PLANS



The company has a defined benefit pension plan (the Plan) in effect, which covers substantially all employees at its Birmingham and Dothan,
Alabama facilities who meet minimum eligibility requirements. Benefits for non-union employees are based upon salary and years of service, while benefits for union employees are based upon a fixed benefit rate and years of service. The funding
policy is consistent with the funding requirements of federal laws and regulations concerning pensions.



Components of the Plans net periodic pension cost were as follows:



|                                   |  |                                |        |   |                                |   |        |  
|---------------------------------- |  | ------------------------------ | ------ | - | ------------------------------ | - | ------ | -
|                                   |  | ThreeMonths EndedMarch 31,2004 |        |   | ThreeMonths EndedMarch 31,2003 |  
|Service cost                       |  | $                              | 642    |   |                                | $ | 577    |  
|Interest cost                      |  |                                | 1,792  |   |                                |   | 1,849  |  
|Expected return on plan assets     |  |                                | (2,190 | ) |                                |   | (2,138 | )
|Amortization of prior service cost |  |                                | 169    |   |                                |   | 218    |  
|Amortization of net (gain) loss    |  |                                | 268    |   |                                |   | 44     |  
|                                   |  |                                |        |   |                                |   |        |  
|Net pension cost                   |  | $                              | 681    |   |                                | $ | 550    |  
|                                   |  |                                |        |   |                                |   |        |  



-9-



---

8. CONTINGENCIES



United States Government Contracts - The company, as a U.S. Government contractor and sub-contractor, is subject to audits, reviews, and
investigations by the government related to its negotiation and performance of government contracts and its accounting for such contracts. Failure to comply with applicable U.S. Government standards by a contractor may result in suspension from
eligibility for award of any new government contracts and a guilty plea or conviction may result in debarment from eligibility for awards. The government may, in certain cases, also terminate existing contracts, recover damages, and impose other
sanctions and penalties. The company believes, based on all available information, that the outcome of any U.S. Government audits, reviews, and investigations would not have a material effect on the companys financial position or results of
operations.



A Significant Portion of the Companys
Revenue is Derived From a Few of its Customers- A small number of the companys customers account for a significant percentage of its revenues. The KC-135 program comprised 65.5% and 61.5% of the companys total revenues during the
three-month periods ended March 31, 2004 and 2003, respectively. The companys two largest programs generated approximately 92.4% and 86.1% of its revenues during the first quarters of 2004 and 2003, respectively. Termination or a disruption of
any of its significant customer contracts, including by way of option years not being exercised, or the inability of the company to renew or replace any of these customer contracts when they expire, could materially harm the companys business
and impair the value of its common stock.



Litigation



Breach of Contract Lawsuits



On October 12, 1995, Falcon Air AB filed a Complaint in the United States
District Court, Northern District of Alabama, alleging that the modification of three Boeing 737 aircraft to Quick Change configuration by the company was defective, limiting the commercial use of the aircraft. The District Court released the case
to alternative dispute resolution until the company requested reinstatement of the case on September 13, 2001. Reinstatement was denied, and the company filed an appeal with the 11thCircuit Court of Appeals for determination on certain procedural issues on October 31, 2001. The parties have subsequently entered into arbitration and
discovery is ongoing. Management believes that the results of this claim will not have a material impact on the companys financial position or results of operations.



On January 16, 2004, the company filed a complaint in the Circuit Court of Dale County, Alabama against GE Capital Aviation
Services, Inc. (GECAS) for monies owed for modification and maintenance services provided on six 737-300 aircraft, all of which were re-delivered to GECAS during 2003 and are in service. On March 24, 2004, the Circuit Court of Dale
County, Alabama denied a motion filed by GECAS to dismiss or stay the proceedings. On January 20, 2004, GECAS filed suit against the companys Pemco World



-10-



---

Air Services, Inc. subsidiary in New York state court, claiming breach of contract with regard to two of
the aircraft re-delivered. On March 5, 2004, the company filed a motion to dismiss the claim filed in the New York state court, which was denied. The Court has ordered mediation in the matter. Management believes that the results of this claim will
not have a material impact on the companys financial position or results of operations.



ACC Capital Corporation (ACC Capital) claims the company improperly terminated leases for computer hardware and software in November of 2002. The company filed a Declaratory Judgment action on February 4,
2003 in the District Court Northern District, Alabama to substantiate the companys end-of-term option to purchase. ACC Capital filed an action in Utah state court on March 17, 2003, which was subsequently removed to federal court on the
companys motion. The company filed its Motion for Partial Summary Judgment on February 9, 2004, and arguments are to be heard by the Court on June 22, 2004. The company believes that the results of this claim will not have a material impact on
the companys financial position or results of operations.



Employment Lawsuits



In December 1999, the
company and its Pemco Aeroplex subsidiary were served with a purported class action in the U.S. District Court, Northern District of Alabama, seeking declaratory, injunctive relief and other compensatory and punitive damages based upon alleged
unlawful employment practices of race discrimination and racial harassment by the companys managers, supervisors, and other employees. The complaint sought damages in the amount of $75 million. On July 27, 2000 the U.S. District Court
determined that the group would not be certified as a class and the plaintiffs withdrew their request for class certification. The Equal Employment Opportunity Commission (EEOC) subsequently entered the case purporting a parallel class
action. The Court denied consolidation of the cases for trial purposes. On June 28, 2002 a jury determined that there was no hostile work environment with regard to any of the 22 plaintiffs in the original case and granted verdicts for the company.
Nine plaintiffs elected to settle with the company prior to the trial. On December 13, 2002 the Court granted the company Summary Judgment in the EEOC case. That judgment has now been appealed to the 11thCircuit Court of Appeals and all briefs filed. Arguments were heard by the Court on March 18, 2004 and the company awaits the Courts decision. The
company has taken effective remedial and corrective action, acted promptly in respect to any specific complaint by an employee, and will vigorously defend this case. Management believes that the results of this claim will not have a material impact
on the companys financial position or results of operations.



Various claims alleging employment discrimination, including race, sex and age, have been made against the company and its subsidiaries by current and former employees at its Birmingham and Dothan, Alabama facilities in proceedings before
the EEOC and before state and federal courts in Alabama. Workers compensation claims brought by employees of Pemco Aeroplex are also pending in Alabama state court. The company believes that no one of these claims is material to the company as
a whole and that such claims are more reflective of the general increase in employment-related litigation in the U.S., and Alabama in particular, than of any actual discriminatory employment practices



-11-



---

by the company or any subsidiary. Except for workers compensation benefits as provided by statute,
the company intends to vigorously defend itself in all litigation arising from these types of claims. Management believes that the results of these claims will not have a material impact on the companys financial position or results of
operations.



The company and its subsidiaries are also parties
to other non-employment related litigation, the results of which are not expected to be material to the companys financial position or results of operations.



Environmental Compliance



In December 1997, the company received an inspection report from the Environmental Protection Agency (EPA) documenting the results of an
inspection at the Birmingham, Alabama facility. The report cited various violations of environmental laws. The company has taken actions to correct the items raised by the inspection. On December 21, 1998, the company and the EPA entered into a
Consent Agreement and Consent Order (CACO) resolving the complaint and compliance order. As part of the CACO, the company agreed to assess a portion of the Birmingham facility for possible contamination by certain constituents and
remediate such contamination as necessary. During 1999, the company drilled test wells and took samples under its Phase I Site Characterization Plan. These samples were forwarded to the EPA in 1999. A Phase II Site Characterization Plan (Phase
II Plan) was submitted to the EPA in 2001 upon receiving the agencys response to the 1999 samples. The Phase II Plan was approved in January 2003 and well installation has been completed. It is the companys policy to accrue
environmental remediation costs when it is probable that such costs will be incurred and when a range of loss can be reasonably estimated. The company reviews the status of all significant existing or potential environmental issues and adjusts its
accruals as necessary. The company recorded liabilities of approximately $74,000 and $100,000 related to the Phase II Plan at March 31, 2004 and December 31, 2003, respectively, which are included in accrued liabilities  other on the
accompanying Consolidated Balance Sheets. The company anticipates the total costs of the Phase II Plan to be approximately $441,000, of which the company has paid approximately $367,000 as of March 31, 2004. Management believes that the results of
the Phase II Plan will not have a material impact on the companys financial position or results of operations.



The company is required to comply with environmental regulations at the federal, state and local levels. These requirements apply especially to the
stripping, cleaning and painting of aircraft. The requirements to comply with environmental regulations have not had, and are not expected to have, a material effect on the companys financial position or results of operations.



9. SEGMENT INFORMATION



The company has three reportable segments: Government Services Segment (GSS), Commercial Services Segment
(CSS), and Manufacturing and Components Segment (MCS). The GSS, located in Birmingham, Alabama, provides aircraft maintenance and modification services for government and military customers. The CSS, located in Dothan,



-12-



---

Alabama, provides commercial aircraft maintenance and modification services on a contract basis to the
owners and operators of large commercial aircraft and also distributes aircraft parts. The MCS, located in California, designs and manufactures a wide array of proprietary aerospace products including various space systems, such as guidance control
systems and launch vehicles, and aircraft cargo-handling systems.



The accounting policies of the segments are the same as those described in the summary of significant accounting policies in the companys 2003 Annual Report on Form 10-K. The company evaluates performance based on total (external and
inter-segment) revenues, gross profits and operating income. The company accounts for inter-segment sales and transfers as if the sales or transfers were to third parties. The amount of intercompany profit is not material. The company does not
allocate income taxes to segments.



The companys
reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different operating and marketing strategies. The CSS and MCS may generate revenues from
governmental entities or programs and the GSS may generate revenues from commercial entities.



The following table presents information about segment profit or loss for the three months ended March 31, 2004 and 2003:



(In Thousands)



|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|----------------------------------------- |  | --- | ------ | - | --- | - | ------ | --- |  | - | ------------ | - |  | - | ------- | -
|Three Months Ended March 31, 2004         |  | GSS |        |   | CSS |   |        | MCS |  |   | Consolidated |  
|Revenues from external domestic customers |  | $   | 29,591 |   |     | $ | 11,151 |     |  | $ | 1,425        |   |  | $ | 42,167  |  
|Revenues from external foreign customers  |  |     |        |   |     |   | 885    |     |  |   | 195          |   |  |   | 1,080   |  
|Inter-company revenues                    |  |     | (10    | ) |     |   | 123    |     |  |   | 156          |   |  |   | 269     |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Total segment revenues                    |  |     | 29,581 |   |     |   | 12,159 |     |  |   | 1,776        |   |  |   | 43,516  |  
|Elimination                               |  |     |        |   |     |   |        |     |  |   |              |   |  |   | (269    | )
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Total Revenue                             |  |     |        |   |     |   |        |     |  |   |              |   |  | $ | 43,247  |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Gross profit                              |  | $   | 8,794  |   |     | $ | 312    |     |  | $ | (171         | ) |  | $ | 8,935   |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Segment operating income (loss)           |  | $   | 3,712  |   |     | $ | (1,542 | )   |  | $ | (260         | ) |  | $ | 1,910   |  
|Interest expense                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   | 225     |  
|Income taxes                              |  |     |        |   |     |   |        |     |  |   |              |   |  |   | 649     |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Net income                                |  |     |        |   |     |   |        |     |  |   |              |   |  | $ | 1,036   |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Assets                                    |  | $   | 68,139 |   |     | $ | 34,144 |     |  | $ | 5,039        |   |  | $ | 107,322 |  
|Depreciation/amortization                 |  |     | 700    |   |     |   | 293    |     |  |   | 46           |   |  |   | 1,039   |  
|Capital Additions                         |  |     | 581    |   |     |   | 272    |     |  |   | 7            |   |  |   | 860     |  



-13-



---

|                                          |  |     |        |     |   |        |     |  |   |              |   |  |   |        |  
|----------------------------------------- |  | --- | ------ | --- | - | ------ | --- |  | - | ------------ | - |  | - | ------ | -
|Three Months Ended March 31, 2003         |  | GSS |        | CSS |   |        | MCS |  |   | Consolidated |  
|Revenues from external domestic customers |  | $   | 21,991 |     | $ | 9,326  |     |  | $ | 1,897        |   |  | $ | 33,214 |  
|Revenues from external foreign customers  |  |     |        |     |   | 2,326  |     |  |   | 129          |   |  |   | 2,455  |  
|Inter-company revenues                    |  |     | 98     |     |   | 44     |     |  |   | 132          |   |  |   | 274    |  
|                                          |  |     |        |     |   |        |     |  |   |              |   |  |   |        |  
|Total segment revenues                    |  |     | 22,089 |     |   | 11,696 |     |  |   | 2,158        |   |  |   | 35,943 |  
|Elimination                               |  |     |        |     |   |        |     |  |   |              |   |  |   | (274   | )
|                                          |  |     |        |     |   |        |     |  |   |              |   |  |   |        |  
|Total Revenue                             |  |     |        |     |   |        |     |  |   |              |   |  | $ | 35,669 |  
|                                          |  |     |        |     |   |        |     |  |   |              |   |  |   |        |  
|Gross profit                              |  | $   | 6,550  |     | $ | (19    | )   |  | $ | (26          | ) |  | $ | 6,505  |  
|                                          |  |     |        |     |   |        |     |  |   |              |   |  |   |        |  
|Segment operating income (loss)           |  | $   | 3,244  |     | $ | (1,671 | )   |  | $ | (238         | ) |  | $ | 1,335  |  
|Interest expense                          |  |     |        |     |   |        |     |  |   |              |   |  |   | 219    |  
|Income taxes                              |  |     |        |     |   |        |     |  |   |              |   |  |   | 423    |  
|                                          |  |     |        |     |   |        |     |  |   |              |   |  |   |        |  
|Net income                                |  |     |        |     |   |        |     |  |   |              |   |  | $ | 693    |  
|                                          |  |     |        |     |   |        |     |  |   |              |   |  |   |        |  
|Assets                                    |  | $   | 60,391 |     | $ | 32,274 |     |  | $ | 6,671        |   |  | $ | 99,336 |  
|Depreciation/amortization                 |  |     | 508    |     |   | 195    |     |  |   | 55           |   |  |   | 758    |  
|Capital Additions                         |  |     | 947    |     |   | 1,508  |     |  |   | 46           |   |  |   | 2,501  |  



Due to the long-term
nature of much of the companys business, the depreciation and amortization amounts recorded in the Consolidated Statements of Income will not directly match the change in accumulated depreciation and amortization reflected on the
companys Consolidated Balance Sheets. This is a result of the capitalization of costs on long-term contracts into work-in-process.



The following tables reconcile the effect of this capitalization of costs for the three months ended March 31, 2004 and 2003:



|                                                                                                          |  |      |       |      |   |    
|--------------------------------------------------------------------------------------------------------- |  | ---- | ----- | ---- | - | ---
|Three Months Ended March 31                                                                               |  | 2004 |       | 2003
|Change in Accumulated Depreciation and Amortization Reflected on the Consolidated Statement of Cash Flows |  | $    | 915   |      | $ | 740
|Net Depreciation and Amortization (Capitalized Into) or Removed from Work-in-Process                      |  |      | 124   |      |   | 18 
|                                                                                                          |  |      |       |      |   |    
|Depreciation and Amortization Recorded in Cost of Goods Sold Upon Delivery of Aircraft                    |  | $    | 1,039 |      | $ | 758
|                                                                                                          |  |      |       |      |   |    



-14-



---

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



INTRODUCTION



The following discussion should be read in conjunction with the companys consolidated financial statements and notes thereto included
herein.



OVERVIEW



The company operates primarily in the aerospace and defense industry and its principal
business is providing aircraft maintenance and modification services to military and commercial customers. The company conducts its business through three operating segments: Government Services Segment (GSS), Commercial Services Segment
(CSS), and Manufacturing and Components Segment (MCS). The companys services are generally provided under traditional contracting agreements that include fixed-price, time and material, cost plus and variations of such
arrangements. The companys revenue and cash flows are derived primarily from services provided under these contracts, and cash flows include the receipt of milestone or progress payments under certain contracts.



RESULTS OF OPERATIONS



Three months ended March 31, 2004

Versus three months ended March 31, 2003



The table below
presents major highlights from the three months ended March 31, 2004 and 2003.



(In $Millions)



|                    |  |      |      |      |   |        |  |      |  
|------------------- |  | ---- | ---- | ---- | - | ------ |  | ---- | -
|                    |  | 2004 |      | 2003 |   | Change | 
|Revenue             |  | $    | 43.2 |      | $ | 35.7   |  | 21.0 | %
|Gross Profit        |  |      | 8.9  |      |   | 6.5    |  | 36.9 | %
|Operating income    |  |      | 1.9  |      |   | 1.3    |  | 46.2 | %
|Income before taxes |  |      | 1.7  |      |   | 1.1    |  | 54.5 | %
|Net income          |  |      | 1.0  |      |   | 0.7    |  | 42.9 | %
|EBITDA              |  |      | 2.9  |      |   | 2.1    |  | 38.1 | %



-15-



---

EBITDA for the quarters ended March 31, 2004 and 2003 was calculated using the following approach:



|                            |  |      |     |      |   |    
|--------------------------- |  | ---- | --- | ---- | - | ---
|                            |  | 2004 |     | 2003
|Net Income                  |  | $    | 1.0 |      | $ | 0.7
|Interest                    |  |      | 0.2 |      |   | 0.2
|Taxes                       |  |      | 0.7 |      |   | 0.4
|Depreciation & Amortization |  |      | 1.0 |      |   | 0.8
|                            |  |      |     |      |   |    
|EBITDA                      |  | $    | 2.9 |      | $ | 2.1
|                            |  |      |     |      |   |    



The company presents Earnings Before
Interest, Taxes, Depreciation and Amortization, more commonly referred to as EBITDA, because its management uses the measure to evaluate the companys performance and to allocate resources. In addition, EBITDA is used as one of the components
to calculate the companys debt covenants. The company believes EBITDA is also an important gauge used by commercial banks, investment banks, other financial institutions, and current and potential investors, to approximate its cash generation
capability. Accordingly, the company has included EBITDA as part of this report. The Depreciation and Amortization amounts used in the EBITDA calculation are those that were recorded in the Consolidated Statements of Operations in this report. Due
to the long-term nature of much of the companys business, the Depreciation and Amortization amounts recorded in the Consolidated Statements of Income will not directly match the change in Accumulated Depreciation and Amortization reflected on
the companys Consolidated Balance Sheets. This is a result of the capitalization of depreciation expense on long-term contracts into Work-in-Process. EBITDA is not a measure of financial performance under generally accepted accounting
principles and should not be considered as a substitute for or superior to other measures of financial performance reported in accordance with GAAP. EBITDA as presented herein may not be comparable to similarly titled measures reported by other
companies.



The table below presents the highlights in Revenue by Operating
Segment from the three months ended March 31, 2004 and 2003.



(In $Millions)



|             |  |      |   |  |      |   |  |        |   |  |          |   
|------------ |  | ---- | - |  | ---- | - |  | ------ | - |  | -------- | --
|             |  | 2004 |   |  | 2003 |   |  | Change |   |  | % Change |   
|GSS          |  | 29.6 |   |  | 22.1 |   |  | 7.5    |   |  | 33.9     | % 
|CSS          |  | 12.1 |   |  | 11.7 |   |  | 0.4    |   |  | 3.4      | % 
|MCS          |  | 1.8  |   |  | 2.2  |   |  | (0.4   | ) |  | (18.2    | %)
|Eliminations |  | (0.3 | ) |  | (0.3 | ) |  |       |   |  | 0.0      | % 
|             |  |      |   |  |      |   |  |        |   |  |          |   
|Total        |  | 43.2 |   |  | 35.7 |   |  | 7.5    |   |  | 21.0     | % 
|             |  |      |   |  |      |   |  |        |   |  |          |   



Without regard to operating segments,
the companys mix of business between government and commercial customers was approximately 29% commercial and 71% government in 2004 and 36% commercial and 64% government in 2003.



-16-



---

GSS revenue increased $7.5 million primarily as a result of an increase in sales under the KC-135 Programmed Depot
Maintenance (PDM) program of approximately $6.4 million and sales related to a new C-130 contract of approximately $0.8 million. During the first quarter of 2004, the GSS delivered seven PDM aircraft compared to five PDM deliveries
during the same period of 2003. In addition to increased PDM deliveries, the GSS performed more time and material based services under the KC-135 PDM program during the first quarter of 2004 versus the first quarter of 2003.



The increase in the CSS revenue of $0.4 million was attributable to an increase in commercial
Maintenance, Repair, and Overhaul (MRO) services to its largest customer of approximately $3.8 million, partially offset by a decrease in other MRO services of approximately $3.4 million. A significant portion of the other MRO services
performed during the first quarter of 2003 related to heavy maintenance on aircraft undergoing cargo conversions. There were no comparable sales during the first quarter of 2004.



Revenue in the MCS decreased $0.4 million in the first quarter of 2004 versus the first quarter of 2003 primarily as a result of the close
out of two government programs during 2003, partially offset by increased sales related to a flight terminations system program. Revenue related to sales of high precision machined parts and other aircraft components remained relatively flat during
the first quarter of 2004 compared to the first quarter of 2003.



Cost of sales
increased to $34.3 million during the first quarter of 2004 from $29.2 million in the first quarter of 2003, primarily as a result of the increase in revenue. Overall, the gross profit percentage of the company increased during this same period to
21.0% in 2004 from 18.2% in 2003. Gross profit at the GSS remained relatively constant at approximately 30%. Gross profit at the CSS improved to approximately 3.1% during the first quarter of 2004 from approximately 0.0% during the same period of
2003. Cost of sales at the CSS during the first quarter of 2003 included training and learning curve costs related to work begun on new types of aircraft. Such costs included a $0.9 million charge for estimated losses on contracts-in-process. There
were no comparable costs at the CSS during the first quarter of 2004.



Selling,
general and administrative (SG&A) expense increased to $7.0 million in the first quarter of 2004 from $5.2 million during the first quarter of 2003 as a result of several factors. The company recorded accounting and legal charges of
approximately $0.9 million during the first quarter of 2004 related to the 2003 financial statement audit and the restatement of the companys financial statements filed in connection with the first three quarters of 2003. In addition, the
company capitalizes certain SG&A costs allocable to the GSS into work-in-process. As a result of a general increase in SG&A expense over the last two fiscal years, coupled with the increase in sales at the GSS quarter over quarter, a greater
amount of SG&A expense was relieved from work-in-process during the first quarter of 2004 compared to the first quarter of 2003. The general increase in SG&A expense included continued investment in the companys Industrial Engineering
function in an effort to improve productivity, expanding marketing and business development capabilities across each segment, and increasing the internal audit function.



Interest expense held relatively constant at approximately $0.2 million during the first quarter of 2004 and 2003.



The company recorded income taxes at an effective rate of 38.5% and 38.0% during the first
quarter of 2004 and 2003, respectively.



-17-



---

LIQUIDITY AND CAPITAL RESOURCES



The table below presents the major indicators of financial condition and liquidity.



(In $Thousands Except Long Term Debt to Equity)



|                                             |  |               |        |                  |   |        |  |   |        |  
|-------------------------------------------- |  | ------------- | ------ | ---------------- | - | ------ |  | - | ------ | -
|                                             |  | March 31,2004 |        | December 31,2003 |   | Change | 
|Cash                                         |  | $             | 158    |                  | $ | 3,156  |  | $ | (2,998 | )
|Working Capital                              |  |               | 27,450 |                  |   | 28,093 |  |   | (643   | )
|Revolving credit facility                    |  |               | 14,567 |                  |   | 14,966 |  |   | (399   | )
|Long term debt and capital lease obligations |  |               | 5,072  |                  |   | 5,333  |  |   | (261   | )
|Shareholders equity                         |  |               | 24,034 |                  |   | 22,975 |  |   | 1,059  |  
|Long term debt to equity                     |  |               | 0.82   |                  |   | 0.88   |  |   | (0.06  | )



The companys primary sources of
liquidity and capital resources include cash flows from operations and borrowing capability through commercial lenders, including unused borrowing capacity on existing revolving credit agreements. Principal factors affecting the companys
liquidity and capital resources position include, but are not limited to, the following: results of operations; expansions and contractions in the industries in which the company operates; funding requirements associated with the companys
defined benefit pension plan; timing of federal income tax payments; transactions under the companys stock repurchase plan; and potential acquisitions and divestitures.



Operating activities used $1.5 million of cash during the three months ended March 31, 2004. Operating activities provided $0.8 million of
cash during the same period of 2003. Cash of $0.9 million and $2.4 million was used during the quarters ended March 31, 2004 and 2003, respectively, for capital expenditures.



At March 31, 2004 the company had additional borrowing capacity of $10.4 million under its Revolving Credit Facility.



The company maintains a defined benefit pension plan (the Plan) that covers
substantially all employees at its Birmingham and Dothan, Alabama facilities. The Plans assets consist of stocks, bonds and cash equivalents. These assets are exposed to various risks, such as interest rate, credit, and overall market
volatility. As a result of unfavorable investment returns related to the Plan in 2001 and 2002, partially offset by favorable returns in 2003, coupled with substantially lower interest rates, the Plan was under-funded by approximately $26.5 million
at December 31, 2003. Pursuant to ERISA funding requirements, the company expects to make contributions of approximately $8.6 million to the Plan during 2004, of which the company has made contributions of approximately $1.7 million through March
31, 2004.



In January 2003, the company began projects to improve its
information system infrastructure. These projects included an upgrade to its enterprise software at GSS and a conversion to the



-18-



---

enterprise software and upgrades to hardware at the CSS, altogether expected to cost approximately $1.5 million. The
company anticipates costs to complete these projects during 2004 to be approximately $0.9 million. The company currently has no other material capital projects underway.



Funding for the advancement of the companys strategic goals, including possible investments in targeted business areas and
acquisitions, is expected to continue. The company plans to finance its capital expenditures, working capital and liquidity requirements through the most advantageous sources of capital available to the company at the time, which may include the
sale of equity or debt securities through public offerings or private placements, the incurrence of additional indebtedness through secured or unsecured borrowings and the reinvestment of proceeds from the disposition of assets. The company believes
that its internally generated liquidity, together with access to external capital resources, will be sufficient to satisfy existing commitments and plans for at least the next twelve months. The company could elect, or could be required, to raise
additional funds during that period, and the company may need to raise additional capital in the future. Additional capital may not be available at all, or may not be available on terms favorable to the company. Any additional issuance of equity or
equity-linked securities may result in substantial dilution to the companys stockholders. The company is continually monitoring and reevaluating its level of investment in all of its operations, as well as the financing sources available to
achieve its goals in each business area.



The aircraft services industry has
been in a consolidation phase generally. As a consequence, the company receives and sometimes initiates inquiries with respect to corporate combinations. The company has not completed any such combinations for a number of years, and there is no
assurance that it will be party to such transactions in the future.



TRADING
ACTIVITIES



The company has not engaged in trading activities or in
trading non-exchange traded contracts. As of March 31, 2004 and 2003, the carrying amounts of the companys financial instruments were estimated to approximate their fair values, due to their short-term nature, and variable or market interest
rates. The company has not hedged its interest rate or foreign exchange risks through the use of derivative financial instruments. See Quantitative and Qualitative Disclosures about Market Risk included in Item 3 of this Report.



RELATED PARTY TRANSACTIONS



The company had an accrual of approximately $0.1 million at March 31, 2003 related to a
consulting agreement with its former Chairman of the Board, Chief Executive Officer and major stockholder. In accordance with the agreement, the amounts were paid over a 6-month period that began December 2002.



On April 23, 2002, the company loaned its current President and Chief Executive Officer
approximately $0.4 million under the terms of a Promissory Note. The Promissory Note carries a fixed interest rate of 5% per annum and is payable within 60 days of the President and Chief Executive Officers termination of employment with the
company. Any change in this related party receivable relates to interest accumulated during the period.



-19-



---

CRITICAL ACCOUNTING POLICIES AND ESTIMATES



The companys significant accounting policies are disclosed in Note 1 of Notes to Consolidated Financial Statements in the
companys 2003 Annual Report on Form 10-K. The preparation of financial statements in conformity with generally accepted accounting principles requires that management use judgments to make estimates and assumptions that affect the amounts
reported in the financial statements. As a result, there is some risk that reported financial results could have been materially different had different methods, assumptions, and estimates been used.



The company believes that of its significant accounting policies, the following may involve a
higher degree of judgment and complexity as used in the preparation of its consolidated financial statements.



Revenue Recognition



Revenue at the
companys GSS and CSS is derived principally under contracts using the percentage-of-completion method as prescribed by Statement of Position 81-1 (SOP 81-1) Accounting for Performance of Construction-Type and Certain Production-Type
Contracts. The nature of the contract and the types of products and services provided are considered when determining the appropriate accounting for a particular contract. The companys contracts at the GSS and CSS generally have fixed
price elements, time-and-material elements, or commonly both. The GSS generally segments the basic and fixed price elements and the time-and-material elements for purposes of accumulating costs and recognizing revenue. For basic and fixed price
elements of a contract, the GSS uses the units-of-delivery method as the basis to measure progress toward completion, with revenue recorded based upon the unit sales value stated in the contract and costs of sales recorded based upon actual unit
cost. Each aircraft is considered a unit for purposes of recognizing revenue. For time-and-material elements of a contract, the GSS uses an output measure based upon units of work performed to measure progress toward completion, with revenue
recorded based upon the stated hourly rates in the contract and costs of sales recorded based upon estimated average costs. The company considers each hour chargeable to the customer as a unit of work performed. Revenue and costs of sales for
time-and-material elements are recognized upon completion of all performance obligations in accordance with the contract and acceptance by the customer. The CSS recognizes revenue and associated costs for both fixed price and time-and-material
elements using units-of-delivery as the basis to measure progress toward completion, and revenue is recorded based upon the unit sales value stated in the contract and costs of sales are recorded based upon actual unit cost.



The companys MCS derives a significant portion of its revenue from cost-reimbursement
type contracts and from sales of precision parts and components. Revenue on cost-reimbursable contracts is recognized to the extent of costs incurred plus a proportionate amount of estimated fee earned. For certain other fixed-price contracts
revenue is recognized when performance milestones have been achieved in accordance with contract terms. Revenue related to sales of individual components and parts is recognized upon delivery to the customer, and when the product price is fixed and
determinable and collection of the resulting receivable is reasonably assured.



-20-



---

Contract accounting requires judgment relative to assessing risks and estimating contract revenues and costs. The company
employs various techniques to project contract revenue and costs which inherently include significant assumptions and estimates. Contract revenues are a function of the terms of the contract and often bear a relationship to contract costs. Contract
costs include labor, material, an allocation of indirect costs, and in the case of certain government contracts, an allocation of general and administrative costs. Techniques for estimating contract costs generally impact the companys proposal
processes, including the determination of pricing for fixed price and time-and-material elements of contracts, the evaluation of profitability on contracts, and the timing and amounts recognized for revenue and cost of sales. In addition, the
company provides for losses on uncompleted contracts in the period in which management determines that the estimated total costs under the contract will exceed the estimated total contract revenues. These estimates are reviewed periodically and any
revisions to accrued losses on contracts-in-process are charged or credited to operations in the period in which the change is determined. Further, an amount equal to contract costs attributable to claims is included in revenues when realization is
probable and the amount can be reasonably estimated. Judgment is required in determining the potential realization of claim revenue and estimating the amounts recoverable. Because of the significance of the judgments and estimates required in these
processes, it is likely that materially different amounts could result from the use of different assumptions or if the underlying conditions were to change. In addition, contracts accounted for under the percentage-of-completion, units-of-delivery
method may result in material fluctuations in revenue and profit margins depending on the timing of delivery and acceptance, the relative proportion of fixed price, time-and-material, and other types of contracts-in-process, and costs incurred in
their performance.



Deferred Taxes



The company records a valuation allowance to reduce its deferred tax assets to the amount
that is more likely than not to be realized. While the company has considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event the company were to
determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should the
company determine that it would not be able to realize all or part of its net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.



Inventories



The company regularly estimates the degree of technological obsolescence in its inventories and provides inventory reserves on that basis.
Though the company believes it has adequately provided for any such declines in inventory value to date, any unanticipated change in technology or potential decertification due to failure to meet design specification could significantly affect the
value of the companys inventories and thereby adversely affect gross margins and results of operations. In addition, an inability of the company to accurately forecast its inventory needs related to its warranty and maintenance obligations
could adversely affect gross margin and results of operations.



-21-



---

Pensions



The company maintains pension plans covering a majority of its employees and retirees, and postretirement benefit plans for retirees that include health care benefits and
life insurance coverage. For financial reporting purposes, net periodic pension and other postretirement benefit costs (income) are calculated based upon a number of actuarial assumptions including a discount rate for plan obligations, assumed rate
of return on pension plan assets, assumed annual rate of compensation increase for plan employees, and an annual rate of increase in the per capita costs of covered postretirement healthcare benefits. Each of these assumptions is based upon the
companys judgment, considering all known trends and uncertainties. Actual asset returns for the company pension plans significantly below the companys assumed rate of return would result in lower net periodic pension income (or higher
expense) in future years. Actual annual rates of increase in the per capita costs of covered postretirement healthcare benefits above assumed rates of increase would result in higher net periodic postretirement benefit costs in future years.



Contingencies



The company has been involved, and may continue to be involved, in various legal proceedings
arising out of the conduct of its business including litigation with customers, employment related lawsuits, purported class actions, and actions brought by governmental authorities. The company has, and will continue to, vigorously defend itself
and to assert available defenses with respect to these matters. Where necessary, the company has accrued an estimate of the probable cost of resolutions of these proceedings based upon consultation with outside counsel and assuming various
strategies. However, a settlement or an adverse resolution of one or more of these matters may result in the payment of significant costs and damages that could have a material adverse effect on the companys financial position or results of
operations.



BACKLOG



The following table presents the companys backlog (in thousands of dollars) at March
31, 2004 and March 31, 2003:



|                |  |      |        |      |   |        
|--------------- |  | ---- | ------ | ---- | - | -------
|Customer Type   |  | 2004 |        | 2003
|U.S. Government |  | $    | 76,503 |      | $ | 98,722 
|Commercial      |  |      | 17,018 |      |   | 19,934 
|                |  |      |        |      |   |        
|Total           |  | $    | 93,521 |      | $ | 118,656
|                |  |      |        |      |   |        



The reduction in government backlog
was related to decreases in both the Government GSS and MCS. The GSS decreased backlog approximately $21.1 million year-over-year due primarily to lower KC-135 aircraft in work. At March 31, 2003, there were 30 KC-135s in backlog versus 26 at
March 31, 2004. Backlog in government programs at the MCS decreased $0.9 million during this same period due to the unit nearing the completion of one of its existing contracts.



Total commercial backlog decreased $2.9 million. Backlog at the CSS decreased $2.9 million while backlog in commercial programs at the MCS
remained unchanged when compared with the



-22-



---

prior year. The decrease in backlog at the CSS is due primarily to sales of aircraft near the end of the quarter from one
of its major customers. In addition, 2003 backlog included several cargo conversions which had incurred hours but had not been sold.



Overall the mix of backlog shifted towards commercial during the two periods moving from 83.2% government and 16.8% commercial for the three months ended March 31, 2003
to 81.8% government and 18.2% commercial for the three months ended March 31, 2004. This shift in mix is primarily a result of the large decrease in the government backlog noted above.



The company includes sub-contracts for government work in its U.S. Government backlog category.



CONTINGENCIES



See Note 8 to the Consolidated Financial Statements.



The Companys Forward-Looking Statements May Prove to be Wrong.



Some of the information under the caption Managements Discussion and Analysis of Financial Condition and Results of
Operations and elsewhere in this Quarterly Report contains forward-looking statements. These forward-looking statements include, but are not limited to, statements about the companys plans, objectives, expectations and intentions, award
or loss of contracts, the outcome of pending or future litigation, estimates of backlog and other statements contained in this Quarterly Report that are not historical facts. When used in this Quarterly Report, the words expects,
anticipates, intends, plans, believes, seeks, estimates and similar expressions are generally intended to identify forward-looking statements. Because these forward-looking
statements involve risks and uncertainties, there are important factors, including the factors discussed under the caption Factors That May Affect Future Performance in the companys 2003 Annual Report on Form 10-K, that could cause
actual results to differ materially from those expressed or implied by these forward-looking statements. The company cautions readers not to place undue reliance on any forwardlooking statements, which speak only as of the date on which they
are made. The company does not undertake any obligation to update or revise any forward-looking statements.



Item 3. Quantitative and Qualitative Disclosures about Market Risk



The company is exposed to market risk from changes in interest rates as part of its normal operations. The company maintains various debt instruments to finance its business operations. The debt consists of fixed and
variable rate debt. The variable rate debt is related to the companys Credit Agreement, which includes a revolving credit facility and one term loan, and another term loan, all as described in Note 5 to the Consolidated Financial Statements.
The Credit Agreements revolving credit facility and term loan bear interest at LIBOR plus 250 basis points and LIBOR plus 275 basis points, respectively, and the other term loan bears interest at BMA plus 36 basis points. These interest rates
were 3.62%, 3.87%, and 1.27%, respectively at March 31, 2004. Had the rate of the variable rate debt increased 100 basis points, net income would have been reduced by approximately $50,000 during the quarter.



-23-



---

Item 4. Controls and Procedures



(a) Evaluation of disclosure controls and procedures. The company maintains disclosure controls and procedures designed to provide
reasonable assurance of achieving the objective that information in its Exchange Act reports is recorded, processed, summarized and reported within the time periods specified and pursuant to the requirements of the Securities and Exchange
Commissions rules and forms. Disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, include controls and procedures designed to ensure that information required to be disclosed by the company in
the reports it files or submits under the Exchange Act is accumulated and communicated to the companys management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure. It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met.



Management carried out an evaluation, with the participation of the companys Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the companys disclosure controls and procedures as of March 31, 2004, the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, the
companys Chief Executive Officer and Chief Financial Officer concluded that the companys disclosure controls and procedures were effective at the reasonable assurance level as of March 31, 2004.



(b) Changes in internal control over financial reporting. During the period covered by
this Quarterly Report on Form 10-Q, the company implemented remedial measures to address a material weakness in internal control over financial reporting identified by the companys independent auditors in connection with their audit of the
companys financial statements for the fiscal year ended December 31, 2003. Management believes these measures materially improved the companys internal control over financial reporting during the quarter. Actions taken included
re-evaluating and adding staff and level of expertise, increasing training of corporate and accounting staff to heighten awareness of generally accepted accounting principles, establishing policies and procedures designed to enhance coordination and
reporting procedures between management and the companys accounting staff, centralizing review and monitoring of accounting issues, and allocating senior accounting personnel to provide additional on-site supervision of accounting functions.
The company believes the measures it has taken and additional measures it continues to implement are reasonably likely to have a material, positive impact on its internal control over financial reporting in future periods.



-24-



---

PART II OTHER INFORMATION



Item 1. Legal Proceedings



See Note 8 to the Consolidated Financial Statements.



Item 6. Exhibits and Reports on Form 8-K.



| | a. | Exhibits
| | -- | --------



| |  |    |  |                                                                                                                         
| |  | -- |  | ------------------------------------------------------------------------------------------------------------------------
| |  |   
| |  | 31 |  | Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                               
| |  |   
| |  | 32 |  | Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
| |  |   
| |  |    |  |                                                                                                                         



| | b. | Reports on Form 8-K
| | -- | -------------------



The company filed no reports on Form 8-K during the quarter ended March 31, 2004.



-25-



---

SIGNATURES



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



|       |  |              |  |  |  |     |  |                                         
|------ |  | ------------ |  |  |  | --- |  | ----------------------------------------
|       |  |              |  |  |  |     |  | PEMCO AVIATION GROUP, INC.              
|       |  |              |  | 
|Dated: |  | May 13, 2004 |  |  |  | By: |  | /s/    Ronald A. Aramini                
|       |  |              |  |  |  |     |  | Ronald A. Aramini, President            
|       |  |              |  |  |  |     |  | and Chief Executive Officer             
|       |  |              |  |  |  |     |  | (Principal Executive Officer)           
|       |  |              |  | 
|Dated: |  | May 13, 2004 |  |  |  | By: |  | /s/    John R. Lee                      
|       |  |              |  |  |  |     |  | John R. Lee, Sr. Vice President and     
|       |  |              |  |  |  |     |  | Chief Financial Officer                 
|       |  |              |  |  |  |     |  | (Principal Finance & Accounting Officer)



-S1-