SECURITIES AND EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q





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





For the Quarterly Period Ended June 30, 2002, 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 (State or other
jurisdiction ofincorporation or organization)

84-0985295 (I.R.S.
Employer Identification No.)





1943 North 50th Street, Birmingham, Alabama (Address of principal executive offices)

35212 (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 the number of shares outstanding of each of the registrants classes of common stock, as of the latest
practicable date.





Class

Outstanding at August 8, 2002Common Stock, $.0001 par value

4,128,792






---




PART I.    FINANCIAL INFORMATION





Item 1.  Financial Statements





PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES





CONSOLIDATED BALANCE SHEETS





ASSETS


(In Thousands)





June 30, 2002
Unaudited


December 31, 2001Current assets:Cash

$
721


$
927Accounts receivable, net


28,523



18,481Inventories, net


12,986



18,669Deferred income taxes


5,146



7,994Prepaid expenses and other


1,832



923Total current assets


49,208



46,994Machinery, equipment, and improvements at cost:Machinery and equipment


27,652



26,547Leasehold improvements


21,992



20,642Construction in process


2,807



94452,451



48,133Less accumulated depreciation and amortization


(28,491
)


(26,180
)Net machinery, equipment, and improvements


23,960



21,953Other non-current assets:Deposits and other


1,373



347Intangible assets, net


6,788



6,8828,161



7,229Total assets

$
81,329


$
76,176





The accompanying notes are an integral part of these consolidated balance
sheets.




1




---




PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES





CONSOLIDATED BALANCE SHEETS





LIABILITIES AND STOCKHOLDERS EQUITY


(In Thousands, except common share information)





June 30, 2002
Unaudited


December 31, 2001Current liabilities:Revolving credit facility

$
11,386


$
11,591Current portion of long-term debt


1,807



2,244Accounts payable


2,208



1,578Accrued liabilitiespayroll related


10,351



10,257Accrued liabilitiesother


17,398



11,596Total current liabilities


43,150



37,266Long-term debt


3,799



3,994Long-term pension benefit liability


14,269



13,523Other long-term liabilities


1,726



2,044Total liabilities


62,944



56,827Stockholders equity:Preferred Stock, $0.0001 par value, 5,000,000 shares authorized, none outstanding


0



0Common stock, $.0001 par value, 12,000,000 shares authorized, 4,110,729 and 4,043,273 issued at June 30, 2002 and
December 31, 2001, respectively


1



1Additional paid-in capital


6,015



5,223Retained earnings


24,613



19,679Treasury stock, at cost348,899 and 7,500 shares at June 30, 2002 and December 31, 2001, respectively


(6,788
)


(98
)Accumulated other comprehensive loss


(5,456
)


(5,456
)Total stockholders equity


18,385



19,349Total liabilities and stockholders equity

$
81,329


$
76,176





The accompanying notes are an integral part of these consolidated
balance sheets.




2




---

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES





UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS


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





Three Months Ended June 30, 2002


Three Months Ended June 30, 2001Net sales

$
41,922


$
42,235Cost of sales


32,692



32,120Gross profit


9,230



10,115Selling, general, and administrative expenses


5,678



5,649Income from operations


3,552



4,466Interest


230



499Litigation, net


(1,480
)


0Income before income taxes


4,802



3,967Provision for income taxes


1,825



444Net income

$
2,977


$
3,523Net income per common share:Basic

$
0.73


$
0.87Diluted

$
0.64


$
0.84Weighted average common shares outstanding:Basic


4,083



4,028Diluted


4,626



4,181





The accompanying notes are an integral part of these consolidated
statements.




3




---

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES





UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS


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





Six Months Ended June 30, 2002


Six Months Ended June 30, 2001Net sales

$
77,967


$
85,790Cost of sales


60,379



66,711Gross profit


17,588



19,079Selling, general, and administrative expenses


10,573



11,060Income from operations


7,015



8,019Interest


535



1,037Litigation, net


(1,480
)


0Income before income taxes


7,960



6,982Provision for income taxes


3,025



1,653Net income

$
4,935


$
5,329Net income per common share:Basic

$
1.21


$
1.32Diluted

$
1.09


$
1.27Weighted average common shares outstanding:Basic


4,075



4,028Diluted


4,531



4,192





The accompanying notes are an integral part of these consolidated
statements.




4




---

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES





UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS


(In Thousands)





Six Months Ended June 30, 2002


Six Months Ended June 30, 2001Cash flows from operating activities:Net income

$
4,935


$
5,329Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization


2,311



1,853Provision for deferred income taxes


2,848



1,653Pension cost in excess of funding


746



693Amortization of intangible asset


93



94Changes in assets and liabilities:Accounts receivable, net


(10,042
)


(2,620
)Inventories


5,683



(3,738
)Prepaid expenses and other


(909
)


(700
)Deposits and other


(1,025
)


(30
)Accounts payable and accrued liabilities


6,104



1,762Total adjustments


5,809



(1,033
)Net cash provided by operating activities


10,744



4,296Cash flows from investing activities:Capital expenditures


(4,318
)


(3,470
)Net cash used in investing activities


(4,318
)


(3,470
)Cash flows from financing activities:Proceeds from exercise of stock options


792



0Purchase of treasury stock


(6,691
)


0Net change under revolving credit facility


(205
)


(266
)Borrowings under long-term debt


613



2,688Principal payments under subordinated debt


0



(2,460
)Principal payments under long-term debt


(1,141
)


(771
)Net cash used in financing activities


(6,632
)


(809
)Net increase/(decrease) in cash


(206
)


17Cash, beginning of period


927



1,441Cash, end of period

$
721


$
1,458Supplemental disclosure of cash flow information:Cash paid during the period for:Interest

$
451


$
953





The accompanying notes are an integral part of these consolidated
statements




5




---

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





As of and for the Quarters Ended


June 30, 2002 and 2001





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 June 30, 2002 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 2001 Annual Report on Form 10-K.





2.  INVENTORIES





Inventories as of June 30, 2002 and December 31, 2001 consist of the following:





June 30, 2002


December 31, 2001(In Thousands)Work in process

$
28,001


$
25,795Finished goods


1,398



2,074Raw materials and supplies


2,861



2,438Total


32,260



30,307Less progress payments and customer deposits


(19,274
)


(11,638
)$
12,986


$
18,669





A portion of the above inventory balances relates to U.S.
Government contracts. The company receives progress payments on the majority of its government contracts. The title to all inventories on which the company receives these payments is vested in the government to the extent of the progress payment
balance.




6




---




3.  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.





The following table represents the net
income per share calculations for the three-month and six-month periods ended June 30, 2002 and 2001:





Three Months
Ended June 30 2002

Three Months
Ended June 30 2001

Six Months
Ended June 30 2002

Six Months
Ended June 30 2001(All numbers In Thousands, except Income Per Share)Net Income

$
2,977

$
3,523

$
4,935

$
5,329Weighted Average Shares


4,083


4,028


4,075


4,028Basic Net Income Per Share

$
0.73

$
0.87

$
1.21

$
1.32Dilutive Securities: Options


543


153


456


164Diluted Weighted Average Shares


4,626


4,181


4,531


4,192Diluted Net Income Per Share

$
0.64

$
0.84

$
1.09

$
1.27





Options to purchase approximately 0 and 353,000 shares of common
stock related to June 30, 2002 and 2001, 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.




7




---




4.  DEBT





Debt as of June 30, 2002 and December 31, 2001 consists of the following:





June 30, 2002

December 31, 2001(In Thousands)Revolving credit facility; interest at Prime plus 0.50% (5.25% at June 30, 2002)

$
11,386

$
11,591Term Loan A; interest at Prime plus 0.50% (5.25% at June 30, 2002)


2,900


2,900Term Loan B; interest at Prime plus 0.75% (5.50% at June 30, 2002)


350


875Capital Equipment Acquisition Facility;interest at Prime plus 0.50% (5.25% at June 30, 2002)


1,283


749Term Loan C; interest at Prime plus 0.75% (5.50% at June 30, 2002)


793


1,266Other obligations: interest from 8.75% to 10.95%,collateralized by security interest in certain
equipment


280


448Total long-term debt


5,606


6,238Less portion reflected as current


1,807


2,244Long term-debt, net of current portion

$
3,799

$
3,994





The company maintains a $20.0 million revolving credit facility,
three term loans that were originated at $6.9 million in the aggregate, and a capital equipment acquisition facility of $3.1 million. Additional amounts available under the revolving credit facility at June 30, 2002, based upon the calculation that
defines the borrowing base, totaled $8.4 million. Under the capital equipment facility, borrowing availability is tied to a percentage of the value of certain capital assets acquired since January 1, 2001 and capital assets that are acquired in
future periods. At June 30, 2002, the company had approximately $1.4 million of additional borrowing capacity under the capital equipment facility.







8




---




The above loans are collateralized by substantially all of the assets of the
company and have various covenants that 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. The company was in compliance with its debt covenants as of June 30, 2002.





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 be used to secure additional financing.





5.  STOCKHOLDERS
EQUITY





Holders of Stock Options under the companys Non-Qualified Stock Option Plan exercised options
for 14,850 shares of the companys common stock during the three months ended June 30, 2002. The company recorded both the exercise price and a tax benefit totaling approximately $0.1 million to Additional Paid In Capital during the second
quarter of 2002. During the six months ended June 30, 2002 holders of Stock Options under the companys Non-Qualified Stock Option Plan, exercised options for approximately 70 thousand shares of the companys common stock, adding with its
associated tax benefit, approximately $0.9 million to Additional Paid In Capital. No holders of Stock Options under the companys Non-Qualified Stock Option Plan, exercised options during the six months ending June 30, 2001.





6.  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 materially adverse effect on the companys consolidated results of operations, financial position, or cash flows.





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 59% and 61% of the companys total revenues for the six-month period ended June 30, 2002 and 2001, respectively. The companys two
largest programs generated approximately 87% of its revenues during this same period of 2002 and 76% in 2001. 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




9




---




contracts when they expire, could materially harm the companys business and impair the value of
its common stock.





Litigation





Hayes International Lawsuit





The companys Pemco Aeroplex subsidiary, successor to
Hayes International, is a defendant in several suits seeking damages and indemnity for claims arising from an Airworthiness Directive issued by the Federal Aviation Administration (FAA). That Directive restricts the cargo capacity of
Boeing 747 aircraft converted pursuant to a Supplemental Type Certificate (STC) for such conversions. Hayes International had performed engineering for the development of the STC during the mid to late 1980s. Certain of the suits also
allege fraud, misrepresentation and violations of the Racketeer Influenced and Corrupt Organization Act. Following several settlements, the only remaining claim was for indemnity on one aircraft operated by Tower Air. The court issued judgment on
the pleadings in favor of the company on March 27, 2002.





Breach of Contract Lawsuits





On October 6, 2000, the companys subsidiary, Pemco Aeroplex, filed suit against Certex of Alabama, an unincorporated division of
Bridon American Corporation, for breach of contract and fraud with regard to the supply of deficient wire rope that was installed as aircraft flight control cables on KC-135 aircraft. The case, filed in the circuit court of Jefferson County,
Alabama, was brought to trial on September 20, 2001 and a jury returned with a verdict in favor of the company in the amount of $7.5 million. The Court, upon a post-judgment motion filed by Certex, reduced the judgment to $2.5 million. Certex
appealed that Order to the Supreme Court of Alabama and subsequently dismissed the appeal upon the companys agreement on April 11, 2002 to accept $2.2 million in settlement.





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 737 aircraft
to Quick Change configuration by the company was defective, limiting the commercial use of the aircraft. The case was ordered to arbitration by the court and sent back to the District Court in 2001 when settlement was not reached. The District court
denied the companys Motion for Reinstatement. The company has filed for a stay of proceedings to resolve certain matters filed before the 11th Circuit Court of Appeals on October 31, 2001, specifically, the issue of whether arbitration is
required where the contract calls for alternative dispute resolution. The STC Amendment, which is the subject of this case, has now been received from the FAA, which should substantially diminish the value of Falcons claim.
Management believes that the results of this lawsuit will not have a material impact on the business of the company.




10




---




Employment Lawsuits





On December 9, 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. Plaintiffs motion for a new trial has been denied. The company has taken effective remedial and corrective action, acted promptly in respect to any specific complaint by any
employee, and will vigorously defend this case.





A purported class action, brought against the company and its
Pemco Aeroplex subsidiary on behalf of those persons hired as replacement workers during the strike by Pemcos UAW union employees, and who were terminated upon settlement of such strike, was dismissed in the third quarter of 1999. Twenty-eight
individuals filed a new action shortly thereafter, in the Circuit Court of Jefferson County, Alabama, which has since been joined by approximately 90 other individuals. The company filed for summary judgment on all claims on February 20, 2000.
Summary judgment was granted with regard to 35 of those individuals. The Court required two individual cases to be tried prior to certification of any issues for appeal. These two cases were tried in June of 2001. The Court directed a verdict on the
companys behalf in one case and a jury returned with a defense verdict in favor of the company in the other case. The company accepted an offer of settlement proposed by the remaining plaintiffs of approximately $0.4 million (or approximately
$4,000 per Plaintiff) and the court has approved that settlement.





Various claims alleging employment
discrimination, including race, sex, age and disability, 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 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. The results of which are not expected to be material to the companys financial condition and results of
operations.




11




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7.  SEGMENT INFORMATION





The company has three reportable segments: Government Services Group, Commercial Services Group, and Manufacturing and Component Group. The Government Services Group,
located in Birmingham, Alabama, provides aircraft maintenance and modification services for government and military customers. The Commercial Services Group, located in Dothan, 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 Manufacturing and Component Group, 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 2001 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, interest income and interest expense 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 Commercial Services and Manufacturing and
Component segments may generate revenues from governmental entities and the Government Services segment may generate revenues from commercial entities. Sales to Governmental entities in the three-months ended June 30, 2002 and 2001 were $27.5
million, and $28.8 million, respectively. Sales to Governmental entities for the six-months ended June 30, 2002 and 2001 were $51.9 million, and $57.1 million, respectively.




12




---

The following table presents information about segment profit or loss for the three months ended June 30, 2002 and 2001:





Government

Commercial


Manufacturing & Component

Consolidated(In Thousands)Three Months Ended June 30, 2002Revenues from external domestic customers

25,469

13,083


3,026

41,578Revenues from external foreign customers

0

216


128

344Inter-segment revenues

1

0


76

77Total segment revenues

25,470

13,299


3,230

41,999Elimination








(77
)Total Revenue








41,922Gross profit

7,807

933


490

9,230Segment operating income (loss)

4,356

(927
)

123

3,552Interest expense








230Litigation, net








(1,480
)Income taxes








1,825Net income








2,977Assets

48,384

24,749


8,196

81,329Depreciation/amortization

485

153


59

697Capital Additions

557

1,484


5

2,046





Government

Commercial


Manufacturing &
Component


ConsolidatedThree Months Ended June 30, 2001Revenues from external domestic customers

25,716

12,535


3,344


41,595Revenues from external foreign customers

0

0


640


640Inter-segment revenues

74

0


0


74Total segment revenues

25,790

12,535


3,984


42,309Elimination









(74
)Total Revenue









42,235Gross profit

7,166

2,097


852


10,115Segment operating income (loss)

5,228

(189
)

(573
)

4,466Interest expense









499Income taxes









444Net income









3,523Assets

39,970

16,915


9,924


66,809Depreciation/amortization

441

95


71


607Capital Additions

612

548


48


1,208




13




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The following table presents information about segment profit or loss for the six months ended June 30, 2002 and 2001:





Government

Commercial


Manufacturing& Component

Consolidated(In Thousands)Six Months Ended June 30, 2002Revenues from external domestic customers

47,689

23,361


6,303

77,353Revenues from external foreign customers

0

301


313

614Inter-segment revenues

1

0


76

77Total segment revenues

47,690

23,662


6,692

78,044Elimination








(77
)Total Revenue








77,967Gross profit

14,869

1,531


1,188

17,588Segment operating income (loss)

8,451

(1,922
)

486

7,015Interest expense








535Litigation, net








(1,480
)Income taxes








3,025Net income








4,935Assets

48,384

24,749


8,196

81,329Depreciation/amortization

1,078

344


154

1,576Capital Additions

1,665

2,648


5

4,318





Government

Commercial


Manufacturing & Component


ConsolidatedSix Months Ended June 30, 2001Revenues from external domestic customers

53,542

22,743


6,077


82,362Revenues from external foreign customers

0

2,228


1,200


3,428Inter-segment revenues

144

0


0


144Total segment revenues

53,686

24,971


7,277


85,934Elimination









(144
)Total Revenue









85,790Gross profit

13,584

3,204


2,291


19,079Segment operating income (loss)

9,307

(1,165
)

(123
)

8,019Interest expense









1,037Income taxes









1,653Net income









5,329Assets

39,970

16,915


9,924


66,809Depreciation/amortization

951

201


138


1,290Capital Additions

2,485

920


65


3,470




14




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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.





Three months ended June 30, 2002


Versus three months ended June 30, 2001





The table below presents major highlights from the quarters ended June 30, 2002 and 2001.





2001

2002

Change(In Millions)Revenue

$
42.2

$
41.9

(0.7
%)Gross Profit


10.1


9.2

(8.9
%)Operating income


4.5


3.6

(20.0
%)Income before taxes


4.0


4.8

20.0
%Net income


3.5


3.0

(14.3
%)EBITDA


5.3


5.9

11.3
%





Sales in the Government Services Group decreased $0.3 million
during the second quarter of 2002, or 1.2%, from $25.8 million in 2001 to $25.5 million in 2002. This decrease was essentially a timing issue. During the second quarter of 2001 the company delivered nine aircraft under the KC-135 Program Depot
Maintenance Contract, whereas in the second quarter of 2002 the company delivered eight KC-135 Program Depot Maintenance aircraft and two JSTAR aircraft.





Sales in the Commercial Services Group increased by $0.8 million, or approximately 6.4%, during the second quarter of 2002, from $12.5 million in 2001 to $13.3 million in 2002. Sales of aircraft
serviced under Maintenance Repair and Component contracts increased $1.5 million. The company completed work on the H-3 helicopter contract in 2001. During the second quarter of 2001 the company had sales of $0.7 million under this contract.





Revenues in the Manufacturing & Component Group decreased by $0.8 million, approximately 20.0%, during the
second quarter of 2002, from $4.0 million in 2001 to $3.2 million in 2002. This decrease is due to the Pemco Engineers subsidiary that had $1.2 million less revenue, 51.4%, in the second quarter of 2002 versus the same quarter of 2001. This revenue
decrease was offset partially by higher quarter-to-quarter revenue, $0.4 million, in the Space Vector subsidiary. The decrease in Pemco Engineers revenue is a result of a downturn in conversion of aircraft for which the unit produces cargo-handling
systems combined with a decrease in sales of replacement parts for cargo-handling systems on aircraft in service.





Without regard to operating segments, the companys mix of business between government and commercial customers shifted from 32.7% commercial and 67.3% government during the second




15




---




quarter of 2001 to 34.4% commercial and 65.6% government during the same period in 2002.





Cost of sales increased during the second quarter from $32.1 million in 2001 to $32.7 million in 2002, primarily as a result of
the company replacing relatively high margin sales at the Pemco Engineers subsidiary with relatively lower margin business at other subsidiaries. Overall, the gross profit percentage of the company decreased from 24.0% in the second quarter of 2001
to 22.0% in the second quarter of 2002.





Selling, general, and administrative (SG&A) expenses
increased slightly, $0.1 million, between the second quarter of 2001, $5.6 million, and the second quarter of 2002, $5.7 million. During the second quarter of 2002 the company spent approximately $0.8 million in legal expenses versus $0.4 million
during the second quarter of 2001. These legal expenses were primarily related to the cases in the table labeled Litigation, net shown below.





Interest expense decreased from $0.5 million during the second quarter of 2001 to $0.2 million during the same period in 2002. The effective average interest rate on the companys revolving credit
facility was approximately 7.33% in 2001 and 5.25% in 2002. In addition to lower interest rates on the companys revolving credit facility year-over-year, the company also reduced its average debt outstanding during the quarter ended June 30,
2002 compared to the quarter ended June 30, 2001.





Earnings Before Interest, Taxes, Depreciation and Amortization
(EBITDA) was approximately $5.9 million for the three months ended June 30, 2002 compared to $5.3 million for the three months ended June 30, 2001.





In the three-month period ended June 30, 2001, the company recorded an income tax credit because of favorable tax benefits generated from an adjustment to its deferred tax valuation allowance, whereas
in the three months ended June 30, 2002, the company recorded an income tax provision on a normalized basis. The effective tax provisions for these two periods were 11% and 38% respectively.





During the second quarter of 2002 the company agreed to settlements on several outstanding legal actions (See Note 6 to the Consolidated Financial Statements). These
settlements are reflected on the Consolidated Statements of Operations as Litigation, net and are composed of the following cases.





Case

AmountLitigation, net In ThousandsNet Award on Product Liability

$
1,960Settlement on Replacement Workers


(388
)Settlement on Alleged Discrimination


(92
)Litigation, net

$
1,480





The large increase in Accounts Receivable between December 31, 2001
and June 30, 2002, reflected on the companys Consolidated Statement of Cash Flows is attributable primarily to the Government




16




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services segment and is due to the combination of systems problems on the companys account with the government payment office and various
issues and challenges associated with establishing a new billing process and methodology between the company and the Boeing Company. The company anticipates that this short-term increase in Accounts Receivable will be corrected during the third
quarter of 2002.





Comparison of Earnings per Share data between the periods ending June 30, 2001 and June 30, 2002
are complicated by several significant differences between the two periods. As noted above, the company had a major difference in its tax accruals due to the approximate $1.0 million reversal of a deferred tax valuation allowance during the three
months ended June 30, 2001, whereas in the three months ended June 30, 2002, the company recorded an income tax provision on a normalized basis. In addition to this tax impact, the company also had a significant increase in dilutive shares,
approximately 390,000. An increase in the price of the companys common stock along with the issuance of approximately 260,000 options under the companys Non-Qualified Stock Option Plan since June 30, 2001, had the effect of making
previously anti-dilutive options dilutive. The effect of the difference in taxes and this large increase in dilutive shares was to lower Diluted Earnings per Share during the period ended June 30, 2002 when compared to the same period in 2001.





Six months ended June 30, 2002


Versus six months
ended June 30, 2001





The table below presents major highlights from the six months ended June 30, 2002 and
2001.





2001

2002

Change(In Millions)Revenue

$
85.8

$
78.0

(9.1
%)Gross Profit


19.1


17.6

(7.9
%)Operating income


8.0


7.0

(12.5
%)Income before taxes


7.0


8.0

14.3
%Net income


5.3


4.9

(7.5
%)EBITDA


9.7


10.2

5.9
%





Revenues for the six months ended June 30, 2002 decreased $7.8
million compared to the same period of 2001. Sales in the Government Services Group decreased by $6.0 million, or 11.2%, from $53.7 million in 2001 to $47.7 million in 2002. This decrease was due primarily to delivering four fewer aircraft under the
KC-135 Program Depot Maintenance (PDM) contract offset, partially, by the delivery of two aircraft under the JSTAR contract.





Sales in the Commercial Services Group decreased by $1.3 million or approximately 5.2%, for the six months ended June 30, 2002, from $25.0 million in 2001 to $23.7 million in 2002. This decrease was primarily due to the delivery of a
cargo conversion aircraft in 2001, $2.3 million, and sales on the H-3 helicopter contract of $1.1 million, with no corresponding deliveries during the same period in 2002. These decreases were partially offset by an increase in commercial
Maintenance, Repair and




17




---

Component revenues of $2.1 million.





The Manufacturing & Component Group saw its revenues decline $0.6 million, approximately 8.0%, for the six months ended June 30, 2002, from $7.3 million in 2001 to $6.7 million in 2002. This
decrease is due to the Pemco Engineers subsidiary that had $2.5 million less revenue for the six months ended June 30, 2002 versus the same period of 2001. This revenue decrease was offset partially by higher period-to-period revenue, $1.8 million,
in the Space Vector subsidiary and the sale of component parts from a discontinued operation of $0.1 million. The decrease in Pemco Engineers revenue is a result of a downturn in conversion of aircraft for which the unit produces cargo-handling
systems combined with a decrease in sales of replacement parts for cargo-handling systems on aircraft in service.





Without regard to operating segments, the companys mix of business between government and commercial customers was 33.4% commercial and 66.6% government during the six months ended June 30, 2001 and 33.5% commercial and 66.5%
government during the same period in 2002.





Cost of sales decreased during the six months ended June 30 from $66.7
million in 2001 to $60.4 million in 2002. In addition to the normal decrease in costs associated with the decreased revenue, cost of sales was also affected by higher production efficiencies during the year, primarily in the companys
Commercial Services Group and also, to a lesser extent, in the Government Services Group. These decreases in cost of sales were offset, partially, by replacing relatively high margin sales at the Pemco Engineers subsidiary with relatively lower
margin business at other subsidiaries. Overall, the companys gross profit percentage increased from 22.2% in the six months ended June 30, 2001 to 22.6% in the same period of 2002.





SG&A decreased during the six months ended June 30, from $11.1 million in 2001 to $10.6 million in 2002. During the six months ended June 30, 2002 and June 30, 2001 the
company spent approximately $1.0 million in legal expenses. These legal expenses were primarily related to the cases in the table labeled Litigation, net shown below.





Interest expense was $1.0 million for the six months ended June 30, 2001 versus $0.5 million during the same period in 2002. The effective average interest rate on the
companys revolving credit facility was approximately 7.97% in 2001 and 5.25% in 2002. In addition to lower interest rates on the companys revolving credit facility year-over-year, the company also reduced its average debt outstanding
during the six months ended June 30, 2002 compared to the six months ended June 30, 2001.





During the six months
ended June 30, 2001, the company recorded an income tax credit because of favorable tax benefits generated from an adjustment to its deferred tax valuation allowance, whereas in the six months ended June 30, 2002, the company recorded an income tax
provision on a normalized basis. The effective tax provisions for these two periods were 24% and 38% respectively.





EBITDA was approximately $10.2 million for the six months ended June 30, 2002, compared to $9.7 million for the six months ended June 30, 2001.





During the second quarter of 2002 the company agreed to settlements on several outstanding legal




18




---

actions (See Note 6 to the Consolidated Financial Statements). These settlements are reflected on the Consolidated Statements of Operations as
Litigation, net and are composed of the following cases.





Case

AmountLitigation, net In ThousandsNet Award on Product Liability

$
1,960Settlement on Replacement Workers


(388
)Settlement on Alleged Discrimination


(92
)Litigation, net

$
1,480





Comparison of Earnings per Share data between the periods ended
June 30, 2001 and June 30, 2002 are complicated by several significant differences between the two periods. As noted above, the company had a major difference in its tax accruals due to the approximate $1.0 million reversal of a deferred tax
valuation allowance during the six months ended June 30, 2001, whereas in the six months ended June 30, 2002, the company recorded an income tax provision on a normalized basis. In addition to this tax impact, the company also had a significant
increase in dilutive shares, approximately 390,000. An increase in the price of the companys common stock along with the issuance of approximately 260,000 options under the companys Non-Qualified Stock Option Plan since June 30, 2001,
had the effect of making previously anti-dilutive options dilutive. The effect of the difference in taxes and this large increase in dilutive shares was to lower Diluted Earnings per Share during the period ended June 30, 2002 when compared to the
same period in 2001.





Liquidity and Capital Resources





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





December 31, 2001


June 30, 2002


Change(In Thousands Except Long Term Debt to Equity)Cash

$
927


$
721


$
(206
)Working Capital


9,728



6,058



(3,671
)Revolving credit facility


11,591



11,386



(205
)Long term debt and capital lease obligations


3,994



3,799



(195
)Shareholders equity


19,349



18,385



(964
)Long term debt to equity


20.6
%


20.6
%


N/a





The companys revolving credit facility is included in current
liabilities.




19




---




Operating activities provided $10.7 million of cash for the six-months ending
June 30, 2002. During this same period, the company borrowed $0.6 million on its capital equipment acquisition facility. This loan carries a variable interest rate that was 5.25% at June 30, 2002. The company also received proceeds from the exercise
of company stock options of $0.8 million. Cash was used during the six-months ended June 30, 2002 for capital expenditures of $4.3 million, and the repurchase of company common stock, $6.7 million.





At June 30, 2002 the company had additional borrowing capacity of $1.4 million under its capital equipment acquisition facility and $8.4
million under its revolving line of credit.





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 primarily 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, the company made a $3.0 million contribution to the Plan during the fourth quarter of 2001. In addition to this contribution, the
company accrued a long-term pension benefit obligation in the amount of $15.3 million, accrued an intangible pension asset of $6.5 million, increased its deferred tax asset by $3.3 million and recorded a $5.5 million charge to comprehensive income.
The company anticipates that it will be required to make further contributions to the Plan during 2002. Under ERISA rules, the company expects that the minimum required contribution in 2002 would be approximately $1.6 million. It is possible that
the company may elect, as it did during 2001, to contribute more than the minimum requirement. The company did not make a contribution to the Plan during the first or second quarters of 2001 or 2002. At December 31, 2001 the Plan was under-funded by
approximately $15.5 million.





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.





In December
2001 the company began construction of an addition to one of the hangers at its Dothan, Alabama facility. The addition is projected to cost approximately $2.5 million. As of the date of this report the company has spent approximately $1.6 million on
this project. This $1.6 million has been temporarily funded by the companys revolving credit facility. The company




20




---

anticipates that it will secure funding for the entire addition through the issuance of an Airport Bond. The company currently has no other
material capital projects underway.





COMMITMENTS AND CONTINGENCIES





FACILITY AND OPERATING LEASES





The
companys manufacturing and service operations are performed principally on leased premises owned by municipal units or authorities. Remaining lease terms range from four months to thirty-one years and provide for basic rentals, plus contingent
rentals based upon a graduated percentage of sales. The company also leases vehicles and equipment under various leasing arrangements.





Future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of June 30, 2002 are as follows:





Year Ending

Facilities

Vehicles And Equipment

Total(In Thousands)2002

$
1,100

$
351

$
1,4512003


1,989


191


2,1802004


1,581


142


1,7232005


1,371


139


1,5102006


1,274


77


1,352Thereafter


18,381


3


18,384Total minimum future rental commitments

$
25,697

$
903

$
26,600





REPAYMENT OF LONG TERM DEBT





Schedule of debt maturing over the next five years at June 30, 2002:





(In Thousands)2002

$
9232003


4,6832004


02005


02006


0Thereafter


0$
5,606





TRADING ACTIVITIES





The company has not engaged in trading activities or in trading non-exchange traded contracts. As of June 30, 2002 and 2001, the carrying amounts of the companys
financial instruments are




21




---

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 accruals of approximately $0.2 million and $0.6 million at June 30, 2002 and 2001, respectively, related to a severance agreement with its former Chairman of the Board, Chief Executive Officer and major stockholder.
In accordance with the agreement, the accrued amounts are being paid over a 36-month period that began January 2000.





On April 23, 2002 the company loaned its current President and Chief Executive Officer $425,000 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.





CRITICAL ACCOUNTING POLICIES AND
ESTIMATES





Reference should be made to Item 7 of the companys 2001 Annual Report on Form 10-K for a
discussion of Critical Accounting Policies and Estimates.





BACKLOG





The following table presents the companys backlog (in thousands of dollars) at June 30, 2002 and June 30, 2001:





Customer Type

2002

2001U.S. Government

$
127,774

$
110,556Commercial


15,130


17,032Total

$
142,904

$
127,588





The growth in government backlog was primarily related to the
companys Government Services Group and the Space Vector subsidiary in the Manufacturing & Component Group. Government Services increased backlog approximately $11.2 million year-over-year while Space Vector increased backlog $6.0 million
during this same period.





Total commercial backlog decreased $1.9 million. The Commercial Services Group increased
backlog $0.7 million while backlog at Pemco Engineers, in the Manufacturing & Component Group, decreased $2.6 million. The decrease in Pemco Engineers backlog is a result of a downturn in conversion of aircraft for which the unit produces
cargo-handling systems combined with a decrease in sales of replacement parts for cargo-handling systems on aircraft in service.




22




---

Overall the mix of backlog shifted towards government during the two periods moving from 86.7% government and 13.3%
commercial for the six-months ended June 30, 2001 to 89.4% government and 10.6% commercial for the six-months ended June 30, 2002.





The company includes sub-contracts for government work in its U.S. Government backlog category. Substantially all of the companys government backlog scheduled for delivery can be terminated at the convenience of the
U.S. Government since orders are often placed well before delivery, and the companys contracts typically provide that orders may be terminated with limited or no penalties.





The company has historically derived an additional $0.40 in sales for each dollar represented in its backlog. The backlog is based upon fixed prices for specific scopes of
work. In performing these scopes of work the company frequently discovers necessary repairs that are out of scope. These additional repairs, which are approved by the customers before being performed, lead to over and above time and
material sales. While it cannot be certain that this work will continue in the future, the company currently has no reason to believe that it will decrease.





Contingencies





See Note 6 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 2001 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 revolving line of
credit, term loans, and capital equipment acquisition facility as noted in Note 4 to the Consolidated Financial Statements and bears interest at prime plus 0.50% or 0.75%, depending upon the loan




23




---

(5.25% and 5.50% at June 30, 2002). If the prime rate had increased 100 basis points, net income would have been reduced by approximately
$27,000 during the quarter, $71,000 year-to-date. The actual fluctuation of interest rates is not determinable, accordingly, actual results of interest rate fluctuations could differ.





PART II    OTHER INFORMATION





Item
1.  Legal Proceedings





See Note 6 to the Consolidated Financial Statements.





Item 4.  Submission of Matters to a Vote of Security Holders





The companys Annual Meeting of Stockholders was held on May 16, 2002. At the meeting, stockholders of the company elected Mark K. Holdsworth and Thomas C. Richards as
Class II directors to serve until 2005.





The number of votes cast for or withheld for each director nominee were
as follows:





Nominee

For

WithheldMark K. Holdsworth

3,526,056

838Thomas C. Richards

3,525,936

958





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





a.  ExhibitsNone





b.  Reports on Form 8-K. No Reports on Form 8-K were filed with the Securities and Exchange Commission during the         quarter ended June 30,
2002.




24




---

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: August 14, 2002

By:  /S/RONALD A. ARAMINI


Ronald A. Aramini President and
Chief Executive Officer (Principal Executive Officer)Dated: August 14, 2002

By:  /S/    JOHN R. LEEJohn R. Lee, Sr. Vice President and
Chief Financial Officer (Principal Finance & Accounting Officer)




25