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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 June 30, 2008,

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





ALABAMA AIRCRAFT INDUSTRIES, 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 50th Street, 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 Company is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of
large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.



|             |  |                                                                          |  |  |  |                               
|------------ |  | ------------------------------------------------------------------------ |  |  |  | ------------------------------
|(Check one): |  | Large accelerated filer     ̈                                             |  |  |  | Accelerated filer     ̈        
|             |  | Non-accelerated filer     ̈ (Do not check if a smaller reporting company) |  |  |  | Smaller reporting company    x

Indicate by check mark whether the registrant is a shell company (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 August 11, 2008
|Common Stock, $.0001 par value |  | 4,128,950                     









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INDEX

ALABAMA AIRCRAFT INDUSTRIES, INC. AND SUBSIDIARIES



|                              |  |                                                                                                   |  |     
|----------------------------- |  | ------------------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                                   |  | PAGE
|                              | 
|PART I. FINANCIAL INFORMATION |  |                                                                                                  
|                              |  |                                                                                                  
|Item 1.                       |  | Financial Statements (Unaudited)                                                                  |  | 1   
|                              |  |                                                                                                  
|                              |  | Consolidated Balance Sheets-June 30, 2008 (Unaudited) and December 31, 2007                       |  | 1   
|                              |  |                                                                                                  
|                              |  | Unaudited Consolidated Statements of Operations For The Three Months Ended June 30, 2008 and 2007 |  | 3   
|                              |  |                                                                                                  
|                              |  | Unaudited Consolidated Statements of Operations For The Six Months Ended June 30, 2008 and 2007   |  | 4   
|                              |  |                                                                                                  
|                              |  | Unaudited Consolidated Statements of Cash Flows For The Six Months ended June 30, 2008 and 2007   |  | 5   
|                              |  |                                                                                                  
|                              |  | Notes to Consolidated Financial Statements                                                        |  | 6   
|                              |  |                                                                                                  
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations             |  | 18  
|                              |  |                                                                                                  
|Item 3.                       |  | Quantitative and Qualitative Disclosures about Market Risk                                        |  | 25  
|                              |  |                                                                                                  
|Item 4T.                      |  | Controls and Procedures                                                                           |  | 25  
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                                  
|                              |  |                                                                                                  
|Item 1.                       |  | Legal Proceedings                                                                                 |  | 27  
|                              |  |                                                                                                  
|Item 1A.                      |  | Risk Factors                                                                                      |  | 27  
|                              |  |                                                                                                  
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                               |  | 28  
|                              |  |                                                                                                  
|Item 6.                       |  | Exhibits                                                                                          |  | 29  
|                              | 
|SIGNATURES                    |  |                                                                                                  



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PART I. FINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------

ALABAMA AIRCRAFT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS

(In Thousands)



|                                               |  |                         |         |   |                  |   |         |  
|---------------------------------------------- |  | ----------------------- | ------- | - | ---------------- | - | ------- | -
|                                               |  | June 30,2008(Unaudited) |         |   | December 31,2007 |  
|Current assets:                                |  |                         |         |   |                  |   |         |  
|Cash and cash equivalents                      |  | $                       | 12,357  |   |                  | $ | 8,799   |  
|Accounts receivable, net                       |  |                         | 5,060   |   |                  |   | 7,397   |  
|Inventories, net                               |  |                         | 4,737   |   |                  |   | 6,317   |  
|Prepaid expenses and other                     |  |                         | 586     |   |                  |   | 620     |  
|Assets of discontinued operations              |  |                         | 4,627   |   |                  |   | 5,437   |  
|                                               |  |                         |         |   |                  |   |         |  
|Total current assets                           |  |                         | 27,367  |   |                  |   | 28,570  |  
|                                               |  |                         |         |   |                  |   |         |  
|Machinery, equipment and improvements at cost: |  |                         |         |   |                  |   |         |  
|Machinery and equipment                        |  |                         | 20,647  |   |                  |   | 20,637  |  
|Leasehold improvements                         |  |                         | 18,828  |   |                  |   | 18,719  |  
|Construction-in-process                        |  |                         |        |   |                  |   | 31      |  
|                                               |  |                         |         |   |                  |   |         |  
|                                               |  |                         | 39,475  |   |                  |   | 39,387  |  
|Less accumulated depreciation and amortization |  |                         | (27,613 | ) |                  |   | (26,808 | )
|                                               |  |                         |         |   |                  |   |         |  
|Net machinery, equipment and improvements      |  |                         | 11,862  |   |                  |   | 12,579  |  
|                                               |  |                         |         |   |                  |   |         |  
|Other non-current assets:                      |  |                         |         |   |                  |   |         |  
|Deposits and other                             |  |                         | 968     |   |                  |   | 3,158   |  
|Restricted cash-letter of credit               |  |                         | 583     |   |                  |   | 1,235   |  
|Related party receivable                       |  |                         |        |   |                  |   | 440     |  
|Assets of discontinued operations              |  |                         | 453     |   |                  |   | 313     |  
|                                               |  |                         |         |   |                  |   |         |  
|Total other non-current assets                 |  |                         | 2,004   |   |                  |   | 5,146   |  
|                                               |  |                         |         |   |                  |   |         |  
|Total assets                                   |  | $                       | 41,233  |   |                  | $ | 46,295  |  
|                                               |  |                         |         |   |                  |   |         |  

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



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ALABAMA AIRCRAFT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

LIABILITIES AND STOCKHOLDERS EQUITY

(In Thousands, Except Share Information)



|                                                                                                                            |  |                         |         |   |                  |   |         |  
|--------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                            |  | June 30,2008(Unaudited) |         |   | December 31,2007 |  
|Current liabilities:                                                                                                        |  |                         |         |   |                  |   |         |  
|Current portion of long-term debt                                                                                           |  | $                       | 5,004   |   |                  | $ | 5       |  
|Accounts payabletrade                                                                                                      |  |                         | 1,620   |   |                  |   | 3,060   |  
|Accrued health and dental                                                                                                   |  |                         | 404     |   |                  |   | 491     |  
|Accrued liabilitiespayroll related                                                                                         |  |                         | 2,422   |   |                  |   | 2,845   |  
|Accrued liabilitiesother                                                                                                   |  |                         | 1,219   |   |                  |   | 1,700   |  
|Customer deposits in excess of cost                                                                                         |  |                         | 3,620   |   |                  |   | 3,657   |  
|Liabilities of discontinued operations                                                                                      |  |                         | 510     |   |                  |   | 619     |  
|                                                                                                                            |  |                         |         |   |                  |   |         |  
|Total current liabilities                                                                                                   |  |                         | 14,799  |   |                  |   | 12,377  |  
|                                                                                                                            |  |                         |         |   |                  |   |         |  
|Long-term debt, less current portion                                                                                        |  |                         |        |   |                  |   | 5,002   |  
|Long-term pension and post-retirement benefit liabilities                                                                   |  |                         | 9,500   |   |                  |   | 9,654   |  
|Other long-term liabilities                                                                                                 |  |                         | 758     |   |                  |   | 2,936   |  
|                                                                                                                            |  |                         |         |   |                  |   |         |  
|Total liabilities                                                                                                           |  |                         | 25,057  |   |                  |   | 29,969  |  
|                                                                                                                            |  |                         |         |   |                  |   |         |  
|Commitments and contingencies (Note 9)                                                                                      |  |                         |         |   |                  |   |         |  
|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, 4,128,950 outstanding at June 30, 2008 and December 31,
2007 |  |                         | 1       |   |                  |   | 1       |  
|Additional paid-in capital                                                                                                  |  |                         | 15,250  |   |                  |   | 15,067  |  
|Retained earnings                                                                                                           |  |                         | 28,750  |   |                  |   | 30,358  |  
|Treasury stock, at cost  413,398 shares at June 30, 2008 and December 31, 2007                                             |  |                         | (8,623  | ) |                  |   | (8,623  | )
|Accumulated other comprehensive loss:                                                                                       |  |                         |         |   |                  |   |         |  
|Pension and post-retirement liabilities                                                                                     |  |                         | (19,202 | ) |                  |   | (20,477 | )
|                                                                                                                            |  |                         |         |   |                  |   |         |  
|Total stockholders equity                                                                                                  |  |                         | 16,176  |   |                  |   | 16,326  |  
|                                                                                                                            |  |                         |         |   |                  |   |         |  
|Total liabilities and stockholders equity                                                                                  |  | $                       | 41,233  |   |                  | $ | 46,295  |  
|                                                                                                                            |  |                         |         |   |                  |   |         |  

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



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ALABAMA AIRCRAFT INDUSTRIES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Information)



|                                                       |  |                               |        |   |                               |   |        |  
|------------------------------------------------------ |  | ----------------------------- | ------ | - | ----------------------------- | - | ------ | -
|                                                       |  | ThreeMonths EndedJune 30,2008 |        |   | ThreeMonths EndedJune 30,2007 |  
|Revenue                                                |  | $                             | 12,508 |   |                               | $ | 15,776 |  
|Cost of revenue                                        |  |                               | 11,295 |   |                               |   | 15,099 |  
|                                                       |  |                               |        |   |                               |   |        |  
|Gross profit                                           |  |                               | 1,213  |   |                               |   | 677    |  
|Selling, general and administrative expenses           |  |                               | 2,153  |   |                               |   | 2,468  |  
|                                                       |  |                               |        |   |                               |   |        |  
|Operating loss                                         |  |                               | (940   | ) |                               |   | (1,791 | )
|Interest expense                                       |  |                               | 194    |   |                               |   | 187    |  
|                                                       |  |                               |        |   |                               |   |        |  
|Loss from continuing operations before income taxes    |  |                               | (1,134 | ) |                               |   | (1,978 | )
|Income tax benefit                                     |  |                               | (70    | ) |                               |   | (798   | )
|                                                       |  |                               |        |   |                               |   |        |  
|Loss from continuing operations                        |  |                               | (1,064 | ) |                               |   | (1,180 | )
|(Loss) income from discontinued operations, net of tax |  |                               | (1,378 | ) |                               |   | 1,806  |  
|                                                       |  |                               |        |   |                               |   |        |  
|Net (loss) income                                      |  | $                             | (2,442 | ) |                               | $ | 626    |  
|                                                       |  |                               |        |   |                               |   |        |  
|Net income per common share:                           |  |                               |        |   |                               |   |        |  
|Basic loss from continuing operations                  |  | $                             | (0.26  | ) |                               | $ | (0.29  | )
|Basic (loss) income from discontinued operations       |  | $                             | (0.33  | ) |                               | $ | 0.44   |  
|Basic net (loss) income per share                      |  | $                             | (0.59  | ) |                               | $ | 0.15   |  
|Diluted loss from continuing operations                |  | $                             | (0.26  | ) |                               | $ | (0.29  | )
|Diluted (loss) income from discontinued operations     |  | $                             | (0.33  | ) |                               | $ | 0.44   |  
|Diluted net (loss) income per share                    |  | $                             | (0.59  | ) |                               | $ | 0.15   |  
|Weighted average common shares outstanding:            |  |                               |        |   |                               |   |        |  
|Basic                                                  |  |                               | 4,129  |   |                               |   | 4,126  |  
|Diluted                                                |  |                               | 4,129  |   |                               |   | 4,126  |  

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



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ALABAMA AIRCRAFT INDUSTRIES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Information)



|                                                             |  |                             |        |   |                             |   |        |  
|------------------------------------------------------------ |  | --------------------------- | ------ | - | --------------------------- | - | ------ | -
|                                                             |  | SixMonths EndedJune 30,2008 |        |   | SixMonths EndedJune 30,2007 |  
|Revenue                                                      |  | $                           | 32,119 |   |                             | $ | 35,413 |  
|Cost of revenue                                              |  |                             | 26,322 |   |                             |   | 32,057 |  
|                                                             |  |                             |        |   |                             |   |        |  
|Gross profit                                                 |  |                             | 5,797  |   |                             |   | 3,356  |  
|Selling, general and administrative expenses                 |  |                             | 5,039  |   |                             |   | 5,382  |  
|                                                             |  |                             |        |   |                             |   |        |  
|Operating income (loss)                                      |  |                             | 758    |   |                             |   | (2,026 | )
|Interest expense                                             |  |                             | 395    |   |                             |   | 375    |  
|                                                             |  |                             |        |   |                             |   |        |  
|Income (loss) from continuing operations before income taxes |  |                             | 363    |   |                             |   | (2,401 | )
|Income tax expense (benefit)                                 |  |                             | 104    |   |                             |   | (1,035 | )
|                                                             |  |                             |        |   |                             |   |        |  
|Income (loss) from continuing operations                     |  |                             | 259    |   |                             |   | (1,366 | )
|(Loss) income from discontinued operations, net of tax       |  |                             | (1,867 | ) |                             |   | 2,888  |  
|                                                             |  |                             |        |   |                             |   |        |  
|Net (loss) income                                            |  | $                           | (1,608 | ) |                             | $ | 1,522  |  
|                                                             |  |                             |        |   |                             |   |        |  
|Net income per common share:                                 |  |                             |        |   |                             |   |        |  
|Basic income (loss) from continuing operations               |  | $                           | 0.06   |   |                             | $ | (0.33  | )
|Basic (loss) income from discontinued operations             |  | $                           | (0.45  | ) |                             | $ | 0.70   |  
|Basic net (loss) income per share                            |  | $                           | (0.39  | ) |                             | $ | 0.37   |  
|Diluted income (loss) from continuing operations             |  | $                           | 0.06   |   |                             | $ | (0.33  | )
|Diluted (loss) income from discontinued operations           |  | $                           | (0.45  | ) |                             | $ | 0.70   |  
|Diluted net (loss) income per share                          |  | $                           | (0.39  | ) |                             | $ | 0.37   |  
|Weighted average common shares outstanding:                  |  |                             |        |   |                             |   |        |  
|Basic                                                        |  |                             | 4,129  |   |                             |   | 4,126  |  
|Diluted                                                      |  |                             | 4,129  |   |                             |   | 4,126  |  

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



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ALABAMA AIRCRAFT INDUSTRIES, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)



|                                                                                         |  |                             |        |   |                             |   |        |  
|---------------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | --------------------------- | - | ------ | -
|                                                                                         |  | SixMonths EndedJune 30,2008 |        |   | SixMonths EndedJune 30,2007 |  
|Cash flows from operating activities:                                                    |  |                             |        |   |                             |   |        |  
|Net (loss) income                                                                        |  | $                           | (1,608 | ) |                             | $ | 1,522  |  
|                                                                                         |  |                             |        |   |                             |   |        |  
|Adjustments to reconcile net (loss) income to net cash provided by operating activities: |  |                             |        |   |                             |   |        |  
|Depreciation and amortization of machinery, equipment and leasehold improvements         |  |                             | 891    |   |                             |   | 1,682  |  
|Amortization of intangible assets                                                        |  |                             |       |   |                             |   | 188    |  
|Provision for deferred income taxes                                                      |  |                             |       |   |                             |   | 1,032  |  
|Funding under (over) pension cost                                                        |  |                             | 1,121  |   |                             |   | (1,955 | )
|Provision for losses on receivables                                                      |  |                             |       |   |                             |   | 148    |  
|Loss on disposals of machinery and equipment                                             |  |                             |       |   |                             |   | 28     |  
|Provision for inventory valuation                                                        |  |                             | 408    |   |                             |   | 329    |  
|Reversal of losses on contracts-in-process                                               |  |                             | (1,000 | ) |                             |   | (166   | )
|Forgiveness of related party receivable                                                  |  |                             | 440    |   |                             |   |       |  
|Stock based compensation expense                                                         |  |                             | 183    |   |                             |   | 581    |  
|Changes in assets and liabilities:                                                       |  |                             |        |   |                             |   |        |  
|Restricted cash                                                                          |  |                             | 652    |   |                             |   |       |  
|Accounts receivable, trade                                                               |  |                             | 2,533  |   |                             |   | 915    |  
|Inventories                                                                              |  |                             | 2,739  |   |                             |   | (2,198 | )
|Prepaid expenses and other                                                               |  |                             | 42     |   |                             |   | 650    |  
|Deposits and other                                                                       |  |                             | 2,188  |   |                             |   | (373   | )
|Customer deposits in excess of cost                                                      |  |                             | 44     |   |                             |   | (157   | )
|Accounts payable and accrued liabilities                                                 |  |                             | (4,729 | ) |                             |   | (813   | )
|                                                                                         |  |                             |        |   |                             |   |        |  
|Total adjustments                                                                        |  |                             | 5,512  |   |                             |   | (109   | )
|                                                                                         |  |                             |        |   |                             |   |        |  
|Net cash provided by operating activities                                                |  |                             | 3,904  |   |                             |   | 1,413  |  
|                                                                                         |  |                             |        |   |                             |   |        |  
|Cash flows from investing activities:                                                    |  |                             |        |   |                             |   |        |  
|Capital expenditures                                                                     |  |                             | (312   | ) |                             |   | (434   | )
|                                                                                         |  |                             |        |   |                             |   |        |  
|Net cash used in investing activities                                                    |  |                             | (312   | ) |                             |   | (434   | )
|                                                                                         |  |                             |        |   |                             |   |        |  
|Cash flows from financing activities:                                                    |  |                             |        |   |                             |   |        |  
|Net change under revolving credit facility                                               |  |                             |       |   |                             |   | (97    | )
|Principal payments under long-term debt                                                  |  |                             | (34    | ) |                             |   | (863   | )
|                                                                                         |  |                             |        |   |                             |   |        |  
|Net cash used in financing activities                                                    |  |                             | (34    | ) |                             |   | (960   | )
|                                                                                         |  |                             |        |   |                             |   |        |  
|Net increase in cash and cash equivalents                                                |  |                             | 3,558  |   |                             |   | 19     |  
|                                                                                         |  |                             |        |   |                             |   |        |  
|Cash and cash equivalents, beginning of period                                           |  |                             | 8,799  |   |                             |   | 23     |  
|                                                                                         |  |                             |        |   |                             |   |        |  
|Cash and cash equivalents, end of period                                                 |  | $                           | 12,357 |   |                             | $ | 42     |  
|                                                                                         |  |                             |        |   |                             |   |        |  
|Supplemental disclosure of cash flow information:                                        |  |                             |        |   |                             |   |        |  
|Cash paid during the period for:                                                         |  |                             |        |   |                             |   |        |  
|Interest                                                                                 |  | $                           | 400    |   |                             | $ | 1,937  |  
|                                                                                         |  |                             |        |   |                             |   |        |  
|Income taxes                                                                             |  | $                           | 789    |   |                             | $ | 59     |  
|                                                                                         |  |                             |        |   |                             |   |        |  

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



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ALABAMA AIRCRAFT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of and for the Six-Month and Three-Month Periods Ended

June 30, 2008 and 2007

1. CONSOLIDATED FINANCIAL STATEMENTS

The interim
consolidated financial statements have been prepared by Alabama Aircraft Industries, 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 three- and six-month periods ended
June 30, 2008 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 2007 Annual Report on Form 10-K.

The Companys primary business, located in Birmingham, Alabama, is providing aircraft
maintenance and modification services, including complete airframe inspection, maintenance, repair and custom airframe design and modification. The Company provides such services for government and military customers through its Government Services
Segment (GSS), which specializes in providing Programmed Depot Maintenance (PDM) on large transport aircraft. The Company historically had three operating segments: its GSS, its Commercial Services Segment (CSS),
and its Manufacturing and Components Segment (MCS). The CSS, located in Dothan, Alabama, provided commercial aircraft maintenance and modification services on a contract basis to the owners and operators of large commercial aircraft. The
MCS, located in California, designs and manufactures a wide array of proprietary aerospace products, including various rocket vehicles, guidance control systems and precision components for launch vehicles. The businesses historically comprising the
CSS were sold in September 2007, and the MCS, which is comprised solely by Space Vector Corporation (SVC), is currently being marketed for sale. Therefore, the business comprising the CSS and MCS are presented in the accompanying
consolidated financial statements and notes as discontinued operations. Accordingly, the Companys continuing operations consist of one operating segment.

The Companys primary sources of liquidity and capital resources include cash-on-hand, cash flows from operations (primarily from collection of accounts receivables and conversion of work-in-process inventory to
cash) and potential borrowing capability through lenders. Principal factors affecting the Companys liquidity and capital resources position include, but are not limited to, the following: results of operations; the results of the
Companys legal action protesting the U.S. Air Force (USAF) award of the KC-135 contract to The Boeing Company (Boeing) (See Note 9); collection of accounts receivable; funding requirements associated with the
Companys defined benefit pension plan; settlements of various claims; and potential divestitures. The Company anticipates that cash-on-hand will be sufficient to fund operations, make minimal capital expenditures and make scheduled payments on
debt obligations for the next twelve months. The Company does not have sufficient cash to make the required contributions to its defined benefit pension plan without negatively impacting the cash and liquidity of the Company during the first quarter
of 2009. Therefore, the Company applied on February 29, 2008 to the Internal Revenue Service for a waiver of contributions for the 2007 plan year which concludes on September 15, 2008. Without a waiver of contributions, the Company would
be required to contribute approximately $3.7 million for the 2007 plan year by September 15, 2008. Contribution calculations for the 2008 plan year have not been completed. However, the Company currently estimates that the quarterly payments
for the 2008 plan year will be approximately $1.1 million to $1.2 million, with the first quarterly payment due April 15, 2008. The Company did not make the first quarterly contribution due April 15, 2008 nor the second quarterly payment
due July 15, 2008. The Company has until September 15, 2009 to make the required contributions for the 2008 plan year.



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Several events could significantly impact the generation, availability and uses of cash over the next
twelve months including:



| |  |  | whether the Company is successful in its legal action protesting the USAF award of the KC-135 contract to Boeing that is pending before the U.S. Court of Federal
Claims;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | whether the Company is granted a waiver of contributions to its defined benefit plan for the 2007 plan year;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | whether the Company applies for and is granted a waiver of contributions to its defined benefit plan for the 2008 plan year;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | whether the Company is successful in selling its subsidiary, SVC;
| | - |  | -----------------------------------------------------------------



| |  |  | whether the Company is successful in winning individual task orders for C-130 maintenance services as a subcontractor with its teammates on an indefinite quantity,
indefinite delivery contract awarded in July 2008;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | whether the Company is able to win additional contracts, including in part as a result of qualifying with the Small Business Administration as a small business
under certain North American Industry Classification System codes;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | whether the Company is able to obtain additional financing from lenders to fund working capital increases that may be necessary if additional contracts are won; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | whether the $5.0 million Senior Secured Note which matures on February 15, 2009 is extended.
| | - |  | --------------------------------------------------------------------------------------------

There are no assurances that the Company will be successful in any of these respects and negative outcomes could adversely impact the Companys
ability to meet financial obligations as they become due.

RECENT ACCOUNTING PRONOUNCEMENTS

FASB Statement No. 157

In
September 2006, the Financial Accounting Standards Board (the FASB) issued Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, which establishes a comprehensive framework for
measuring fair value and expands disclosures about fair value measurements. Specifically, this Statement sets forth a definition of fair value, and establishes a hierarchy prioritizing the inputs to valuation techniques, giving the highest
priority to quoted prices in active markets for identical assets and liabilities and the lowest priority to unobservable inputs. The Statement defines levels within the hierarchy as follows:



| |  |  | Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the
measurement date.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Level 2 inputs are inputs, other than quoted prices included within Level 1, which are observable for the assets or liability, either directly or indirectly.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Level 3 inputs are unobservable inputs.
| | - |  | ---------------------------------------

In February 2008, the FASB issued FSP 157-2, which delays the effective date of SFAS No. 157 for all nonfinancial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring
basis (at least annually) until fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The Company adopted the provisions of SFAS No. 157 for financial assets and liabilities as of
January 1, 2008. There was no significant impact to the Companys Consolidated Financial Statements from the adoption of SFAS No. 157. The Company is currently evaluating the potential impact that the application of SFAS
No. 157 to its nonfinancial assets and liabilities will have on its Consolidated Financial Statements.

The following table summarizes
the financial instruments measured at fair value in the accompanying consolidated balance sheet as of June 30, 2008:

(In Thousands)



|                                      |         |                                            |         |  |         |   |       |   |   |  |   |    
|------------------------------------- | ------- | ------------------------------------------ | ------- |  | ------- | - | ----- | - | - |  | - | ---
|                                      |         | Fair Value Measurements as ofJune 30,
2008
|                                      | Level 1 |                                            | Level 2 |  | Level 3 |   | Total
|Assets                                |         |                                            |         |  |         |   |       |   |   |  |   |    
|Deferred Compensation Plan Assets (1) |         | $                                          | 758     |  | $       |  |       | $ |  |  | $ | 758



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|(1) | Deferred compensation plan assets, included in the accompanying consolidated balance sheets in deposits and other, are measured using quoted market prices in the active markets.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

FASB Statement No. 159

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS No. 159) which permits entities to choose to measure, on an
item-by-item basis, specified financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected are required to be reported in earnings at each reporting
date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The provisions of this Statement are required to be applied prospectively. The Company adopted SFAS No. 159 in the first quarter of
2008 and did not elect the fair value option for any items that were not already required to be measured at fair value in accordance with accounting principles generally accepted in the United States. As such, there was no significant impact to the
Companys Consolidated Financial Statements from the adoption of SFAS No. 159.

In December 2007, the FASB In December 2007, the
FASB issued Statement of Financial Accounting Standards No. 141(R), Business Combinations (SFAS No. 141(R)). SFAS No. 141(R) replaces SFAS No. 141, Business Combinations, but retains the requirement that
the purchase method of accounting for acquisitions be used for all business combinations. SFAS No. 141(R) expands on the disclosures previously required by SFAS No. 141, better defines the acquirer and the acquisition date in a business
combination, and establishes principles for recognizing and measuring the assets acquired (including goodwill), the liabilities assumed and any noncontrolling interests in the acquired business. SFAS No. 141(R) also requires an acquirer to
record an adjustment to income tax expense for changes in valuation allowances or uncertain tax positions related to acquired businesses. SFAS No. 141(R) is effective for all business combinations with an acquisition date in the first annual
period following December 15, 2008; early adoption is not permitted. The Company will adopt this statement as of January 1, 2009. The Company is currently evaluating the impact that SFAS No. 141(R) will have on its financial position,
results of operations or cash flows.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160,
Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB No. 51 (SFAS No. 160). SFAS No. 160 requires that noncontrolling (or minority) interests in subsidiaries be reported in the
equity section of the companys balance sheet, rather than in a mezzanine section of the balance sheet between liabilities and equity. SFAS No. 160 also changes the manner in which the net income of the subsidiary is reported and disclosed
in the controlling companys income statement. SFAS No. 160 also establishes guidelines for accounting for changes in ownership percentages and for deconsolidation. SFAS No. 160 is effective for financial statements for fiscal years
beginning on or after December 1, 2008 and interim periods within those years. The adoption of SFAS No. 160 is not expected to have a material impact on the Companys financial position, results of operations or cash flows.

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and
Hedging Activitiesan amendment of Financial Accounting Standards No. 133 (SFAS No. 161). SFAS No. 161 expands the disclosure requirements for derivative instruments and for hedging activities. This statement
requires more specific disclosures regarding how and why an entity uses derivative instruments, how derivative instruments and related hedge items are accounted for and how derivative instruments and related hedge items affect an entitys
financial position, results of operations and cash flows. The provisions of this standard will be effective for the Company beginning January 1, 2009. Since SFAS No. 161 only requires additional disclosures concerning derivatives and
hedging activities, this standard is not expected to have a material impact on the Companys financial position, results of operations or cash flows.



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##### Table of Contents

2. INCOME FROM CONTINUING OPERATIONS PER SHARE

Computation of basic and diluted income from continuing operations per share for the three-month and six-month periods ended June 30, 2008 and 2007
is as follows:

(In Thousands, Except Share and Per Share Information)



|                                         |  |                                |        |   |                   |       |                 |   |       |  
|---------------------------------------- |  | ------------------------------ | ------ | - | ----------------- | ----- | --------------- | - | ----- | -
|For the Three Months Ended June 30, 2008 |  | Loss fromContinuingOperations  |        |   | SharesOutstanding |       | Loss PerShare   |  
|Basic loss and per share amounts         |  | $                              | (1,064 | ) |                   | 4,129 |                 | $ | (0.26 | )
|Dilutive securities                      |  |                                |       |   |                   |      |                 |   |      |  
|                                         |  |                                |        |   |                   |       |                 |   |       |  
|Diluted loss and per share amounts       |  | $                              | (1,064 | ) |                   | 4,129 |                 | $ | (0.26 | )
|                                         |  |                                |        |   |                   |       |                 |   |       |  
|                                         |  |                                |       
|For the Three Months Ended June 30, 2007 |  | Loss fromContinuingOperations  |        |   | SharesOutstanding |       | Loss PerShare   |  
|Basic loss and per share amounts         |  | $                              | (1,180 | ) |                   | 4,126 |                 | $ | (0.29 | )
|Dilutive securities                      |  |                                |       |   |                   |      |                 |   |      |  
|                                         |  |                                |        |   |                   |       |                 |   |       |  
|Diluted loss and per share amounts       |  | $                              | (1,180 | ) |                   | 4,126 |                 | $ | (0.29 | )
|                                         |  |                                |        |   |                   |       |                 |   |       |  
|                                         |  |                                |       
|For the Six Months Ended June 30, 2008   |  | IncomefromContinuingOperations |        |   | SharesOutstanding |       | IncomePer Share |  
|Basic income and per share amounts       |  | $                              | 259    |   |                   | 4,129 |                 | $ | 0.06  |  
|Dilutive securities                      |  |                                |       |   |                   |      |                 |   |      |  
|                                         |  |                                |        |   |                   |       |                 |   |       |  
|Diluted income and per share amounts     |  | $                              | 259    |   |                   | 4,129 |                 | $ | 0.06  |  
|                                         |  |                                |        |   |                   |       |                 |   |       |  
|                                         |  |                                |       
|For the Six Months Ended June 30, 2007   |  | Loss fromContinuingOperations  |        |   | SharesOutstanding |       | Loss PerShare   |  
|Basic loss and per share amounts         |  | $                              | (1,366 | ) |                   | 4,126 |                 | $ | (0.33 | )
|Dilutive securities                      |  |                                |       |   |                   |      |                 |   |      |  
|                                         |  |                                |        |   |                   |       |                 |   |       |  
|Diluted loss and per share amounts       |  | $                              | (1,366 | ) |                   | 4,126 |                 | $ | (0.33 | )
|                                         |  |                                |        |   |                   |       |                 |   |       |  

Options to purchase 1,285,312 and 982,374 shares of Common Stock during the three months ended
June 30, 2008 and 2007, respectively, and options to purchase 1,285,312 and 1,080,039 shares of Common Stock during the six months ended June 30, 2008 and 2007, respectively, were excluded from the computation of diluted net loss per share
because the option exercise price was greater than the average market price of the shares.



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3. INVENTORIES

Inventories as of June 30, 2008 and December 31, 2007 consisted of the following:

(In Thousands)



|                                              |  |              |        |   |                  |   |        |  
|--------------------------------------------- |  | ------------ | ------ | - | ---------------- | - | ------ | -
|                                              |  | June 30,2008 |        |   | December 31,2007 |  
|Work in process                               |  | $            | 4,990  |   |                  | $ | 9,100  |  
|Raw materials and supplies                    |  |              | 6,081  |   |                  |   | 6,209  |  
|Finished goods                                |  |              | 786    |   |                  |   | 786    |  
|                                              |  |              |        |   |                  |   |        |  
|Total                                         |  |              | 11,857 |   |                  |   | 16,095 |  
|Less reserves for obsolete inventory          |  |              | (3,507 | ) |                  |   | (3,100 | )
|Less milestone payments and customer deposits |  |              | (3,613 | ) |                  |   | (6,678 | )
|                                              |  |              |        |   |                  |   |        |  
|Total inventories                             |  | $            | 4,737  |   |                  | $ | 6,317  |  
|                                              |  |              |        |   |                  |   |        |  

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.

4. DEBT

Debt as of June 30, 2008 and December 31, 2007 consisted of the following:

(In Thousands)



|                                                                                                             |  |              |        |   |                  |   |       |  
|------------------------------------------------------------------------------------------------------------ |  | ------------ | ------ | - | ---------------- | - | ----- | -
|                                                                                                             |  | June 30,2008 |        |   | December 31,2007 |  
|Senior Secured Note, interest at 15%                                                                         |  | $            | 5,000  |   |                  | $ | 5,000 |  
|Capital lease obligations; interest from 5% to 15%, collateralized by security interest in certain equipment |  |              | 4      |   |                  |   | 7     |  
|                                                                                                             |  |              |        |   |                  |   |       |  
|Total long-term debt                                                                                         |  |              | 5,004  |   |                  |   | 5,007 |  
|Less portion reflected as current                                                                            |  |              | (5,004 | ) |                  |   | (5    | )
|                                                                                                             |  |              |        |   |                  |   |       |  
|Long term-debt, net of current portion                                                                       |  | $            |       |   |                  | $ | 5,002 |  
|                                                                                                             |  |              |        |   |                  |   |       |  

On February 15, 2006, the Company entered into a Note Purchase Agreement with Silver Canyon
Services, Inc. (Silver Canyon), pursuant to which the Company issued to Silver Canyon a senior secured note in the principal amount of $5.0 million (the Note). The Note accrues interest at an annual rate of 15%, which is
payable quarterly in arrears. The Company may, at its election, redeem the Note at a price equal to 100% of the principal amount then outstanding, together with accrued and unpaid interest thereon. The Note contains customary events of default. The
payment of all outstanding principal, interest and other amounts owing under the Note may be declared immediately due and payable upon the occurrence of an event of default. On July 31, 2006, the Note was purchased by Special Value Bond Fund,
LLC, which is managed by Tennenbaum Capital Partners, LLC, a related party of the Company. The Note Purchase Agreement was amended on July 31, 2007 to extend the maturity date of the Note to February 15, 2009.

If additional financing is needed, the Companys recent negative results of operations and the uncertainties regarding future contract awards will
likely make it more difficult and expensive for the Company to raise additional capital that may be necessary to continue its operations. If the Company cannot raise adequate funds on acceptable terms, or at all, its business could be materially
harmed.



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5. INCOME TAXES

During the six months ended June 30, 2008 and 2007, the Company recorded income tax expense (benefit) using an effective rate of 28.7% and 43.1% respectively. The effective income tax rate for the six months
ended June 30, 2008 was impacted by the utilization of federal and state net operating loss carryforwards and the 100% valuation allowance on all deferred tax assets.

6. STOCK OPTIONS

Under the Companys Nonqualified Stock Option Plan (the Stock Option
Plan), a maximum aggregate of 2,000,000 shares of Common Stock have been reserved for grants to key personnel. The Stock Option Plan expires by its terms on September 8, 2009. Options available to be granted under the Stock Option Plan
amounted to approximately 136,000 at June 30, 2008. Options granted under the Stock Option Plan become exercisable over staggered periods and expire ten years after the date of grant.

Effective January 1, 2006, the Company adopted SFAS No. 123(R),Share Based Payment, which revises SFAS No. 123,Accounting
for Stock-Based Compensation. The Company elected to use the modified prospective transition method. SFAS No. 123(R) requires the Company to recognize expense related to the fair value of its stock-based compensation awards, including
employee stock options, over the service period (generally the vesting period) in the consolidated financial statements. SFAS No. 123(R) permits entities to use any option-pricing model that meets the fair value objective in the Statement. For
options with graded vesting, the Company values the stock option grants and recognizes compensation expense as if each vesting portion of the award was a separate award. Under the modified prospective method, awards that were granted, modified, or
settled on or after January 1, 2006 are measured and accounted for in accordance with SFAS No. 123(R). Unvested equity-classified awards that were granted prior to January 1, 2006 will continue to be accounted for in accordance with
SFAS No. 123, except that all awards are recognized in the results of operations over the remaining vesting periods. The compensation cost recorded for these awards will be based on their grant-date fair value as calculated for the pro forma
disclosures required by SFAS No. 123. The impact of forfeitures that may occur prior to vesting is also estimated and considered in the amount recognized. In addition, the realization of tax benefits in excess of amounts recognized for
financial reporting purposes will be recognized as a financing activity, rather than as an operating activity as in the past.

The following
table summarizes stock option activity for the six months ended June 30, 2008:



|                                    |  |                      |   |  |                                         |      
|----------------------------------- |  | -------------------- | - |  | --------------------------------------- | -----
|                                    |  | Shares(In Thousands) |   |  | Weighted averageexercise priceper
share
|Outstanding as of December 31, 2007 |  | 1,157                |   |  | $                                       | 18.49
|Granted                             |  | 153                  |   |  |                                         | 6.00 
|Exercised                           |  |                     |   |  |                                         |     
|Forfeited/Expired                   |  | (25                  | ) |  |                                         | 20.24
|                                    |  |                      |   |  |                                         |      
|Outstanding as of June 30, 2008     |  | 1,285                |   |  |                                         | 16.97
|                                    |  |                      |   |  |                                         |      
|Exercisable as of June 30, 2008     |  | 1,197                |   |  |                                         | 17.64
|                                    |  |                      |   |  |                                         |      

The weighted average remaining term for outstanding stock options was 5.5 years at June 30,
2008. The aggregate intrinsic value at June 30, 2008 and 2007 was $0 and $522,312, respectively, for stock options outstanding and $0 and $403,557, respectively, for stock options exercisable. The intrinsic value for stock options is calculated
based on the exercise price of the underlying awards and the market price of the Companys common stock for those awards for which the market price exceeds the exercise price as of the reporting date.



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##### Table of Contents

The fair value of the options granted during the six months ended June 30, 2008 and 2007, were $1.24
and $3.90 respectively, and were estimated on the date of grant using the binominal method using the following weighted-average assumptions:



|                        |  |                              |   |  |                              |  
|----------------------- |  | ---------------------------- | - |  | ---------------------------- | -
|                        |  | Six MonthsEndedJune 30, 2008 |   |  | Six MonthsEndedJune 30, 2007 |  
|Risk-free interest rate |  | 3.49                         | % |  | 4.54                         | %
|Expected volatility     |  | 74                           | % |  | 60                           | %
|Expected term           |  | 5.12                         |   |  | 4.38                         |  
|Dividend yield          |  | 0                            | % |  | 0                            | %
|Exercise Factor         |  | 2.00                         |   |  | 2.00                         |  
|Post-Vest %             |  | 4.67                         | % |  | 5.04                         | %

The options pricing model used to calculate the fair value of the options granted requires the
input of subjective assumptions that will usually have a significant impact on the fair value estimated. Risk-free interest rates reflect the yield on zero-coupon U.S. Treasury securities with a remaining term equal to the full term of the options
granted. Expected volatilities are based on historical volatility of the Companys common stock since January 1, 2000. Expected terms are based on historical terms of grantee exercise behavior. Expected dividend yield is zero because the
Company has not and does not expect to declare dividends. The exercise factors are based on the historical rate by which the price must increase before the grantee is expected to exercise. The post-vest % is based on historical rate of post-vest
terminations.

SFAS No. 123(R) requires the recognition of stock-based compensation for the number of awards that are ultimately
expected to vest. As a result, for most awards, recognized stock-based compensation was reduced for estimated forfeitures prior to vesting primarily based on historical annual forfeiture rates of approximately 10%. Estimated forfeitures will be
reassessed in subsequent periods and may change based on new facts and circumstances. As of June 30, 2008, approximately $155,000 of unrecognized stock compensation related to unvested awards (net of estimated forfeitures) is expected to be
recognized over a weighted-average period of 1.4 years. There were no stock options exercised during the six months ended June 30, 2008 or 2007.

7. DEFERRED COMPENSATION PLAN

On December 28, 2006, the Company and Mr. Ronald A. Aramini, its President and
Chief Executive Officer entered into a Second Amendment (the Second Amendment) to the Executive Agreement, dated as of May 3, 2002 (the Agreement), between the Company and Mr. Aramini. The Agreement, as amended,
provided for annual contributions by the Company to an associated rabbi trust for the benefit of Mr. Aramini over the term of his employment agreement. The Company contributed $359,861 during January 2007 for the 2006 calendar year. Pursuant to
the Second Amendment to the Agreement, the Companys final obligation to make a final $380,326 lump sum trust contribution for the 2007 calendar year was eliminated.

Company contributions to the trust are invested by the trustee and are to be disbursed to Mr. Aramini in accordance with the terms of the Agreement. The assets of the rabbi trust are invested in U.S. treasury
bills and do not include Company Common Stock. In February 2008, the Plan disbursed approximately $2.1 million to Mr. Aramini from the deferred compensation plan assets, thereby reducing the deferred compensation plan liabilities by $2.1
million.

The fair market values of the assets in the rabbi trust at June 30, 2008 and December 31, 2007 were $0.8 million and
$2.9 million, respectively, and are reflected in the deposits and other line item in the accompanying consolidated balance sheets. The deferred compensation liability is adjusted, with a corresponding charge or credit to compensation cost, to
reflect changes in the contractual liability in an amount equal to the change in the fair market value of the assets of the rabbi trust. The amounts accrued under this plan were $0.8 million and $2.9 million at June 30, 2008 and
December 31, 2007, respectively, and are reflected in other long-term liabilities in the accompanying consolidated balance sheets.

8. EMPLOYEE
BENEFIT PLANS

The Company has a defined benefit pension plan (the Pension Plan) in effect, which covers substantially all
employees at its Birmingham, Alabama facility 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 Company froze the Pension Plan effective December 31, 2007 for all non-union employees. The funding policy is consistent with the funding requirements under federal laws and regulations concerning pensions. During the six months
ended June 30,



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##### Table of Contents

2008, the Company made no contributions to the Pension Plan. The Company does not expect to make any contributions to the Pension Plan in 2008 as the Company
does not have sufficient cash to make the required contributions to the Pension Plan without negatively impacting the cash and liquidity of the Company during the first quarter of 2009. Therefore, the Company applied on February 29, 2008 to the
Internal Revenue Service for a waiver of contributions for the 2007 plan year which concludes on September 15, 2008. Without a waiver of contributions, the Company would be required to contribute approximately $3.7 million for the 2007 plan
year by September 15, 2008. While contribution calculations for the 2008 plan year have not been completed, the Company currently estimates that the quarterly payments for the 2008 plan year will be approximately $1.1 million to $1.2 million
with the first quarterly payment due April 15, 2008. The Company did not make the first quarterly contribution due April 15, 2008 nor the second quarterly contribution due July 15, 2008. The Company has until September 15, 2009
to make the required contributions for the 2008 plan year.

Components of the Pension Plans net periodic pension cost included in
continuing operations were as follows:

(In Thousands)



|                                   |  |                               |        |   |                               |   |        |                             |  |   |                             |   |  |   |        |  
|---------------------------------- |  | ----------------------------- | ------ | - | ----------------------------- | - | ------ | --------------------------- |  | - | --------------------------- | - |  | - | ------ | -
|                                   |  | ThreeMonths EndedJune 30,2008 |        |   | ThreeMonths EndedJune 30,2007 |   |        | SixMonths EndedJune 30,2008 |  |   | SixMonths EndedJune 30,2007 |  
|Service cost                       |  | $                             | 318    |   |                               | $ | 751    |                             |  | $ | 636                         |   |  | $ | 1,502  |  
|Interest cost                      |  |                               | 1,598  |   |                               |   | 1,964  |                             |  |   | 3,196                       |   |  |   | 3,928  |  
|Expected return on plan assets     |  |                               | (1,993 | ) |                               |   | (2,444 | )                           |  |   | (3,986                      | ) |  |   | (4,888 | )
|Amortization of prior service cost |  |                               | 190    |   |                               |   | 333    |                             |  |   | 380                         |   |  |   | 666    |  
|Amortization of net loss           |  |                               | 447    |   |                               |   | 729    |                             |  |   | 895                         |   |  |   | 1,458  |  
|                                   |  |                               |        |   |                               |   |        |                             |  |   |                             |   |  |   |        |  
|Net pension cost                   |  | $                             | 560    |   |                               | $ | 1,333  |                             |  | $ | 1,121                       |   |  | $ | 2,666  |  
|                                   |  |                               |        |   |                               |   |        |                             |  |   |                             |   |  |   |        |  

9. 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 adverse effect on the Companys
consolidated financial position and results of operations.

Concentrations

A small number of the Companys customers account for a significant percentage of its revenues. Contracts and sub-contracts with the U.S. Government
comprised 100% of the Companys revenues from continuing operations during each of the six months ended June 30, 2008 and 2007. The KC-135 program in and of itself comprised 82% and 73% of the Companys total revenues from continuing
operations during the six-month periods ended June 30, 2008 and 2007, respectively. Termination or a disruption of any of these contracts (including by way of option years not being exercised), or the inability of the Company to renew or
replace any of these contracts when they expire, could have a material adverse effect on the Companys financial position or results of operations.

Litigation

Breach of Contract Lawsuits

On June 27, 2008, the Company filed a complaint in the United States Court of Federal Claims (the Court) protesting the actions of the
Air Force in connection with the award to The Boeing Company (Boeing) of the KC-135 Program Depot Maintenance contract. On July 3, 2008, the Court granted Boeings motion to intervene in the case. On July 18, 2008, Boeing
filed a motion to dismiss the Companys complaint, asserting that the Company is not an interested party with respect to the



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contract award, to which the Company is currently preparing a response. On July 25, 2008, the Court issued an order granting in part the Companys
motion to supplement the administrative record and to take discovery. The Company also has filed a motion for judgment on the administrative record that is currently pending before the Court. The Company has expended substantial financial resources
in connection with these events. Management believes an adverse decision with respect to the Companys claims would have a material adverse effect on the Companys financial condition and prospects, materially harm the Companys
business and impair the value of its Common Stock.

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 nine 737-300 aircraft, all of which were re-delivered to GECAS during 2003 and are in service. On
January 20, 2004, the Company received service of a suit filed against the Companys former subsidiary, Pemco World Air Services, Inc. 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. On March 24, 2004, the Circuit Court of Dale County, Alabama denied a motion filed by GECAS to dismiss or stay the
proceedings. GECAS has subsequently paid in full charges owed on four of the nine aircraft. The New York Court ordered mediation in the matter. Mediation took place on October 6, 2004, but was unsuccessful in bringing resolution. The case was
again mediated on October 6, 2006 without success. On October 16, 2006, the Court granted the Company partial summary judgment as to two of the five GECAS counterclaims. Discovery was completed on September 15, 2007. The Court has set
a trial date of January 12, 2009 for this case. Management believes that the results of the counterclaims by GECAS will not have a material impact on the Companys financial position or results of operations.

Employment Lawsuits

Various claims
alleging employment discrimination, including race, sex, disability and age, have been made against the Company and its subsidiaries by current and former employees at its Birmingham, Alabama facility in proceedings before the EEOC and before state
and federal courts in Alabama. Workers compensation claims brought by employees are also pending in Alabama state court. The Company believes that none of these claims, individually or in the aggregate, are material to the Company 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. Management believes that the results of these claims will not have a material impact on 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, wells installed and favorable sampling events recorded. The Company compiled the
results and submitted a revised work plan to the agency which was accepted on July 30, 2004. The Media Clean-up Standard Report, as required, was submitted to the EPA in January 2005. 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 $100,000 related to the Phase II Plan at both June 30, 2008 and December 31, 2007, 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 $550,000, of which the Company had paid approximately $450,000 as of June 30, 2008. 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.

In March 2005, Pemco Aeroplex received notice from the
South Carolina Department of Health and Environmental Control (DHEC) that it was believed to be a potentially responsible party (PRP) with regard to contamination found on the Philips Service Corporation (PSC)
site located in Rock Hill, South Carolina. Pemco was listed as a PRP due to alleged use by the Company of contract services in disposal of hazardous substances. The Company joined a large group of existing PRP



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##### Table of Contents

notification recipients in retaining environmental counsel. The Company believes it is possible that paint chips were disposed of with this contractor
beginning in 1997. PSC filed for bankruptcy in 2003. The database of manifests located on-site at PSC has been reviewed and the waste-in compilations have been completed, but remain subject to revision. The PRP group continues to increase. In late
February, 2007, a cash out settlement offer was mailed to 2,100 PRPs that had sent 15,000 lbs or less to the site and a consent decree is currently being negotiated with them. The Company has not been notified of a cash-out opportunity to date
and remains a member of the continuing PRP group (Group), with a manifest estimation of 0.05% of waste at the site or 0.1% of the total of Group waste sent to the site. It is believed that the Companys potential liability will not
exceed $50,000. The Company believes it is adequately insured in this matter. Management believes that the resolution of the above matter will not have a material impact on the Companys financial position or results of operations.

In addition, in conjunction with the sale of Pemco World Air Services, Inc., formerly a wholly owned subsidiary of the Company (PWAS), to
WAS Aviation Services, Inc., an affiliate of Sun Capital Partners, Inc. (WAS), WAS and the Company contracted for division of any environmental liability that may be required to meet applicable environmental remediation standards at the
Companys former Dothan, Alabama facilities such that, in the event significant environmental remediation is required, WAS will bear the risk of the first $1.0 million dollars of such losses and the Company will bear the risk of any such losses
in excess of $1.0 million but not to exceed $2.0 million in the aggregate. As a result, WAS would be responsible for all losses in excess of $3.0 million. The funds required to meet the Companys obligations were escrowed for a five-year period
beginning September 19, 2007. No portion of the escrowed funds was considered as a portion of the gain recognized by the Company in connection with the sale of PWAS.

Furthermore, the Company is subject to various environmental regulations at the federal, state, and local levels, particularly with respect to the stripping, cleaning, and painting of aircraft. Compliance 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.

10. DISCONTINUED OPERATIONS

On September 19, 2007, the Company sold all of the outstanding
stock of PWAS to WAS. The sale was approved by the Companys stockholders on September 17, 2007. PWAS comprised substantially all of the CSS. In the second quarter of 2008, the Board of Directors approved a plan to divest the
Companys subsidiary, SVC, which comprised all of the MCS. The historical financial results of PWAS and SVC have been presented in the accompanying consolidated financial statements as discontinued operations for all periods presented.

In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the business
operations of PWAS and SVC are reported as discontinued operations and, accordingly, income from discontinued operations have been reported separately from continuing operations. Revenue and income from discontinued operations for the three- and
six-month periods ended June 30, 2008 and 2007, respectively, were as follows:

(In Thousands)



|                                                               |  |                    |        |                  |              |   |              |  |   |              |   |  |   |       
|-------------------------------------------------------------- |  | ------------------ | ------ | ---------------- | ------------ | - | ------------ |  | - | ------------ | - |  | - | ------
|                                                               |  | Three Months Ended |        | Six Months Ended
|                                                               |  | June 30,2008       |        |                  | June 30,2007 |   | June 30,2008 |  |   | June 30,2007
|                                                               |  | (In Thousands)     |        | (In Thousands)  
|Revenue from discontinued operations                           |  | $                  | 496    |                  |              | $ | 37,400       |  | $ | 2,015        |   |  | $ | 70,167
|(Loss) income before income taxes from discontinued operations |  | $                  | (1,378 | )                |              | $ | 3,028        |  | $ | (1,867       | ) |  | $ | 5,076 
|Income tax expense from discontinued operations                |  |                    |       |                  |              |   | 1,222        |  |   |             |   |  |   | 2,188 
|                                                               |  |                    |        |                  |              |   |              |  |   |              |   |  |   |       
|(Loss) income from discontinued operations                     |  | $                  | (1,378 | )                |              | $ | 1,806        |  | $ | (1,867       | ) |  | $ | 2,888 
|                                                               |  |                    |        |                  |              |   |              |  |   |              |   |  |   |       

Included within the results from discontinued operations is an allocation of interest expense.
Interest expense allocated to discontinued operations was approximately $2,000 and $5,000 for the three- and six-month periods ended June 30, 2008, respectively. Interest expense allocated to discontinued operations was approximately $869,000
and $1,684,000 for the three- and six-month periods ended June 30, 2007, respectively.



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##### Table of Contents

To conform with this presentation, all prior periods have been reclassified. As a result, the assets and
liabilities of the discontinued operations have been reclassified on the balance sheet from the historical classifications and presented under the captions assets of discontinued operations and liabilities of discontinued
operations, respectively.

As of June 30, 2008 and December 31, 2007, net assets of discontinued operations, consisted of
the following:

(In Thousands)



|                                                  |                |                         |       |   |                  |   |       |  
|------------------------------------------------- | -------------- | ----------------------- | ----- | - | ---------------- | - | ----- | -
|                                                  |                | June 30,2008(unaudited) |       |   | December 31,2007 |  
|                                                  | (In Thousands) |                        
|Cash overdraft                                    |                | $                       | (88   | ) |                  | $ | (49   | )
|Accounts receivable, net                          |                |                         | 3,770 |   |                  |   | 3,966 |  
|Inventories, net                                  |                |                         | 920   |   |                  |   | 1,487 |  
|Prepaid expenses and other                        |                |                         | 25    |   |                  |   | 33    |  
|                                                  |                |                         |       |   |                  |   |       |  
|Current assets                                    |                |                         | 4,627 |   |                  |   | 5,437 |  
|                                                  |                |                         |       |   |                  |   |       |  
|Property, plant and equipment, net                |                |                         | 396   |   |                  |   | 258   |  
|Deposits and other                                |                |                         | 57    |   |                  |   | 55    |  
|                                                  |                |                         |       |   |                  |   |       |  
|Non-current Assets                                |                |                         | 453   |   |                  |   | 313   |  
|                                                  |                |                         |       |   |                  |   |       |  
|Total assets                                      |                | $                       | 5,080 |   |                  | $ | 5,750 |  
|                                                  |                |                         |       |   |                  |   |       |  
|Current portion of long term debt                 |                | $                       | 44    |   |                  | $ | 75    |  
|Accounts payable                                  |                |                         | 203   |   |                  |   | 380   |  
|Accrued expenses                                  |                |                         | 131   |   |                  |   | 113   |  
|Customer deposits in excess of cost               |                |                         | 132   |   |                  |   | 51    |  
|                                                  |                |                         |       |   |                  |   |       |  
|Current Liabilities                               |                |                         | 510   |   |                  |   | 619   |  
|                                                  |                |                         |       |   |                  |   |       |  
|Long-term debt, less current portion              |                |                         |      |   |                  |   |      |  
|Long-term pension and post-retirement Liabilities |                |                         |      |   |                  |   |      |  
|Other long-term liabilities                       |                |                         |      |   |                  |   |      |  
|                                                  |                |                         |       |   |                  |   |       |  
|Non-current Liabilities                           |                |                         |      |   |                  |   |      |  
|                                                  |                |                         |       |   |                  |   |       |  
|Total liabilities                                 |                |                         | 510   |   |                  |   | 619   |  
|                                                  |                |                         |       |   |                  |   |       |  
|Net assets                                        |                | $                       | 4,570 |   |                  | $ | 5,131 |  
|                                                  |                |                         |       |   |                  |   |       |  

11. RESTRICTED CASH

Upon consummation of the sale of PWAS, the Company was required by Wachovia Bank to post cash collateral for an outstanding letter of credit covering workers compensation claims in the amount of approximately $1.2
million. The Companys workers compensation insurance carrier agreed to reduce the required letter of credit to $580,000 once PWAS secured a separate letter of credit for their workers compensation claims. In April 2008, PWAS secured a separate
letter of credit and the Company was able to reduce the letter of credit and the required collateral to $580,000. The restricted cash of $580,000 has no contractual release date and has been classified as long-term in the consolidated balance
sheets.

12. RELATED PARTY TRANSACTIONS

On April 23, 2002, the Company loaned Ronald A. Aramini, its President and Chief Executive Officer, approximately $0.4 million under the terms of a promissory note. The promissory note carried a fixed interest rate of 5% per annum
and was payable within 60 days of Mr. Araminis termination of employment with the Company. On March 26, 2007, Mr. Aramini paid the accumulated interest on the promissory note. On February 1, 2008, the Company forgave in
full the loan represented by the promissory note, including all accrued and unpaid interest to date, in recognition of Mr. Araminis dual role as Chief Executive Officer of the Company and as acting President of the Companys former
subsidiary, PWAS, including Mr. Araminis critical



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##### Table of Contents

role in the successful sale of PWAS. The Company recorded a charge to selling, general and administrative expenses for the forgiveness of the loan.



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##### Table of Contents

|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 the U.S. Government and military customers. The Companys services are
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.

The financial condition of the Company, which
operated as a subcontractor to the Boeing Company (Boeing), has been impacted by several extraordinary events in connection with the U.S. Air Force (USAF) KC-135 Program Depot Maintenance (PDM) program and the
related recompetition for the new KC-135 contract award. In summary, from May 2005 through June 2006, the Company worked in cooperation with Boeing to submit a proposal on the new KC-135 contract under a Memorandum of Agreement with Boeing
(MOA). After filing an initial proposal with the USAF, which included critical financial and operational information on the Companys KC-135 program, the Company believes Boeing breached the MOA due to the USAFs reducing the
number of aircraft in the request for proposal. As part of the Companys teaming arrangement with Boeing on the existing KC-135 contract, the Company had already spent several million dollars to meet Boeings new requirement that the
Company adopt its KC-135 methodology. From July 2006 to September 2007, the Company spent another million dollars preparing its own proposal for the new KC-135 contract. The Companys proposal for the KC-135 PDM program was unsuccessful as the
contract was awarded to Boeing in September 2007. The Company filed a protest with the Government Accountability Office (GAO) and the contract was stayed for 100 days pending the results of the protest. On December 27, 2007 the GAO
upheld in part the Companys protest on the basis that the USAF failed to conduct a proper analysis of Boeings cost/price proposal for realism or potential risk. The USAF filed a Request for Reconsideration on January 7, 2008, which
was denied by the GAO on February 1, 2008. On March 3, 2008, the USAF advised the GAO that in response to its recommendation by the GAO it had completed additional review and that the Companys proposal was not selected for award.
Company officials attended a debriefing from the USAF on the new award decision on March 7, 2008. The Company filed a protest on the new award decision on March 11, 2008 as to the USAFs lack of proper evaluation to meet GAO
recommendations and sudden post-award change of work scope under the contract recompete. On May 2, 2008, the GAO dismissed the change of work scope portion of the protest on the basis that the USAF has not made a determination regarding
potential changes to the contract requirements. The GAO decision provides the Company the right to re-submit its protest for consideration in the event the USAF subsequently pursues a course of action consistent with the Companys factual
allegations. On June 13, 2008, the GAO denied the remainder of the Companys March 11 protest. On June 27, 2008, the Company filed a complaint in the United States Court of Federal Claims (the Court) protesting the
actions of the Air Force in connection with the award to Boeing of the KC-135 PDM contract. On July 3, 2008, the Court granted Boeings motion to intervene in the case. On July 18, 2008, Boeing filed a motion to dismiss the
Companys complaint, asserting that the Company is not an interested party with respect to the contract award, to which the Company is currently preparing a response. On July 25, 2008, the Court issued an order granting in part the
Companys motion to supplement the administrative record and to take discovery. The Company also has filed a motion for judgment on the administrative record that is currently pending before the Court. The Company has expended substantial
financial resources in connection with these events.

In order to adjust for and mitigate the effects of the events discussed above, the Company has taken
several significant steps. On November 6, 2007 the Company officially qualified with the Small Business Administration as a small business for military contracts. The Company believes that this will provide vital opportunities for defense
contracts which were previously unavailable. Management has taken significant steps to reduce costs including headcount reductions, administrative cost reductions, freezing its defined benefit pension plan (the Pension Plan) for salaried
employees as of December 31, 2007, eliminating salary increases for 2008 and restructuring the medical and dental benefit plans. In addition, the Board of Directors, in a unified move to support the Company, agreed to a 50% reduction in all
Board fees in 2008.

If the new legal action in connection with the KC-135 PDM contract does not result in a positive outcome for the Company, it would
have a material adverse effect on the Companys financial condition and prospects, materially harm the Companys business and impair the value of its Common Stock. The Company and Boeing continue to be teamed on the KC-135 Bridge Contract
for which the USAF exercised a second six-month option to extend through September 30, 2008. There are no assurances that the Company will receive more than the eight aircraft already inducted during these two six-month extensions of the KC-135
Bridge Contract.



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##### Table of Contents

RESULTS OF OPERATIONS

Three months ended June 30, 2008 versus three months ended June 30, 2007

The table below presents major highlights from the three
months ended June 30, 2008 and 2007, excluding the results of discontinued operations except for net (loss) income.

(In Millions)



|                                             |  |      |       |   |      |   |       |          |  |        |   
|-------------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | -------- |  | ------ | --
|                                             |  | 2008 |       |   | 2007 |   |       | % Change | 
|Revenue                                      |  | $    | 12.51 |   |      | $ | 15.78 |          |  | (20.7  | )%
|Gross profit                                 |  |      | 1.21  |   |      |   | 0.68  |          |  | 77.9   | % 
|Operating loss from continuing operations    |  |      | (0.94 | ) |      |   | (1.79 | )        |  | 47.5   | % 
|Loss from continuing operations before taxes |  |      | (1.13 | ) |      |   | (1.98 | )        |  | 42.9   | % 
|Loss from continuing operations              |  |      | (1.06 | ) |      |   | (1.18 | )        |  | 10.2   | % 
|Net (loss) income                            |  |      | (2.44 | ) |      |   | 0.63  |          |  | (487.3 | )%
|EBITDA from continuing operations            |  |      | (0.52 | ) |      |   | (1.36 | )        |  | 61.8   | % 

The Company defines operating loss from continuing operations, as shown in the above table, as revenues less cost
of revenues, less selling, general and administrative expenses.

EBITDA from continuing operations for the quarters ended June 30, 2008 and 2007 was
calculated using the following approach:

(In Millions)



|                                  |  |      |       |   |      |   |       |  
|--------------------------------- |  | ---- | ----- | - | ---- | - | ----- | -
|                                  |  | 2008 |       |   | 2007 |  
|Loss from continuing operations   |  | $    | (1.06 | ) |      | $ | (1.18 | )
|Interest expense                  |  |      | 0.19  |   |      |   | 0.19  |  
|Taxes                             |  |      | (0.07 | ) |      |   | (0.80 | )
|Depreciation and amortization     |  |      | 0.42  |   |      |   | 0.43  |  
|                                  |  |      |       |   |      |   |       |  
|EBITDA from continuing operations |  | $    | (0.52 | ) |      | $ | (1.36 | )
|                                  |  |      |       |   |      |   |       |  

The Company presents Earnings Before Interest, Taxes, Depreciation and Amortization from continuing operations,
more commonly referred to as EBITDA from continuing operations, because its management uses the measure to evaluate the Companys performance and to allocate resources. In addition, the Company believes EBITDA is 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 operations 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 from continuing operations is not a measure of financial performance under generally accepted accounting principles in the United States (GAAP) and should not be
considered as a substitute for or superior to other measures of financial performance reported in accordance with GAAP. EBITDA from continuing operations as presented herein may not be comparable to similarly titled measures reported by other
companies.

The Companys 2008 second quarter revenue decreased $3.3 million as compared to 2007 second quarter revenue. Revenue from the KC-135 PDM
program decreased $1.4 million during the second quarter of 2008 versus the second quarter of 2007. The KC-135 program, which accounted for 82% of revenue in the second quarter of 2008 and 73% of revenue in the second quarter of 2007, allows for the
Company to provide services on PDM aircraft, drop-in aircraft, and other aircraft related areas. During each of the second quarter of 2008 and second quarter of 2007, the Company delivered three PDM aircraft and no drop-ins. Revenue decreased on the
KC-135 program in the second quarter of 2008 versus the second quarter of 2007 due to a decrease in the contractual price for each aircraft delivered. The Company did not deliver any P-3 aircraft in the second quarter of 2008 versus one P-3 aircraft
in the second



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##### Table of Contents

quarter of 2007, resulting in a decrease in P-3 revenue of $1.4 million. The Company is continuing to pursue additional contracts to perform maintenance
services on P-3 aircraft. Revenue decreased $0.5 million under contracts to perform non-routine maintenance work on other aircraft, primarily USAF C-130 aircraft.

Gross profit increased from $0.7 million during the second quarter of 2007 to $1.2 million during the second quarter of 2008. Gross profit on KC-135 revenue decreased $0.2 million due to decreased revenue. Cost of revenue on the KC-135
program decreased as a percentage of revenue due to increased efficiencies on the KC-135 maintenance line. Gross profit increased $0.9 million as a result of losses on the P-3 program recorded in the second quarter of 2007 for which there were no
comparable losses in the second quarter of 2008.

Selling, general and administrative (SG&A) expenses decreased $0.3 million during the
second quarter of 2008 compared to the second quarter of 2007. The Company made expense reductions of $0.9 million in the second quarter of 2008 as compared to the second quarter of 2007. These expense reductions were partially offset by $0.6
million of legal fees associated with the KC-135 contract protest and legal action. During the second quarter of 2007, the Company incurred $0.6 million of corporate SG&A expenses that previously had been allocated to PWAS and SVC for segment
reporting purposes. Under accounting principles generally accepted in the United States, these allocated amounts are recorded in continuing operations rather than discontinued operations.

Total interest expense, (including amounts that are included in discontinued operations of $0.9 million), decreased to $0.2 million in the second quarter of 2008 from
$1.1 million in the second quarter of 2007. Interest expense decreased primarily as a result of the extinguishment of a large portion of the Companys debt when PWAS was sold.

During the second quarter of 2008, the Company recorded income tax expense at an effective rate of 6.2% for continuing operations as a result of utilizing net operating loss carryforwards which previously were subject
to a deferred tax valuation allowance. At June 30, 2008 and December 31, 2007, all deferred tax assets were subject to a deferred tax valuation allowance. During the second quarter of 2007, the Company recorded income tax benefits at an
effective rate of 40.3%. The effective income tax rate is impacted by the allocation of taxable gains or losses between operations in Alabama and California. Net operating loss carry forwards for discontinued operations in California were subject to
a deferred tax valuation allowance in the second quarter of 2007.

Results from Discontinued Operations

Revenue at SVC decreased from $3.4 million in the second quarter of 2007 to $0.5 million in the second quarter of 2008. The decrease in revenue is due to the completion
or decreased scope of work on several engineering and manufacturing contracts. SVC recorded $1.4 million in losses in the second quarter of 2008 as a result of the decrease in revenue and for cost overruns on a material battery contract.

Six months ended June 30, 2008 versus six months ended June 30, 2007

The table below presents major highlights from the six months ended June 30, 2008 and 2007, excluding the results of discontinued operations except for net (loss) income.

(In Millions)



|                                                      |  |      |       |   |      |   |       |          |  |        |   
|----------------------------------------------------- |  | ---- | ----- | - | ---- | - | ----- | -------- |  | ------ | --
|                                                      |  | 2008 |       |   | 2007 |   |       | % Change | 
|Revenue                                               |  | $    | 32.12 |   |      | $ | 35.41 |          |  | (9.3   | )%
|Gross profit                                          |  |      | 5.80  |   |      |   | 3.36  |          |  | 72.6   | % 
|Operating income (loss) from continuing operations    |  |      | 0.76  |   |      |   | (2.03 | )        |  | 137.4  | % 
|Income (loss) from continuing operations before taxes |  |      | 0.36  |   |      |   | (2.40 | )        |  | 115.0  | % 
|Income (loss) from continuing operations              |  |      | 0.26  |   |      |   | (1.37 | )        |  | 119.0  | % 
|Net (loss) income                                     |  |      | (1.61 | ) |      |   | 1.52  |          |  | (205.9 | )%
|EBITDA from continuing operations                     |  |      | 1.70  |   |      |   | (1.17 | )        |  | 245.3  | % 

The Company defines operating income (loss) from continuing operations, as shown in the above table, as revenues
less cost of revenues, less selling, general and administrative expenses.

EBITDA from continuing operations for the six months ended June 30, 2008
and 2007 was calculated using the following approach:

(In Millions)



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##### Table of Contents

|                                         |  |      |      |      |   |       |  
|---------------------------------------- |  | ---- | ---- | ---- | - | ----- | -
|                                         |  | 2008 |      | 2007 |  
|Income (loss) from continuing operations |  | $    | 0.26 |      | $ | (1.37 | )
|Interest expense                         |  |      | 0.40 |      |   | 0.38  |  
|Taxes                                    |  |      | 0.10 |      |   | (1.04 | )
|Depreciation and amortization            |  |      | 0.94 |      |   | 0.86  |  
|                                         |  |      |      |      |   |       |  
|EBITDA from continuing operations        |  | $    | 1.70 |      | $ | (1.17 | )
|                                         |  |      |      |      |   |       |  

The Companys revenue for the first six months of 2008 declined $3.3 million from revenue for the first six
months of 2007. Revenue from the KC-135 PDM program increased $0.4 million during the first six months of 2008 versus the first six months of 2007. The KC-135 program, which accounted for 82% of revenue in the first six months of 2008 and 73% of
revenue in the first six months of 2007, allows for the Company to provide services on PDM aircraft, drop-in aircraft, and other aircraft related areas. During each of the first six months of 2008 and first six months of 2007, the Company delivered
seven PDM aircraft and no drop-ins. Revenue increased on the KC-135 program in the first six months of 2008 versus the first six months of 2007 due to an increase in the contractual price for each aircraft delivered. The Company delivered one P-3
aircraft in the first six months of 2008 versus three P-3 aircraft in the first six months of 2007, resulting in a decrease in P-3 revenue of $2.5 million. The Company is continuing to pursue additional contracts to perform maintenance services on
P-3 aircraft. Revenue decreased $1.2 million under contracts to perform non-routine maintenance work on other aircraft, primarily USAF C-130 aircraft.

Gross profit increased from $3.4 million during the first six months of 2007 to $5.8 million during the first six months of 2008. Gross profit on KC-135 revenue increased $1.4 million due to increased revenue and improvements in
productivity. Cost of revenue on the KC-135 program decreased as a percentage of revenue due to increased efficiencies on the KC-135 maintenance line. Gross profit increased $1.1 million as a result of losses on the P-3 program in the first six
months of 2007 for which there were no comparable losses in the first six months of 2008.

SG&A expenses decreased $0.3 million during the first six
months of 2008 compared to the first six months of 2007. The Company made expense reductions of $1.8 million in the first six months of 2008 as compared to the first six months of 2007. These expense reductions were partially offset by $1.0 million
of legal fees associated with the KC-135 contract protest and legal action. Also, during the first six months of 2008, the Company forgave a related party receivable and accrued interest of $0.5 million (See RELATED PARTY
TRANSACTIONS below). During the first six months of 2007, the Company incurred $1.6 million of corporate SG&A expenses that previously had been allocated to PWAS and SVC for segment reporting purposes. Under accounting principles
generally accepted in the United States, these allocated amounts are recorded in continuing operations rather than discontinued operations.

Total interest
expense, (including amounts that are included in discontinued operations of $1.7 million), decreased to $0.4 million in the first six months of 2008 from $2.1 million in the first six months of 2007. Interest expense decreased primarily as a result
of extinguishing a large portion of the Companys debt when PWAS was sold.

During the first six months of 2008, the Company recorded income tax
expense at an effective rate of 28.7% for continuing operations as a result of utilizing net operating loss carryforwards which previously were subject to a deferred tax valuation allowance. At June 30, 2008 and December 31, 2007, all
deferred tax assets were subject to a deferred tax valuation allowance. During the first six months of 2007, the Company recorded income tax benefits at an effective rate of 43.1%. The effective income tax rate is impacted by the allocation of
taxable gains or losses between operations in Alabama and California. Net operating loss carry forwards for discontinued operations in California were subject to a deferred tax valuation allowance in the first six months of 2007.

Results from Discontinued Operations

Revenue at SVC decreased from
$5.0 million in the first six months of 2007 to $2.0 million in the first six months of 2008. The decrease in revenue is due to the completion or decreased scope of work on several engineering and manufacturing contracts. SVC recorded $1.9 million
in losses in the first six months of 2008 as a result of the decrease in revenue and for cost overruns on a material battery contract.

LIQUIDITY AND
CAPITAL RESOURCES

General

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



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(In Thousands, Except Ratios)



|                                   |  |              |        |                  |   |        |  |   |        |  
|---------------------------------- |  | ------------ | ------ | ---------------- | - | ------ |  | - | ------ | -
|                                   |  | June 30,2008 |        | December 31,2007 |   | Change | 
|Cash                               |  | $            | 12,357 |                  | $ | 8,799  |  | $ | 3,558  |  
|Working capital                    |  |              | 12,568 |                  |   | 16,193 |  |   | (3,625 | )
|Debt and capital lease obligations |  |              | 5,004  |                  |   | 5,007  |  |   | (3     | )
|Stockholders equity               |  |              | 16,176 |                  |   | 16,326 |  |   | (150   | )
|Debt to equity ratio               |  |              | 0.31   |                  |   | 0.31   |  |   | 0.00   |  

Working Capital

The Company has no current arrangements with respect to sources of additional financing, and its negative results of operations in prior years and the current lack of long-term contracts, exacerbated by the current state of the credit
markets, will likely make it more difficult and expensive for the Company to raise additional capital that may be necessary to continue its operations.

The Companys primary sources of liquidity and capital resources include cash-on-hand, cash flows from operations (primarily from collection of accounts receivables and conversion of work-in-process inventory to cash) and potential
borrowing capability through lenders. Principal factors affecting the Companys liquidity and capital resources position include, but are not limited to, the following: results of operations; the results of the Companys legal action
protesting the U.S. Air Force (USAF) award of the KC-135 contract to Boeing; collection of accounts receivable; funding requirements associated with the Companys defined benefit pension plan; settlements of various claims; and
potential divestitures. The Company anticipates that cash-on-hand will be sufficient to fund operations, make minimal capital expenditures and make scheduled payments on debt obligations for the next twelve months. The Company does not have
sufficient cash to make the required contributions to its defined benefit pension plan without negatively impacting the cash and liquidity of the Company during the first quarter of 2009. Therefore, the Company applied on February 29, 2008 to
the Internal Revenue Service for a waiver of contributions for the 2007 plan year which concludes on September 15, 2008. Without a waiver of contributions, the Company would be required to contribute approximately $3.7 million for the 2007 plan
year by September 15, 2008. Contribution calculations for the 2008 plan year have not been completed. However, the Company currently estimates that the quarterly payments for the 2008 plan year will be approximately $1.1 million to $1.2
million, with the first quarterly payment due April 15, 2008. The Company did not make the first quarterly contribution due April 15, 2008 nor the second quarterly payment due July 15, 2008. The Company has until September 15,
2009 to make the required contributions for the 2008 plan year.

Several events could significantly impact the generation, availability and uses of cash
over the next twelve months including:



| |  |  | whether the Company is successful in its legal action protesting the USAF award of the KC-135 contract to Boeing that is pending before the U.S. Court of Federal
Claims;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | whether the Company is granted a waiver of contributions to its defined benefit plan for the 2007 plan year;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | whether the Company applies for and is granted a waiver of contributions to its defined benefit plan for the 2008 plan year;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | whether the Company is successful in selling its subsidiary, SVC;
| | - |  | -----------------------------------------------------------------



| |  |  | whether the Company is successful in winning individual task orders for C-130 maintenance services as a subcontractor with its teammates on an indefinite quantity,
indefinite delivery contract awarded in July 2008;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | whether the Company is able to win additional contracts, including in part as a result of qualifying with the Small Business Administration as a small business
under certain North American Industry Classification System codes;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | whether the Company is able to obtain additional financing from lenders to fund working capital increases that may be necessary if additional contracts are won; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | whether the $5.0 million Senior Secured Note which matures on February 15, 2009 is extended.
| | - |  | --------------------------------------------------------------------------------------------

There are no assurances that the Company will be successful in any of these respects and negative outcomes could adversely impact the Companys ability to meet
financial obligations as they become due.

Cash Flow Overview

Operating activities provided $3.9 million during the first six months of 2008, compared to $1.4 million during the first six months of 2007. Cash payments to fund the Companys Pension Plan exceeded pension expense by $2.0 million in
the first six months of 2007 versus pension expense exceeding contributions to the Pension Plan by $1.1 million in the first six months of 2008 due to the



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Company not making any contributions in 2008. The reduction of accounts receivable and inventories, partially offset by a reduction of accounts payable and
accrued liabilities, provided $2.7 million of cash in the first six months of 2008. Cash of $0.3 million and $0.4 million was used during the first six months of 2008 and 2007, respectively, for minimal capital expenditures. Financing activities
used $1.0 million in the first six months of 2007, as the Company used $1.0 million to service the revolving credit facility and long-term debt during the first six months of 2007.

Future Capital Requirements

The Companys potential capital requirements over the next twelve months include:
required minimum funding of the Pension Plan (noted below), principal and interest payments of long-term debt, the cost of the legal action protesting the award of the KC-135 PDM contract to Boeing, and working capital required to fund increases in
accounts receivable, inventory and equipment if the Company is awarded new contracts.

The Pension Plan covers substantially all employees at the
Companys Birmingham, Alabama facility. The Pension Plans assets consist primarily of equity mutual funds, bond mutual funds, hedge funds 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 Pension Plan during 2002 and 2001, coupled with an increase in actuarial liability resulting from lower interest rates, increased mortality rates and the terms
of the collective bargaining agreements entered into in 2005, the Pension Plan was under-funded by approximately $9.2 million and $18.8 million at December 31, 2007 and 2006, respectively.

The Company does not have sufficient cash to make the required contributions to the Pension Plan without negatively impacting the cash and liquidity of the Company
during the first quarter of 2009. Therefore, the Company applied on February 29, 2008 to the Internal Revenue Service for a waiver of contributions for the 2007 plan year which concludes on September 15, 2008. Without a waiver of
contributions, the Company would be required to contribute approximately $3.7 million for the 2007 plan year by September 15, 2008. While contribution calculations for the 2008 plan year have not been completed, the Company currently estimates
that the quarterly payments for the 2008 plan year will be approximately $1.1 million to $1.2 million, with the first quarterly payment due April 15, 2008. The Company did not make the first quarterly contribution due April 15, 2008 nor
the second quarterly payment due July 15, 2008. The Company has until September 15, 2009 to make the required contributions for the 2008 plan year. There are no assurances that the waiver will be granted. If the waiver is not granted, the
Company may not have sufficient internal resources to fund operations for the next twelve months and will have to pursue external financing which may or may not be available.

Senior Secured Debt

On February 15, 2006, the Company entered into a Note Purchase Agreement with Silver Canyon
Services, Inc. (Silver Canyon) pursuant to which the Company issued to Silver Canyon a senior secured note in the principal amount of $5.0 million (the Note). The Note accrues interest at an annual rate of 15%, which is
payable quarterly in arrears beginning March 1, 2006. The Company may, at its election, redeem the Note at a price equal to 100% of the principal amount then outstanding, together with accrued and unpaid interest thereon. The Note contains
customary events of default and the payment of all outstanding principal, interest and other amounts owed under the Note may be declared immediately due and payable by the lender upon the occurrence of an event of default, subject to certain
standstill provisions. On July 31, 2006, Silver Canyon sold the Note and assigned the Note Purchase Agreement to the Special Value Bond Fund, LLC, which is managed by Tennenbaum Capital Partners, LLC, a related party of the Company. On
February 15, 2007, the Company entered into an Amended and Restated Senior Secured Note with Special Value Bond Fund, LLC, pursuant to which the maturity date for the principal amount of the Note was extended to the earlier of
(1) February 15, 2008, or (2) the date on which amounts outstanding under the Companys revolving credit facility become due and payable. In addition, the Company executed Amendment No. 1 to the Note Purchase Agreement with
Special Value Bond Fund, LLC, to confirm a revised maturity date for the Note. On July 31, 2007, the Company entered into an Amended and Restated Senior Secured Note with Special Value Bond Fund, LLC, in which the maturity date for the
principal amount of the Note was extended until February 15, 2009. All other terms and conditions of the Note and the Note Purchase Agreement remain the same. There are no assurances that the maturity date of the Note will be extended again,
and payment of the Note could negatively impact the cash and liquidity of the Company during the first quarter of 2009.

Funding Sources

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 using existing cash and cash equivalents, the incurrence of additional indebtedness through secured or unsecured borrowings and the reinvestment of proceeds from the potential disposition of
SVC. Additional capital may not be available at all, or may not be available on terms favorable to the Company. While not planned, any additional issuance of equity or equity-linked securities through the sale of equity or
debt securities through public offerings or private placements may result in substantial dilution to the Companys stockholders. The Company is continually monitoring and



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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 generally been in a consolidation phase. As a consequence, the Company sometimes receives and sometimes initiates
inquiries with respect to corporate combinations. However, there can be no assurances that the Company will be party to any such transactions in the future.

RELATED PARTY TRANSACTIONS

On April 23, 2002, the Company loaned Ronald A. Aramini, its President and Chief Executive Officer,
approximately $0.4 million under the terms of a promissory note. The promissory note carried a fixed interest rate of 5% per annum and was payable within 60 days of Mr. Araminis termination of employment with the Company. On
March 26, 2007, Mr. Aramini paid the accumulated interest on the promissory note. On February 1, 2008, the Company forgave in full the loan represented by the promissory note, including all accrued and unpaid interest to date, in
recognition of Mr. Araminis dual role as Chief Executive Officer of the Company and as acting President of the Companys former subsidiary, PWAS, including Mr. Araminis critical role in the successful sale of PWAS.

On December 28, 2006, the Company and Mr. Aramini entered into a Second Amendment (the Second Amendment), to the Executive Deferred
Compensation Agreement, dated as of May 3, 2002 (the Agreement), between the Company and Mr. Aramini. The Agreement, as amended, provided for annual contributions by the Company to an associated rabbi trust for the benefit of
Mr. Aramini over the term of his employment agreement. The Company contributed $359,861 during January 2007 for the 2006 calendar year. Pursuant to the Second Amendment to the Agreement, the Companys obligation to make a final $380,326
lump sum trust contribution for the 2007 calendar year was eliminated. Company contributions to the trust are invested by the trustee and are to be disbursed to Mr. Aramini in accordance with the terms of the Agreement. In February 2008, the
Plan disbursed approximately $2.1 million to Mr. Aramini from the deferred compensation plan assets, thereby reducing the deferred compensation plan liabilities by $2.1 million.

As discussed above, on February 15, 2006, the Company entered into a Note Purchase Agreement with Silver Canyon, pursuant to which the Company issued the Note to Silver Canyon. On July 31, 2006, Silver
Canyon assigned the Note Purchase Agreement and sold the Note to Special Value Bond Fund, LLC, which is managed by Tennenbaum Capital Partners, LLC. Michael E. Tennenbaum is the Senior Partner of Tennenbaum Capital Partners, LLC and is Chairman of
the Board of Directors of the Company. The Note Purchase Agreement was amended on July 31, 2007 to extend the maturity date of the Note to February 15, 2009.

INTERNAL CONTROLS AND PROCEDURES

The Company experienced a significant level of turnover of financial personnel in
2007 and 2008 and experienced a reduction of full-time finance employees. As a result thereof, the Company determined that the material weakness due to the lack of financial resources remained at June 30, 2008 and December 31, 2007. The
Company re-evaluated the staffing of its accounting function both in terms of number of personnel and level of expertise during the second quarter of 2008. As a result of this re-evaluation, the Company has added an additional certified public
accountant and a senior accountant to its staff of accounting personnel to address the lack of resources in the financial close and reporting processes. In addition, the Company believes the sale of PWAS will simplify the financial reporting in 2008
and future periods. Except as noted above, there have been no changes to the Companys internal control over financial reporting that occurred during the Companys six months ended June 30, 2008 that have materially affected or that
are reasonably likely to materially affect the Companys internal control over financial reporting.

CRITICAL ACCOUNTING POLICIES

Managements discussion and analysis of financial condition and results of operations is based upon the consolidated financial statements, which have been
prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities at the date of the consolidated financial statements and the reported amount of revenues and expenses during the reporting period. Actual results may differ from these estimates under different assumptions or
conditions.



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At least quarterly, management reevaluates its judgments and estimates which are based on historical experience, current trends and various other assumptions
that are believed to be reasonable under the circumstances.

Our critical accounting policies are included in our Annual Report on Form 10-K for the year
ended December 31, 2007. We believe that there have been no significant changes during the six months ended June 30, 2008 to the critical accounting policies disclosed in the Annual Report on Form 10-K for the year ended December 31,
2007.

BACKLOG

The following table presents the
Companys backlog from continuing operations at June 30, 2008 and December 31, 2007:

(In Thousands)



|                |  |              |        |                  |   |       
|--------------- |  | ------------ | ------ | ---------------- | - | ------
|Customer Type   |  | June 30,2008 |        | December 31,2007
|KC-135 Aircraft |  | $            | 12,233 |                  | $ | 24,945
|C-130 Aircraft  |  |              | 1,111  |                  |   | 2,160 
|P-3 Aircraft    |  |              |       |                  |   | 1,274 
|                |  |              |        |                  |   |       
|Total           |  | $            | 13,344 |                  | $ | 28,379
|                |  |              |        |                  |   |       

Total backlog decreased $15.0 million during the first half of 2008. Substantially all of the Companys
contracts are in the final completion phase. The Company has proposed and is expecting to continue to propose on several U.S. Government programs in the next twelve months. The Company expects that several U.S. Government program awards will be made
by the end of the U.S. Governments fiscal year which ends on September 30, 2008. However, there can be no assurance that the Company will receive any of these awards.

CONTINGENCIES

See Note 9 to the Consolidated Financial Statements.

FORWARD-LOOKING STATEMENTSCAUTIONARY LANGUAGE

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 are forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995 (set forth in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended). 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, may, will,
should, could and similar expressions are generally intended to identify forward-looking statements. Because these forward-looking statements involve risks and uncertainties, there are important factors discussed under
Item 1A. Risk Factors in this Quarterly Report on Form 10-Q and in the Companys 2007 Annual Report on Form 10-K, which 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 not exposed to market risk from changes in interest rates as part of its normal operations as it has no variable rate debt outstanding.



|Item 4T. | 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 SEC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



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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 June 30, 2008, the end of the period covered by this report. Based on that evaluation and the issues discussed below, the Companys
Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures were not effective at the reasonable assurance level as of June 30, 2008.

(b)Changes in internal control over financial reporting.

In
addition to managements evaluation of disclosure controls and procedures as discussed above, in connection with the audit of the Companys financial statements for the fiscal year ended December 31, 2007, the Company is continuing to
review and enhance policies and procedures involving accounting, information systems and monitoring.

The Company experienced a significant level of
turnover of financial personnel in 2007 and 2008 and experienced a reduction of full-time finance employees. As a result thereof, the Company determined that the material weakness due to the lack of financial resources existed at June 30, 2008
and December 31, 2007. The Company re-evaluated the staffing of its accounting function both in terms of number of personnel and level of expertise during the second quarter of 2008. As a result of this re-evaluation, the Company has added an
additional certified public accountant and a senior accountant to its staff of accounting personnel to address the lack of resources in the financial close and reporting processes. In addition, the Company believes the sale of PWAS will simplify the
financial reporting in 2008 and future periods.

Except as noted above, there have been no changes to the Companys internal control over financial
reporting that occurred during the Companys six months ended June 30, 2008 that have materially affected or that are reasonably likely to materially affect the Companys internal control over financial reporting.



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PART II OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------

See Note 9 to the Consolidated Financial
Statements.



|Item 1A. | Risk Factors
|-------- | ------------

There have been no material changes from the Risk
Factors previously disclosed in the Companys 2007 Annual Report on Form 10-K, other than with respect to the following risk factor, which has been revised to reflect that the Government Accountability Office has dismissed the Companys
protest of the award of the USAF KC-135 contracts and that the Company has filed a complaint with the United States Court of Federal Claims protesting the actions of the Air Force in connection with the award to Boeing of the KC-135-PDM contract.

All of the Companys Revenues is Derived From a Few Contracts, and the Termination or Failure to Renew Any of Them Could Materially Harm the
Companys Business.

A small number of contracts accounts for all of the Companys revenues. Contracts with the U.S. Government comprised
approximately 100% of the Companys revenues from continuing operations during 2008 and 2007. The USAF KC-135 PDM program in and of itself accounted for 82% of revenue in the first six months of 2008 and 73% of revenue in the first six months
of 2007. Termination of a contract, a dispute over compliance with contract terms, a disruption of any of these contracts (including option years not being exercised), or the inability of the Company to renew or replace any of these contracts when
they expire, could materially harm its business and impair the value of its Common Stock.

Boeing LSS and AAII-Birmingham agreed to continue as partners on
the KC-135 PDM program during August 2005. This agreement resulted from the USAF decision to re-compete the KC-135 PDM contract. In the spring of 2006, the USAF changed the best estimated quantity (BEQ) for the competition for the
follow-on contract from 44 to 24 aircraft annually. With this reduction, Boeing purported to terminate the Boeing/AAII-Birmingham teaming agreement. The Company requested, and the government agreed, to open the competition to additional potential
suppliers. GSS developed an independent proposal which was submitted to the USAF in September 2006. A Request for a Final Proposal Revision was released by the USAF in mid-January 2007, to which the Company responded on February 23, 2007. The
Companys proposal for the KC-135 PDM program was unsuccessful as the contract was awarded to Boeing in September 2007. The Company filed a protest with the Government Accountability Office (GAO) and the contract was stayed for 100
days pending the results of the protest. On December 27, 2007 the GAO upheld in part the Companys protest on the basis that the USAF failed to conduct a proper analysis of Boeings cost/price proposal for realism or potential risk.
The USAF filed a Request for Reconsideration on January 7, 2008, which was denied by the GAO on February 1, 2008. On March 3, 2008, the USAF advised the Company that in response to the recommendation by the GAO it had completed
additional review, documentation and a new award decision and that the Companys proposal was not selected for award. Company officials attended a debriefing from the USAF on the new award decision on March 7, 2008. The Company filed a
protest on the new award decision on March 11, 2008 as to the USAFs lack of proper evaluation to meet GAO recommendations and sudden post-award change of work scope under the contract recompete. On May 2, 2008, the GAO dismissed the
change-of-work protest on the basis that the USAF has not made a determination regarding potential changes to the contract requirements. The GAO decision provides the Company the right to re-submit its protest for consideration in the event the USAF
subsequently pursues a course of action consistent with the Companys factual allegations. On June 13, 2008, the GAO denied the remainder of the Companys March 11 protest. On June 27, 2008, the Company filed a complaint in
the United States Court of Federal Claims (the Court) protesting the actions of the Air Force in connection with the award to Boeing of the KC-135 PDM contract. On July 3, 2008, the Court granted Boeings motion to intervene in
the case. On July 18, 2008, Boeing filed a motion to dismiss the Companys complaint, asserting that the Company is not an interested party with respect to the contract award, to which the Company is currently preparing a response. On
July 25, 2008, the Court issued an order granting in part the Companys motion to supplement the administrative record and to take discovery. The Company also has filed a motion for judgment on the administrative record that is currently
pending before the Court. The Company has expended substantial financial resources in connection with these events. If the protest does not result in a positive outcome for the Company, it could have a material adverse effect on the Companys
financial condition and prospects, materially harm the Companys business and impair the value of its Common Stock.

The Company is a Party to
Legal Proceedings that Could be Costly to Resolve or the Outcome of which Could have a Material Adverse Effect on the Companys Financial Condition and Prospects, Materially Harm the Companys Business and Impair the Value of its Common
Stock.

The Company is exposed to legal claims relating to the services it provides. The Company is currently a party to several legal proceedings,
including breach of contract claims and claims based on the Companys employment practices. While the Company maintains insurance covering many risks from its business, the insurance may not cover all relevant claims or may not provide



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##### Table of Contents

sufficient coverage. If the Companys insurance coverage does not cover all costs resulting from these claims, an adverse determination on these claims
could materially harm the Companys business and impair the value of its Common Stock. In addition, On June 27, 2008, the Company filed a complaint in the United States Court of Federal Claims (the Court) protesting the actions
of the Air Force in connection with the award to Boeing of the KC-135 PDM contract. On July 3, 2008, the Court granted Boeings motion to intervene in the case. On July 18, 2008, Boeing filed a motion to dismiss the Companys
complaint, asserting that the Company is not an interested party with respect to the contract award, to which the Company is currently preparing a response. On July 25, 2008, the Court issued an order granting in part the Companys motion
to supplement the administrative record and to take discovery. The Company also has filed a motion for judgment on the administrative record that is currently pending before the Court. If the protest does not result in a positive outcome for the
Company, it could have a material adverse effect on the Companys financial condition and prospects, materially harm the Companys business and impair the value of its Common Stock.



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

The
Companys Annual Meeting of Stockholders was held on May 15, 2008. At the meeting, stockholders elected Hugh Steven Wilson and Thomas C. Richards as Class II directors to serve until 2011.

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



|                   |  |           |  |         
|------------------ |  | --------- |  | --------
|Nominee            |  | For       |  | Withheld
|Hugh Steven Wilson |  | 3,333,562 |  | 66,172  
|Thomas C. Richards |  | 3,373,743 |  | 25,991  

Robert E. Joyal and Michael E. Tennenbaum continued in office as members of the Board of Directors with their
terms expiring at the 2009 Annual Meeting of Stockholders. Ronald A. Aramini, Harold T. Skip Bowling and Ronald W. Yates continued in office as members of the Board of Directors with their terms expiring at the 2010 Annual Meeting of
Stockholders.



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|Item 6. | Exhibits
|------- | --------



|              |  |                                                                                                                         
|------------- |  | ------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                             
|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.



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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.



|                       |  |                                   |  |                                                                             
|---------------------- |  | --------------------------------- |  | ----------------------------------------------------------------------------
|                       |  | ALABAMA AIRCRAFT INDUSTRIES, INC.
|                       |  |                                  
|Dated: August 14, 2008 |  | By:                               |  | /s/ Ronald A. Aramini                                                       
|                       |  |                                   |  | Ronald A. Aramini, President                                                
|                       |  |                                   |  | and Chief Executive Officer (Principal Executive Officer)                   
|                       |  |                                  
|Dated: August 14, 2008 |  | By:                               |  | /s/ Randall C. Shealy                                                       
|                       |  |                                   |  | Randall C. Shealy, Senior Vice President and                                
|                       |  |                                   |  | Chief Financial Officer (Principal Financial Officer and Accounting Officer)



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