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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 September 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.



|                        |  |                                                  |  |                           |  |  
|----------------------- |  | ------------------------------------------------ |  | ------------------------- |  | -
|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 November 10, 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-September 30, 2008 (Unaudited) and December 31, 2007                       |  | 1   
|                              |  |                                                                                                       
|                              |  | Unaudited Consolidated Statements of Operations For The Three Months Ended September 30, 2008 and 2007 |  | 3   
|                              |  |                                                                                                       
|                              |  | Unaudited Consolidated Statements of Operations For The Nine Months Ended September 30, 2008 and 2007  |  | 4   
|                              |  |                                                                                                       
|                              |  | Unaudited Consolidated Statements of Cash Flows For The Nine Months ended September 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                                             |  | 26  
|                              |  |                                                                                                       
|Item 4T.                      |  | Controls and Procedures                                                                                |  | 26  
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                                       
|                              |  |                                                                                                       
|Item 1.                       |  | Legal Proceedings                                                                                      |  | 27  
|                              |  |                                                                                                       
|Item 1A.                      |  | Risk Factors                                                                                           |  | 27  
|                              |  |                                                                                                       
|Item 6.                       |  | Exhibits                                                                                               |  | 29  
|                              | 
|SIGNATURES                    |  | 30                                                                                                    



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##### Table of Contents

PART I. FINANCIAL INFORMATION



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

ALABAMA AIRCRAFT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

ASSETS

(In Thousands)



|                                               |  |                              |         |   |                  |   |         |  
|---------------------------------------------- |  | ---------------------------- | ------- | - | ---------------- | - | ------- | -
|                                               |  | September 30,2008(Unaudited) |         |   | December 31,2007 |  
|Current assets:                                |  |                              |         |   |                  |   |         |  
|Cash and cash equivalents                      |  | $                            | 7,795   |   |                  | $ | 8,799   |  
|Accounts receivable, net                       |  |                              | 5,881   |   |                  |   | 7,397   |  
|Inventories, net                               |  |                              | 4,339   |   |                  |   | 6,317   |  
|Prepaid expenses and other                     |  |                              | 1,002   |   |                  |   | 620     |  
|Assets of discontinued operations              |  |                              | 3,609   |   |                  |   | 5,437   |  
|                                               |  |                              |         |   |                  |   |         |  
|Total current assets                           |  |                              | 22,626  |   |                  |   | 28,570  |  
|                                               |  |                              |         |   |                  |   |         |  
|Machinery, equipment and improvements at cost: |  |                              |         |   |                  |   |         |  
|Machinery and equipment                        |  |                              | 20,677  |   |                  |   | 20,637  |  
|Leasehold improvements                         |  |                              | 18,921  |   |                  |   | 18,719  |  
|Construction-in-process                        |  |                              |        |   |                  |   | 31      |  
|                                               |  |                              |         |   |                  |   |         |  
|                                               |  |                              | 39,598  |   |                  |   | 39,387  |  
|Less accumulated depreciation and amortization |  |                              | (28,010 | ) |                  |   | (26,808 | )
|                                               |  |                              |         |   |                  |   |         |  
|Net machinery, equipment and improvements      |  |                              | 11,588  |   |                  |   | 12,579  |  
|                                               |  |                              |         |   |                  |   |         |  
|Other non-current assets:                      |  |                              |         |   |                  |   |         |  
|Deposits and other                             |  |                              | 973     |   |                  |   | 3,158   |  
|Restricted cash-letter of credit               |  |                              | 586     |   |                  |   | 1,235   |  
|Related party receivable                       |  |                              |        |   |                  |   | 440     |  
|Assets of discontinued operations              |  |                              | 452     |   |                  |   | 313     |  
|                                               |  |                              |         |   |                  |   |         |  
|Total other non-current assets                 |  |                              | 2,011   |   |                  |   | 5,146   |  
|                                               |  |                              |         |   |                  |   |         |  
|Total assets                                   |  | $                            | 36,225  |   |                  | $ | 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)



|                                                                                                                                 |  |                              |         |   |                  |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                 |  | September 30,2008(Unaudited) |         |   | December 31,2007 |  
|Current liabilities:                                                                                                             |  |                              |         |   |                  |   |         |  
|Current portion of long-term debt                                                                                                |  | $                            | 5,003   |   |                  | $ | 5       |  
|Accounts payabletrade                                                                                                           |  |                              | 2,107   |   |                  |   | 3,060   |  
|Accrued health and dental                                                                                                        |  |                              | 364     |   |                  |   | 491     |  
|Accrued liabilitiespayroll related                                                                                              |  |                              | 2,684   |   |                  |   | 2,845   |  
|Accrued liabilitiesother                                                                                                        |  |                              | 1,074   |   |                  |   | 1,700   |  
|Customer deposits in excess of cost                                                                                              |  |                              | 3,020   |   |                  |   | 3,657   |  
|Liabilities of discontinued operations                                                                                           |  |                              | 566     |   |                  |   | 619     |  
|                                                                                                                                 |  |                              |         |   |                  |   |         |  
|Total current liabilities                                                                                                        |  |                              | 14,818  |   |                  |   | 12,377  |  
|                                                                                                                                 |  |                              |         |   |                  |   |         |  
|Long-term debt, less current portion                                                                                             |  |                              |        |   |                  |   | 5,002   |  
|Long-term pension and post-retirement benefit liabilities                                                                        |  |                              | 5,541   |   |                  |   | 9,654   |  
|Other long-term liabilities                                                                                                      |  |                              | 763     |   |                  |   | 2,936   |  
|                                                                                                                                 |  |                              |         |   |                  |   |         |  
|Total liabilities                                                                                                                |  |                              | 21,122  |   |                  |   | 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 September 30, 2008 and December 31, 2007 |  |                              | 1       |   |                  |   | 1       |  
|Additional paid-in capital                                                                                                       |  |                              | 15,287  |   |                  |   | 15,067  |  
|Retained earnings                                                                                                                |  |                              | 27,002  |   |                  |   | 30,358  |  
|Treasury stock, at cost  413,398 shares at September 30, 2008 and December 31, 2007                                             |  |                              | (8,623  | ) |                  |   | (8,623  | )
|Accumulated other comprehensive loss:Pension and post-retirement liabilities                                                     |  |                              | (18,564 | ) |                  |   | (20,477 | )
|                                                                                                                                 |  |                              |         |   |                  |   |         |  
|Total stockholders equity                                                                                                       |  |                              | 15,103  |   |                  |   | 16,326  |  
|                                                                                                                                 |  |                              |         |   |                  |   |         |  
|Total liabilities and stockholders equity                                                                                       |  | $                            | 36,225  |   |                  | $ | 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 EndedSeptember 30,2008 |        |   | ThreeMonths EndedSeptember 30,2007 |  
|Revenue                                                |  | $                                  | 6,773  |   |                                    | $ | 13,903  |  
|Cost of revenue                                        |  |                                    | 6,691  |   |                                    |   | 14,234  |  
|                                                       |  |                                    |        |   |                                    |   |         |  
|Gross profit (loss)                                    |  |                                    | 82     |   |                                    |   | (331    | )
|Selling, general and administrative expenses           |  |                                    | 1,394  |   |                                    |   | 2,126   |  
|                                                       |  |                                    |        |   |                                    |   |         |  
|Operating loss                                         |  |                                    | (1,312 | ) |                                    |   | (2,457  | )
|Interest expense                                       |  |                                    | 192    |   |                                    |   | 188     |  
|                                                       |  |                                    |        |   |                                    |   |         |  
|Loss from continuing operations before income taxes    |  |                                    | (1,504 | ) |                                    |   | (2,645  | )
|Income tax (benefit) expense                           |  |                                    | (394   | ) |                                    |   | 8,211   |  
|                                                       |  |                                    |        |   |                                    |   |         |  
|Loss from continuing operations                        |  |                                    | (1,110 | ) |                                    |   | (10,856 | )
|(Loss) income from discontinued operations, net of tax |  |                                    | (638   | ) |                                    |   | 49      |  
|Gain on sale of discontinued operations, net of tax    |  |                                    |       |   |                                    |   | 11,343  |  
|                                                       |  |                                    |        |   |                                    |   |         |  
|Net (loss) income                                      |  | $                                  | (1,748 | ) |                                    | $ | 536     |  
|                                                       |  |                                    |        |   |                                    |   |         |  
|Net loss per common share:                             |  |                                    |        |   |                                    |   |         |  
|Basic loss from continuing operations                  |  | $                                  | (0.27  | ) |                                    | $ | (2.63   | )
|Basic (loss) income from discontinued operations       |  | $                                  | (0.15  | ) |                                    | $ | 2.76    |  
|Basic net (loss) income per share                      |  | $                                  | (0.42  | ) |                                    | $ | 0.13    |  
|Diluted loss from continuing operations                |  | $                                  | (0.27  | ) |                                    | $ | (2.63   | )
|Diluted (loss) income from discontinued operations     |  | $                                  | (0.15  | ) |                                    | $ | 2.76    |  
|Diluted net (loss) income per share                    |  | $                                  | (0.42  | ) |                                    | $ | 0.13    |  
|Weighted average common shares outstanding:            |  |                                    |        |   |                                    |   |         |  
|Basic                                                  |  |                                    | 4,129  |   |                                    |   | 4,128   |  
|Diluted                                                |  |                                    | 4,129  |   |                                    |   | 4,128   |  

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)



|                                                       |  |                                   |        |   |                                   |   |         |  
|------------------------------------------------------ |  | --------------------------------- | ------ | - | --------------------------------- | - | ------- | -
|                                                       |  | NineMonths EndedSeptember 30,2008 |        |   | NineMonths EndedSeptember 30,2007 |  
|Revenue                                                |  | $                                 | 38,892 |   |                                   | $ | 49,316  |  
|Cost of revenue                                        |  |                                   | 33,013 |   |                                   |   | 46,291  |  
|                                                       |  |                                   |        |   |                                   |   |         |  
|Gross profit                                           |  |                                   | 5,879  |   |                                   |   | 3,025   |  
|Selling, general and administrative expenses           |  |                                   | 6,433  |   |                                   |   | 7,508   |  
|                                                       |  |                                   |        |   |                                   |   |         |  
|Operating loss                                         |  |                                   | (554   | ) |                                   |   | (4,483  | )
|Interest expense                                       |  |                                   | 587    |   |                                   |   | 563     |  
|                                                       |  |                                   |        |   |                                   |   |         |  
|Loss from continuing operations before income taxes    |  |                                   | (1,141 | ) |                                   |   | (5,046  | )
|Income tax (benefit) expense                           |  |                                   | (290   | ) |                                   |   | 7,176   |  
|                                                       |  |                                   |        |   |                                   |   |         |  
|Loss from continuing operations                        |  |                                   | (851   | ) |                                   |   | (12,222 | )
|(Loss) income from discontinued operations, net of tax |  |                                   | (2,505 | ) |                                   |   | 2,937   |  
|Gain on sale of discontinued operations, net of tax    |  |                                   |       |   |                                   |   | 11,343  |  
|                                                       |  |                                   |        |   |                                   |   |         |  
|Net (loss) income                                      |  | $                                 | (3,356 | ) |                                   | $ | 2,058   |  
|                                                       |  |                                   |        |   |                                   |   |         |  
|Net loss per common share:                             |  |                                   |        |   |                                   |   |         |  
|Basic loss from continuing operations                  |  | $                                 | (0.21  | ) |                                   | $ | (2.96   | )
|Basic (loss) income from discontinued operations       |  | $                                 | (0.61  | ) |                                   | $ | 3.46    |  
|Basic net (loss) income per share                      |  | $                                 | (0.81  | ) |                                   | $ | 0.50    |  
|Diluted loss from continuing operations                |  | $                                 | (0.21  | ) |                                   | $ | (2.96   | )
|Diluted (loss) income from discontinued operations     |  | $                                 | (0.61  | ) |                                   | $ | 3.46    |  
|Diluted net (loss) income per share                    |  | $                                 | (0.81  | ) |                                   | $ | 0.50    |  
|Weighted average common shares outstanding:            |  |                                   |        |   |                                   |   |         |  
|Basic                                                  |  |                                   | 4,129  |   |                                   |   | 4,127   |  
|Diluted                                                |  |                                   | 4,129  |   |                                   |   | 4,127   |  

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)



|                                                                                     |  |                                   |        |   |                                   |   |         |  
|------------------------------------------------------------------------------------ |  | --------------------------------- | ------ | - | --------------------------------- | - | ------- | -
|                                                                                     |  | NineMonths EndedSeptember 30,2008 |        |   | NineMonths EndedSeptember 30,2007 |  
|Cash flows from operating activities:                                                |  |                                   |        |   |                                   |   |         |  
|Net (loss) income                                                                    |  | $                                 | (3,356 | ) |                                   | $ | 2,058   |  
|                                                                                     |  |                                   |        |   |                                   |   |         |  
|Adjustments to reconcile net (loss) income to net cash used in operating activities: |  |                                   |        |   |                                   |   |         |  
|Depreciation and amortization of machinery, equipment and leasehold improvements     |  |                                   | 1,339  |   |                                   |   | 2,348   |  
|Amortization of intangible assets                                                    |  |                                   |       |   |                                   |   | 260     |  
|Provision for deferred income taxes                                                  |  |                                   |       |   |                                   |   | 14,514  |  
|Funding in excess of pension cost                                                    |  |                                   | (2,200 | ) |                                   |   | (5,125  | )
|Provision for losses on receivables                                                  |  |                                   | 61     |   |                                   |   | 381     |  
|Provision for inventory valuation                                                    |  |                                   | 576    |   |                                   |   | (69     | )
|Gain on Sale of Pemco World Air Services                                             |  |                                   |       |   |                                   |   | (17,463 | )
|Loss on disposals of machinery and equipment                                         |  |                                   |       |   |                                   |   | 42      |  
|Reversal of losses on contracts-in-process                                           |  |                                   | (1,261 | ) |                                   |   | (460    | )
|Forgiveness of related party receivable                                              |  |                                   | 440    |   |                                   |   |        |  
|Stock based compensation expense                                                     |  |                                   | 220    |   |                                   |   | 646     |  
|Changes in assets and liabilities:                                                   |  |                                   |        |   |                                   |   |         |  
|Restricted cash                                                                      |  |                                   | 649    |   |                                   |   | (1,235  | )
|Accounts receivable, trade                                                           |  |                                   | 2,812  |   |                                   |   | 2,782   |  
|Inventories                                                                          |  |                                   | 3,175  |   |                                   |   | (884    | )
|Prepaid expenses and other                                                           |  |                                   | (384   | ) |                                   |   | 674     |  
|Deposits and other                                                                   |  |                                   | 2,185  |   |                                   |   | (423    | )
|Customer deposits in excess of cost                                                  |  |                                   | (448   | ) |                                   |   | 3,110   |  
|Accounts payable and accrued liabilities                                             |  |                                   | (4,274 | ) |                                   |   | (1,860  | )
|                                                                                     |  |                                   |        |   |                                   |   |         |  
|Total adjustments                                                                    |  |                                   | 2,890  |   |                                   |   | (2,762  | )
|                                                                                     |  |                                   |        |   |                                   |   |         |  
|Net cash used in operating activities                                                |  |                                   | (466   | ) |                                   |   | (704    | )
|                                                                                     |  |                                   |        |   |                                   |   |         |  
|Cash flows from investing activities:                                                |  |                                   |        |   |                                   |   |         |  
|Capital expenditures                                                                 |  |                                   | (487   | ) |                                   |   | (577    | )
|Proceeds from the sale of Pemco World Air Services                                   |  |                                   |       |   |                                   |   | 31,265  |  
|                                                                                     |  |                                   |        |   |                                   |   |         |  
|Net cash (used in) provided by investing activities                                  |  |                                   | (487   | ) |                                   |   | 30,688  |  
|                                                                                     |  |                                   |        |   |                                   |   |         |  
|Cash flows from financing activities:                                                |  |                                   |        |   |                                   |   |         |  
|Proceeds from exercise of stock options                                              |  |                                   |       |   |                                   |   | 8       |  
|Net change under revolving credit facility                                           |  |                                   |       |   |                                   |   | (21,855 | )
|Principal payments under long-term debt                                              |  |                                   | (51    | ) |                                   |   | (1,736  | )
|Restricted cash-Airport Authority Term Loan                                          |  |                                   |       |   |                                   |   | (1,960  | )
|                                                                                     |  |                                   |        |   |                                   |   |         |  
|Net cash used in financing activities                                                |  |                                   | (51    | ) |                                   |   | (25,543 | )
|                                                                                     |  |                                   |        |   |                                   |   |         |  
|Net (decrease) increase in cash and cash equivalents                                 |  |                                   | (1,004 | ) |                                   |   | 4,441   |  
|                                                                                     |  |                                   |        |   |                                   |   |         |  
|Cash and cash equivalents, beginning of period                                       |  |                                   | 8,799  |   |                                   |   | 23      |  
|                                                                                     |  |                                   |        |   |                                   |   |         |  
|Cash and cash equivalents, end of period                                             |  | $                                 | 7,795  |   |                                   | $ | 4,464   |  
|                                                                                     |  |                                   |        |   |                                   |   |         |  
|Supplemental disclosure of cash flow information:                                    |  |                                   |        |   |                                   |   |         |  
|Cash paid during the period for:                                                     |  |                                   |        |   |                                   |   |         |  
|Interest                                                                             |  | $                                 | 595    |   |                                   | $ | 2,688   |  
|                                                                                     |  |                                   |        |   |                                   |   |         |  
|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 Nine-Month and Three-Month Periods Ended

September 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 nine-month periods ended
September 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 and cash flows from operations (primarily from collection of accounts receivable and conversion of work-in-process inventory
to cash). Principal factors affecting the Companys liquidity and capital resources position include, but are not limited to, the following: results of operations; the number of KC-135 inducted as a result of the U.S. Air Force
(USAF) extension of the Companys KC-135 bridge contract with The Boeing Company (Boeing) (See Note 9); collection of accounts receivable; funding requirements associated with the Companys defined benefit pension
plan (Pension Plan); settlements of various claims; and potential divestiture of SVC. The Company anticipates that cash-on-hand will be sufficient to fund operations, make moderate capital expenditures, make scheduled interest payments
on its debt obligation for the next twelve months and make the required contributions to its Pension Plan in the event a waiver of pension contributions is not granted by the Internal Revenue Service (IRS). The Company is currently in
negotiations to extend the maturity date of its debt.

The Company applied on February 29, 2008 to the IRS for a waiver of
contributions for the 2007 plan year which concluded on September 15, 2008. On September 15, 2008, the Company contributed $3.9 million to the Pension Plan, fully satisfying the contribution requirements for the 2007 plan year. On
September 23, 2008, the IRS issued a tentative denial of the 2007 plan year waiver request. Company officials have met with representatives from the IRS and the Pension Benefit Guaranty Corporation (PBGC) and presented additional
information concerning the 2007 plan year pension waiver request. A final answer from the IRS on the 2007 plan year waiver request is expected in early December 2008. If a waiver is granted, the contributions for the 2007 plan year already made may
be considered a 2008 plan year contribution or the Companys waiver request may be converted from a 2007 plan year waiver request to a 2008 plan year waiver request. Without a waiver of contributions, the Company would be required to contribute
approximately $2.1 million for the 2008 plan year for missed quarterly contributions. The Company did not make the first quarterly contribution due April 15, 2008, the second quarterly contribution due July 15, 2008, or the third quarterly
contribution due October 15, 2008. As a result of the missed quarterly contributions, the PBGC filed liens on the Companys assets. 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 granted a waiver of contributions to its defined benefit plan for the 2007 plan year;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | whether recent stock market volatility increases the required minimum contributions to the defined benefit plan for the 2009 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 current negotiations are successful in extending the maturity date of the $5.0 million Senior Secured Note which matures on February 15, 2009.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------

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

In September 2006, the Financial Accounting Standards Board (the FASB) issued Statement of Financial Accounting Standards
(SFAS) No. 157, Fair Value Measurements(SFAS No. 157), 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 September 30, 2008:

(In
Thousands)



|                                      |         |                                                 |         |  |         |   |       |   |   |  |   |    
|------------------------------------- | ------- | ----------------------------------------------- | ------- |  | ------- | - | ----- | - | - |  | - | ---
|                                      |         | Fair Value Measurements as ofSeptember 30, 2008
|                                      | Level 1 |                                                 | Level 2 |  | Level 3 |   | Total
|Assets                                |         |                                                 |         |  |         |   |       |   |   |  |   |    
|Deferred Compensation Plan Assets (1) |         | $                                               | 763     |  | $       |  |       | $ |  |  | $ | 763



|(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.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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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 issued SFAS 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 adoption of SFAS
No. 141(R) is not expected to have a material impact on the Companys financial position, results of operations or cash flows.

In
December 2007, the FASB issued SFAS 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 SFAS 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.

In May 2008, the FASB issued SFAS No. 162,The Hierarchy of Generally Accepted Accounting Principles. SFAS No. 162 defines the order in which accounting principles that are generally accepted
should be followed. SFAS No. 162 is effective for fiscal years beginning after November 15, 2008. We expect that the adoption of SFAS No. 162 will not have a material impact on our consolidated financial position, results of
operations or cash flows.

COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) consists primarily of net income (loss) and the after tax impact of the pension and postretirement liabilities. Comprehensive (loss) was approximately ($1,111,000) and ($1,443,000) for the
three and nine-month periods ended September 30, 2008. Comprehensive income was approximately $1,461,000 and $4,337,000 for the three and nine-month periods ended September 30, 2007.



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2. INCOME FROM CONTINUING OPERATIONS PER SHARE

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

(In Thousands, Except Share and Per Share Information)



|                                              |  |                               |         |   |                   |       |               |   |       |  
|--------------------------------------------- |  | ----------------------------- | ------- | - | ----------------- | ----- | ------------- | - | ----- | -
|For the Three Months Ended September 30, 2008 |  | Loss fromContinuingOperations |         |   | SharesOutstanding |       | Loss PerShare |  
|Basic loss and per share amounts              |  | $                             | (1,110  | ) |                   | 4,129 |               | $ | (0.27 | )
|Dilutive securities                           |  |                               |        |   |                   |      |               |   |      |  
|                                              |  |                               |         |   |                   |       |               |   |       |  
|Diluted loss and per share amounts            |  | $                             | (1,110  | ) |                   | 4,129 |               | $ | (0.27 | )
|                                              |  |                               |         |   |                   |       |               |   |       |  
|                                              |  |                               |        
|For the Three Months Ended September 30, 2007 |  | Loss fromContinuingOperations |         |   | SharesOutstanding |       | Loss PerShare |  
|Basic loss and per share amounts              |  | $                             | (10,856 | ) |                   | 4,128 |               | $ | (2.63 | )
|Dilutive securities                           |  |                               |        |   |                   |      |               |   |      |  
|                                              |  |                               |         |   |                   |       |               |   |       |  
|Diluted loss and per share amounts            |  | $                             | (10,856 | ) |                   | 4,128 |               | $ | (2.63 | )
|                                              |  |                               |         |   |                   |       |               |   |       |  
|                                              |  |                               |        
|For the Nine Months Ended September 30, 2008  |  | Loss fromContinuingOperations |         |   | SharesOutstanding |       | Loss PerShare |  
|Basic loss and per share amounts              |  | $                             | (851    | ) |                   | 4,129 |               | $ | (0.21 | )
|Dilutive securities                           |  |                               |        |   |                   |      |               |   |      |  
|                                              |  |                               |         |   |                   |       |               |   |       |  
|Diluted loss and per share amounts            |  | $                             | (851    | ) |                   | 4,129 |               | $ | (0.21 | )
|                                              |  |                               |         |   |                   |       |               |   |       |  
|                                              |  |                               |        
|For the Nine Months Ended September 30, 2007  |  | Loss fromContinuingOperations |         |   | SharesOutstanding |       | Loss PerShare |  
|Basic loss and per share amounts              |  | $                             | (12,222 | ) |                   | 4,127 |               | $ | (2.96 | )
|Dilutive securities                           |  |                               |        |   |                   |      |               |   |      |  
|                                              |  |                               |         |   |                   |       |               |   |       |  
|Diluted loss and per share amounts            |  | $                             | (12,222 | ) |                   | 4,127 |               | $ | (2.96 | )
|                                              |  |                               |         |   |                   |       |               |   |       |  

Options to purchase 1,262,879 and 967,590 shares of common stock during the three months ended
September 30, 2008 and 2007, respectively, and options to purchase 1,262,879 and 977,143 shares of common stock during the nine months ended September 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 September 30, 2008 and December 31, 2007 consisted of the following:

(In
Thousands)



|                                              |  |                   |        |   |                  |   |        |  
|--------------------------------------------- |  | ----------------- | ------ | - | ---------------- | - | ------ | -
|                                              |  | September 30,2008 |        |   | December 31,2007 |  
|Work in process                               |  | $                 | 8,755  |   |                  | $ | 9,100  |  
|Raw materials and supplies                    |  |                   | 6,162  |   |                  |   | 6,209  |  
|Finished goods                                |  |                   | 786    |   |                  |   | 786    |  
|                                              |  |                   |        |   |                  |   |        |  
|Total                                         |  |                   | 15,703 |   |                  |   | 16,095 |  
|Less reserves for obsolete inventory          |  |                   | (3,675 | ) |                  |   | (3,100 | )
|Less milestone payments and customer deposits |  |                   | (7,689 | ) |                  |   | (6,678 | )
|                                              |  |                   |        |   |                  |   |        |  
|Total inventories                             |  | $                 | 4,339  |   |                  | $ | 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 September 30, 2008 and December 31, 2007 consisted of the following:

(In Thousands)



|                                                                                                             |  |                   |        |   |                  |   |       |  
|------------------------------------------------------------------------------------------------------------ |  | ----------------- | ------ | - | ---------------- | - | ----- | -
|                                                                                                             |  | September 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 |  |                   | 3      |   |                  |   | 7     |  
|                                                                                                             |  |                   |        |   |                  |   |       |  
|Total long-term debt                                                                                         |  |                   | 5,003  |   |                  |   | 5,007 |  
|Less portion reflected as current                                                                            |  |                   | (5,003 | ) |                  |   | (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. The Company is currently in
negotiations with representatives of the Special Value Bond Fund, LLC to extend the maturity date of the note.

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

The effective income tax rate for the three months and nine months ended September 30, 2008 and 2007 was impacted by the 100% valuation allowance on all deferred tax assets. During the three months and nine
months ended September 30, 2008, the Company recorded an income tax benefit of $0.3 million related to the recovery of amounts previously expensed in 2007.

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
159,000 at September 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 nine months
ended September 30, 2008:



|                                     |  |                       |   |  |                                         |      
|------------------------------------ |  | --------------------- | - |  | --------------------------------------- | -----
|                                     |  | Options(In Thousands) |   |  | Weighted averageexercise priceper
share
|Outstanding as of December 31, 2007  |  | 1,157                 |   |  | $                                       | 18.49
|Granted                              |  | 153                   |   |  |                                         | 6.00 
|Exercised                            |  |                      |   |  |                                         |     
|Forfeited/Expired                    |  | (47                   | ) |  |                                         | 20.81
|                                     |  |                       |   |  |                                         |      
|Outstanding as of September 30, 2008 |  | 1,263                 |   |  |                                         | 16.89
|                                     |  |                       |   |  |                                         |      
|Exercisable as of September 30, 2008 |  | 1,175                 |   |  |                                         | 17.57
|                                     |  |                       |   |  |                                         |      

The weighted average remaining term for outstanding stock options was 5.3 years at
September 30, 2008. The aggregate intrinsic value at September 30, 2008 and 2007 was $0 for stock options outstanding and $0 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 nine months ended September 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:



|                        |  |                                    |   |  |                                    |  
|----------------------- |  | ---------------------------------- | - |  | ---------------------------------- | -
|                        |  | Nine MonthsEndedSeptember 30, 2008 |   |  | Nine MonthsEndedSeptember 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 September 30, 2008, approximately $119,000 of unrecognized stock compensation related to unvested awards (net of estimated forfeitures) is expected to
be recognized over a weighted-average period of 1.2 years. There were no stock options exercised during the nine months ended September 30, 2008. Holders of stock options under the Companys Stock Option Plan exercised options for 2,750
shares of the Companys common stock during the three months and nine months ended September 30, 2007. The Company recorded the exercise price of the options, totaling approximately $8,000 to additional paid-in capital during the three
months and nine months ended September 30, 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 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 September 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 September 30, 2008 and December 31, 2007,
respectively, and are reflected in other long-term liabilities in the accompanying consolidated balance sheets.



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8. EMPLOYEE BENEFIT PLANS

The Company has a defined benefit 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 nine months ended September 30, 2008, the Company made $3.9 million in contributions to the Pension Plan.

The Company applied on February 29, 2008 to the IRS for a waiver of contributions for the 2007 plan year which concluded on September 15, 2008.
On September 15, 2008, the Company contributed $3.9 million to the Pension Plan, fully satisfying the contribution requirements for the 2007 plan year. On September 23, 2008, the IRS issued a tentative denial of the 2007 plan year waiver
request. Company officials have met with representatives from the IRS and the PBGC and presented additional information concerning the 2007 plan year pension waiver request. A final response from the IRS on the 2007 plan year waiver request is
expected in early December 2008. If a waiver is granted, the contributions for the 2007 plan year already made may be considered a 2008 plan year contribution or the Companys waiver request may be converted from a 2007 plan year waiver request
to a 2008 plan year waiver request. Without a waiver of contributions, the Company would be required to contribute approximately $2.1 million for the 2008 plan year for missed quarterly contributions. The Company did not make the first quarterly
contribution due April 15, 2008, the second quarterly contribution due July 15, 2008, or the third quarterly contribution due October 15, 2008. As a result of the missed quarterly contributions, the PBGC filed liens on the
Companys assets. 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 EndedSeptember 30,2008 |        |   | ThreeMonths EndedSeptember 30,2007 |   |        | NineMonths EndedSeptember 30,2008 |  |   | NineMonths EndedSeptember 30,2007 |  
|Service cost                       |  | $                                  | 318    |   |                                    | $ | 556    |                                   |  | $ | 952                               |   |  | $ | 1,369  |  
|Interest cost                      |  |                                    | 1,598  |   |                                    |   | 1,894  |                                   |  |   | 4,794                             |   |  |   | 4,665  |  
|Expected return on plan assets     |  |                                    | (1,993 | ) |                                    |   | (2,305 | )                                 |  |   | (5,979                            | ) |  |   | (5,675 | )
|Amortization of prior service cost |  |                                    | 190    |   |                                    |   | 294    |                                   |  |   | 572                               |   |  |   | 724    |  
|Amortization of net loss           |  |                                    | 447    |   |                                    |   | 631    |                                   |  |   | 1,341                             |   |  |   | 1,555  |  
|                                   |  |                                    |        |   |                                    |   |        |                                   |  |   |                                   |   |  |   |        |  
|Net pension cost                   |  | $                                  | 560    |   |                                    | $ | 1,070  |                                   |  | $ | 1,680                             |   |  | $ | 2,638  |  
|                                   |  |                                    |        |   |                                    |   |        |                                   |  |   |                                   |   |  |   |        |  

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 or 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 nine months ended September 30, 2008 and 2007. The KC-135 program in and of itself comprised 82% and 72% of the Companys total revenues from
continuing operations during the nine-month periods ended September 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.



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Litigation

KC-135 PDM Contract and Breach of Contract Lawsuit

On June 27, 2008, the Company filed a
complaint in the United States Court of Federal Claims (the Court) protesting the actions of the USAF in connection with the award to Boeing of the KC-135 Program Depot Maintenance (PDM) contract. On July 3, 2008, the
Court granted Boeings motion to intervene in the case. On September 30, 2008, the Court set aside the KC-135 PDM solicitation enjoining the USAF from proceeding with the award to Boeing and requiring a resolicitation of the procurement
that will explicitly address the role of the aging KC-135 fleet on the PDM process. The Company is currently negotiating a subcontract with Boeing for KC-135 PDM work to be performed until a new solicitation and award is completed by the USAF
pursuant to the Courts order.

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 September 30, 2008 and December 31, 2007, which are included in accrued liabilitiesother on the accompanying consolidated
balance



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##### Table of Contents

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
September 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 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 PRPs 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. (PWAS), formerly a wholly owned
subsidiary of the Company, to WAS Aviation Services, Inc. (WAS), an affiliate of Sun Capital Partners, Inc., WAS and the Company contracted for the 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 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 nine-month periods ended September 30, 2008 and 2007, respectively, were as follows:



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(In Thousands)



|                                                               |                   |                    |      |                   |                   |   |                   |   |  |                   |        |   |  |   |       
|-------------------------------------------------------------- | ----------------- | ------------------ | ---- | ----------------- | ----------------- | - | ----------------- | - |  | ----------------- | ------ | - |  | - | ------
|                                                               |                   | Three Months Ended |      |                   | Nine Months Ended
|                                                               | September 30,2008 |                    |      | September 30,2007 |                   |   | September 30,2008 |   |  | September 30,2007
|                                                               | (In Thousands)    |                    |      | (In Thousands)   
|Revenue from discontinued operations                           |                   | $                  | 791  |                   |                   | $ | 19,570            |   |  | $                 | 2,806  |   |  | $ | 89,792
|(Loss) income before income taxes from discontinued operations |                   | $                  | (638 | )                 |                   | $ | (264              | ) |  | $                 | (2,505 | ) |  | $ | 4,943 
|Income tax (benefit) expense from discontinued operations      |                   |                    |     |                   |                   |   | (313              | ) |  |                   |       |   |  |   | 2,006 
|                                                               |                   |                    |      |                   |                   |   |                   |   |  |                   |        |   |  |   |       
|(Loss) income from discontinued operations                     |                   | $                  | (638 | )                 |                   | $ | 49                |   |  | $                 | (2,505 | ) |  | $ | 2,937 
|                                                               |                   |                    |      |                   |                   |   |                   |   |  |                   |        |   |  |   |       

Included within the results from discontinued operations is an allocation of interest expense. No
interest expense was allocated to discontinued operations for the three- and nine-month periods ended September 30, 2008. Interest expense allocated to discontinued operations was approximately $576,000 and $2,259,000 for the three- and
nine-month periods ended September 30, 2007, respectively.

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.



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##### Table of Contents

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

(In Thousands)



|                                                  |                |                               |       |   |                  |   |       |  
|------------------------------------------------- | -------------- | ----------------------------- | ----- | - | ---------------- | - | ----- | -
|                                                  |                | September 30, 2008(unaudited) |       |   | December 31,2007 |  
|                                                  | (In Thousands) |                              
|Cash overdraft                                    |                | $                             | (10   | ) |                  | $ | (49   | )
|Accounts receivable, net                          |                |                               | 2,609 |   |                  |   | 3,966 |  
|Inventories, net                                  |                |                               | 975   |   |                  |   | 1,487 |  
|Prepaid expenses and other                        |                |                               | 35    |   |                  |   | 33    |  
|                                                  |                |                               |       |   |                  |   |       |  
|Current assets                                    |                |                               | 3,609 |   |                  |   | 5,437 |  
|                                                  |                |                               |       |   |                  |   |       |  
|Property, plant and equipment, net                |                |                               | 397   |   |                  |   | 258   |  
|Deposits and other                                |                |                               | 55    |   |                  |   | 55    |  
|                                                  |                |                               |       |   |                  |   |       |  
|Non-current assets                                |                |                               | 452   |   |                  |   | 313   |  
|                                                  |                |                               |       |   |                  |   |       |  
|Total assets                                      |                | $                             | 4,061 |   |                  | $ | 5,750 |  
|                                                  |                |                               |       |   |                  |   |       |  
|Current portion of long term debt                 |                | $                             | 28    |   |                  | $ | 75    |  
|Accounts payable                                  |                |                               | 175   |   |                  |   | 380   |  
|Accrued expenses                                  |                |                               | 123   |   |                  |   | 113   |  
|Customer deposits in excess of cost               |                |                               | 240   |   |                  |   | 51    |  
|                                                  |                |                               |       |   |                  |   |       |  
|Current liabilities                               |                |                               | 566   |   |                  |   | 619   |  
|                                                  |                |                               |       |   |                  |   |       |  
|Long-term debt, less current portion              |                |                               |      |   |                  |   |      |  
|Long-term pension and post-retirement liabilities |                |                               |      |   |                  |   |      |  
|Other long-term liabilities                       |                |                               |      |   |                  |   |      |  
|                                                  |                |                               |       |   |                  |   |       |  
|Non-current liabilities                           |                |                               |      |   |                  |   |      |  
|                                                  |                |                               |       |   |                  |   |       |  
|Total liabilities                                 |                |                               | 566   |   |                  |   | 619   |  
|                                                  |                |                               |       |   |                  |   |       |  
|Net assets                                        |                | $                             | 3,495 |   |                  | $ | 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 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 and results of operations
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. As discussed in previous filings, 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. From July 2006 to September 2007, the Company prepared 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 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. On March 3, 2008, the USAF advised the GAO that in response to the recommendation by the GAO it had completed additional review and
that the Companys proposal was not selected for award. 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 June 13, 2008, the GAO denied 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 USAF 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 September 30, 2008, the Court set aside the KC-135
PDM solicitation enjoining the USAF from proceeding with the award to Boeing and requiring a resolicitation of the procurement that will explicitly address the role of the aging KC-135 fleet on the PDM process. The Company is currently negotiating a
subcontract with Boeing for KC-135 PDM work to be performed until a new solicitation and award is completed by the USAF pursuant to the Courts order.

The Company applied on February 29, 2008 to the IRS for a waiver of contributions for the 2007 plan year which concluded on September 15, 2008. On September 15, 2008, the Company contributed $3.9 million to the Pension Plan,
fully satisfying the contribution requirements for the 2007 plan year. On September 23, 2008, the IRS issued a tentative denial of the 2007 plan year waiver request. Company officials have met with representatives from the IRS and the Pension
Benefit Guaranty Corporation (PBGC) and presented additional information concerning the 2007 plan year pension waiver request. A final answer from the IRS on the 2007 plan year waiver request is expected in early December 2008. If a
waiver is granted, the contributions for the 2007 plan year already made may be considered a 2008 plan year contribution or the Companys waiver request may be converted from a 2007 plan year waiver request to a 2008 plan year waiver request.
Without a waiver of contributions, the Company would be required to contribute approximately $2.1 million for the 2008 plan year for missed quarterly contributions. The Company did not make the first quarterly contribution due April 15, 2008,
the second quarterly contribution due July 15, 2008, or the third quarterly contribution due October 15, 2008. As a result of the missed quarterly contributions, the PBGC filed liens on the Companys assets. The Company has until
September 15, 2009 to make the required contributions for the 2008 plan year.



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##### Table of Contents

RESULTS OF OPERATIONS

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

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

(In
Millions)



|                                             |  |      |       |   |      |   |        |          |  |        |   
|-------------------------------------------- |  | ---- | ----- | - | ---- | - | ------ | -------- |  | ------ | --
|                                             |  | 2008 |       |   | 2007 |   |        | % Change | 
|Revenue                                      |  | $    | 6.77  |   |      | $ | 13.90  |          |  | (51.3  | )%
|Gross profit (loss)                          |  |      | 0.08  |   |      |   | (0.33  | )        |  | 124.2  | % 
|Operating loss from continuing operations    |  |      | (1.31 | ) |      |   | (2.46  | )        |  | 46.7   | % 
|Loss from continuing operations before taxes |  |      | (1.50 | ) |      |   | (2.65  | )        |  | 43.4   | % 
|Loss from continuing operations              |  |      | (1.11 | ) |      |   | (10.86 | )        |  | 89.8   | % 
|Net (loss) income                            |  |      | (1.75 | ) |      |   | 0.54   |          |  | (424.1 | )%
|EBITDA from continuing operations            |  |      | (1.05 | ) |      |   | (2.07  | )        |  | 49.3   | % 

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 September 30, 2008 and 2007
was calculated using the following approach:

(In Millions)



|                                  |  |      |       |   |      |   |        |  
|--------------------------------- |  | ---- | ----- | - | ---- | - | ------ | -
|                                  |  | 2008 |       |   | 2007 |  
|Loss from continuing operations   |  | $    | (1.11 | ) |      | $ | (10.86 | )
|Interest expense                  |  |      | 0.19  |   |      |   | 0.19   |  
|Taxes                             |  |      | (0.39 | ) |      |   | 8.21   |  
|Depreciation and amortization     |  |      | 0.26  |   |      |   | 0.39   |  
|                                  |  |      |       |   |      |   |        |  
|EBITDA from continuing operations |  | $    | (1.05 | ) |      | $ | (2.07  | )
|                                  |  |      |       |   |      |   |        |  

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 third quarter revenue decreased $7.1 million as compared to 2007 third quarter revenue. Revenue from the KC-135 PDM
program decreased $3.9 million during the third quarter of 2008 versus the third quarter of 2007. The KC-135 program, which accounted for 84% of revenue in the third quarter of 2008 and 69% of revenue in the third quarter of 2007, allows for the
Company to provide services on PDM aircraft, drop-in aircraft, and other aircraft related areas. The Company delivered one PDM aircraft in the third quarter of 2008 compared to two PDM aircraft in the third quarter of 2007. Revenue decreased on the
KC-135 program in the third quarter of 2008 versus the third quarter of 2007 due to a decrease in the contractual price for each aircraft



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##### Table of Contents

delivered and a temporary reduction of the work hours on the program. The Company did not deliver any P-3 aircraft in the third quarter of 2008 versus one
P-3 aircraft in the third quarter of 2007, resulting in a decrease in P-3 revenue of $1.3 million. The Company is continuing to pursue additional contracts to perform maintenance services on P-3 aircraft. Revenue decreased $1.9 million under
contracts to perform non-routine maintenance work on other aircraft, primarily USAF C-130 aircraft.

Gross profit increased from a loss of $0.3 million
during the third quarter of 2007 to a profit of $0.1 million during the third quarter of 2008. Gross profit on KC-135 revenue decreased $1.6 million due to decreased revenue and low volume. Cost of revenue on the KC-135 program increased as a
percentage of revenue due to increased inefficiencies on the KC-135 maintenance line caused by unusually low volume. Gross profit increased $0.6 million as a result of losses on the P-3 program recorded in the third quarter of 2007 for which there
were no comparable losses in the third quarter of 2008. The Company recorded losses on the USAF C-130 program of $0.5 million in the third quarter of 2007 for which there were no comparable losses in the third quarter of 2008. During the third
quarter of 2007, the Company recorded a charge of $0.6 million to reduce the value of KC-135 specific inventory to its net realizable value as a result of the contract being awarded to Boeing.

Selling, general and administrative (SG&A) expenses decreased $0.7 million during the third quarter of 2008 compared to the third quarter of 2007. The
Company reduced expenses by $1.1 million in the third quarter of 2008 as compared to the third quarter of 2007 due to reduced revenue and expense controls implemented by the Company in late 2007. These expense reductions were partially offset by
$0.4 million of legal fees associated with the KC-135 contract protest and legal action. During the third quarter of 2007, the Company incurred $0.4 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 ($0.6 million in 2007), decreased to $0.2 million in the third quarter of 2008
from $0.8 million in the third 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 third quarter of 2007, due principally to the KC-135 contract not being awarded to the Company, the Company recorded a $9.7 million valuation allowance against deferred income tax accounts which
substantially increased the reported income tax expense in the third quarter of 2007. At September 30, 2008 and December 31, 2007, all deferred tax assets continued to be subject to a deferred tax valuation allowance. During the third
quarter of 2008, the Company recorded an income tax benefit of $0.3 million related to the recovery of amounts previously expensed in 2007.

Results
from Discontinued Operations

Revenue at SVC decreased from $1.0 million in the third quarter of 2007 to $0.8 million in the third 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 $0.4 million in losses in the third quarter of 2008 as a result of the decrease in revenue and for cost overruns
on a material battery contract.

Nine months ended September 30, 2008 versus nine months ended September 30, 2007

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

(In Millions)



|                                             |  |      |       |   |      |   |        |          |  |        |   
|-------------------------------------------- |  | ---- | ----- | - | ---- | - | ------ | -------- |  | ------ | --
|                                             |  | 2008 |       |   | 2007 |   |        | % Change | 
|Revenue                                      |  | $    | 38.89 |   |      | $ | 49.32  |          |  | (21.1  | )%
|Gross profit                                 |  |      | 5.88  |   |      |   | 3.03   |          |  | 94.1   | % 
|Operating loss from continuing operations    |  |      | (0.55 | ) |      |   | (4.48  | )        |  | 87.7   | % 
|Loss from continuing operations before taxes |  |      | (1.14 | ) |      |   | (5.05  | )        |  | 77.4   | % 
|Loss from continuing operations              |  |      | (0.85 | ) |      |   | (12.22 | )        |  | 93.0   | % 
|Net (loss) income                            |  |      | (3.36 | ) |      |   | 2.06   |          |  | (263.1 | )%
|EBITDA from continuing operations            |  |      | 0.65  |   |      |   | (3.23  | )        |  | 120.1  | % 

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.



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##### Table of Contents

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

(In Millions)



|                                  |  |      |       |   |      |   |        |  
|--------------------------------- |  | ---- | ----- | - | ---- | - | ------ | -
|                                  |  | 2008 |       |   | 2007 |  
|Loss from continuing operations   |  | $    | (0.85 | ) |      | $ | (12.22 | )
|Interest expense                  |  |      | 0.59  |   |      |   | 0.56   |  
|Taxes                             |  |      | (0.29 | ) |      |   | 7.18   |  
|Depreciation and amortization     |  |      | 1.20  |   |      |   | 1.25   |  
|                                  |  |      |       |   |      |   |        |  
|EBITDA from continuing operations |  | $    | 0.65  |   |      | $ | (3.23  | )
|                                  |  |      |       |   |      |   |        |  

The Companys revenue for the first nine months of 2008 declined $10.4 million from revenue for the first
nine months of 2007. Revenue from the KC-135 PDM program declined $3.4 million during the first nine months of 2008 versus the first nine months of 2007. The KC-135 program, which accounted for 82% of revenue in the first nine months of 2008 and 72%
of revenue in the first nine months of 2007, allows for the Company to provide services on PDM aircraft, drop-in aircraft, and other aircraft related areas. The Company delivered eight PDM aircraft during the first nine months of 2008 compared to
nine PDM aircraft during the first nine months of 2007. Revenue decreased on the KC-135 program in the first nine months of 2008 versus the first nine months of 2007 due to a decrease in the contractual price for each aircraft delivered and a
temporary reduction of the work hours on the program. The Company delivered one P-3 aircraft in the first nine months of 2008 versus four P-3 aircraft in the first nine months of 2007, resulting in a decrease in P-3 revenue of $3.8 million. The
Company is continuing to pursue additional contracts to perform maintenance services on P-3 aircraft. Revenue decreased $3.2 million under contracts to perform non-routine maintenance work on other aircraft, primarily USAF C-130 aircraft.

Gross profit increased from $3.0 million during the first nine months of 2007 to $5.9 million during the first nine months 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. During the first nine months of 2007, the Company
recorded a charge of $0.6 million to reduce the value of KC-135 specific inventory to its net realizable value as a result of the contract being awarded to Boeing. Gross profit increased $1.8 million as a result of losses on the P-3 program in the
first nine months of 2007 for which there were no comparable losses in the first nine months of 2008.

SG&A expenses decreased $1.1 million during the
first nine months of 2008 compared to the first nine months of 2007. The Company reduced expenses by $3.0 million in the first nine months of 2008 as compared to the first nine months of 2007 due to reduced revenue and expense controls implemented
by the Company in late 2007. These expense reductions were partially offset by $1.4 million of legal fees associated with the KC-135 contract protest and legal action. Also, during the first nine 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 nine months of 2007, the Company incurred $2.1 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 ($2.2 million in 2007), decreased to $0.6 million in the first nine months of 2008
from $2.8 million in the first nine 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 nine months of 2007, due principally to the KC-135 contract not being awarded to the Company, the Company recorded a $9.7 million valuation allowance against deferred income tax accounts which
substantially increased the reported income tax expense in the first nine months of 2007. At September 30, 2008 and December 31, 2007, all deferred tax assets continued to be subject to a deferred tax valuation allowance. During the first
nine months of 2008, the Company recorded an income tax benefit of $0.3 million related to the recovery of amounts previously expensed in 2007.

Results
from Discontinued Operations

Revenue at SVC decreased from $6.0 million in the first nine months of 2007 to $2.8 million in the first nine 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 nine months of 2008 as a result of the decrease in revenue and for
cost overruns on a material battery contract.



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LIQUIDITY AND CAPITAL RESOURCES

General

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

(In Thousands, Except Ratios)



|                                   |  |                   |        |                  |   |        |  |   |        |  
|---------------------------------- |  | ----------------- | ------ | ---------------- | - | ------ |  | - | ------ | -
|                                   |  | September 30,2008 |        | December 31,2007 |   | Change | 
|Cash                               |  | $                 | 7,795  |                  | $ | 8,799  |  | $ | (1,004 | )
|Working capital                    |  |                   | 7,808  |                  |   | 16,193 |  |   | (8,385 | )
|Debt and capital lease obligations |  |                   | 5,003  |                  |   | 5,007  |  |   | (4     | )
|Stockholders equity               |  |                   | 15,103 |                  |   | 16,326 |  |   | (1,223 | )
|Debt to equity ratio               |  |                   | 0.33   |                  |   | 0.31   |  |   | 0.02   |  

Working Capital

The Company has no current arrangements with respect to sources of additional financing, and its negative results of operations and the Companys current lack of long-term contracts, exacerbated by the current state of the credit
markets, will likely make it more difficult and unlikely 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 and cash flows from operations (primarily from collection of accounts receivable and conversion of work-in-process inventory to cash). Principal factors affecting
the Companys liquidity and capital resources position include, but are not limited to, the following: results of operations; the number of KC-135 inducted as a result of the USAF extension of the Companys KC-135 bridge contract with
Boeing (See Note 9); collection of accounts receivable; funding requirements associated with the Companys defined benefit pension plan; settlements of various claims; and the potential divestiture of SVC. The Company anticipates that
cash-on-hand will be sufficient to fund operations, make moderate capital expenditures, make scheduled payments on its debt obligation for the next twelve months and make the required contributions to the Pension Plan in the event a waiver of
pension contributions is not granted by the Internal Revenue Service (IRS).

The Company applied on February 29, 2008 to the IRS for a
waiver of contributions for the 2007 plan year which concluded on September 15, 2008. On September 15, 2008, the Company contributed $3.9 million to the Pension Plan, fully satisfying the contribution requirements for the 2007 plan year.
On September 23, 2008, the IRS issued a tentative denial of the 2007 plan year waiver request. Company officials have met with representatives from the IRS and the Pension Benefit Guaranty Corporation (PBGC) and presented additional
information concerning the 2007 plan year pension waiver request. A final answer from the IRS on the 2007 plan year waiver request is expected in early December 2008. If a waiver is granted, the contributions for the 2007 plan year already made may
be considered 2008 plan year contributions or the Companys waiver request may be converted from a 2007 plan year waiver request to a 2008 plan year waiver request. Without a waiver of contributions, the Company would be required to contribute
approximately $2.1 million for the 2008 plan year for missed quarterly contributions. The Company did not make the first quarterly contribution due April 15, 2008, the second quarterly contribution due July 15, 2008 or the third quarterly
contribution due October 15, 2008. As a result of the missed quarterly contributions, the PBGC filed liens on the Companys assets. 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 granted a waiver of contributions to its defined benefit plan for the 2007 plan year;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | whether recent stock market volatility increases the required minimum contributions to the defined benefit plan for the 2009 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 current negotiations are successful in extending the maturity date of the $5.0 million Senior Secured Note which matures on February 15, 2009.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------

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 used $0.5 million during the first nine months of 2008, compared to $0.7 million during the first nine months of 2007. Cash payments to fund the
Companys Pension Plan exceeded pension expense by $2.2 million in the first nine months of 2008 and exceeded pension expense by $5.1 million in the first nine months of 2007. The reduction of accounts receivable, inventories and deposits,
partially offset by a reduction of accounts payable and accrued liabilities, provided $3.9 million of cash in the first nine months of 2008. Cash of $0.5 million and $0.6 million was used during the first nine months of 2008 and 2007, respectively,
for minimal capital expenditures. The sale of PWAS generated $31.3 million of cash during the first nine months of 2007. The Company used a portion of the proceeds from the sale of PWAS to pay off $21.4 million in long-term debt and a revolving
credit facility on September 19, 2007. During the first nine months of 2007, in total, the Company used $1.7 million to reduce long-term debt and used $21.9 million to pay off its revolving credit facility.

Future Capital Requirements

The Companys potential capital
requirements over the next twelve months include: required minimum funding of the Pension Plan (described above), principal and interest payments on long-term debt, 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. Recent steep declines in the stock market may increase the under-funded amount substantially
and could cause a substantial increase in future required contributions.

The Company applied on February 29, 2008 to the IRS for a waiver of
contributions for the 2007 plan year which concluded on September 15, 2008. On September 15, 2008, the Company contributed $3.9 million to the Pension Plan fully satisfying the contribution requirements for the 2007 plan year. On
September 23, 2008, the IRS issued a tentative denial of the 2007 plan year waiver request. Company officials have met with representatives from the IRS and the PBGC and presented additional information concerning the 2007 plan year pension
waiver request. A final answer from the IRS on the 2007 plan year waiver request is expected in early December 2008. If a waiver is granted, the contributions for the 2007 plan year already made may be considered 2008 plan year contributions or the
Companys waiver request may be converted from a 2007 plan year waiver request to a 2008 plan year waiver request. Without a waiver of contributions, the Company would be required to contribute approximately $2.1 million for the 2008 plan year
for missed quarterly contributions. The Company did not make the first quarterly contribution due April 15, 2008, the second quarterly contribution due July 15, 2008, nor the third quarterly contribution due October 15, 2008. As a
result of the missed quarterly contributions, the PBGC filed liens on the Companys assets. The Company has until September 15, 2009 to make the required contributions for the 2008 plan year.



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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.
The Company is currently in negotiations with representatives of the Special Value Bond Fund, LLC to extend the maturity date of the Note. However, 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. As a result of the recent volatility in the capital markets, the cost and availability of credit has been and may continue
to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in
some cases, cease to provide funding to borrowers. 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. Domestic and international capital markets have also been experiencing heightened volatility and turmoil, potentially making it more difficult to raise capital through the
issuance of equity securities. The Company is continually monitoring and re-evaluating 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.



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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. The Company is currently in negotiations to further extend the maturity date of the Note.

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.
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. The new accounting personnel are currently familiarizing themselves with the Companys
processes and financial system. The Company has determined that the material weakness related to the lack of financial personnel with experience at the Company existed at September 30, 2008 and December 31, 2007. Except as noted above,
there have been no changes to the Companys internal control over financial reporting that occurred during the Companys nine months ended September 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. 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 nine months ended September 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 September 30,
2008 and December 31, 2007:

(In Thousands)



|                |  |                   |        |                  |   |       
|--------------- |  | ----------------- | ------ | ---------------- | - | ------
|Customer Type   |  | September 30,2008 |        | December 31,2007
|KC-135 Aircraft |  | $                 | 28,505 |                  | $ | 24,945
|C-130 Aircraft  |  |                   | 892    |                  |   | 2,160 
|P-3 Aircraft    |  |                   |       |                  |   | 1,274 
|                |  |                   |        |                  |   |       
|Total           |  | $                 | 29,397 |                  | $ | 28,379
|                |  |                   |        |                  |   |       

Total backlog increased $1.0 million during the first nine months of 2008 due to the induction of six KC-135
aircraft in the third quarter of 2008. The Company expects to receive additional inductions of KC-135 aircraft under the extension of the bridge contract the USAF executed with Boeing to maintain adequate sources of maintenance services while the
KC-135 contract is re-competed. The Company has proposed and is expecting to continue to propose on several C-130 related U.S. government programs in the next twelve months. The Company is currently completing two C-130 aircraft inducted under the
Flexible Acquisition and Sustainment Tool (FAST). The Company is a subcontractor on several teams which were awarded contracts under the Future Flexible Acquisition and Sustainment Tool (F2AST) program. The Company expects the USAF to begin issuing
task orders under the F2AST program in the first quarter of 2009. The Company inducted a P-3 aircraft on November 10, 2008 under a subcontract with L-3 Communications. The Company expects to induct additional P-3 aircraft in the next twelve
months and grow the backlog of P-3 work.

CONTINGENCIES

See Note 9 to the Consolidated Financial Statements.



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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 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 September 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 September 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. 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. The new accounting personnel are currently familiarizing themselves with the Companys processes and
financial systems. The Company has determined that the material weakness related to the lack of financial personnel with experience at the Company existed at September 30, 2008 and December 31, 2007.

Except as noted above, there have been no changes to the Companys internal control over financial reporting that occurred during the nine months ended
September 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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##### Table of Contents

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 factors, the first of which has been revised to reflect that the Court of Federal Claims setting aside the KC-135 PDM
solicitation enjoining the USAF from proceeding with the award to Boeing and requiring a resolicitation of the procurement that will explicitly address the role of the aging KC-135 fleet on the PDM process, and the last of which has been revised to
reflect the impact of recent market volatility on the Pension Plan and that the PBGC has filed liens on the Companys assets.

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 nine months of 2008 and 72% of revenue in the first nine 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.

The financial condition and results of operations of the Company, which operated as a subcontractor to Boeing, has been impacted by several extraordinary events in
connection with the USAF KC-135 PDM program and the related recompetition for the new KC-135 contract award. As discussed in previous filings, from May 2005 through June 2006, the Company worked in cooperation with Boeing to submit a joint 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. From July 2006 to September 2007, the Company prepared 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 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. On March 3, 2008, the USAF advised the GAO that in response to the recommendation by the GAO it had completed additional
review and that the Companys proposal was not selected for award. 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 June 13, 2008, the GAO denied 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 USAF 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 September 30, 2008, the Court set
aside the KC-135 PDM solicitation, enjoining the USAF from proceeding with the award to Boeing and requiring a resolicitation of the procurement that will explicitly address the role of the aging KC-135 fleet on the PDM process. The Company is
currently negotiating a subcontract with Boeing for KC-135 PDM work to be performed until a new solicitation and award is completed pursuant to the Courts order. If the Company is not successful in the new re-competition for the KC-135 PDM, 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s Trust for its Defined Benefit Plan is Under-Funded and Subject to Financial Market Forces.

The
Company maintains a defined benefit plan (the Pension Plan), which covers substantially all employees at its Birmingham, Alabama facilities. 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. At December 31, 2007, the Pension Plan was underfunded by $9.2 million. Changes in investment returns,
discount assumptions, mortality assumptions or benefit obligations may have a significant impact on the funded status of the Pension Plan. Unless and until the Pension Plan under-funding is remedied sufficiently, the making of minimum required
contributions may adversely affect the Companys liquidity and cash flow, which could materially harm its business and impair the value of its common stock. Recent steep declines in the stock market may increase the under-funded amount
substantially and could cause a substantial increase in future required contributions.



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##### Table of Contents

The Company applied on February 29, 2008 to the IRS for a waiver of contributions for the 2007 plan year which
concluded on September 15, 2008. On September 15, 2008, the Company contributed $3.9 million to the Pension Plan, fully satisfying the contribution requirements for the 2007 plan year. On September 23, 2008, the IRS issued a tentative
denial of the 2007 plan year waiver request. Company officials have met with representatives from the IRS and the PBGC and presented additional information concerning the 2007 plan year pension waiver request. A final answer from the IRS on the 2007
plan year waiver request is expected in early December 2008. If a waiver is granted, the contributions for the 2007 plan year already made may be considered a 2008 plan year contribution or the Companys waiver request may be converted from a
2007 plan year waiver request to a 2008 plan year waiver request. Without a waiver of contributions, the Company would be required to contribute approximately $2.1 million for the 2008 plan year for missed quarterly contributions. The Company did
not make the first quarterly contribution due April 15, 2008, the second quarterly contribution due July 15, 2008, or the third quarterly contribution due October 15, 2008. As a result of the missed quarterly contributions, the PBGC
filed liens on the Companys assets. 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.



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##### Table of Contents

|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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##### Table of Contents

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: November 14, 2008 |  | By:                               |  | /s/ Ronald A. Aramini                                               
|                         |  |                                   |  | Ronald A. Aramini, President and Chief Executive
Officer            
|                         |  |                                   |  | (Principal Executive Officer)                                       
|                         |  |                                  
|Dated: November 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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