##### Table of Contents

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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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



For the Quarterly Period Ended September 30, 2005,



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



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PEMCO AVIATION GROUP, INC.

(Exact name of registrant as specified in its charter)



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



1943 North 50thStreet, Birmingham, Alabama 35212

(Address of principal executive offices) (Zip Code)



205-510-4051

(Registrants telephone number, including area code)



---



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



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



Indicate 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, 2005
|Common Stock, $.0001 par value |  | 4,524,663                       



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##### Table of Contents

INDEX



PEMCO AVIATION GROUP, INC. AND
SUBSIDIARIES



|                              |  |                                                                                                       |  |     
|----------------------------- |  | ----------------------------------------------------------------------------------------------------- |  | ----
|                              |  |                                                                                                       |  | PAGE
|PART I.
FINANCIAL INFORMATION |  |                                                                                                      
|                              |  |                                                                                                      
|Item 1.                       |  | Financial Statements (Unaudited)                                                                      |  | S-3 
|                              |  |                                                                                                      
|                              |  | Unaudited Consolidated Balance SheetsSeptember 30, 2005 and December 31, 2004                         |  | S-3 
|                              |  |                                                                                                      
|                              |  | Unaudited Consolidated Statements of OperationsFor The Three Months Ended September 30, 2005 and 2004 |  | S-5 
|                              |  |                                                                                                      
|                              |  | Unaudited Consolidated Statements of OperationsFor The Nine Months Ended September 30, 2005 and 2004  |  | S-6 
|                              |  |                                                                                                      
|                              |  | Unaudited Consolidated Statements of Cash FlowsFor The Nine Months ended September 30, 2005 and 2004  |  | S-7 
|                              |  |                                                                                                      
|                              |  | Notes to Consolidated Financial Statements                                                            |  | S-8 
|                              |  |                                                                                                      
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                 |  | S-19
|                              |  |                                                                                                      
|Item 3.                       |  | Quantitative and Qualitative Disclosures about Market Risk                                            |  | S-30
|                              |  |                                                                                                      
|Item 4.                       |  | Controls and Procedures                                                                               |  | S-30
|                              | 
|PART II.
OTHER INFORMATION    |  |                                                                                                      
|                              |  |                                                                                                      
|Item 1.                       |  | Legal Proceedings                                                                                     |  | S-32
|                              |  |                                                                                                      
|Item 3.                       |  | Defaults Upon Senior Securities                                                                       |  | S-32
|                              |  |                                                                                                      
|Item 5.                       |  | Other Information                                                                                     |  | S-32
|                              |  |                                                                                                      
|Item 6.                       |  | Exhibits                                                                                              |  | S-32
|                              | 
|SIGNATURES                    |  | S-33                                                                                                 



-S2-



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##### Table of Contents

PART I. FINANCIAL INFORMATION



Item 1. Financial Statements



PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS



ASSETS

(In Thousands)



|                                               |  |                   |         |   |                  |   |         |  
|---------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                               |  | September 30,2005 |         |   | December 31,2004 |  
|                                               |  | Unaudited         |         |   |                  |  
|Current assets:                                |  |                   |         |   |                  |   |         |  
|Cash and cash equivalents                      |  | $                 | 42      |   |                  | $ | 3,354   |  
|Accounts receivable, net                       |  |                   | 18,917  |   |                  |   | 38,247  |  
|Inventories, net                               |  |                   | 23,880  |   |                  |   | 21,512  |  
|Deferred income taxes                          |  |                   | 3,315   |   |                  |   | 2,966   |  
|Prepaid expenses and other                     |  |                   | 2,323   |   |                  |   | 2,144   |  
|                                               |  |                   |         |   |                  |   |         |  
|Total current assets                           |  |                   | 48,477  |   |                  |   | 68,223  |  
|                                               |  |                   |         |   |                  |   |         |  
|Machinery, equipment and improvements at cost: |  |                   |         |   |                  |   |         |  
|Machinery and equipment                        |  |                   | 33,053  |   |                  |   | 34,119  |  
|Leasehold improvements                         |  |                   | 29,511  |   |                  |   | 27,563  |  
|Construction-in-process                        |  |                   | 798     |   |                  |   | 1,573   |  
|                                               |  |                   |         |   |                  |   |         |  
|                                               |  |                   | 63,362  |   |                  |   | 63,255  |  
|Less accumulated depreciation and amortization |  |                   | (38,388 | ) |                  |   | (38,250 | )
|                                               |  |                   |         |   |                  |   |         |  
|Net machinery, equipment and improvements      |  |                   | 24,974  |   |                  |   | 25,005  |  
|                                               |  |                   |         |   |                  |   |         |  
|Other non-current assets:                      |  |                   |         |   |                  |   |         |  
|Deposits and other                             |  |                   | 2,301   |   |                  |   | 2,005   |  
|Deferred income taxes                          |  |                   | 9,166   |   |                  |   | 7,435   |  
|Related party receivable                       |  |                   | 498     |   |                  |   | 482     |  
|Intangible pension asset                       |  |                   | 3,863   |   |                  |   | 3,863   |  
|Intangible assets, net                         |  |                   | 130     |   |                  |   | 112     |  
|                                               |  |                   |         |   |                  |   |         |  
|                                               |  |                   | 15,958  |   |                  |   | 13,897  |  
|                                               |  |                   |         |   |                  |   |         |  
|Total assets                                   |  | $                 | 89,409  |   |                  | $ | 107,125 |  
|                                               |  |                   |         |   |                  |   |         |  



The accompanying notes
are an integral part

of these consolidated statements.



-S3-



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##### Table of Contents

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS



LIABILITIES AND STOCKHOLDERS EQUITY

(In Thousands, Except Common Share Information)



|                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                             |  | September 30,2005 |         |   | December 31,2004 |  
|                                                                                                                                                             |  | Unaudited         |         |   |                  |  
|Current liabilities:                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Current portion of long-term debt                                                                                                                            |  | $                 | 23,864  |   |                  | $ | 7,447   |  
|Current portion of pension liability                                                                                                                         |  |                   | 10,490  |   |                  |   | 7,832   |  
|Current portion of income tax liability                                                                                                                      |  |                   |        |   |                  |   | 59      |  
|Accounts payable - trade                                                                                                                                     |  |                   | 7,587   |   |                  |   | 14,034  |  
|Accrued health and dental                                                                                                                                    |  |                   | 637     |   |                  |   | 1,326   |  
|Accrued liabilities - payroll related                                                                                                                        |  |                   | 6,744   |   |                  |   | 6,345   |  
|Accrued liabilities - other                                                                                                                                  |  |                   | 4,571   |   |                  |   | 4,790   |  
|Customer deposits in excess of cost                                                                                                                          |  |                   | 8,019   |   |                  |   | 883     |  
|                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|Total current liabilities                                                                                                                                    |  |                   | 61,912  |   |                  |   | 42,716  |  
|                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|Long-term debt, less current portion                                                                                                                         |  |                   | 1,960   |   |                  |   | 30,494  |  
|Long-term pension benefit liability                                                                                                                          |  |                   | 7,655   |   |                  |   | 13,308  |  
|Other long-term liabilities                                                                                                                                  |  |                   | 2,237   |   |                  |   | 2,129   |  
|                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|Total liabilities                                                                                                                                            |  |                   | 73,764  |   |                  |   | 88,647  |  
|                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|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, 4,111,265 and 4,104,344 outstanding at September 30, 2005 and
December 31, 2004, respectively |  |                   | 1       |   |                  |   | 1       |  
|Additional paid-in capital                                                                                                                                   |  |                   | 13,165  |   |                  |   | 12,807  |  
|Retained earnings                                                                                                                                            |  |                   | 31,752  |   |                  |   | 34,708  |  
|Treasury stock, at cost  413,398 shares at September 30, 2005 and December 31, 2004                                                                         |  |                   | (8,623  | ) |                  |   | (8,623  | )
|Accumulated other comprehensive income (loss)                                                                                                                |  |                   |         |   |                  |   |         |  
|Net unrealized gain on investments                                                                                                                           |  |                   |        |   |                  |   | 235     |  
|Minimum pension liability                                                                                                                                    |  |                   | (20,650 | ) |                  |   | (20,650 | )
|                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|Total stockholders equity                                                                                                                                   |  |                   | 15,645  |   |                  |   | 18,478  |  
|                                                                                                                                                             |  |                   |         |   |                  |   |         |  
|Total liabilities and stockholders equity                                                                                                                   |  | $                 | 89,409  |   |                  | $ | 107,125 |  
|                                                                                                                                                             |  |                   |         |   |                  |   |         |  



The accompanying notes
are an integral part

of these consolidated statements.



-S4-



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##### Table of Contents

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

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



|                                             |  |                                     |        |   |                                     |   |        |  
|-------------------------------------------- |  | ----------------------------------- | ------ | - | ----------------------------------- | - | ------ | -
|                                             |  | Three Months EndedSeptember 30,2005 |        |   | Three Months EndedSeptember 30,2004 |  
|Net sales                                    |  | $                                   | 31,025 |   |                                     | $ | 54,911 |  
|Cost of sales                                |  |                                     | 28,684 |   |                                     |   | 45,914 |  
|                                             |  |                                     |        |   |                                     |   |        |  
|Gross profit                                 |  |                                     | 2,341  |   |                                     |   | 8,997  |  
|                                             |  |                                    
|Selling, general and administrative expenses |  |                                     | 6,554  |   |                                     |   | 8,194  |  
|Provision for doubtful accounts              |  |                                     | 1,519  |   |                                     |   |       |  
|                                             |  |                                     |        |   |                                     |   |        |  
|(Loss)/Income from operations                |  |                                     | (5,732 | ) |                                     |   | 803    |  
|                                             |  |                                    
|Interest expense                             |  |                                     | (489   | ) |                                     |   | (351   | )
|                                             |  |                                     |        |   |                                     |   |        |  
|(Loss)/Income before income taxes            |  |                                     | (6,221 | ) |                                     |   | 452    |  
|Income tax (benefit)/expense                 |  |                                     | (2,474 | ) |                                     |   | 174    |  
|                                             |  |                                     |        |   |                                     |   |        |  
|Net (loss)/income                            |  | $                                   | (3,747 | ) |                                     | $ | 278    |  
|                                             |  |                                     |        |   |                                     |   |        |  
|Net (loss)/income per common share:          |  |                                     |        |   |                                     |   |        |  
|Basic                                        |  | $                                   | (0.91  | ) |                                     | $ | 0.07   |  
|Diluted                                      |  | $                                   | (0.91  | ) |                                     | $ | 0.06   |  
|                                             |  |                                    
|Weighted average common shares outstanding:  |  |                                     |        |   |                                     |   |        |  
|Basic                                        |  |                                     | 4,111  |   |                                     |   | 4,138  |  
|Diluted                                      |  |                                     | 4,111  |   |                                     |   | 4,360  |  



The accompanying notes
are an integral part

of these consolidated statements.



-S5-



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##### Table of Contents

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

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



|                                             |  |                                    |         |   |                                    |   |         |  
|-------------------------------------------- |  | ---------------------------------- | ------- | - | ---------------------------------- | - | ------- | -
|                                             |  | Nine Months EndedSeptember 30,2005 |         |   | Nine Months EndedSeptember 30,2004 |  
|Net sales                                    |  | $                                  | 113,672 |   |                                    | $ | 141,674 |  
|Cost of sales                                |  |                                    | 98,181  |   |                                    |   | 118,084 |  
|                                             |  |                                    |         |   |                                    |   |         |  
|Gross profit                                 |  |                                    | 15,491  |   |                                    |   | 23,590  |  
|                                             |  |                                   
|Selling, general and administrative expenses |  |                                    | 18,087  |   |                                    |   | 22,423  |  
|Provision for doubtful accounts              |  |                                    | 1,519   |   |                                    |   |        |  
|                                             |  |                                    |         |   |                                    |   |         |  
|(Loss)/Income from operations                |  |                                    | (4,115  | ) |                                    |   | 1,167   |  
|                                             |  |                                   
|Other income                                 |  |                                    | 650     |   |                                    |   |        |  
|Interest expense                             |  |                                    | (1,397  | ) |                                    |   | (853    | )
|                                             |  |                                    |         |   |                                    |   |         |  
|(Loss)/Income before income taxes            |  |                                    | (4,862  | ) |                                    |   | 314     |  
|Income tax (benefit)/expense                 |  |                                    | (1,906  | ) |                                    |   | 121     |  
|                                             |  |                                    |         |   |                                    |   |         |  
|Net (loss)/income                            |  | $                                  | (2,956  | ) |                                    | $ | 193     |  
|                                             |  |                                    |         |   |                                    |   |         |  
|Net (loss)/income per common share:          |  |                                    |         |   |                                    |   |         |  
|Basic                                        |  | $                                  | (0.72   | ) |                                    | $ | 0.05    |  
|Diluted                                      |  | $                                  | (0.72   | ) |                                    | $ | 0.04    |  
|                                             |  |                                   
|Weighted average common shares outstanding:  |  |                                    |         |   |                                    |   |         |  
|Basic                                        |  |                                    | 4,107   |   |                                    |   | 4,083   |  
|Diluted                                      |  |                                    | 4,107   |   |                                    |   | 4,461   |  



The accompanying notes
are an integral part

of these consolidated statements



-S6-



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##### Table of Contents

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

|                                                                                            |  |                                    |         |   |                                    |   |        |  
|------------------------------------------------------------------------------------------- |  | ---------------------------------- | ------- | - | ---------------------------------- | - | ------ | -
|                                                                                            |  | Nine Months EndedSeptember 30,2005 |         |   | Nine Months EndedSeptember 30,2004 |  
|Cash flows from operating activities:                                                       |  |                                    |         |   |                                    |   |        |  
|Net (loss)/income                                                                           |  | $                                  | (2,956  | ) |                                    | $ | 193    |  
|                                                                                            |  |                                    |         |   |                                    |   |        |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities: |  |                                    |         |   |                                    |   |        |  
|Depreciation and amortization of machinery, equipment and leasehold improvements            |  |                                    | 2,846   |   |                                    |   | 2,659  |  
|Amortization of intangible assets                                                           |  |                                    | 37      |   |                                    |   | 107    |  
|Provision for deferred income taxes                                                         |  |                                    | (1,906  | ) |                                    |   | (942   | )
|Funding over pension cost                                                                   |  |                                    | (2,995  | ) |                                    |   | (4,577 | )
|Provision for losses on receivables                                                         |  |                                    | 1,519   |   |                                    |   |       |  
|Loss on disposals of machinery and equipment                                                |  |                                    | 81      |   |                                    |   |       |  
|Provision for losses on contracts-in-process                                                |  |                                    | 1,433   |   |                                    |   | 2,176  |  
|Non cash compensation expense for option extension                                          |  |                                    | 221     |   |                                    |   |       |  
|Realized gain on deferred compensation plan investments                                     |  |                                    | (340    | ) |                                    |   |       |  
|Changes in assets and liabilities:                                                          |  |                                    |         |   |                                    |   |        |  
|Accounts receivable, trade                                                                  |  |                                    | 17,811  |   |                                    |   | 3,443  |  
|Related party receivable                                                                    |  |                                    |        |   |                                    |   | (16    | )
|Inventories                                                                                 |  |                                    | (3,771  | ) |                                    |   | (7,383 | )
|Prepaid expenses and other                                                                  |  |                                    | (179    | ) |                                    |   | (714   | )
|Deposits and other                                                                          |  |                                    | (354    | ) |                                    |   | 375    |  
|Customer deposits in excess of cost                                                         |  |                                    | 7,136   |   |                                    |   | (3,214 | )
|Accounts payable and accrued liabilities                                                    |  |                                    | (6,907  | ) |                                    |   | 910    |  
|                                                                                            |  |                                    |         |   |                                    |   |        |  
|Total adjustments                                                                           |  |                                    | 14,632  |   |                                    |   | (7,176 | )
|                                                                                            |  |                                    |         |   |                                    |   |        |  
|Net cash provided by (used in) operating activities                                         |  |                                    | 11,676  |   |                                    |   | (6,983 | )
|                                                                                            |  |                                    |         |   |                                    |   |        |  
|Cash flows from investing activities:                                                       |  |                                    |         |   |                                    |   |        |  
|Capital expenditures                                                                        |  |                                    | (2,926  | ) |                                    |   | (2,967 | )
|                                                                                            |  |                                    |         |   |                                    |   |        |  
|Net cash used in investing activities                                                       |  |                                    | (2,926  | ) |                                    |   | (2,967 | )
|                                                                                            |  |                                    |         |   |                                    |   |        |  
|Cash flows from financing activities:                                                       |  |                                    |         |   |                                    |   |        |  
|Proceeds from exercise of stock options                                                     |  |                                    | 111     |   |                                    |   | 2,259  |  
|Purchase of treasury stock                                                                  |  |                                    |        |   |                                    |   | (1,580 | )
|Net change under revolving credit facility                                                  |  |                                    | (10,986 | ) |                                    |   | 5,889  |  
|Principal payments under long-term debt                                                     |  |                                    | (1,131  | ) |                                    |   | (774   | )
|Borrowings under long-term debt                                                             |  |                                    |        |   |                                    |   | 1,767  |  
|Other                                                                                       |  |                                    | (56     | ) |                                    |   |       |  
|                                                                                            |  |                                    |         |   |                                    |   |        |  
|Net cash (used in) provided by financing activities                                         |  |                                    | (12,062 | ) |                                    |   | 7,561  |  
|                                                                                            |  |                                    |         |   |                                    |   |        |  
|Net decrease in cash and cash equivalents                                                   |  |                                    | (3,312  | ) |                                    |   | (2,389 | )
|                                                                                            |  |                                    |         |   |                                    |   |        |  
|Cash and cash equivalents, beginning of period                                              |  |                                    | 3,354   |   |                                    |   | 3,156  |  
|                                                                                            |  |                                    |         |   |                                    |   |        |  
|Cash and cash equivalents, end of period                                                    |  | $                                  | 42      |   |                                    | $ | 767    |  
|                                                                                            |  |                                    |         |   |                                    |   |        |  
|Supplemental disclosure of cash flow information:                                           |  |                                    |         |   |                                    |   |        |  
|Cash paid during the period for:                                                            |  |                                    |         |   |                                    |   |        |  
|Interest                                                                                    |  | $                                  | 1,359   |   |                                    | $ | 853    |  
|                                                                                            |  |                                    |         |   |                                    |   |        |  
|Income taxes                                                                                |  | $                                  | 115     |   |                                    | $ | 709    |  
|                                                                                            |  |                                    |         |   |                                    |   |        |  



The accompanying notes
are an integral part

of these consolidated statements



-S7-



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##### Table of Contents

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

As of and for the Quarters Ended

September 30, 2005 and 2004



1.CONSOLIDATED FINANCIAL STATEMENTS



The
interim consolidated financial statements have been prepared by Pemco Aviation Group, Inc. (the Company) following the requirements of the Securities and Exchange Commission for interim reporting, and are unaudited. In the opinion of
management, all adjustments necessary for a fair presentation are reflected in the interim financial statements. Such adjustments are of a normal and recurring nature. The results of operations for the period ended September 30, 2005 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 2004 Annual Report on
Form 10-K.



2. ASSIGNMENT OF LEASE



On September 2, 2004, the Company, through its Air International
Incorporated (AIA) subsidiary, entered into an Asset Purchase Agreement with Avantair, Inc. The Asset Purchase Agreement provided for the assignment of AIAs lease agreement with Pinellas County, Florida to Avantair, Inc., located
on the leased premises located at the St. Petersburg-Clearwater International Airport. During January 2005, Avantair, Inc. assigned its rights under the Asset Purchase Agreement to AvAero Services, LLC (AvAero). AIA completed the
assignment of its lease agreement and the sale of the airplane hangars and other personal property to AvAero pursuant to an Assignment, Assumption and Amendment of Lease dated April 21, 2005. The Company recognized a gain of approximately $0.65
million that is included in other income on the consolidated statements of operations for the nine-months ended September 30, 2005.



3.NET (LOSS) INCOME PER SHARE



Basic net (loss) income per share was computed by dividing net (loss) income by the weighted average number of shares of Common Stock outstanding during
the periods. Diluted net (loss) income per share was computed by dividing net (loss) income by the weighted average number of shares of Common Stock and the dilutive effects of the shares awarded under the Companys Non-Qualified Stock Option
Plan, based on the treasury stock method using an average fair market value of the stock during the respective periods. In periods with net losses all Common Stock equivalents are excluded from the per share calculation; therefore, the basic loss
per share equals the diluted loss per share.



The following
table represents the net (loss) income per share calculations for the three-month and nine-month periods ended September 30, 2005 and 2004:



(All numbers in thousands, except income per share)



|                                    |  |                                     |        |   |                                     |   |                                    |  |   |                                    |   |  |   |      
|----------------------------------- |  | ----------------------------------- | ------ | - | ----------------------------------- | - | ---------------------------------- |  | - | ---------------------------------- | - |  | - | -----
|                                    |  | Three Months EndedSeptember 30,2005 |        |   | Three Months EndedSeptember 30,2004 |   | Nine Months EndedSeptember 30,2005 |  |   | Nine Months EndedSeptember 30,2004
|Net (loss) income                   |  | $                                   | (3,747 | ) |                                     | $ | 278                                |  | $ | (2,956                             | ) |  | $ | 193  
|Weighted average shares             |  |                                     | 4,111  |   |                                     |   | 4,138                              |  |   | 4,107                              |   |  |   | 4,083
|Basic net (loss) income per share   |  | $                                   | (0.91  | ) |                                     | $ | 0.07                               |  | $ | (0.72                              | ) |  | $ | 0.05 
|Dilutive securities                 |  |                                     |       |   |                                     |   | 222                                |  |   |                                   |   |  |   | 378  
|Diluted weighted average shares     |  |                                     | 4,111  |   |                                     |   | 4,360                              |  |   | 4,107                              |   |  |   | 4,461
|Diluted net (loss) income per share |  | $                                   | (0.91  | ) |                                     | $ | 0.06                               |  | $ | (0.72                              | ) |  | $ | 0.04 



Options to purchase
225,333 and 211,333 shares of Common Stock at September 30, 2004 were excluded from the computation of diluted net income per share for the three months ended and nine months ended September 30, 2004, respectively, because the option
exercise price was greater than the average market price of the shares.



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4.STOCK OPTIONS



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



The Company uses the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 Accounting for Stock Issued to Employees for stock option grants to individuals defined as employees. Accordingly, no
compensation expense is recognized for options granted at or above the fair market value of the underlying stock on the grant date. Stock options granted during 2005 were valued using a binomial method. Stock options granted during prior periods
were valued using another method. The following table illustrates what the effect on net (loss) income and net (loss) income per share would have been if the Company had applied the fair value recognition provisions of FASB Statement No. 123 to
stock options granted to employees.



(In thousands except per
share information)



|                                                                    |  |                                     |        |   |                                     |   |      |                                    |  |   |                                    |   |  |   |        |  
|------------------------------------------------------------------- |  | ----------------------------------- | ------ | - | ----------------------------------- | - | ---- | ---------------------------------- |  | - | ---------------------------------- | - |  | - | ------ | -
|                                                                    |  | Three Months EndedSeptember 30,2005 |        |   | Three Months EndedSeptember 30,2004 |   |      | Nine Months EndedSeptember 30,2005 |  |   | Nine Months EndedSeptember 30,2004 |  
|Net (loss)/income  as reported                                     |  | $                                   | (3,747 | ) |                                     | $ | 278  |                                    |  | $ | (2,956                             | ) |  | $ | 193    |  
|Stock based compensation under fair value method, net of tax effect |  |                                     | (167   | ) |                                     |   | (182 | )                                  |  |   | (723                               | ) |  |   | (1,339 | )
|                                                                    |  |                                     |        |   |                                     |   |      |                                    |  |   |                                    |   |  |   |        |  
|Net (loss)/income  pro forma                                       |  | $                                   | (3,914 | ) |                                     | $ | 96   |                                    |  | $ | (3,679                             | ) |  | $ | (1,146 | )
|                                                                    |  |                                     |        |   |                                     |   |      |                                    |  |   |                                    |   |  |   |        |  
|Net (loss)/income per share, basic  as reported                    |  | $                                   | (0.91  | ) |                                     | $ | 0.07 |                                    |  | $ | (0.72                              | ) |  | $ | 0.05   |  
|                                                                    |  |                                     |        |   |                                     |   |      |                                    |  |   |                                    |   |  |   |        |  
|Net (loss)/income per share, diluted  as reported                  |  | $                                   | (0.91  | ) |                                     | $ | 0.06 |                                    |  | $ | (0.72                              | ) |  | $ | 0.04   |  
|                                                                    |  |                                     |        |   |                                     |   |      |                                    |  |   |                                    |   |  |   |        |  
|Net (loss)/income per share, basic  pro forma                      |  | $                                   | (0.95  | ) |                                     | $ | 0.02 |                                    |  | $ | (0.90                              | ) |  | $ | (0.28  | )
|                                                                    |  |                                     |        |   |                                     |   |      |                                    |  |   |                                    |   |  |   |        |  
|Net (loss)/income per share, diluted  pro forma                    |  | $                                   | (0.95  | ) |                                     | $ | 0.02 |                                    |  | $ | (0.90                              | ) |  | $ | (0.28  | )
|                                                                    |  |                                     |        |   |                                     |   |      |                                    |  |   |                                    |   |  |   |        |  



In December 2004, the
Financial Accounting Standards Board (FASB) published FASB Statement No. 123 (revised 2004), Share-Based Payment (FAS 123(R) or the Statement). FAS 123(R) requires that the compensation cost
relating to share-based payment transactions, including grants of employee stock options, be recognized in financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued. FAS 123(R) specifies
that the fair value must be estimated using a valuation technique that (1) is applied in a manner consistent with the fair value measurement objective and the other requirements of the Statement, (2) is based on established principles of
financial economic theory and generally applied to that field, and (3) reflects all substantive characteristics of the instrument. FAS 123(R) permits entities to use any option-pricing model that meets the fair value objective in the Statement.



The Statement will be effective for the Company in the first
quarter of 2006. As of the effective date, the Company intends to apply the Statement using a modified version of prospective application. Under that transition method, compensation cost is recognized for (1) all awards granted after the
required effective date and to awards modified, cancelled, or repurchased after that date and (2) the portion of prior awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards
calculated for either recognition or pro forma disclosures under SFAS 123.



The impact of this Statement on the Company in fiscal 2006 and beyond will depend upon various factors, among them being our future compensation strategy. The pro forma compensation costs presented in the table



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above and in prior filings for the Company have been calculated using an option pricing model and may not
be indicative of amounts that should be expected in future years. As of the date of this filing, no decisions have been made as to which option pricing model is most appropriate for the Company.



5.INVENTORIES



Inventories as of September 30, 2005 and December 31, 2004
consisted of the following:



(In thousands)



|                                              |  |                   |         |   |                  |   |         |  
|--------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                              |  | September 30,2005 |         |   | December 31,2004 |  
|Work in process                               |  | $                 | 25,425  |   |                  | $ | 23,400  |  
|Finished goods                                |  |                   | 2,361   |   |                  |   | 2,118   |  
|Raw materials and supplies                    |  |                   | 13,197  |   |                  |   | 13,444  |  
|                                              |  |                   |         |   |                  |   |         |  
|Total                                         |  |                   | 40,983  |   |                  |   | 38,962  |  
|Less reserves for obsolete inventory          |  |                   | (3,904  | ) |                  |   | (4,661  | )
|Less milestone payments and customer deposits |  |                   | (13,199 | ) |                  |   | (12,789 | )
|                                              |  |                   |         |   |                  |   |         |  
|                                              |  | $                 | 23,880  |   |                  | $ | 21,512  |  
|                                              |  |                   |         |   |                  |   |         |  



A substantial portion
of the above inventories relate to U.S. Government contracts or sub-contracts. The Company receives milestone payments on the majority of its government contracts. The Company limited inventoried costs to amounts estimated to be recoverable at its
Dothan, Alabama facility during a lock out of the union employees.



6.DEBT



Debt as of
September 30, 2005 and December 31, 2004 consisted of the following:



(In thousands)



|                                                                                                                 |  |                   |         |   |                  |   |        |  
|---------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------ | -
|                                                                                                                 |  | September 30,2005 |         |   | December 31,2004 |  
|Revolving Credit Facility; interest at LIBOR plus 2.75% (6.44% at September 30, 2005)                            |  | $                 | 19,793  |   |                  | $ | 30,779 |  
|Bank Term Loan; interest at LIBOR plus 3.00% (6.69% at September 30, 2005)                                       |  |                   | 2,250   |   |                  |   | 3,000  |  
|Treasury Stock Term Loan; Interest at LIBOR plus 3.00% (6.69% at September 30, 2005)                             |  |                   | 1,617   |   |                  |   | 1,797  |  
|Airport Authority Term Loan; interest at BMA plus 0.36% (2.90% at September 30, 2005)                            |  |                   | 2,140   |   |                  |   | 2,320  |  
|Capital Lease Obligations; interest from 5.0% to 11.0%, collateralized by security interest in certain equipment |  |                   | 24      |   |                  |   | 45     |  
|                                                                                                                 |  |                   |         |   |                  |   |        |  
|Total long-term debt                                                                                             |  |                   | 25,824  |   |                  |   | 37,941 |  
|Less portion reflected as current                                                                                |  |                   | (23,864 | ) |                  |   | (7,447 | )
|                                                                                                                 |  |                   |         |   |                  |   |        |  
|Long term-debt, net of current portion                                                                           |  | $                 | 1,960   |   |                  | $ | 30,494 |  
|                                                                                                                 |  |                   |         |   |                  |   |        |  



On December 16,
2002, the Company executed a Credit Agreement (the Credit Agreement) that provides for a revolving credit facility and a term loan (the Revolving Credit Facility and Bank Term Loan, respectively). The original
commitment under the Revolving Credit Facility was $25.0 million and was subsequently increased to $33.0 million. On June 28, 2005, the Revolving Credit Facility maturity date was extended to October 15, 2006 and the commitment level was
set at $28.0 million. The Revolving Credit



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Facility bears interest at LIBOR plus 2.00% to 2.75% (6.44% at September 30, 2005), determined based
on the ratio of adjusted funded debt to earnings before interest, taxes, depreciation and amortization, each as defined in the Credit Agreement.



Borrowing availability under the Revolving Credit Facility is tied to percentages of eligible accounts receivable and inventories. The Company had
borrowings of approximately $19.8 million outstanding under the Revolving Credit Facility at September 30, 2005. Remaining borrowing capacity available under the facility at September 30, 2005, based upon the calculation that defines the
borrowing base, totaled approximately $2.4 million.



The Bank
Term Loan has a term of five years and bears interest at LIBOR plus 2.25% to 3.00% (6.69% at September 30, 2005), determined based on the ratio of adjusted funded debt to earnings before interest, taxes, depreciation and amortization, each as
defined in the Credit Agreement. The original principal amount of $5.0 million is payable in 60 monthly installments of $83,333 plus interest, which payments began January 31, 2003.



On May 22, 2003, the Company amended the Credit Agreement to create a line of credit for the repurchase of the
Companys Common Stock (Treasury Stock Term Loan). The term for the Treasury Stock Term Loan expired on May 22, 2005. The repayment terms of the Treasury Stock Term Loan require repayment in 30 equal monthly installments of
approximately $59,890 plus interest, which payments began July 1, 2005.



The Airport Authority Term Loan was originated on November 26, 2002, has a term of 15 years, and bears interest at the Bond Market Association (BMA) plus 0.36% (2.90% at September 30, 2005). The Airport
Authority Term Loan is payable in 14 annual installments of approximately $180,000, which began on September 30, 2004. A Letter of Credit supports the Airport Authority Term Loan and has a fee of 1.0% per year with a five-year term.



All of the above facilities have provisions for increases in
the interest rate and acceleration of debt during any period when an event of default exists.



Principal maturities of debt as of September 30, 2005, over the next five years and in the aggregate thereafter are as follows:



(In Thousands)



|           |  |   |       
|---------- |  | - | ------
|Current    |  | $ | 23,864
|1-3 years  |  |   | 360   
|3-5 years  |  |   | 360   
|Thereafter |  |   | 1,240 
|           |  |   |       
|           |  | $ | 25,824
|           |  |   |       



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



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



During the first and second quarters of 2005 and the fourth quarter of 2004, the Company violated the fixed charge coverage ratio covenant under the
Revolving Credit Facility due to losses incurred by the Company during 2005 and 2004. On March 31, 2005, the Company obtained a waiver from the lender for the fixed charge coverage ratio covenant violation with respect to the first quarter of
2005 and the fourth quarter of 2004 and amended the Credit Agreement to revise the calculation of the fixed charge coverage ratio for the second and third quarters of 2005 using annualized 2005 results instead of total results of the past four
quarters and to increase the adjusted tangible net worth covenant from approximately $30.0 million to $33.5



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million. On August 11, 2005, the Company obtained a waiver from the lender for the fixed charge
coverage ratio covenant violation with respect to the second and third quarters of 2005 and amended the Credit Agreement to revise the calculation of the fixed charge coverage ratio for the fourth quarter of 2005, decreasing the required ratio of
operating income to fixed charges from 1.2 to 1.0 and increasing the adjusted tangible net worth covenant from approximately $33.5 million to $38.5 million.



During the third quarter of 2005, the Company violated the revised adjusted tangible net worth covenant. As a result of this violation, the Company has
classified all debt covered by the Credit Agreement as short-term in the Consolidated Balance Sheets. The lenders have waived all violations of debt covenants through September 30, 2005. The Company has no current arrangements with respect to
sources of additional financing and the recent negative results of operations will likely make it more difficult and expensive for the Company to raise additional capital that may be necessary to continue their operations. The Companys ability
to continue to borrow funds from the lenders under the Credit Agreement is dependent on their ability to meet the lenders borrowing conditions at the relevant times. If the Company is unable to comply with the covenants in the future and the
lender does not grant a waiver, the outstanding borrowings under the Credit Agreement may become immediately due and payable and interest rates may increase although the lender has not indicated an intent to cause this to happen.



7.STOCKHOLDERS EQUITY



Holders of stock options under the Companys Non-Qualified Stock Option
Plan exercised options for 4,250 and 22,410 shares of the Companys Common Stock during the three months ended September 30, 2005 and 2004, respectively. The Company recorded both the exercise price and a tax benefit totaling approximately
$86,000 and $237,000 to Additional Paid-In Capital during the third quarters of 2005 and 2004, respectively, relating to these exercises. During the nine months ended September 30, 2005 and 2004, holders of stock options exercised options for
6,921 shares and 106,855 shares of the Companys Common Stock, respectively. The Company recorded the exercise price net of the tax benefit totaling approximately $137,000 and $2.3 million to Additional Paid-In Capital during the third quarters
of 2005 and 2004, respectively, relating to these exercises.



8.
DEFERRED COMPENSATION PLAN



The Company has a deferred
compensation arrangement for its Chief Executive Officer that generally provides for payments upon retirement, death or termination of employment. The Company funds the deferred compensation liability by making contributions to a rabbi trust. The
contributions are invested in money market and mutual funds, and do not include Company Common Stock. During the first quarter of 2005, the Company liquidated the assets in the rabbi trust and reinvested the entire proceeds, reflecting the
Companys decision to more actively manage the portfolio. Concurrent with this change, the Company reclassified the investments from available-for-sale to trading securities, which results in the recognition of unrealized holding gains and
losses in current earnings rather than in stockholders equity. The Company recognized a $0.3 million gain upon the sale of the assets, which is reflected as a reduction to SG&A in the accompanying consolidated statements of operations for
the nine month period ended September 30, 2005. The fair market values of the assets in the rabbi trust at September 30, 2005 and December 31, 2004 were $2.0 million and $1.7 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 fair market value of the compensation
liability. The amounts accrued under this plan were $2.0 million and $1.7 million at September 30, 2005 and December 31, 2004, respectively, and are reflected in other long-term liabilities in the accompanying consolidated balance sheets.



9.EMPLOYEE BENEFIT PLANS



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



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



|                                   |  |                                     |        |   |                                     |   |        |                                    |  |   |                                    |   |  |   |        |  
|---------------------------------- |  | ----------------------------------- | ------ | - | ----------------------------------- | - | ------ | ---------------------------------- |  | - | ---------------------------------- | - |  | - | ------ | -
|                                   |  | Three Months EndedSeptember 30,2005 |        |   | Three Months EndedSeptember 30,2004 |   |        | Nine Months EndedSeptember 30,2005 |  |   | Nine Months EndedSeptember 30,2004 |  
|Service cost                       |  | $                                   | 743    |   |                                     | $ | 642    |                                    |  | $ | 2,063                              |   |  | $ | 1,926  |  
|Interest cost                      |  |                                     | 1,864  |   |                                     |   | 1,792  |                                    |  |   | 5,412                              |   |  |   | 5,376  |  
|Expected return on plan assets     |  |                                     | (2,218 | ) |                                     |   | (2,190 | )                                  |  |   | (6,654                             | ) |  |   | (6,570 | )
|Amortization of prior service cost |  |                                     | 318    |   |                                     |   | 169    |                                    |  |   | 620                                |   |  |   | 507    |  
|Amortization of net loss           |  |                                     | 506    |   |                                     |   | 268    |                                    |  |   | 1,518                              |   |  |   | 804    |  
|                                   |  |                                     |        |   |                                     |   |        |                                    |  |   |                                    |   |  |   |        |  
|Net pension cost                   |  | $                                   | 1,213  |   |                                     | $ | 681    |                                    |  | $ | 2,959                              |   |  | $ | 2,043  |  
|                                   |  |                                     |        |   |                                     |   |        |                                    |  |   |                                    |   |  |   |        |  



10.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 U. S. Government may,
in certain cases, also terminate existing contracts, recover damages, and impose other sanctions and penalties. The Company believes, based on all available information, that the outcome of any U.S. Government audits, reviews, and investigations
would not have a material effect on the Companys financial position or results of operations.



On October 19, 2005, the Company received notification from the U.S. Government that an audit of the KC-135 contract for services provided from
1990 to 1994 had been completed and the Company owed the U.S. Government approximately $1.1 million. A preliminary investigation by the Company of its internal records did not indicate that any amount was owed on this contract. The
Company is in the process of accumulating all historical records related to this contract to compare with the records used by the U.S. Government in the audit of the contract. If the internal records of the Company are incorrect, the Company would
be liable for $1.1 million for this contract. No amount has been accrued at September 30, 2005 for the resolution of this matter.



The Company has a contract with the U.S. Coast Guard that expired in August 2005. The Company has incurred significant losses in 2003, 2004 and 2005
related to this contract. In addition, several aircraft have been delivered after the original contractual delivery date due to additional work performed on the aircraft. This work was required by the customer after the aircraft were undergoing
maintenance. Final resolution of all the issues related to this contract, which could result in additional amounts owed to the U.S. Coast Guard or to the Company, may take a significant amount of time. No asset or liability has been accrued at
September 30, 2005 other than the additional cost related to completing maintenance services on existing aircraft. The Company expects to be substantially complete with all Coast Guard work by the end of the fourth quarter.



A Significant Portion of the Companys Revenue is Derived From a Few
of its Customers - A small number of the Companys customers account for a significant percentage of its revenues. The KC-135 program comprised 44% and 70% of the Companys total revenues during the nine-month periods ended
September 30, 2005 and 2004, respectively. The Companys two largest programs generated approximately 69% and 83% of its revenues during the nine-month periods ended September 30, 2005 and 2004, respectively. The Companys
largest commercial customer declared Chapter 11 bankruptcy during the third quarter of 2005. The Company recorded a charge of $1.5 million related to this bankruptcy. The Company is continuing to provide services to this customer; however, the
future impact on the Company of the bankruptcy filing cannot be determined. Termination or a disruption of any of its significant customer contracts, including by way of option years not being exercised, or the inability of the Company to renew or
replace any of these customer contracts when they expire, could have a material adverse effect on the Companys business, financial position or results of operations.



Litigation



Breach of Contract Lawsuits



On October 12, 1995, Falcon Air AB filed a complaint in the United States District Court, Northern District of Alabama, alleging that the
modification by the Company of three Boeing 737 aircraft to quick-change configuration was defective, limiting the commercial use of the aircraft. The District Court released the case to alternative dispute resolution until the Company requested
reinstatement of the case on September 13, 2001.



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Reinstatement was denied, and on October 31, 2001 the Company filed an appeal with the
11thCircuit Court of Appeals for determination on certain procedural issues. The parties have subsequently entered
into arbitration, the first hearing being held on November 7, 2005. Management believes that the results of this claim will not have a material impact on the Companys financial position or results of operations.



On January 16, 2004, the Company filed a complaint in the Circuit Court
of Dale County, Alabama against GE Capital Aviation Services, Inc. (GECAS) for amounts owed for modification and maintenance services provided on six 737-300 aircraft, all of which were re-delivered to GECAS during 2003 and are in
service. On January 20, 2004, the Company received service of a suit filed against the Companys Pemco World Air Services, Inc. subsidiary in New York state court, claiming breach of contract with regard to two of the aircraft
re-delivered. On March 5, 2004, the Company filed a motion to dismiss the claim filed in the New York state court, which was denied. 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 six aircraft. The New York Court ordered mediation in the matter. Mediation took place on October 6, 2004, but was unsuccessful in bringing resolution.
Litigation is currently in the discovery phase and trial has been set in Dale County, Alabama for February 2006. Management believes that the results of the claim by GECAS will not have a material impact on the Companys financial position or
results of operations.



On November 9, 1994, the Company
was awarded a contract to perform standard depot level maintenance (SDLM) and engineering design work (Executive Transport) on an H-3 helicopter. A modification of the contract occurred in September 1996, to include Egyptian
Air Force helicopters in the depot level maintenance program (EDLM). In 2002, the Company filed three separate Requests for Equitable Adjustment (REA) with the Navy totaling over $4.9 million plus interest. The claims include
entitlement to additional sums due to severe funding issues and lack or delay of required support in materials, equipment and engineering data for the H-3 program. Negotiations for settlement were unsuccessful. In January 2004, the Company elected
to file the claims with the Armed Services Board of Contract Appeals (ASBCA), which consolidated the SDLM, Executive Transport and EDLM appeals into one case for litigation purposes. Discovery is currently in process.



Employment Lawsuits



In December 1999, the Company and Pemco Aeroplex were served with a
purported class action in the U.S. District Court, Northern District of Alabama, seeking declaratory, injunctive relief and other compensatory and punitive damages based upon alleged unlawful employment practices of race discrimination and racial
harassment by the Companys managers, supervisors and other employees. The complaint sought damages in the amount of $75 million. On July 27, 2000, the U.S. District Court determined that the group would not be certified as a class since
the plaintiffs withdrew their request for class certification. The Equal Employment Opportunity Commission (EEOC) subsequently entered the case purporting a parallel class action. The Court denied consolidation of the cases for trial
purposes but provided for consolidated discovery. On June 28, 2002, a jury determined that there was no hostile work environment in the original case and granted verdicts for the Company with regard to all 22 plaintiffs. Nine plaintiffs elected
to settle with the Company prior to the trial. On December 13, 2002 the Court granted the Company summary judgment in the EEOC case. That judgment was appealed to the 11thCircuit Court of Appeals by the EEOC. The panel reinstated the case to federal district court. On October 27, 2004 the Company petitioned the
11thCircuit to rehear the case. The petition was denied on December 23, 2004. The Company filed a Petition for
a Writ of Certiorari with the United States Supreme Court on March 23, 2005, which was denied on October 3, 2005. The case is now remanded back to federal district court in Birmingham, Alabama. The Company believes it has taken effective
remedial and corrective action, acted promptly in respect to any specific complaint by an employee, and will vigorously defend this case. Management believes that the results of this claim will not have a material impact on the Companys
financial position or results of operations.



Various claims
alleging employment discrimination, including race, sex, disability and age, have been made against the Company and its subsidiaries by current and former employees at its Birmingham and Dothan, Alabama facilities in proceedings before the EEOC and
before state and federal courts in Alabama. Workers compensation claims brought by employees 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



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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.



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



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Environmental Compliance



In December 1997, the Company received an inspection report from the Environmental Protection Agency (EPA)
documenting the results of an inspection at the Birmingham, Alabama facility. The report cited various violations of environmental laws. The Company has taken actions to correct the items raised by the inspection. On December 21, 1998, the
Company and the EPA entered into a Consent Agreement and Consent Order (CACO) resolving the complaint and compliance order. As part of the CACO, the Company agreed to assess a portion of the Birmingham facility for possible contamination
by certain constituents and remediate such contamination as necessary. During 1999, the Company drilled test wells and took samples under its Phase I Site Characterization Plan. These samples were forwarded to the EPA in 1999. A Phase II Site
Characterization Plan (Phase II Plan) was submitted to the EPA in 2001 upon receiving the agencys response to the 1999 samples. The Phase II Plan was approved in January 2003, and wells were 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 and no response has
been received. 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, 2005 and December 31, 2004, which are included
in accrued liabilities  other on the accompanying Consolidated Balance Sheets. The Company anticipates the total cost of the Phase II Plan to be approximately $550,000, of which the Company has paid approximately $450,000 as of
September 30, 2005. Management believes that the results of the Phase II Plan will not have a material impact on the Companys financial position or results of operations.



The Company is required to comply with environmental regulations at the federal, state and local levels. These requirements
apply especially to the stripping, cleaning and painting of aircraft. Management believes that compliance with environmental regulations will not have a material impact on the Companys financial position or results of operations.



11.SEGMENT INFORMATION



The Company has three reportable segments: Government Services Segment
(GSS), Commercial Services Segment (CSS), and Manufacturing and Components Segment (MCS). The GSS, located in Birmingham, Alabama, provides aircraft maintenance and modification services for government and
military customers. The CSS, located in Dothan, Alabama, provides commercial aircraft maintenance and modification services on a contract basis to the owners and operators of large commercial aircraft and also distributes aircraft parts. The MCS,
located in California, designs and manufactures a wide array of proprietary aerospace products including various space systems, such as guidance control systems and launch vehicles, and aircraft cargo-handling systems.



The accounting policies of the segments are the same as those described in
the summary of significant accounting policies in the Companys 2004 Annual Report on Form 10-K. The Company evaluates performance based on total (external and inter-segment) revenues, gross profits and operating income. The Company accounts
for inter-segment sales and transfers as if the sales or transfers were to third parties. The amount of intercompany profit is eliminated. The Company does not allocate income taxes to segments.



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



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##### Table of Contents

The following table presents information about segment profit or loss for the three-month periods ended
September 30, 2005 and 2004:



(In Thousands)



|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|----------------------------------------- |  | --- | ------ | - | --- | - | ------ | --- |  | - | ------------ | - |  | - | ------- | -
|Three Months Ended September 30, 2005     |  | GSS |        |   | CSS |   |        | MCS |  |   | Consolidated |  
|Revenues from external domestic customers |  | $   | 18,041 |   |     | $ | 8,475  |     |  | $ | 3,852        |   |  | $ | 30,368  |  
|Revenues from external foreign customers  |  |     |       |   |     |   | 551    |     |  |   | 106          |   |  |   | 657     |  
|Inter-company revenues                    |  |     |       |   |     |   | 96     |     |  |   | 43           |   |  |   | 139     |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Total segment revenues                    |  |     | 18,041 |   |     |   | 9,122  |     |  |   | 4,001        |   |  |   | 31,164  |  
|Elimination                               |  |     |        |   |     |   |        |     |  |   |              |   |  |   | (139    | )
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Total revenue                             |  |     |        |   |     |   |        |     |  |   |              |   |  | $ | 31,025  |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Gross profit                              |  | $   | 1,430  |   |     | $ | (365   | )   |  | $ | 1,276        |   |  | $ | 2,341   |  
|Segment operating loss                    |  |     | (1,088 | ) |     |   | (4,617 | )   |  |   | (27          | ) |  |   | (5,732  | )
|Other income                              |  |     |        |   |     |   |        |     |  |   |              |   |  | $ |        |  
|Interest benefit                          |  |     |        |   |     |   |        |     |  |   |              |   |  | $ | (489    | )
|Income tax benefit                        |  |     |        |   |     |   |        |     |  |   |              |   |  | $ | (2,474  | )
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Net loss                                  |  |     |        |   |     |   |        |     |  |   |              |   |  | $ | (3,747  | )
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Assets                                    |  | $   | 49,432 |   |     | $ | 33,134 |     |  | $ | 6,843        |   |  | $ | 89,409  |  
|Depreciation/amortization                 |  |     | 394    |   |     |   | 646    |     |  |   | 110          |   |  |   | 1,150   |  
|Capital additions                         |  |     | 961    |   |     |   | 77     |     |  |   | 356          |   |  |   | 1,394   |  
|                                          |  |     |        |  
|Three Months Ended September 30, 2004     |  | GSS |        |   | CSS |   |        | MCS |  |   | Consolidated |  
|Revenues from external domestic customers |  | $   | 36,406 |   |     | $ | 15,958 |     |  | $ | 1,529        |   |  | $ | 53,893  |  
|Revenues from external foreign customers  |  |     |       |   |     |   | 938    |     |  |   | 80           |   |  |   | 1,018   |  
|Inter-company revenues                    |  |     |       |   |     |   | 293    |     |  |   | 54           |   |  |   | 347     |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Total segment revenues                    |  |     | 36,406 |   |     |   | 17,189 |     |  |   | 1,663        |   |  |   | 55,258  |  
|Elimination                               |  |     |        |   |     |   |        |     |  |   |              |   |  |   | (347    | )
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Total revenue                             |  |     |        |   |     |   |        |     |  |   |              |   |  | $ | 54,911  |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Gross profit                              |  | $   | 5,395  |   |     | $ | 3,088  |     |  | $ | 514          |   |  | $ | 8,997   |  
|Segment operating income/(loss)           |  |     | 1,491  |   |     |   | 72     |     |  |   | (760         | ) |  |   | 803     |  
|Interest expense                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   | (351    | )
|Income tax expense                        |  |     |        |   |     |   |        |     |  |   |              |   |  |   | 174     |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Net income                                |  |     |        |   |     |   |        |     |  |   |              |   |  | $ | 278     |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Assets                                    |  | $   | 63,276 |   |     | $ | 39,716 |     |  | $ | 5,418        |   |  | $ | 108,410 |  
|Depreciation/amortization                 |  |     | 925    |   |     |   | 395    |     |  |   | 50           |   |  |   | 1,370   |  
|Capital additions                         |  |     | 815    |   |     |   | 206    |     |  |   | 14           |   |  |   | 1,035   |  



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##### Table of Contents

The following table presents information about segment profit or loss for the nine-month periods ended September 30,
2005 and 2004:



(In Thousands)



|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|----------------------------------------- |  | --- | ------ | - | --- | - | ------ | --- |  | - | ------------ | - |  | - | ------- | -
|Nine Months Ended September 30, 2005      |  | GSS |        |   | CSS |   |        | MCS |  |   | Consolidated |  
|Revenues from external domestic customers |  | $   | 58,702 |   |     | $ | 38,976 |     |  | $ | 11,102       |   |  | $ | 108,780 |  
|Revenues from external foreign customers  |  |     |       |   |     |   | 4,352  |     |  |   | 540          |   |  |   | 4,892   |  
|Inter-company revenues                    |  |     |       |   |     |   | 294    |     |  |   | 149          |   |  |   | 443     |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Total segment revenues                    |  |     | 58,702 |   |     |   | 43,622 |     |  |   | 11,791       |   |  |   | 114,115 |  
|Elimination                               |  |     |        |   |     |   |        |     |  |   |              |   |  |   | (443    | )
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Total revenue                             |  |     |        |   |     |   |        |     |  |   |              |   |  | $ | 113,672 |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Gross profit                              |  | $   | 6,853  |   |     | $ | 5,058  |     |  | $ | 3,580        |   |  | $ | 15,491  |  
|Segment operating income/(loss)           |  |     | (560   | ) |     |   | (3,836 | )   |  |   | 281          |   |  |   | (4,115  | )
|Other income                              |  |     |        |   |     |   |        |     |  |   |              |   |  |   | 650     |  
|Interest expense                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   | (1,397  | )
|Income tax expense                        |  |     |        |   |     |   |        |     |  |   |              |   |  |   | (1,906  | )
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Net loss                                  |  |     |        |   |     |   |        |     |  |   |              |   |  | $ | (2,956  | )
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Assets                                    |  | $   | 49,432 |   |     | $ | 33,134 |     |  | $ | 6,843        |   |  | $ | 89,409  |  
|Depreciation/amortization                 |  |     | 1,186  |   |     |   | 1,503  |     |  |   | 194          |   |  |   | 2,883   |  
|Capital additions                         |  |     | 2,094  |   |     |   | 268    |     |  |   | 564          |   |  |   | 2,926   |  
|                                          |  |     |        |  
|Nine Months Ended September 30, 2004      |  | GSS |        |   | CSS |   |        | MCS |  |   | Consolidated |  
|Revenues from external domestic customers |  | $   | 92,286 |   |     | $ | 37,105 |     |  | $ | 4,657        |   |  | $ | 134,048 |  
|Revenues from external foreign customers  |  |     |       |   |     |   | 7,197  |     |  |   | 429          |   |  |   | 7,626   |  
|Inter-company revenues                    |  |     |       |   |     |   | 2,849  |     |  |   | 360          |   |  |   | 3,209   |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Total segment revenues                    |  |     | 92,286 |   |     |   | 47,151 |     |  |   | 5,446        |   |  |   | 144,883 |  
|Elimination                               |  |     |        |   |     |   |        |     |  |   |              |   |  |   | (3,209  | )
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Total revenue                             |  |     |        |   |     |   |        |     |  |   |              |   |  | $ | 141,674 |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Gross profit                              |  | $   | 19,467 |   |     | $ | 5,409  |     |  | $ | (1,286       | ) |  | $ | 23,590  |  
|Segment operating income/(loss)           |  |     | 6,576  |   |     |   | (4,026 | )   |  |   | (1,383       | ) |  |   | 1,167   |  
|Interest expense                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   | (853    | )
|Income tax benefit                        |  |     |        |   |     |   |        |     |  |   |              |   |  |   | 121     |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Net income                                |  |     |        |   |     |   |        |     |  |   |              |   |  | $ | 193     |  
|                                          |  |     |        |   |     |   |        |     |  |   |              |   |  |   |         |  
|Assets                                    |  | $   | 63,276 |   |     | $ | 39,716 |     |  | $ | 5,418        |   |  | $ | 108,410 |  
|Depreciation/amortization                 |  |     | 1,527  |   |     |   | 1,026  |     |  |   | 213          |   |  |   | 2,766   |  
|Capital additions                         |  |     | 2,025  |   |     |   | 872    |     |  |   | 70           |   |  |   | 2,967   |  



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 costs on long-term contracts into work-in-process inventory.



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



RESULTS OF OPERATIONS



Three months ended September 30, 2005

Versus three months ended September 30, 2004



The table below presents major highlights from the three
months ended September 30, 2005 and 2004.



(In $Millions)



|                           |  |      |       |   |      |   |          |  |         |   
|-------------------------- |  | ---- | ----- | - | ---- | - | -------- |  | ------- | --
|                           |  | 2005 |       |   | 2004 |   | % Change | 
|Revenue                    |  | $    | 31.03 |   |      | $ | 54.91    |  | (43.5   | )%
|Gross Profit               |  |      | 2.34  |   |      |   | 9.00     |  | (74.0   | )%
|Operating (loss)/income    |  |      | (5.73 | ) |      |   | 0.80     |  | (813.8  | )%
|(Loss)/Income before taxes |  |      | (6.22 | ) |      |   | 0.45     |  | (1476.3 | )%
|Net (loss)/income          |  |      | (3.75 | ) |      |   | 0.28     |  | (1439.3 | )%
|EBITDA                     |  |      | (4.58 | ) |      |   | 2.17     |  | (310.6  | )%



EBITDA for the quarters ended September 30, 2005 and 2004 was calculated using the following approach:



(In $Millions)



|                              |  |      |       |   |      |   |     
|----------------------------- |  | ---- | ----- | - | ---- | - | ----
|                              |  | 2005 |       |   | 2004
|Net (loss)/income             |  | $    | (3.75 | ) |      | $ | 0.28
|Interest                      |  |      | 0.49  |   |      |   | 0.35
|Tax (benefit)/expense         |  |      | (2.47 | ) |      |   | 0.17
|Depreciation and Amortization |  |      | 1.15  |   |      |   | 1.37
|                              |  |      |       |   |      |   |     
|EBITDA                        |  | $    | (4.58 | ) |      | $ | 2.17
|                              |  |      |       |   |      |   |     



The Company presents Earnings Before
Interest, Taxes, Depreciation and Amortization, more commonly referred to as EBITDA, because its management uses the measure to evaluate the Companys performance and to allocate resources. In addition, EBITDA is used as one of the components
to calculate the Companys debt covenants. The Company believes EBITDA is also an important gauge used by commercial banks, investment banks, other financial institutions, and current and potential investors to approximate its cash generation
capability. Accordingly, the Company has included EBITDA as part of this report. The depreciation and amortization amounts used in the EBITDA calculation are those that were recorded in the consolidated statements of operations in this report. Due
to the long-term nature of much of the Companys business, the depreciation and amortization amounts recorded in the



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##### Table of Contents

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 inventory. EBITDA is not a measure of financial performance under generally
accepted accounting principles and should not be considered as a substitute for or superior to other measures of financial performance reported in accordance with GAAP. EBITDA as presented herein may not be comparable to similarly titled measures
reported by other companies.



The decline in revenue was attributable to
reduced deliveries on the KC-135 program at the Companys Birmingham, Alabama facility, a temporary reduction of commercial work from the Companys largest commercial customer and a lockout of the union employees at the Companys
Dothan, Alabama facility. The reduced deliveries on the KC-135 program were the result of a temporary reduction of aircraft inducted for maintenance. The volume of aircraft inducted has returned to historical levels and deliveries of KC-135 aircraft
are expected to increase in future quarters compared to the third quarter of 2005. CSSs largest customer accelerated maintenance on its aircraft in 2005 in anticipation of a strike by its mechanics. As a result, the customer inducted fewer
aircraft at the Companys Dothan facility in the third quarter of 2005. Also during the third quarter of 2005, the customer declared Chapter 11 bankruptcy. The Company reserved $1.5 million for potential uncollectible accounts receivable from
the customer as a result of the bankruptcy. On August 7, 2005, members of the International Association of Machinists (IAM) union at the Companys Dothan facility voted to authorize union representatives to strike after the union contract
expired on August 9, 2005. On August 11, 2005, the Company elected to lock out union workers. The lock out ended on October 11, 2005 when an agreement was reached with the union. The Company expects the Dothan facility to return to
historical levels of business by the beginning of the first quarter of 2006.



The table below presents the highlights in revenue by operating segment for the three-month periods ended September 30, 2005 and 2004.



(In $Millions)



|             |  |      |       |   |      |   |       |        |  |   |          |   |  |       |   
|------------ |  | ---- | ----- | - | ---- | - | ----- | ------ |  | - | -------- | - |  | ----- | --
|             |  | 2005 |       |   | 2004 |   |       | Change |  |   | % Change |  
|GSS          |  | $    | 18.04 |   |      | $ | 36.41 |        |  | $ | (18.37   | ) |  | (50.5 | )%
|CSS          |  |      | 9.12  |   |      |   | 17.19 |        |  |   | (8.07    | ) |  | (46.9 | )%
|MCS          |  |      | 4.00  |   |      |   | 1.66  |        |  |   | 2.34     |   |  | 141.0 | % 
|Eliminations |  |      | (0.14 | ) |      |   | (0.35 | )      |  |   | 0.21     |   |  |       |   
|             |  |      |       |   |      |   |       |        |  |   |          |   |  |       |   
|Total        |  | $    | 31.02 |   |      | $ | 54.91 |        |  | $ | (23.89   | ) |  | (43.5 | )%
|             |  |      |       |   |      |   |       |        |  |   |          |   |  |       |   



Without regard to operating segments,
the Companys mix of revenue between government and commercial customers was approximately 35% commercial and 65% government in 2005 and 34% commercial and 66% government in 2004.



GSS revenue decreased $18.4 million primarily as a result of lower revenue under the KC-135 Programmed Depot Maintenance (PDM)
program of approximately $18.4 million. Only three KC-135 aircraft were delivered in the third quarter of 2005 versus ten in the third quarter of 2004. During the second quarter of 2005, the United States Air Force (USAF) advised us that
they were assessing the availability of funds related to the KC-135 program for the balance of the U.S. government fiscal year which ended September 30, 2005. During this assessment, aircraft inputs were suspended which ultimately resulted in
delayed arrivals and reduced inputs during the second quarter of 2005 which resulted in reduced deliveries in the third quarter. Inductions increased during the third quarter and deliveries are expected to return to normal levels in future quarters.
GSS completed inspections on two Air Force C-130s during the third quarter of 2004 generating revenue of $0.9 million for which there was no comparable revenue in 2005. PDM revenue on C-130 aircraft under another contract with the USAF increased
$0.5 million during 2005.



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##### Table of Contents

CSS revenue decreased $8.1 million as a result of decreased 737 cargo conversion work of $5.0 million due to delivering
two cargo conversion aircraft in the third quarter of 2004 for which there was no comparable revenue in the third quarter of 2005. Revenue from CSS largest commercial customer decreased $2.2 million due to inducting fewer aircraft in the third
quarter. Revenue for MRO services on DC-8 aircraft was $1.8 million in the third quarter of 2004 due to the delivery of one aircraft for which there was no comparable revenue in the third quarter of 2005. The decreases in revenue were partially
offset by an increase in commercial MRO services on 767 aircraft of $1.3 million.



MCS revenue increased $2.3 million in the third quarter of 2005 versus the third quarter of 2004. Revenues increased $2.0 million at Space Vector Corporation due to additional work on U.S. government launch vehicle programs. Revenue at
Pemco Engineers related to sales of high precision machined parts and other aircraft components increased $0.3 million during the third quarter of 2005 compared to the third quarter of 2004.



Cost of sales decreased $17.2 million, or 38%, to $28.7 million during the third quarter of
2005 as a result of the lower revenue base. Cost of sales was 92% and 84% of revenue in the third quarters of 2005 and 2004, respectively. Gross profit was significantly impacted by the results of CSS which experienced negative gross profit of $1.9
million for the third quarter of 2005 as a result of CSS largest commercial customer inducting fewer aircraft and the lockout of union employees. Gross profit was reduced by charges related to the USCG C-130 program of $1.7 million in the
third quarter of 2005. The Company was notified by the Coast Guard that options for additional C-130 aircraft would not be exercised. The Company expects the Coast Guard program to be substantially complete by the end of the fourth quarter of 2005.



Selling, General and Administrative (SG&A) expenses decreased
$1.6 million, or 20.0%, to $6.6 million in 2005. As a percentage of sales, SG&A expenses increased to 21.1% in 2005 from 14.9% in 2004. The increase in SG&A expense as a percentage of revenue was primarily caused by the low sales volume at
CSS which increased the percentage by 4.1%. The Company also incurred $0.2 million of stock-based compensation expense and $0.2 million in relocation expense for Pemco Engineers during the third quarter of 2005.



The Company also recorded a $1.5 million provision against accounts receivable during the
third quarter related to the Chapter 11 filing by our largest commercial customer disclosed above. Interest expense increased $0.1 million due to increases in variable interest rates compared to 2004.



Nine months ended September 30, 2005

Versus nine months ended September 30, 2004



The table below presents major highlights from the nine-months ended September 30, 2005 and 2004.



(In $Millions)



|                           |  |      |        |   |      |   |          |  |         |   
|-------------------------- |  | ---- | ------ | - | ---- | - | -------- |  | ------- | --
|                           |  | 2005 |        |   | 2004 |   | % Change | 
|Revenue                    |  | $    | 113.67 |   |      | $ | 141.67   |  | (19.8   | )%
|Gross Profit               |  |      | 15.49  |   |      |   | 23.59    |  | (34.3   | )%
|Operating (loss)/income    |  |      | (4.12  | ) |      |   | 1.17     |  | (452.6  | )%
|(Loss)/Income before taxes |  |      | (4.86  | ) |      |   | 0.31     |  | (1648.4 | )%
|Net (loss)/income          |  |      | (2.96  | ) |      |   | 0.19     |  | (1657.9 | )%
|EBITDA                     |  |      | (0.58  | ) |      |   | 3.93     |  | (115.0  | )%





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##### Table of Contents

EBITDA for the nine months ended September 30, 2005 and 2004 was calculated using
the following approach:



(In $Millions)



|                              |  |      |       |   |      |   |     
|----------------------------- |  | ---- | ----- | - | ---- | - | ----
|                              |  | 2005 |       |   | 2004
|Net (Loss)/Income             |  | $    | (2.96 | ) |      | $ | 0.19
|Interest                      |  |      | 1.40  |   |      |   | 0.85
|Tax (benefit)/expense         |  |      | (1.91 | ) |      |   | 0.12
|Depreciation and Amortization |  |      | 2.89  |   |      |   | 2.77
|                              |  |      |       |   |      |   |     
|EBITDA                        |  | $    | (0.58 | ) |      | $ | 3.93
|                              |  |      |       |   |      |   |     



The overall decline in revenue was
attributable to reduced work on the KC-135 program, a temporary reduction of commercial work at the Companys Dothan, Alabama facility that began in the second quarter of 2005 and a lock out of the union employees at the Companys Dothan,
Alabama facility in the third quarter of 2005. Gross profit as a percentage of revenue decreased from 16.7% to 13.6%. The decrease in gross profit was due to losses recorded for the Coast Guard program and decreases in operational efficiency caused
by reduced deliveries on the KC-135 program at the Companys Birmingham, Alabama facility, a temporary reduction of commercial work from the Companys largest commercial customer and a lock out of the union employees at the Companys
Dothan, Alabama facility. The Company expects to regain its operational efficiency during the fourth quarter of 2005 as business volume increases.



The table below presents the highlights in revenue by operating segment for the nine month period ended September 30, 2005 and 2004.



(In $Millions)



|             |  |      |        |   |      |   |        |        |  |   |          |   |  |       |   
|------------ |  | ---- | ------ | - | ---- | - | ------ | ------ |  | - | -------- | - |  | ----- | --
|             |  | 2005 |        |   | 2004 |   |        | Change |  |   | % Change |  
|GSS          |  | $    | 58.70  |   |      | $ | 92.28  |        |  | $ | (33.58   | ) |  | (36.4 | )%
|CSS          |  |      | 43.62  |   |      |   | 47.15  |        |  |   | (3.53    | ) |  | (7.5  | )%
|MCS          |  |      | 11.79  |   |      |   | 5.45   |        |  |   | 6.34     |   |  | 116.3 | % 
|Eliminations |  |      | (0.44  | ) |      |   | (3.21  | )      |  |   | 2.77     |   |  |       |   
|             |  |      |        |   |      |   |        |        |  |   |          |   |  |       |   
|Total        |  | $    | 113.67 |   |      | $ | 141.67 |        |  | $ | (28.00   | ) |  | (19.8 | )%
|             |  |      |        |   |      |   |        |        |  |   |          |   |  |       |   



Without regard to operating segments,
the Companys mix of revenue between government and commercial customers was approximately 43% commercial and 57% government in the first nine months of fiscal year 2005 and 35% commercial and 65% government in the first nine months of fiscal
year 2004.



GSS revenue decreased $33.6 million for the nine-month period ended
September 30, 2005 versus the nine-month period ended September 30, 2004. Revenues under the KC-135 program decreased by $33.2 million as a result of delivering 33% fewer KC-135 PDM aircraft in the nine-month period ended
September 30, 2005 than in the comparable period in 2004. During the second quarter of 2005, the United States Air Force advised us that they were assessing the availability of funds related to the KC-135 program for the balance of the U.S.
Government fiscal year which ended September 30, 2005. During this assessment, aircraft inputs were suspended which ultimately resulted in delayed arrivals and reduced inputs during the second quarter of 2005. As a result, revenue from the
KC-135 program for the second and third quarters was affected. GSS performed inspections on eight C-130s during the first nine months of 2004 generating revenue of $3.3 million for which there was no comparable revenue in 2005. GSS generated $6.7
million in revenue from non-routine services for the USCG and the delivery of one USCG aircraft in 2005, compared to $5.6 million in revenue from non-routine services for the USCG and for the delivery of two USCG aircraft in 2004.



The decrease in the CSS revenue of $3.5 million was attributable to a decrease in 737 cargo
conversion work, and decreased inter-company revenue related to the conclusion of the KC-135 flight controls program, offset by an increase in commercial MRO services.



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Revenue at the MCS increased $6.4 million in the first three quarters of 2005 versus the first three quarters of 2004.
Revenues at Space Vector Corporation increased $5.7 million due to additional work on U.S. government launch vehicle programs. Revenue at Pemco Engineers related to cargo systems and sales of high precision machined parts increased $0.7 million
during the first nine months of 2005 compared to the first nine months of 2004.



Cost of sales decreased $19.9 million to $98.2 million during the first nine months of 2005 as a result of the lower revenue base. Cost of sales decreased at a slightly lower rate than revenue because of charges related to the USCG C-130
program and fixed expenses. Gross profit was impacted by charges related to the USCG C-130 program of $4.0 million and $1.5 million in the first nine months of 2005 and 2004, respectively. The Company was notified by the Coast Guard that options for
additional C-130 aircraft would not be exercised. This program resulted in significant losses for the Company in 2003, 2004 and 2005 of $2.7 million, $3.4 million and $4.0 million, respectively. In 2004, costs were incurred related to improving
productivity and cost associated with projects to improve material flow to the aircraft, including point of use supply programs. Overall, the gross profit percentage of the Company decreased during this same period to 13.6% in the first nine months
of 2005 from 16.7% in the first nine months of 2004.



SG&A expenses
decreased $4.3 million, or 19.3%, to $18.1 million in the first nine months of 2005. As a percentage of sales, SG&A expenses were 15.9% during the first nine months of 2005 compared to 15.8% in the first nine months of 2004. The decrease in
SG&A expense is primarily attributable to a charge of $0.9 million related to the purchasing of stock upon exercise of options from a former employee in 2004, approximately $2.5 million in accounting and legal charges during the first three
quarters of 2004 related to the 2003 financial statement audit and the restatement of the Companys financial statements filed in connection with the first three quarters of 2003.



The Company also recorded a gain of $0.65 million on the assignment of a lease located at the St. Petersburg-Clearwater International
Airport. Interest expense increased $0.5 million due to increases in variable interest rates compared to 2004.



LIQUIDITY AND CAPITAL RESOURCES



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



(In $ Thousands, except debt to equity)



|                                                                |  |                    |         |   |                   |   |        |  |   |         |  
|--------------------------------------------------------------- |  | ------------------ | ------- | - | ----------------- | - | ------ |  | - | ------- | -
|                                                                |  | September 30, 2005 |         |   | December 31, 2004 |   | Change | 
|Cash and cash equivalents                                       |  | $                  | 42      |   |                   | $ | 3,354  |  | $ | (3,312  | )
|Working capital                                                 |  |                    | (13,435 | ) |                   |   | 25,507 |  |   | (38,942 | )
|Current portion of long-term debt and capital lease obligations |  |                    | 23,864  |   |                   |   | 7,447  |  |   | 16,417  |  
|Long-term debt and capital lease obligations                    |  |                    | 1,960   |   |                   |   | 30,494 |  |   | (28,534 | )
|Stockholders equity                                            |  |                    | 15,645  |   |                   |   | 18,478 |  |   | (2,833  | )
|Debt to equity                                                  |  |                    | 1.65    |   |                   |   | 2.05   |  |   | (0.40   | )



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



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Working Capital



As discussed below, the Company was in violation of various debt covenant ratios as of September 30, 2005. As a result, all outstanding debt under our Credit
Agreement has been classified as current on the Consolidated Balance Sheets. The reclassification of long-term debt to current resulted in working capital decreasing from a positive $8.5 million to a negative $13.4 million. As a result of the debt
covenant violations, the outstanding borrowings under the Credit Agreement may become immediately due and payable and interest rates may increase although the lenders have not indicated an intent to do so. Our ability to meet current and future
payment obligations is dependent upon our ability to improve operating performance, obtain additional financing from current or alternative lenders, or a combination of the above items. The lenders have waived all defaults of debt covenants through
September 30, 2005. While we believe our operating performance will improve and that our lenders will not accelerate debt obligations, there can be no assurances we will be successful and we may require additional capital to meet our operating
needs, which may not be available on favorable terms, or at all. Our estimates for the fourth quarter of 2005 and the first quarter of 2006 assume additional working capital needs as we begin programs for new customers and continue to increase
staffing at the Dothan facility. We will continue to monitor our financial results and liquidity position and, if necessary, implement further reductions in expenses and capital expenditures. We have no current arrangements with respect to sources
of additional financing and our recent negative results of operations will likely make it more difficult and expensive for the Company to raise additional capital that may be necessary to continue our operations. Our ability to continue to borrow
funds from our lenders under the Credit Agreement is dependent on our ability to meet the lenders borrowing conditions at the relevant times.



Cash Flow Overview



Operating activities provided $11.7 million of cash during the nine months ended September 30, 2005 and used $7.0 million of cash during the same period of 2004. Cash of $2.9 million and $3.0 million was used
during the first nine months of 2005 and 2004, respectively, for capital expenditures. The Company contributed $6.0 million and $6.5 million during 2005 and 2004, respectively, to fund its pension plan. The Company used $1.1 million and $0.8 million
during each of 2005 and 2004 to fund principal payments of long-term debt and used $11.0 million during 2005 to reduce borrowings under the revolving credit facility. A major source of cash was the reduction of accounts receivable of $17.8 million
due to decreased revenue from major customers and the renegotiation of payment terms in April 2005 with the Companys largest customer which reduced the contractual collection period by 50%. The decrease in accounts receivable was partially
offset by decreases in accounts payable of $6.9 million.



Future Capital
Requirements



The Company has four large potential capital requirements:
required minimum funding of the defined benefit pension plan, current maturities of long-term debt, working capital increases associated with new contracts and capital expenditures.



The Company maintains a defined benefit pension plan (the Plan), which covers substantially all employees at its Birmingham and
Dothan, Alabama facilities. The 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 Plan in 2001 and 2002, partially offset by favorable returns in 2003 and 2004, coupled with substantially lower interest rates, the Plan was under-funded by approximately $23.3
million at December 31, 2004. Pursuant to minimum funding requirements of ERISA, the Company expects to contribute approximately $10.5 million to the Plan during the next twelve months.



Current maturities of debt at September 30, 2005 and December 31, 2004 totaled
$23.9 million and $7.4 million, respectively. As discussed more extensively below, current maturities of debt at September 30, 2005 and December 31, 2004 included $19.8 million and $5.8 million, respectively, payable under the Revolving
Credit Facility.



The Company expects to begin a long-term contract for P-3
Orion aircraft for the U.S. Navy with its partner, L-3 Communications, in the fourth quarter of 2005. Other new programs are expected to begin in the first quarter of 2006. The Company expects working capital to increase $5.0 to $8.0 million in the
first half of 2006 for these programs.



The Company has begun an initiative to
improve hanger facilities for the GSS in Birmingham. The Company completed the renovation of Bay 2 and other facility upgrades in Birmingham during the nine months ended September 30, 2005.



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Future upgrades and additional facility improvements will depend on new business and availability of resources. The
Company anticipates total capital expenditures of $3.0 to $4.0 million during 2005, of which $2.9 million has been spent through September 30, 2005.



Revolving Credit Facility



On December 16, 2002, the Company executed a Credit Agreement (the Credit Agreement) that provides for a revolving credit facility and a term loan (the
Revolving Credit Facility and Bank Term Loan, respectively). The original commitment under the Revolving Credit Facility was $25.0 million and was subsequently increased to $33.0 million. On June 28, 2005, the Revolving
Credit Facility maturity date was extended to October 15, 2006 and the commitment level was set at $28.0 million. The Revolving Credit Facility bears interest at LIBOR plus 2.00% to 2.75% (6.44% at September 30, 2005), determined based on
the ratio of adjusted funded debt to earnings before interest, taxes, depreciation and amortization, each as defined in the Credit Agreement. The Company reduced borrowings under the Revolving Credit Facility from $30.8 million as of
December 31, 2004 to $19.8 million as of September 30, 2005, principally as a result of cash provided by operating activities. As a result of violating debt covenants discussed below, all $19.8 million outstanding under the Revolving
Credit Facility as of September 30, 2005 has been classified in current maturities compared to $5.8 million in current maturities under the revolver as of December 31, 2004.



Borrowing availability under the Revolving Credit Facility is tied to percentages of eligible accounts receivable and inventories. The
Company had borrowings of approximately $19.8 million outstanding under the Revolving Credit Facility at September 30, 2005. Remaining borrowing capacity available under the facility at September 30, 2005, based upon the calculation that
defines the borrowing base, totaled approximately $2.4 million.



During the
first and second quarters of 2005 and the fourth quarter of 2004, the Company violated the fixed charge coverage ratio covenant under the Revolving Credit Facility due to losses incurred by the Company during 2005 and 2004. As of September 30,
2005, the Company violated the adjusted tangible net worth covenant. The lenders have waived all violations of debt covenants through September 30, 2005. On March 31, 2005, the Company obtained a waiver from the lender for the fixed charge
coverage ratio covenant violation with respect to the first quarter of 2005 and the fourth quarter of 2004 and amended the Credit Agreement to revise the calculation of the fixed charge coverage ratio for the second and third quarters of 2005 using
annualized 2005 results instead of total results of the past four quarters and to increase the adjusted tangible net worth covenant from approximately $30.0 million to $33.5 million. On August 11, 2005, the Company obtained a waiver from the
lender for the fixed charge coverage ratio covenant violation with respect to the second and third quarters of 2005 and amended the Credit Agreement was amended to revise the calculation of the fixed charge coverage ratio for the fourth quarter of
2005, decreasing the required ratio of operating income to fixed charges from 1.2 to 1.0 and increasing the adjusted tangible net worth covenant from approximately $33.5 million to $38.5 million. If the Company is unable to comply with the covenants
in the future and the lender does not grant a waiver, the outstanding borrowings under the Credit Agreement may become immediately due and payable and interest rates may increase although the lenders have not indicated an intent to cause this to
happen.



Funding Sources



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



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The aircraft services industry has been in a consolidation phase generally. As a consequence, the Company receives and
sometimes initiates inquiries with respect to corporate combinations. The Company has not completed any such combinations for a number of years, and there is no assurance that it will be party to such transactions in the future. On June 23,
2005, the Company announced it had engaged Bear, Stearns & Co. as its financial advisor to assist the Company in its exploration of strategic alternatives. There is no assurance that the consideration of strategic alternatives by the
Company will lead to any action.



TRADING ACTIVITIES



The Company has not engaged in trading activities or in trading non-exchange traded
contracts. As of September 30, 2005 and 2004, the carrying amounts of the Companys financial instruments were estimated to approximate their fair values, due to their short-term nature, and variable or market interest rates. The Company
has not hedged its interest rate or foreign exchange risks through the use of derivative financial instruments. See Quantitative and Qualitative Disclosures about Market Risk included in Item 3 of Part I of this Report.



RELATED PARTY TRANSACTIONS



On April 23, 2002, the Company loaned its current President and Chief Executive Officer
approximately $0.4 million under the terms of a Promissory Note. The Promissory Note carries a fixed interest rate of 5.0% per annum and is payable within 60 days of the President and Chief Executive Officers termination of employment
with the Company. Any change in this related party receivable relates to interest accumulated during the period.



CRITICAL ACCOUNTING POLICIES AND ESTIMATES



The Companys significant accounting policies are disclosed in Note 1 of the Notes to Consolidated Financial Statements in the Companys 2004 Annual Report on
Form 10-K. The preparation of financial statements in conformity with generally accepted accounting principles requires that management use judgments to make estimates and assumptions that affect the amounts reported in the financial statements. As
a result, there is some risk that reported financial results could have been materially different had different methods, assumptions, and estimates been used.



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



Revenue Recognition



Revenue at the GSS is derived principally from aircraft maintenance and modification
services performed under contracts or subcontracts with government and military customers. The GSS recognizes revenue and associated costs under such contracts on the percentage-of-completion method as prescribed by Statement of Position 81-1
(SOP 81-1), Accounting for Performance of Construction-Type and Certain Production-Type Contracts. These contracts generally provide for routine maintenance and modification services at fixed prices detailed in the contract.
Any non-routine maintenance and modification services are provided based upon estimated labor hours at fixed hourly rates. The Company segments the routine and the non-routine services for purposes of accumulating costs and recognizing revenue. For
routine services, the Company uses the units-of-delivery method as the basis to measure progress toward completion, with revenue recorded based upon the unit sales value stated in the contract and costs of sales recorded based upon actual unit cost.
An aircraft is considered delivered when work is substantially complete and acceptance by the customer has occurred. For non-routine services, the Company uses an output measure based upon units of work performed to measure progress toward
completion, with revenue recorded based upon the stated hourly rates in the contract and costs of sales recorded based upon estimated average costs. The Company considers each task performed for the customer as a unit of work performed. Revenue and
costs of sales are recognized upon completion of all performance obligations in accordance with the contract. Such work is performed and completed throughout the PDM process.



Revenue at the CSS is derived principally from aircraft maintenance, modification, and conversion programs under contracts with the owners
and operators of large commercial airlines. The CSS recognizes revenue and associated costs for all work performed under such contracts on a percentage-of-completion method, as prescribed by SOP 81-1, using units-of-delivery as the basis to measure
progress toward completion. Revenue is recorded based upon the unit sales value stated in the contract and costs of sales are recorded based upon actual unit cost.



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The MCS derives a significant portion of its revenue from cost-reimbursement type contracts accounted for under the
principles prescribed by SOP 81-1 and from sales of precision parts and components. Revenue on cost-reimbursable contracts is recognized to the extent of costs incurred plus a proportionate amount of estimated fee earned. For certain other
fixed-price contracts, revenue is recognized when performance milestones have been achieved in accordance with contract terms. Revenue related to sales of individual components and parts is recognized upon delivery to the customer, and when the
product price is fixed and determinable and collection of the resulting receivable is reasonably assured.



Contract accounting requires judgment relative to assessing risks and estimating contract revenues and costs. The Company employs various techniques to project contract revenue and costs which inherently include
significant assumptions and estimates. Contract revenues are a function of the terms of the contract and often bear a relationship to contract costs. Contract costs include labor, material, an allocation of indirect costs, and, in the case of
certain government contracts, an allocation of general and administrative costs. Techniques for estimating contract costs generally impact the Companys proposal processes, including the determination of pricing for routine and non-routine
elements of contracts, the evaluation of profitability on contracts, and the timing and amounts recognized for revenue and cost of sales. The Company provides for losses on uncompleted contracts in the period in which management determines that the
estimated total costs under the contract will exceed the estimated total contract revenues. These estimates are reviewed periodically and any revisions are charged or credited to operations in the period in which the change is determined. An amount
equal to contract costs attributable to claims is included in revenues when realization is probable and the amount can be reasonably estimated. Judgment is required in determining the potential realization of claim revenue and estimating the amounts
recoverable. Because of the significance of the judgments and estimates required in these processes, it is likely that materially different amounts could result from the use of different assumptions or if the underlying conditions were to change. In
addition, contracts accounted for under the percentage-of-completion, units-of-delivery method may result in material fluctuations in revenue and profit margins depending on the timing of delivery and performance, the relative proportion of fixed
price, cost reimbursement, and other types of contracts-in-process, and costs incurred in their performance. For additional information regarding accounting policies the Company has established for recognizing revenue, see Revenue
Recognition in Note 1 to the Consolidated Financial Statements in the Companys 2004 Annual Report on Form 10-K.



Allowance for Doubtful Accounts



The Companys allowance for doubtful accounts is generally recorded on the specific identification method. This method involves subjectivity and generally includes
an evaluation of historical experience with the customer, current relationship with the customer, aging of the receivable, contract terms, discussion with the customer, marketing, and contracts personnel, as well as other available data.



Given the nature of the GSSs business and customers, write-offs have historically
been nominal. GSS customers are primarily the U.S. Government and, more recently, Boeing Corporation. The CSS primarily services the commercial airline market, and is therefore more susceptible to collectibility issues. Generally, the
Companys services are contract driven, and fees for services performed in accordance with the agreed upon terms of the contract with the customer are collected. MCS business involving commercial customers has experienced some collectibility
problems; however, historical MCS write-offs have been insignificant to the Companys operations as a whole.



Inventory Reserves



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



Deferred Taxes



The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. While
the Company has considered future taxable income and ongoing prudent and feasible tax planning



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strategies in assessing the need for the valuation allowance, in the event the Company were to determine that it would be
able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should the Company determine that it would
not be able to realize all or part of its net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged against income in the period such determination was made.



Machinery, Equipment and Improvements and Impairment



Machinery, equipment and leasehold improvements are stated at cost, less accumulated
depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives. In the case of leasehold improvements, the useful life is the shorter of the lease period or the economic life
of the improvements. The Company estimates the useful lives based on historical experience and expectations of future conditions. Should the actual useful lives be less than estimated, additional depreciation expense or recording a loss on disposal
may be required.



The Company reviews machinery, equipment and improvements for
impairment whenever there is an indication that their carrying amount may not be recoverable and performs impairment tests on groups of assets that have separately identifiable cash flow. The Company compares the carrying amount of the assets with
the undiscounted expected future cash flows to determine if an impairment exists. If an impairment exists, assets classified as held and used are written down to fair value and are depreciated over their remaining useful life, while assets
classified as held for sale are written down to fair value less cost to sell. The actual fair value may differ from the estimate.



Pension and Postretirement Plans



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



Warranties



The Company provides warranties covering workmanship and materials under its PDM and MRO
maintenance contracts that generally range from six to 18 months after an aircraft is delivered, depending on the specific terms of each contract. The Company provides warranties under its cargo conversion contracts that generally range from
approximately three to ten years from the date of aircraft delivery on structure, electrical systems and other components directly associated with the conversion system and one year from the date of aircraft delivery on workmanship and materials
related to general maintenance performed concurrent with the conversion. The Company provides a reserve for anticipated warranty claims based on historical experience, current warranty trends, and specific warranty terms. Periodic adjustments to the
reserve are made as events occur that indicate changes are necessary.



Insurance Reserves



The Company is currently self-insured for
employee medical coverage and has a large deductible for workers compensation claims. The Company records a liability for the ultimate settlement of claims incurred as of the balance sheet date based upon estimates provided by the companies
that administer the claims on the Companys behalf. The Company also reviews historical payment trends and identified specific claims in determining the reasonableness of the reserve. Adjustments to the reserve are made when the facts and
circumstances of the underlying claims change. Should the actual settlement of the medical or workers compensation claims be greater than estimated, additional expense will be recorded.



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Contingencies



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



BACKLOG



The following table presents the Companys backlog (in thousands of dollars) at September 30, 2005 and December 31, 2004:



|                |  |                    |        |                   |   |       
|--------------- |  | ------------------ | ------ | ----------------- | - | ------
|Customer Type   |  | September 30, 2005 |        | December 31, 2004
|U.S. Government |  | $                  | 45,459 |                   | $ | 48,562
|Commercial      |  |                    | 23,597 |                   |   | 17,026
|                |  |                    |        |                   |   |       
|Total           |  | $                  | 69,056 |                   | $ | 65,588
|                |  |                    |        |                   |   |       



The reduction in government backlog
was related to decreases in the KC-135 program at GSS offset by increases at MCS. The GSS decreased backlog approximately $3.5 million year-over-year due primarily to fewer KC-135 aircraft in work. Backlog in government programs at the MCS increased
$0.4 million during this same period due to award of contracts related to U.S. government launch vehicle programs.



Total commercial backlog increased $6.6 million. The increase in backlog at the CSS is due primarily to a contract for aircraft conversion work including five firm
conversion orders offset by lower inputs of aircraft from the CSS largest customer, which has performed fewer heavy maintenance checks on its aircraft during the second and third quarters of 2005 compared to 2004. This reduction in the number
of aircraft inputs at our commercial facility in Dothan, Alabama is expected to be temporary and a return to historical aircraft inputs from this customer is expected to result in the commercial business returning to historical levels by the first
quarter of 2006.



Overall, the mix of backlog shifted from 74% U.S. Government
and 26% commercial at December 31, 2004 to 66% U.S. Government and 34% commercial at September 30, 2005. The shift to commercial from U.S. Government results primarily from the increase in backlog at the CSS described above.



The backlog at September 30, 2005 is higher than at the end of 2004 and is expected to
increase further by December 31, 2005. The Company expects to begin providing sustainment work on the P-3 Orion maritime patrol and antisubmarine warfare aircraft for the U.S. Navy with its partner, L-3 Communications, in the fourth quarter of
2005. The Company anticipates that the increasing backlog will result in revenue and net income growth in future years.



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



CONTINGENCIES



See Note 10 to the Consolidated Financial Statements.



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



Some of the information under the caption Managements Discussion and Analysis of
Financial Condition and Results of Operations and elsewhere in this Quarterly Report are forward-looking statements that are entitled to the protection of the safe harbors contained 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, anticipated increase in demand for conversions, maintenance services, the outcome of pending or future litigation, compliance with debt covenants under borrowing arrangements, 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,



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intends, plans, believes, seeks, estimates and similar
expressions are generally intended to identify forward-looking statements. Because these forward-looking statements involve risks and uncertainties, there are important factors, including the factors discussed under the caption Factors That
May Affect Future Performance in the Companys 2004 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, whether as a result of new information,
future events or otherwise.



Item 3. Quantitative and Qualitative Disclosures about Market Risk



The Company is exposed to market risk from changes in interest rates as part of its normal operations. The Company maintains various debt instruments to finance its business operations. The debt consists of fixed and
variable rate debt. The variable rate debt is related to the Companys Credit Agreement, which includes a revolving credit facility and two term loans, all as described in Note 6 to the Consolidated Financial Statements (see Item 1
herein). The Credit Agreements revolving credit facility bears interest at LIBOR plus 275 basis points (6.44% at September 30, 2005). Each of the term loans under the Credit Agreement bears interest at LIBOR plus 300 basis points (6.69%
at September 30, 2005). The Airport Authority Term Loan bears interest at BMA plus 36 basis points (2.90% at September 30, 2005). Had the interest rate of the variable rate debt increased 100 basis points, net loss would have been
increased by approximately $0.3 million during the first nine months of 2005.



Item 4. Controls and Procedures



(a)
Evaluation of disclosure controls and procedures.



The Company
maintains disclosure controls and procedures designed to provide reasonable assurance of achieving the objective that information in its Exchange Act reports is recorded, processed, summarized and reported within the time periods specified and
pursuant to the requirements of the Securities and Exchange Commissions rules and forms. Disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, include controls and procedures designed to ensure
that information required to be disclosed by the Company in the reports filed or submitted under the Exchange Act is accumulated and communicated to the Companys management, including the 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, 2005, 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. The Company performed
additional procedures at September 30, 2005 in areas identified as having material weaknesses to verify that the financial information presented herein is materially accurate.



(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 audits of the
Companys financial statements for the fiscal years ended December 31, 2004 and 2003, including the restatement of its financial statements for the first three quarters of fiscal year 2003, the Company is continuing to review and enhance
policies and procedures involving accounting, information systems and monitoring.



During the audit of the 2003 financial statements, the Companys independent registered public accounting firm identified four reportable conditions that together constituted a material weakness in internal control over financial
reporting involving the incorrect applications of generally accepted accounting principles as a result of personnel in certain areas of the Company who did not have a full understanding of pertinent accounting and financial reporting principles
and as a result of the untimely resolution of errors. The resulting reportable conditions were (i) lack of appropriate analysis and support for revenue recognition matters; (ii) lack of appropriate analysis and support pertaining to
estimates to complete certain contracts made in connection with projecting losses on contracts in a current period; (iii) lack of appropriate analysis and support for inventory accounting matters; and (iv) lack of appropriate analysis and
support for the reconciliation of inter-company transactions.



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The Company implemented the following corrective action plan to remediate the material weakness identified during the
audit of the 2003 financial statements: (i) re-evaluated and added staffing and level of expertise; (ii) increased training of its corporate and accounting staff to heighten awareness among corporate and accounting personnel of generally
accepted accounting principles; (iii) established policies and procedures, including documentation, designed to enhance coordination and reporting procedures between management and the Companys accounting staff; (iv) centralized
review and monitoring of accounting issues; and (v) re-allocated senior accounting personnel to provide additional on-site supervision of accounting functions.



Specifically, the Company implemented the following:



| |  |  | During the first quarter and the early part of the second quarter of 2004, the Company evaluated the reportable conditions and adopted nine new formal corporate policies related to
the four reportable conditions, including policies addressing revenue recognition, contract loss, and the reconciliation of inventory and intercompany accounts. These new policies, which in the aggregate cover all of the Companys segments,
include:
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 1. | Corporate Intercompany Reconciliation Policy,
| | -- | ---------------------------------------------



| | 2. | Corporate Inventory Reconciliation Policy,
| | -- | ------------------------------------------



| | 3. | Pemco Aeroplex Revenue Recognition Policy,
| | -- | ------------------------------------------



| | 4. | Pemco Aeroplex Contract Loss Policy,
| | -- | ------------------------------------



| | 5. | Pemco World Air Services Revenue Recognition Policy,
| | -- | ----------------------------------------------------



| | 6. | Pemco World Air Services Contract Loss Policy,
| | -- | ----------------------------------------------



| | 7. | Space Vector Revenue Recognition Policy,
| | -- | ----------------------------------------



| | 8. | Space Vector Contract Loss Policy, and
| | -- | --------------------------------------



| | 9. | Pemco Engineers Revenue Recognition Policy.
| | -- | -------------------------------------------



| |  |  | In furtherance of implementing the new policies described above, in April of 2004, the Company engaged Navigant Consulting, Inc. to independently review those policies as well as
the Companys implementation of them. Navigant focused primarily on revenue recognition and contract loss accruals. The Company gave Navigant access to all necessary personnel for Navigant to evaluate the Companys new policies as well as
other aspects of the Companys disclosure controls and procedures. Subsequently, Navigant provided the Company with several recommendations to further strengthen the Companys disclosure controls and procedures, including (i) using
current productivity to measure future productivity; (ii) revising the Companys spreadsheets used for calculation of loss accrual and estimated time to complete; and (iii) reorganizing and supplementing the data package provided by
the segment controllers to Corporate Accounting regarding each aircraft in work, which is reviewed in connection with the end of quarter review. The Company implemented those recommendations during the second and third quarters of 2004.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | At the end of the first quarter of 2004, the Company, with KPMGs assistance, conducted a training seminar for the Chief Executive Officer, the Chief Financial Officer,
Presidents of the Companys subsidiaries, production personnel and contracts personnel on revenue recognition and the estimation of loss contracts. The seminar provided further education to non-accounting personnel regarding the importance of
revenue recognition and estimates to complete for loss accruals in accordance with GAAP. In addition, accounting personnel met with KPMG on Sections 302 and 404 of the Sarbanes-Oxley Act of 2002, revenue recognition (SAB 101 and SOP 81-1) and
contract loss accruals. The Company intends to conduct similar seminars periodically in the future.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | At the end of the first quarter of 2004, the Company created a seven person disclosure committee consisting of the Companys Corporate Controller or Chief Accounting Officer,
four segment controllers, the Companys general counsel and one member of the Companys internal audit staff. The disclosure committee, which meets at least once a quarter, assists the Chief Executive Officer and Chief Financial Officer in
fulfilling their responsibility for oversight of the accuracy and timeliness of the disclosures made by the Company by assisting in various tasks, in each case subject to the supervision and oversight of the Chief Executive Officer and Chief
Financial Officer. Such tasks include designing appropriate disclosure controls, monitoring the integrity and effectiveness of the Companys disclosure controls and reviewing and supervising the preparation of the Companys periodic and
current reports, proxy statements, registration statements and any other information filed with the Commission.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | During the third quarter of 2004, the Company hired two additional persons for the positions of Assistant Controller and Inventory Accountant. The Assistant Controller is a
Certified Public Accountant (CPA), and the Inventory Accountant has significant inventory control and reconciliation experience. During the fourth quarter of 2004, the Company hired a Vice President of Accounting with GAAP expertise.
With the most recent additions, the Company now employs seven CPAs in its accounting area. Moreover, the Company re-allocated several employees with significant GAAP experience to different positions within the Company and its subsidiaries to
strengthen its human resources and GAAP expertise in appropriate areas.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The corrective action plan was not implemented within sufficient time prior to the audit of the 2004 financial statements to fully remediate the material weakness identified in the prior year. Additionally, during the audit of the 2004
financial statements, the Companys independent registered public accounting firm identified the following material weaknesses in internal control over financial reporting: (i) lack of appropriate controls to timely record liabilities for
services performed in 2004 for which the invoices were not processed at December 31, 2004; (ii) lack of appropriate analysis and support for inventory matters; (iii) lack of appropriate analysis and support for payroll accruals;
(iv) lack of adequate evaluation of leasehold improvements placed in service from 1982 to 2001; and (v) lack of segregation of duties related to system access controls. Internal controls related to the reconciliation and reviews of the
accounts described in items (i)  (iv) in the previous sentence were not operating sufficiently to detect and correct potential errors to the financial statements. The Company has expanded the scope of the corrective action plan to
include a comprehensive review of the overall internal control structure and information systems modification requirements in an effort to remediate the material weaknesses which existed as of December 31, 2004. The corrective action plan
includes detailed reviews of the reconciliation process for significant accounts, analysis of existing accounting policies, and increased financial audits by the Companys internal audit staff. The corrective action plan described above has
been implemented at September 30, 2005. The review of the overall internal control structure and information system modification requirements is ongoing and will continue into 2006.



Except as noted above, there have been no changes to the Companys internal control over financial reporting that occurred during the
Companys fiscal quarter ended September 30, 2005 that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



PART II OTHER INFORMATION



Item 1. Legal Proceedings



See Note 10 to the Consolidated Financial Statements.



Item 3. Defaults Upon Senior Securities



As of
September 30, 2005, the Company violated the adjusted tangible net worth covenant in its Credit Agreement. As a result of this violation, the Company has classified all debt covered by the Credit Agreement ($19.8 million outstanding at September 30,
2005) as short-term in the Consolidated Balance Sheets. The lender has waived all violations of debt covenants through September 30, 2005. If the Company is unable to comply with the covenants in the future and the lender does not grant a waiver,
the outstanding borrowings under the Credit Agreement may become immediately due and payable and interest rates may increase. See Note 6 to the Consolidated Financial Statements.



Item 5. Other Information



See Item 3 above.



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.



|                         |  |                            |  |                                             
|------------------------ |  | -------------------------- |  | --------------------------------------------
|                         |  | PEMCO AVIATION GROUP, INC.
|                         |  |                           
|Dated: November 14, 2005 |  | By:                        |  | /s/ Ronald A. Aramini                       
|                         |  |                            |  | Ronald A. Aramini, President                
|                         |  |                            |  | and Chief Executive Officer                 
|                         |  |                            |  | (Principal Executive Officer)               
|                         |  |                           
|Dated: November 14, 2005 |  | By:                        |  | /s/ John R. Lee                             
|                         |  |                            |  | John R. Lee, Sr. Vice President and         
|                         |  |                            |  | Chief Financial Officer                     
|                         |  |                            |  | (Principal Financial Officer)               
|                         |  |                           
|Dated: November 14, 2005 |  | By:                        |  | /s/ Randall C. Shealy                       
|                         |  |                            |  | Randall C. Shealy, Vice President-Accounting
|                         |  |                            |  | (Principal Accounting Officer)              



-S33-