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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

OR

Commission file number: 0-13829

PEMCO AVIATION GROUP, INC.
(Exact name of registrant as specified in its charter)

205-592-0011
(Registrant’s telephone number, including area code)

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

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

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

ASSETS
(In Thousands)

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

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

LIABILITIES AND STOCKHOLDERS’ EQUITY
(In Thousands, except common share information)

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

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Net Income per Common Share Information)

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

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Net Income per Common Share Information)

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

PEMCO AVIATION GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)

The accompanying notes are an integral part of these consolidated statements

1.  CONSOLIDATED FINANCIAL STATEMENTS

2.  INVENTORIES

(In Thousands)

3.  NET INCOME PER SHARE

(All numbers In Thousands, except Income Per Share)

4.  DEBT

(In Thousands)

5.  STOCKHOLDERS’ EQUITY

6.  CONTINGENCIES

Litigation

7.  SEGMENT INFORMATION

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

(In Thousands)

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

(In Thousands)

Introduction

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

Three months ended September 30, 2002
Versus three months ended September 30, 2001

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

Sales in the Government Services Group decreased by $6.8 million during the third quarter of 2002, or 26.0%, from $26.2 million in 2001 to $19.4 million in 2002. This decrease is essentially a timing issue due to the limitation of good test flight weather in Birmingham, Alabama caused by tropical storms in late September. During the third quarter of 2001 the company delivered nine aircraft under the KC-135 Programmed Depot Maintenance contract, whereas in the third quarter of 2002 the company delivered six KC-135 Programmed Depot Maintenance aircraft.

Sales in the Commercial Services Group increased by $2.0 million, or approximately 18.0%, during the third quarter of 2002, from $11.1 million in 2001 to $13.1 million in 2002. Sales of aircraft serviced under Maintenance, Repair, Conversion, and Component contracts increased $2.4 million. During the third quarter of 2002 the company converted the first B737-300 aircraft from passenger to cargo configuration under its amended STC. The company completed work on the H-3 helicopter contract in 2001. During the third quarter of 2001 the company had sales of $0.4 million under this contract.

Sales in the Manufacturing & Component Group decreased by $1.2 million, approximately 28.6%, during the third quarter of 2002, from $4.2 million in 2001 to $3.0 million in 2002. This decrease is due primarily to the Pemco Engineers subsidiary that had $1.1 million less revenue, a 54.1% decrease for this subsidiary, in the third quarter of 2002 versus the same quarter of 2001. The Space Vector subsidiary had a decrease of $0.1 million in revenue during this same period. The decrease in Pemco Engineers revenue is a result of lower orders for deliveries of replacement parts for cargo-handling systems on aircraft in service during the three months ended September 30, 2002.

Without regard to operating segments, the company’s mix of business between government and commercial customers was 39.3% commercial and 60.7 % government during the third quarter of 2002 shifting from 30.4% commercial and 69.6% government during the same period in 2001.

Cost of sales decreased by $3.5 million during the third quarter of 2002, from $32.6 million in 2001 to $29.1 million in 2002. This decrease is primarily a result of the company delivering fewer aircraft under its KC-135 Programmed Depot Maintenance contract, as described above. This decrease was partially offset by the company replacing relatively high margin sales at the Pemco Engineers subsidiary with relatively lower margin business at other subsidiaries, additional expenses incurred at the Commercial Services Group as it revised its production processes to accommodate changes in the design of the B737-300 cargo conversion and losses incurred at the Government Services Group on the delivery of a JSTAR aircraft and a KC-135 aircraft under a transition contract. This KC-135 incurred several delays due to an inability to obtain required parts under the contract that had the tendency to increase costs. Overall, the gross profit percentage of the company was 17 .8% in the third quarter of 2002 a decrease from 21.4% in the third quarter of 2001.

Selling, general, and administrative (“SG&A”) expenses were $4.8 million in the third quarters of 2002 and 2001.

Interest expense was $0.3 million during the third quarter of 2002 a decrease from $0.4 million during the same period in 2001. The effective average interest rate on the company’s revolving credit facility was approximately 5.25% in 2002 and 6.57% in 2001. This decrease in interest rate was partially offset by an increase of $1.0 million in average debt outstanding during the quarter ended September 30, 2002 compared to the quarter ended September 30, 2001. The average debt outstanding at the end of the quarter ended September 30, 2002 was impacted by the company borrowing $6.7 million to purchase Treasury Stock at the end of the second quarter of 2002.

Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) was approximately $2.2 million for the three months ended September 30, 2002 compared to $4.9 million for the three months ended September 30, 2001.

The large increase in Accounts Receivable between December 31, 2001 and September 30, 2002, reflected on the company’s Consolidated Statement of Cash Flows is attributable primarily to the Government services segment and is due to the combination of systems problems on the company’s account with the government payment office and various issues and challenges associated with establishing a new billing process and methodology between the company and the Boeing Company. The company anticipates that this short-term increase in Accounts Receivable will be corrected during the fourth quarter of 2002.

The increase in Accrued Liabilities – Other between December 31, 2001 and September 30, 2002, reflected on the company’s Consolidated Statement of Cash Flows is attributable to the Government Services Group and is due primarily to milestone payments and deferred income associated with the contract between the company and the McDonnell Douglas Corporation, a wholly owned subsidiary of the Boeing Company, for work on the KC-135 Programmed Depot Maintenance contract. Work under this contract began in the fourth quarter of 2001.

Nine months ended September 30, 2002
Versus nine months ended September 30, 2001

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

Revenues for the nine months ended September 30, 2002 decreased by $13.8 million compared to the same period of 2001. Sales in the Government Services Group decreased by $12.8 million, or 16.0%, from $79.9 million in 2001 to $67.1 million in 2002. This decrease was due primarily to delivering seven fewer aircraft under the KC-135 Programmed Depot Maintenance (PDM) contract during the comparable nine month periods. Three aircraft of this seven aircraft decrease are essentially a timing issue due to the limitation of good test flight weather in Birmingham, Alabama caused by tropical storms in late September.

Sales in the Commercial Services Group increased by $0.6 million or approximately 1.7%, for the nine months ended September 30, 2002, from $36.1 million in 2001 to $36.7 million in 2002. This increase was primarily due to an increase in commercial Maintenance, Repair, Conversion, and Component revenues of $2.1 million. The company completed work on the H-3 helicopter contract in 2001. During the nine months ended September 30, 2001 the company had sales of $1.5 million under this contract.

The Manufacturing & Component Group saw its revenues decline $1.8 million, approximately 15.7%, for the nine months ended September 30, 2002, from $11.5 million in 2001 to $9.7 million in 2002. This decrease is due to the Pemco Engineers subsidiary that had $3.6 million less revenue for the nine months ended September 30, 2002 versus the same period of 2001. This revenue decrease was offset partially by higher period-to-period revenue, $1.8 million, in the Space Vector subsidiary. The decrease in Pemco Engineers revenue is a result of a downturn in conversion of aircraft for which the unit produces cargo-handling systems combined with a decrease in sales of replacement parts for cargo-handling systems on aircraft in service.

Without regard to operating segments, the company’s mix of business between government and commercial customers was 64.6% government and 35.4% commercial during the nine months ended September 30, 2002 and 67.5% government and 32.5% commercial during the same period in 2001.

Cost of sales decreased $9.8 million during the nine months ended September 30, from $99.3

million in 2001 to $89.5 million in 2002. Offsetting the normal decrease in costs associated with the decreased revenue, cost of sales was also affected by higher production efficiencies during the year, primarily in the company’s Commercial Services Group and also, to a lesser extent, in the Government Services Group. These decreases in cost of sales were offset, partially, by replacing relatively high margin sales at the Pemco Engineers subsidiary with relatively lower margin business at other subsidiaries, additional expenses incurred at the Commercial Services Group as it revised its production processes to accommodate changes in the design of the B737-300 cargo conversion, and losses incurred at the Government Services Group on the delivery of a JSTAR aircraft and a KC-135 aircraft under a transition contract. Overall, the company’s gross profit percentage was 21.1% in the nine months ended September 30, 2002 a decrease from 22.0% in the same period of 2001.

SG&A expenses were $15.4 million during the nine months ended September 30, 2002, a decrease from $15.8 million in 2001.

Interest expense was $0.9 million for the nine months ended September 30, 2002 versus $1.4 million during the same period in 2001. The effective average interest rate on the company’s revolving credit facility was approximately 5.25% in 2002 and 7.56% in 2001. In addition to lower interest rates on the company’s revolving credit facility year-over-year, the company also reduced its average debt outstanding during the nine months ended September 30, 2002 compared to the nine months ended September 30, 2001. The average debt outstanding at September 30, 2002 was impacted by the company borrowing $6.7 million to purchase Treasury Stock at the end of the second quarter of 2002.

During the nine months ended September 30, 2001, the company recorded an income tax credit because of favorable tax benefits generated from an adjustment to its deferred tax valuation allowance, whereas in the nine months ended September 30, 2002, the company recorded an income tax provision with no tax benefits. The effective tax provisions for these two periods were 28% and 38% respectively.

EBITDA was approximately $12.5 million for the nine months ended September 30, 2002, compared to $14.6 million for the nine months ended September 30, 2001.

During the second quarter of 2002 the company agreed to settlements on several outstanding legal actions (See Note 6 to the Consolidated Financial Statements included in the company’s Form 10-Q for the quarter ended June 30, 2002). These settlements are reflected on the Consolidated Statements of Operations as “Litigation, net” and are composed of the following cases:

Litigation, net
(In Thousands)

Liquidity and Capital Resources

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

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

Operating activities provided $10.1 million of cash during the nine-months ended September 30, 2002. During this same period, the company borrowed $1.2 million on its capital equipment acquisition facility. This loan carries a variable interest rate that was 5.25% at September 30, 2002. The company also received proceeds from the exercise of company stock options of $0.9 million and a tax benefit of $0.2 million from the exercise of these options. Cash was used during the nine-months ended September 30, 2002 for capital expenditures of $5.5 million, and the repurchase of company common stock, $6.7 million.

At September 30, 2002 the company had additional borrowing capacity of $1.1 million under its capital equipment acquisition facility and $7.3 million under its revolving line of credit.

The company maintains a defined benefit pension plan (the “Plan”) that covers substantially all employees at its Birmingham and Dothan, Alabama facilities. The Plan’s assets consist primarily of stocks, bonds and cash equivalents. These assets are exposed to various risks, such as interest rate, credit, and overall market volatility. As a result of unfavorable investment returns related to the Plan in 2001, the company made a $3.0 million contribution to the Plan during the fourth quarter of 2001. In addition to this contribution, the company accrued a long-term pension benefit obligation in the amount of $15.3 million, accrued an intangible pension asset of $6.5 million, increased its deferred tax asset by $3.3 million and recorded a $5.5 million charge to comprehensive income. The company anticipates that it will be required to make further contributions to the Plan during the fourth quarter of 2002. Under ERISA rules, the company expects that the minimum required contribution in 2002 would be approximately $1.6 million. It is possible that the company may elect, as it did during 2001, to contribute more than the minimum requirement. The company did not make a contribution to the Plan during the first, second, or third quarters of 2001 or the first and second quarters of 2002. A contribution of approximately $0.8 million was made during the third quarter of 2002. At December 31, 2001 the Plan was under-funded by approximately $15.5 million.

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

The Company from time to time evaluates opportunities and strategic alternatives, including but not limited to joint ventures, mergers and acquisitions. These alternatives may also include sales of single or multiple assets when the Company perceives opportunities to capture value and re-deploy proceeds. The Company’s consideration of these alternatives is part of its ongoing strategic planning process. There can be no assurance that any such alternative, if undertaken and consummated, would not materially adversely affect the Company. We are engaged in no active discussions related to such opportunities or strategic alternatives at the present time.

In December 2001 the company began construction of an addition to one of the hangers at its Dothan, Alabama facility. The addition is projected to cost approximately $2.5 million. As of the date of this report the company has spent approximately $1.8 million on this project. This $1.8 million has been temporarily funded by the company’s revolving credit facility. The company anticipates that it will secure funding for the entire addition through the issuance of an Airport Bond. The company currently has no other material capital projects underway.

In October 2002, the company announced that its Board of Directors had approved an exchange offer (subject to receipt of an independent solvency opinion and satisfactory arrangements with its senior lender) under which the company would offer to exchange new debt securities for up to two million shares of the company’s outstanding common stock. The new debt securities would be issued with a face amount of $22.00 per share of common stock. The company also announced that it intends to affect a four for one split of its common stock if the exchange offer is completed.

COMMITMENTS AND CONTINGENCIES

The company’s manufacturing and service operations are performed principally on leased premises owned by municipal units or authorities. Remaining lease terms range from eleven months to thirty-one years and provide for basic rentals, plus contingent rentals based upon a graduated

percentage of sales. The company also leases vehicles and equipment under various leasing arrangements.

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

(In Thousands)

REPAYMENT OF LONG TERM DEBT

Schedule of long term debt maturing over the next five years at September 30, 2002:

(In Thousands)

TRADING ACTIVITIES

The company has not engaged in trading activities or in trading non-exchange traded contracts. As of September 30, 2002 and 2001, the carrying amounts of the company’s financial instruments were estimated to approximate their fair values, due to their short-term nature, and variable or market interest rates. The company has not hedged its interest rate or foreign exchange risks through the use of derivative financial instruments. See “Quantitative and Qualitative Disclosures about Market Risk” included in Item 3 of this Report.

RELATED PARTY TRANSACTIONS

The company had accruals of approximately $0.1 million and $0.5 million at September 30, 2002 and 2001, respectively, related to a severance agreement with its former Chairman of the Board, Chief Executive Officer and major stockholder. In accordance with the agreement, the accrued amounts are being paid over a 36-month period that began January 2000.

On April 23, 2002 the company loaned its current President and Chief Executive Officer $425,000 under the terms of a Promissory Note. The Promissory Note carries a fixed interest rate of 5% per annum and is payable within 60 days of the President and Chief Executive Officer’s termination of employment with the company.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

BACKLOG

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

The growth in government backlog was primarily related to the Government Services Group and offset partially by a decrease at the Space Vector subsidiary in the Manufacturing & Component Group. Government Services increased backlog approximately $16.9 million year-over-year due primarily to the KC-135 contract. Backlog at Space Vector decreased $4.3 million during this same period due to the unit nearing the completion of one of its existing contracts.

Total commercial backlog decreased $4.2 million. Backlog at the Commercial Services Group decreased $2.3 million while backlog at Pemco Engineers, in the Manufacturing & Component Group, decreased $1.9 million. The decrease in backlog at the Commercial Services Group is due primarily to timing of input commitments from one of its major customers. The decrease in Pemco Engineers backlog is a result of a downturn in conversion of aircraft for which the unit produces cargo-handling systems combined with a decrease in sales of replacement parts for cargo-handling systems on aircraft in service.

Overall the mix of backlog shifted towards government during the two periods moving from 88.4% government and 11.6% commercial for the nine months ended September 30, 2001 to 92.1% government and 7.9% commercial for the nine months ended September 30, 2002.

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

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CONTINGENCIES

See Note 6 to the Consolidated Financial Statements.

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

Some of the information under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this Quarterly Report contains forward-looking statements. These forward-looking statements include, but are not limited to, statements about the company’s plans, objectives, expectations and intentions, award or loss of contracts, the outcome of pending or future litigation, estimates of backlog and other statements contained in this Quarterly Report that are not historical facts. When used in this Quarterly Report, the words “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and similar expressions are generally intended to identify forward-looking statements. Because these forward-looking statements involve risks and uncertainties, there are important factors, including the factors discussed under the caption “Factors That May Affect Future Performance” in the company’s 2001 Annual Report on Form 10-K, that could cause actual results to differ materially from those expressed or implied by these forward-looking statements. The company cautions readers not to place undue reliance on any forward–looking statements, which speak only as of the date on which they are made. The company does not undertake any obligation to update or revise any forward-looking statements.

The company is exposed to market risk from changes in interest rates as part of its normal operations. The company maintains various debt instruments to finance its business operations. The debt consists of fixed and variable rate debt. The variable rate debt is related to the company’s revolving line of credit, term loans, and capital equipment acquisition facility as noted in Note 4 to the Consolidated Financial Statements and bears interest at prime plus 0.50% or 0.75%, depending upon the loan (5.25% and 5.50% at September 30, 2002). If the prime rate had increased 100 basis points, net income would have been reduced by approximately $42,000 during the quarter, $113,000 year-to-date.

The company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to the company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls

and procedures.

Within 90 days prior to the date of this Quarterly Report, the company carried out an evaluation, under the supervision and with the participation of the company’s management, including the company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the company’s disclosure controls and procedures. Based on the foregoing, the company’s Chief Executive Officer and Chief Financial Officer concluded that the company’s disclosure controls and procedures were effective.

There have been no significant changes in the company’s internal controls or in other factors that could significantly affect the internal controls subsequent to the date the company completed its evaluation.

PART II      OTHER INFORMATION

See Note 6 to the Consolidated Financial Statements.

None.

The Federal Aviation Administration approved the company’s amended STC for B737-300 cargo conversions on April 11, 2002. The amended STC substantially increases the cycles between inspections for aircraft converted under the STC. Although there can be no assurances in this regard, the company believes that market demand for its B737-300 cargo conversions will significantly increase in the coming years due to the amended STC. The company is currently in discussions with several cargo carriers and leasing companies for multiple near term conversions of aircraft under this STC.

On October 14, 2002, the company announced that it expects its revenues and earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the year ending December 31, 2002 to be about $160 million and $19 million, respectively. Based on expected growth in its military and cargo businesses and continued efficiency improvements, the company expects revenue and EBITDA for the year ending December 31, 2003 to increase to about $170 million and $25 million, respectively. Because of expected reductions in the company’s working capital needs in 2003, the company expects that funds from operations will exceed its current amount of debt and other funding needs.

         Exhibits – None

         Reports on Form 8-K.

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.

I, Ronald A. Aramini, certify that:

I, John R. Lee, certify that: