UPDATE 2-US watchdog faults Air Force on Boeing contract

(Adds Pemco comment, paragraph 3; background)

By Jim Wolf

WASHINGTON, Dec 27 (Reuters) - The U.S. Government Accountability Office on Thursday faulted the Air Force again for its handling of a contract with Boeing Co (BA.N), upholding in part a protest by rival Pemco Aviation Group Inc PAGI.O.

At issue is a potential $1.2 billion contract for depot maintenance of KC-135 mid-air refueling aircraft awarded to Boeing over Pemco on Sept. 10.

Pemco, based in Birmingham, Alabama, said it was "extremely pleased" by the GAO ruling. The company maintains and modifies aircraft for the U.S. government and other customers. It also develops and manufactures rocket vehicles and control systems.

The GAO decision was the latest setback of an Air Force deal with Boeing, scarred by a corruption scandal that landed two company officials in prison in 2005.

The service is likely to undergo more scrutiny as it awards a contact for 179 refueling tankers worth about $40 billion, described by Air Force Secretary Michael Wynne as his top acquisition priority.

Boeing is competing against a team made up of Northrop Grumman (NOC.N) and Airbus parent EADS (EAD.PA) for the contract, due to be awarded no sooner than late February.

Recent GAO rulings have upheld protests from other bidders and prompted the Air Force to rerun a contest for a potential $15 billion combat rescue helicopter fleet that was originally given to Boeing.

Pemco claimed the Air Force's evaluation of the KC-135 deal was flawed in several ways, including its tally of the rivals' past performance, mission capability, and cost and price data.

"Our decision sustains the protest challenging the cost/price evaluation because the record does not reflect any Air Force analysis as to the realism of certain changes Boeing introduced in its final proposals," said the GAO, Congress's non-partisan audit and investigative arm.

Nor did the record show any Air Force analysis of the potential risk associated with the changes made by Boeing although one was required, the GAO said in a statement.

The GAO recommended the Air Force perform and document the work it found was missing.

In a one-sentence response, Lt. Col. Jennifer Cassidy, an Air Force spokeswoman, said the service would evaluate the GAO ruling, which is a recommendation, not an order.

Boeing remained confident it will "again be determined to have offered the best value to the Air Force for the KC-135" contract, said Forrest Gossett, a company spokesman.

Pemco spokeswoman Doris Sewell said, "We believe firmly that proper evaluation of the proposals will establish Pemco clearly as the low-cost, low-risk provider for KC-135 service." Pemco is changing its name to Alabama Aircraft Industries Inc. on Jan. 1.