**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended March 31, 2004**

 

**CommissionFile Number 333-70363**

 

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**DECRANE HOLDINGS CO.**

(Exact name of registrantas specified in its charter)

 
| **Delaware**                                                                                         |   | **13-4019703**                        |
|------------------------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization)                                     |   | (I.R.S. Employer  Identification No.) |
|                                                                                                 |   |                                  |
| **c/o Credit Suisse First Boston /  DLJ Merchant Banking Partners II, L.P.**                         |
| **Eleven Madison Avenue, New York, NY  10010**                                                       |
| (Address, including zip  code, of principal executive offices)                                       |
|                                                                                                 |   |                                  |
| **(212) 325-2000**                                                                                   |
| (Registrant’s telephone  number, including area code)                                           |
|                                                                                                 |   |                                  |
| **(Not Applicable)**                                                                                 |
| (Former address and  telephone number of principal executive offices, if changed since last  report) |

 

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Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  ý** **Yes   o No

 

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

 

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The number ofshares of Registrant’s Common Stock, $.01 par value, outstanding as ofMay 3, 2004 was 4,009,297 shares.

 

** **

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**Table of Contents**

 
| **Part I – Financial  Information** |                                                                                                       |
|------------------------------------------|------------------------------------------------------------------------------------------------------------|
|                                     |                                                                                                       |   |
| **Item 1.**                              | **Financial Statements  (Unaudited)**                                                                      |   |
|                                     |                                                                                                       |   |
|                                     | Consolidated Balance Sheets  as of March 31, 2004 and December 31, 2003                                    |   |
|                                     |                                                                                                       |   |
|                                     | Consolidated  Statements of Operations for the three months ended March 31, 2004 and 2003                  |   |
|                                     |                                                                                                       |   |
|                                     | Consolidated  Statements of Stockholders’ Equity (Deficit) for the three months ended March  31, 2004 |   |
|                                     |                                                                                                       |   |
|                                     | Consolidated  Statements of Cash Flows for the three months ended March 31, 2004 and 2003                  |   |
|                                     |                                                                                                       |   |
|                                     | Condensed  Notes to Consolidated Financial Statements                                                      |   |
|                                     |                                                                                                       |   |
| **Item  2.**                             | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations**            |   |
|                                     |                                                                                                       |   |
|                                     | Results of Operations                                                                                      |   |
|                                     |                                                                                                       |   |
|                                     |                                                                                                       | Performance Measures |   |
|                                     |                                                                                                       |   |   |
|                                     |                                                                                                       | Changes in Accounting  Principles |   |
|                                     |                                                                                                       |   |   |
|                                     |                                                                                                       | Three months ended March 31  2004 |   |
|                                     |                                                                                                       |   |
|                                     | Liquidity and Capital  Resources                                                                           |   |
|                                     |                                                                                                       |   |
|                                     | Disclosure  of Contractual Obligations and Commitments                                                     |   |
|                                     |                                                                                                       |   |
|                                     | Disclosure  About Off-Balance Sheet Commitments and Indemnities                                            |   |
|                                     |                                                                                                       |   |
|                                     | Recent Accounting  Pronouncements                                                                          |   |
|                                     |                                                                                                       |   |
|                                     | Special  Note Regarding Forward Looking Statements and Risk Factors                                        |   |
|                                     |                                                                                                       |   |
| **Item  3.**                             | **Quantitative  and Qualitative Disclosure About Market Risk**                                             |   |
|                                     |                                                                                                       |   |
| **Item 4.**                              | **Controls and Procedures**                                                                                |   |
|                                     |                                                                                                       |   |
| **Part II – Other Information**     |                                                                                                       |
|                                     |                                                                                                       |   |
| **Item  1.**                             | **Legal  Proceedings**                                                                                     |   |
|                                     |                                                                                                       |   |
| **Item 6.**                              | **Exhibits and Reports  on Form 8-K**                                                                      |   |
|                                     |                                                                                                       |   |
|                                     | Exhibits                                                                                                   |   |
|                                     |                                                                                                       |   |
|                                     | Reports on Form 8-K                                                                                        |   |
|                                     |                                                                                                       |   |
| **Signatures**                           |                                                                                                       |   |

 

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**PARTI – FINANCIAL INFORMATION**

**ITEM1.****          FINANCIALSTATEMENTS**

**DECRANE HOLDINGS CO. AND SUBSIDIARY**

**ConsolidatedBalance Sheets**

 
| **(In thousands, except share data)**                                                                                                               |   | **March 31,  2004** |       | **December 31,  2003** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|------------|-----------------------------|------------|
|                                                                                                                                                |   | **(Unaudited)**          | ** ** |                        | ** ** |
|                                                                                                                                                |   |                     |       |                        |       |
| **Assets**                                                                                                                                          |   |                     |       |                        |       |
|                                                                                                                                                |   |                     |       |                        |       |
| Current assets:                                                                                                                                     |   |                     |       |                        |       |
| Cash and cash  equivalents                                                                                                                          |   | $                        | 2,689      |                        | $          | 6,936 |   |
| Accounts  receivable, net                                                                                                                           |   | 26,969                   |       | 21,455                      |       |
| Inventories                                                                                                                                         |   | 47,621                   |       | 42,981                      |       |
| Prepaid expenses  and other current assets                                                                                                          |   | 1,159                    |       | 1,082                       |       |
| Total current  assets                                                                                                                               |   | 78,438                   |       | 72,454                      |       |
|                                                                                                                                                |   |                     |       |                        |       |
| Property and  equipment, net                                                                                                                        |   | 29,962                   |       | 30,900                      |       |
| Goodwill                                                                                                                                            |   | 162,430                  |       | 162,430                     |       |
| Other assets,  principally intangibles, net                                                                                                         |   | 36,407                   |       | 38,092                      |       |
| Total assets                                                                                                                                        |   | $                        | 307,237    |                        | $          | 303,876 |   |
|                                                                                                                                                |   |                     |       |                        |       |
| **Liabilities, Mandatorily Redeemable  Preferred Stock and Stockholders’ Equity (Deficit)**                                                    |   |                     |       |                        |       |
|                                                                                                                                                |   |                     |       |                        |       |
| Current  liabilities:                                                                                                                               |   |                     |       |                        |       |
| Current portion  of long-term debt                                                                                                                  |   | $                        | 1,271      |                        | $          | 1,198 |   |
| Accounts payable                                                                                                                                    |   | 14,943                   |       | 15,462                      |       |
| Accrued  liabilities                                                                                                                                |   | 19,953                   |       | 17,890                      |       |
| Income taxes  payable                                                                                                                               |   | 41                       |       | —                      |       |
| Total current  liabilities                                                                                                                          |   | 36,208                   |       | 34,550                      |       |
|                                                                                                                                                |   |                     |       |                        |       |
| Long-term debt                                                                                                                                      |   | 277,326                  |       | 268,208                     |       |
| Mandatorily  redeemable preferred stock                                                                                                             |   | 116,585                  |       | —                      |       |
| Other long-term  liabilities                                                                                                                        |   | 5,366                    |       | 5,464                       |       |
|                                                                                                                                                |   |                     |       |                        |       |
| Commitments and  contingencies (Note 9)                                                                                                             |   |                     |       |                        |       |
|                                                                                                                                                |   |                     |       |                        |       |
| Mandatorily  redeemable preferred stock                                                                                                             |   | —                   |       | 112,237                     |       |
|                                                                                                                                                |   |                     |       |                        |       |
| Stockholders’  equity (deficit):                                                                                                               |   |                     |       |                        |       |
| Undesignated  preferred stock, $.01 par value, 1,140,000 shares authorized; None issued and  outstanding as of March 31, 2004 and December 31, 2003 |   | —                   |       | —                      |       |
| Common stock,  $.01 par value, 10,000,000 shares authorized; 4,009,297 shares issued and  outstanding as of March 31, 2004 and December 31, 2003    |   | 40                       |       | 40                          |       |
| Additional  paid-in capital                                                                                                                         |   | 61,475                   |       | 61,475                      |       |
| Notes receivable  for shares sold                                                                                                                   |   | (1,286                   | )          | (1,268                      | )          |
| Accumulated  deficit                                                                                                                                |   | (188,209                 | )          | (176,562                    | )          |
| Accumulated  other comprehensive loss                                                                                                               |   | (268                     | )          | (268                        | )          |
| Total  stockholders’ equity (deficit)                                                                                                          |   | (128,248                 | )          | (116,583                    | )          |
| Total  liabilities, mandatorily redeemable preferred stock and stockholders’ equity  (deficit)                                                 |   | $                        | 307,237    |                        | $          | 303,876 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

1

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**DECRANE HOLDINGS CO. AND SUBSIDIARY**

 

**Consolidated Statements of Operations**

 
|                                                               |   | **Three  Months Ended  March 31,** |    |
|--------------------------------------------------------------------|--------|-----------------------------------------|---------|
| **(In thousands)**                                                 |   | **2004**                                |    | **2003** |   |
|                                                               |   | **(Unaudited)**                         |    |
| Revenues                                                           |   | $                                       | 48,597  |   | $ | 41,900 |   |
| Cost of sales                                                      |   | 36,839                                  |    | 28,878 |   |
|                                                               |   |                                    |    |   |   |
| Gross profit                                                       |   | 11,758                                  |    | 13,022 |   |
|                                                               |   |                                    |    |   |   |
| Operating  expenses:                                               |   |                                    |    |   |   |
| Selling, general  and administrative expenses                      |   | 7,237                                   |    | 9,930 |   |
| Research and  development expenses                                 |   | 2,181                                   |    | 1,573 |   |
| Amortization of  intangible assets                                 |   | 912                                     |    | 912 |   |
| Total operating  expenses                                          |   | 10,330                                  |    | 12,415 |   |
|                                                               |   |                                    |    |   |   |
| Income from  operations                                            |   | 1,428                                   |    | 607 |   |
|                                                               |   |                                    |    |   |   |
| Other expenses:                                                    |   |                                    |    |   |   |
| Interest expense                                                   |   | 8,702                                   |    | 5,869 |   |
| Mandatorily  redeemable preferred stock dividends                  |   | 4,231                                   |    | 1,597 |   |
| Other expenses,  net                                               |   | 112                                     |    | 339 |   |
|                                                               |   |                                    |    |   |   |
| Loss from  continuing operations before provision for income taxes |   | (11,617                                 | )       | (7,198 | ) |
| Provision for  income (taxes) benefit                              |   | (30                                     | )       | 1,265 |   |
|                                                               |   |                                    |    |   |   |
| Loss from  continuing operations                                   |   | (11,647                                 | )       | (5,933 | ) |
|                                                               |   |                                    |    |   |   |
| Loss from  discontinued operations, net of tax                     |   | —                                  |    | (6,397 | ) |
| Cumulative  effect of change in accounting principles              |   | —                                  |    | (13,764 | ) |
|                                                               |   |                                    |    |   |   |
| Net loss                                                           |   | (11,647                                 | )       | (26,094 | ) |
|                                                               |   |                                    |    |   |   |
| Noncash  preferred stock dividend accretion                        |   | —                                  |    | (2,178 | ) |
|                                                               |   |                                    |    |   |   |
| Net loss  applicable to common stockholders                        |   | $                                       | (11,647 | ) | $ | (28,272 | ) |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

2

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**DECRANE HOLDINGS CO. AND SUBSIDIARY**

 

**Consolidated Statement of Stockholders’ Equity (Deficit)**

 
|                                  |   | **Common  Stock** |   | **Additional  Paid-in** |   | **Notes  Receivable  For Shares** |   | **Accumulated** |   | **Accumulated  Other  Comprehensive** |   |     |   |
|---------------------------------------|--------|-------------------|--------|-------------------------|--------|-----------------------------------|--------|-----------------|--------|---------------------------------------|--------|----------|--------|
| **(In thousands, except share data)** |   | **Shares**        |   | **Amount**              |   | **Capital**                       |   | **Sold**        |   | **Deficit**                           |   | **Loss** |   | **Total** |   |
|                                  |   |              |   |                    |   |                              |   |            |   |                                  |   |     |   |   |   |   |   |   |   |   |   |
| Balance, December 31, 2003       |   | 4,009,297         |   | $                       | 40     |                              | $      | 61,475          |   | $                                     | (1,268 | )        | $      | (176,562 | ) | $ | (268 | ) | $ | (116,583 | ) |
|                                  |   |              |   |                    |   |                              |   |            |   |                                  |   |     |   |   |   |
| Comprehensive  loss:                  |   |              |   |                    |   |                              |   |            |   |                                  |   |     |   |   |   |
| Net loss                              |   | —            |   | —                  |   | —                            |   | —          |   | (11,647                               | )      | —   |   | (11,647 | ) |
|                                  |   |              |   |                    |   |                              |   |            |   |                                  |   |     |   |   |   |
| Notes receivable  interest accrued    |   | —            |   | —                  |   | —                            |   | (18             | )      | —                                |   | —   |   | (18 | ) |
|                                  |   |              |   |                    |   |                              |   |            |   |                                  |   |     |   |   |   |   |   |   |   |   |   |
| Balance, March  31, 2004 (Unaudited)  |   | 4,009,297         |   | $                       | 40     |                              | $      | 61,475          |   | $                                     | (1,286 | )        | $      | (188,209 | ) | $ | (268 | ) | $ | (128,248 | ) |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

3

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**DECRANE HOLDINGS CO. AND SUBSIDIARY**

 

**Consolidated Statements of Cash Flows**

 
|                                                                               |   | **Three  Months Ended  March 31,** |    |
|------------------------------------------------------------------------------------|--------|------------------------------------|---------|
| **(In thousands)**                                                                 |   | **2004**                           |    | **2003** |   |
|                                                                               |   | **(Unaudited)**                    |    |
| **Cash  flows from operating activities:**                                         |   |                               |    |   |   |
| Net loss                                                                           |   | $                                  | (11,647 | ) | $ | (26,094 | ) |
| Adjustments to  reconcile net income to net cash provided by operating activities: |   |                               |    |   |   |
| Cumulative  effect of change in accounting principles                              |   | —                             |    | 13,764 |   |
| Loss from  discontinued operations                                                 |   | —                             |    | 6,397 |   |
| Depreciation and  amortization                                                     |   | 3,116                              |    | 3,211 |   |
| Mandatorily  redeemable preferred stock dividends                                  |   | 4,231                              |    | 1,597 |   |
| Interest  accretion on second-lien term debt                                       |   | 606                                |    | — |   |
| Preferred stock  redemption value accretion                                        |   | 117                                |    | — |   |
| Deferred income  taxes                                                             |   | —                             |    | (1,869 | ) |
| Other, net                                                                         |   | 10                                 |    | 404 |   |
| Changes in  assets and liabilities:                                                |   |                               |    |   |   |
| Accounts  receivable                                                               |   | (5,514                             | )       | (233 | ) |
| Inventories                                                                        |   | (4,640                             | )       | (9,861 | ) |
| Prepaid expenses  and other assets                                                 |   | (192                               | )       | (3,248 | ) |
| Accounts payable                                                                   |   | (519                               | )       | 2,521 |   |
| Accrued  liabilities                                                               |   | 2,063                              |    | (7,877 | ) |
| Income taxes  payable                                                              |   | 139                                |    | 46 |   |
| Other long-term  liabilities                                                       |   | (98                                | )       | (1,125 | ) |
| Net cash used  for operating activities                                            |   | (12,328                            | )       | (22,367 | ) |
|                                                                               |   |                               |    |   |   |
| **Cash  flows from investing activities:**                                         |   |                               |    |   |   |
| Capital  expenditures                                                              |   | (504                               | )       | (1,098 | ) |
| Cash paid for  acquisition contingent consideration                                |   | —                             |    | (600 | ) |
| Net cash used  for investing activities                                            |   | (504                               | )       | (1,698 | ) |
|                                                                               |   |                               |    |   |   |
| **Cash  flows from financing activities:**                                         |   |                               |    |   |   |
| Debt borrowings:                                                                   |   |                               |    |   |   |
| Revolving line  of credit, net                                                     |   | 8,850                              |    | 27,150 |   |
| Other secured  long-term                                                           |   | 46                                 |    | — |   |
| Debt repayments:                                                                   |   |                               |    |   |   |
| First-lien term  debt                                                              |   | —                             |    | (3,275 | ) |
| Other secured  long-term debt                                                      |   | (311                               | )       | (935 | ) |
| Net cash  provided by financing activities                                         |   | 8,585                              |    | 22,940 |   |
|                                                                               |   |                               |    |   |   |
| Net cash  provided by discontinued operations                                      |   | —                             |    | 3,341 |   |
|                                                                               |   |                               |    |   |   |
| Net increase  (decrease) in cash and cash equivalents                              |   | (4,247                             | )       | 2,216 |   |
| Cash and cash  equivalents at beginning of period                                  |   | 6,936                              |    | 12,421 |   |
| Cash and cash  equivalents at end of period                                        |   | $                                  | 2,689   |   | $ | 14,637 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

4

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**DECRANE HOLDINGS CO. AND SUBSIDIARY**

 

**Condensed Notes to Consolidated Financial Statements**

**(Unaudited)**

 

**Note 1.**          Summary of SignificantAccounting Policies

** **

**Basis of Presentation**

** **

These consolidatedinterim financial statements are unaudited. The Company believes the interim financial statements are presented on abasis consistent with the audited financial statements and include alladjustments necessary for a fair presentation of the financial condition,results of operations and cash flows for such interim periods.  All of these adjustments are normalrecurring adjustments.

 

Preparation of theseconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires the Company to makeestimates and judgments that affect the reported amounts of assets, liabilitiesand disclosure of contingent assets and liabilities at the date of theconsolidated financial statements and the reported amounts of revenues andexpenses during the reporting periods. Actual results could differ from those estimates.

 

The results of operationsfor interim periods do not necessarily predict the operating results for anyother interim period or for the full year. The consolidated balance sheet as of December 31, 2003 has been derivedfrom audited financial statements but does not include all disclosures requiredby accounting principles generally accepted in the United States of America aspermitted by interim reporting requirements. These consolidated interim financial statements should be read in conjunctionwith Management’s Discussion and Analysis of Financial Condition and Results ofOperations and the audited financial statements and related notes included inthe Company’s 2003 Form 10-K. Reclassifications have been made to the financial statements for priorperiods to conform to the current year presentation.

 

**Changes in AccountingPrinciples**

** **

***SFAS No. 150Adopted January 1, 2004***

** **

Effective January 1,2004, the Company adopted SFAS No. 150, “Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity.”  SFAS No. 150 establishes standards for theclassification and measurement of certain financial instruments withcharacteristics of both liabilities and equity.  SFAS No. 150 requires classification of financial instrumentswithin its scope as a liability, including financial instruments issued in theform of shares that are mandatorily redeemable, because those financialinstruments are deemed to be, in essence, obligations of the issuer.  As a result of adopting of SFAS No. 150 onJanuary 1, 2004, all mandatorily redeemable preferred stock was reclassified asa liability and all quarterly dividends are reflected as a charge againstpre-tax income.  In periods prior toJanuary 1, 2004, DeCrane Holdings’ 14% preferred stock dividends were deductedin arriving at the net income or loss applicable to the Company’s commonstockholders; DeCrane Aircraft’s 16% preferred stock dividends were chargedagainst pre-tax income as minority interest in preferred stock of subsidiary.

 

The following tablesummarizes the results of operations for the three months ended March 31, 2003as if SFAS No. 150 had been in effect as of the beginning of 2003.

 

5

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|                             |   | **Three  Months Ended  March 31, 2003** |   |
|----------------------------------|--------|-----------------------------------------|--------|
| **(In thousands)**               |   | **As  Reported**                        |   | **Pro Forma** |   |
|                             |   | **(Unaudited)**                         |   |
| Loss from  continuing operations |   | $                                       | (5,933 | ) | $ | (8,111 | ) |
| Net loss                         |   | (26,094                                 | )      | (28,272 | ) |
|                                  |        |                                         |        |  |  |  |  |

 

The pro forma datareflects $2,178,000 of DeCrane Holdings 14% preferred stock dividends as acharge against income during the period.

 

***Discontinued Useof Program Accounting Commencing January 1, 2003***

** **

As more fully describedin “Note 1—Change in Accounting Principle” to the audited financial statementsincluded in the Company’s 2003 Form 10-K, the Company elected to discontinuethe use of program accounting for the costs of products manufactured fordelivery under production-type contracts. As a result, certain deferred program costs are no longer included ininventory commencing January 1, 2003.

 

This change in accountingpolicy was made after concluding the 2003 fiscal year but was appliedretroactively to the beginning of the year, January 1, 2003, as required bygenerally accepted accounting principles. As a result of the change, program-related product development costs arenow classified as a component of research and development expenses in theconsolidated financial statements rather than classified as a component ofinventory cost.  As a result of thechange, the Company has restated its results of operations for the three monthsended March 31, 2003 by charging $1,573,000 of previously inventoried costs toresearch and development expense and recording a $13,764,000 charge as ofJanuary 1, 2003 to reflect the cumulative effect of the change inaccounting principle.

 

**Stock Option Plan**

** **

The Company has onestock-based employee compensation plan, which is more fully described in thenotes to its audited financial statements. As permitted under SFAS No. 123, “Accounting for Stock-BasedCompensation,” the Company measures compensation expense related to theemployee stock option plan utilizing the intrinsic value method as prescribedby Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued toEmployees,” and related interpretations. No stock-based employee compensation cost is reflected in net income(loss), as all options granted under the plan had an exercise price equal tothe value of the underlying common stock on the date of grant.

 

The following tableillustrates the effect on net income if the Company had applied the fair valuerecognition provisions of SFAS No. 123 to stock-based employee compensation.

 
|                                                                                                                                           |   | **Three  Months Ended  March 31,** |    |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------|---------|
| **(In thousands)**                                                                                                                             |   | **2004**                           |    | **2003** |   |
|                                                                                                                                           |   | **(Unaudited)**                    |    |
| Net loss, as  reported                                                                                                                         |   | $                                  | (11,647 | ) | $ | (26,094 | ) |
| Less total  stock-based employee compensation expense determined under the fair value  based method for all awards, net of related tax effects |   | (81                                | )       | (94 | ) |
| Pro forma net  loss                                                                                                                            |   | $                                  | (11,728 | ) | $ | (26,188 | ) |

 

The effect of applyingSFAS No. 123 may not be representative of the pro forma effect in futureyears since additional options may be granted during those future years.

 

6

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**Note 2.**          Disposition of SpecialtyAvionics Group

** **

On March 14, 2003, theCompany entered into a definitive agreement to sell its equity interests in thesubsidiaries comprising its Specialty Avionics Group for $140,000,000 incash.  The sale was consummated on May23, 2003.  Based upon the fair value of thegroup implied in the definitive agreement, the Company determined that the carryingvalue of the group’s net assets was not fully recoverable.  As required by SFAS No. 142, the Companyrecorded a goodwill impairment charge of $7,500,000 during the three monthsended March 31, 2003 to reduce the carrying value to the estimatednet realizable value established by the definitive agreement.  As a result of the sale, the SpecialtyAvionics Group is presented as a discontinued operation in the accompanyingconsolidated financial statements.

 

In accordance with theFinancial Accounting Standards Board’s Emerging Issues Task Force Issue No.87-24, “Allocation of Interest to Discontinued Operations,” as amended,interest expense includes interest on debt that is to be assumed by the buyeras well as interest on the $130,723,000 of debt that was required to be repaidas a result of the sale.  Interestexpense was based on the historical interest rates charged during each of theperiods.  In addition, and also in accordancewith EITF 87-24, costs and expenses exclude the allocation of general corporateoverhead.

 

The following tablessummarize the results operations and cash flows of the Specialty Avionics Groupfor the three months ended March 31, 2003.

 
| **(In thousands)**                                  |   | **Three  Months Ended  March 31,  2003** |   |
|-----------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                |   | **(Unaudited)**                               |   |
| Results of  Operations:                             |   |                                          |   |
| Revenues                                            |   | $                                             | 23,470 |   |
|                                                |   |                                          |   |
| Operating  expenses:                                |   |                                          |   |
| Costs and  expenses                                 |   | 18,992                                        |   |
| Impairment of  goodwill                             |   | 7,500                                         |   |
| Amortization of  intangible assets                  |   | 557                                           |   |
| Total operating  expenses                           |   | 27,049                                        |   |
|                                                |   |                                          |   |
| Loss from  operations                               |   | (3,579                                        | )      |
|                                                |   |                                          |   |
| Other expenses:                                     |   |                                          |   |
| Interest  expense:                                  |   |                                          |   |
| Debt required to  be repaid with proceeds from sale |   | 1,806                                         |   |
| Debt obligations  assumed by the buyer              |   | 202                                           |   |
| Other expenses,  net                                |   | 101                                           |   |
|                                                |   |                                          |   |
| Pre-tax loss                                        |   | (5,688                                        | )      |
| Provision for  income taxes                         |   | (709                                          | )      |
|                                                |   |                                          |   |
| Net loss from  discontinued operations              |   | $                                             | (6,397 | ) |

 

7

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| **(In thousands)**                              |   | **Three  Months Ended  March 31,  2003** |   |
|-------------------------------------------------|--------|-----------------------------------------------|--------|
|                                            |   | **(Unaudited)**                               |   |
| Cash Flows  Provided By (Used For):             |   |                                          |   |
| Operating  activities                           |   | $                                             | 4,138  |   |
| Investing  activities                           |   | (269                                          | )      |
| Financing  activities                           |   | (587                                          | )      |
| Net increase in  cash and cash equivalents      |   | 57                                            |   |
| Effect of  foreign currency translation on cash |   | 2                                             |   |
| Net cash  provided by discontinued operations   |   | $                                             | 3,341  |   |

 

**Note 3.**          Inventories

** **

Inventories are comprisedof the following as of March 31, 2004 and December 31, 2003:

 
| **(In thousands)**                                                           |   | **March 31,  2004** |   | **December 31,  2003** |   |
|------------------------------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
|                                                                         |   | **(Unaudited)**          |   |                        |   |
| Raw materials                                                                |   | $                        | 31,838 |                        | $      | 30,414 |   |
| Work-in-process                                                              |   | 11,379                   |   | 6,817                       |   |
| Finished goods                                                               |   | 1,028                    |   | 1,693                       |   |
| Costs and  estimated earnings in excess of billings on uncompleted contracts |   | 3,376                    |   | 4,057                       |   |
| Total  inventories                                                           |   | $                        | 47,621 |                        | $      | 42,981 |   |

 

Total costs and estimatedearnings on all uncompleted contracts as of March 31, 2004 andDecember 31, 2004 are comprised of the following:

 
| **(In thousands)**                                                            |   | **March 31,  2004** |   | **December 31,  2003** |   |
|-------------------------------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
|                                                                          |   | **(Unaudited)**          |   |                        |   |
| Costs incurred  on uncompleted contracts                                      |   | $                        | 71,977 |                        | $      | 71,784 |   |
| Estimated  earnings recognized                                                |   | 78,358                   |   | 77,782                      |   |
| Total costs and  estimated earnings                                           |   | 150,335                  |   | 149,566                     |   |
| Less billings to  date                                                        |   | (150,581                 | )      | (145,661                    | )      |
| Net                                                                           |   | $                        | (246   | )                           | $      | 3,905 |   |
|                                                                          |   |                     |   |                        |   |
| Balance sheet  classification:                                                |   |                     |   |                        |   |
| Asset – Costs  and estimated earnings in excess of billings              |   | $                        | 3,376  |                        | $      | 4,057 |   |
| Liability –  Billings in excess of costs and estimated earnings (Note 5) |   | (3,622                   | )      | (112                        | )      |
| Net                                                                           |   | $                        | (246   | )                           | $      | 3,945 |   |

 

8

----

 

**Note 4.**          Other Assets,Principally Intangibles

** **

Other assets arecomprised of the following as of March 31, 2004 and December 31, 2003:

 
| **(In thousands)**                                       |   | **March 31,  2004** |   | **December 31,  2003** |   |
|----------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
|                                                     |   | **(Unaudited)**          |   |                        |   |
| Identifiable  intangible assets with finite useful lives |   | $                        | 24,543 |                        | $      | 25,455 |   |
| Deferred  financing costs                                |   | 11,022                   |   | 11,812                      |   |
| Other  non-amortizable assets                            |   | 842                      |   | 825                         |   |
| Total other  assets                                      |   | $                        | 36,407 |                        | $      | 38,092 |   |

 

**Identifiable IntangibleAssets with Finite Useful Lives**

** **

Identifiable intangibleassets with finite useful lives are comprised of the following as ofMarch 31, 2004 and December 31, 2003:

 
|                            |   | **March 31,  2004 (Unaudited)** |   | **December 31,  2003**   |   |
|---------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
| **(In thousands)**              |   | **Cost**                        |   | **Accumulated  Amortization** |   | **Net** |   | **Cost** |   | **Accumulated  Amortization** |   | **Net** |   |
| FAA  certifications             |   | $                               | 22,272 |                          | $      | (6,593 | ) | $ | 15,679 |   | $ | 22,272 |   | $ | (6,222 | ) | $ | 16,050 |   |
| Engineering  drawings           |   | 7,645                           |   | (2,413                        | )      | 5,232 |   | 7,645 |   | (2,286 | ) | 5,359 |   |
| Other  identifiable intangibles |   | 11,345                          |   | (7,713                        | )      | 3,632 |   | 11,345 |   | (7,299 | ) | 4,046 |   |
| Total  identifiable intangibles |   | $                               | 41,262 |                          | $      | (16,719 | ) | $ | 24,543 |   | $ | 41,262 |   | $ | (15,807 | ) | $ | 25,455 |   |

 

Estimated annualamortization expense for all identifiable intangible assets with finite usefullives for the five-year period ending December 31, 2008 is as follows:2004 – $3,644,000; 2005 – $3,477,000; 2006 – $2,275,000; 2007 – $2,175,000; and2008 – $2,171,000.

 

**Note 5.**          Accrued Liabilities

** **

Accrued liabilities arecomprised of the following as of March 31, 2004 and December 31, 2003:

 
| **(In thousands)**                                                           |   | **March 31,  2004** |   | **December 31,  2003** |   |
|------------------------------------------------------------------------------|--------|--------------------------|--------|-----------------------------|--------|
|                                                                         |   | **(Unaudited)**          |   |                        |   |
| Salaries, wages,  compensated absences and payroll related taxes             |   | $                        | 5,024  |                        | $      | 4,017 |   |
| Billings in  excess of costs and estimated earnings on uncompleted contracts |   | 3,622                    |   | 112                         |   |
| Accrued interest                                                             |   | 3,556                    |   | 4,969                       |   |
| Customer  advances and deposits                                              |   | 2,696                    |   | 3,147                       |   |
| Current portion  of accrued product warranty obligations                     |   | 2,077                    |   | 2,064                       |   |
| Other accrued  liabilities                                                   |   | 2,978                    |   | 3,581                       |   |
| Total accrued  liabilities                                                   |   | $                        | 19,953 |                        | $      | 17,890 |   |

 

9

----

 

**Note 6.**          Long-Term Debt

** **

Long-term debt includes the following amounts as ofMarch 31, 2004 and December 31, 2003:

 
| **(In thousands)**                                                           |   | **March 31,  2004** |    | **December 31,  2003** |   |
|------------------------------------------------------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                                                                         |   | **(Unaudited)**          |    |                        |   |
|                                                                         |   |                     |    |                        |   |
| First-lien  credit facility:                                                 |   |                     |    |                        |   |
| Term debt                                                                    |   | $                        | 80,521  |                        | $      | 80,521 |   |
| Revolving line  of credit                                                    |   | 8,850                    |    | —                      |   |
| Second-lien term  debt                                                       |   | 80,673                   |    | 80,067                      |   |
| Capital lease  obligations and other debt, secured by property and equipment |   | 8,553                    |    | 8,818                       |   |
| 12% subordinated  notes                                                      |   | 100,000                  |    | 100,000                     |   |
| Total long-term  debt                                                        |   | 278,597                  |    | 269,406                     |   |
| Less current  portion                                                        |   | (1,271                   | )       | (1,198                      | )      |
| Long-term debt,  less current portion                                        |   | $                        | 277,326 |                        | $      | 268,208 |   |

 

A portion of the interestcharged on the second-lien term debt is pay-in-kind or “accreted” interest,payable at maturity.  An additional$606,000 of pay-in-kind interest accreted to the initial principal balance ofthe term debt during the three months ended March 31, 2004.

 

As of March 31, 2004, theCompany had irrevocable standby letters of credit in the amount of $318,000issued and outstanding under the first-lien credit facility, which reducesborrowings available under the $24,000,000 revolving line of credit.

 

**Note 7.**          Mandatorily RedeemablePreferred Stock

** **

As more fully describedin “Note 1—Changes in Accounting Principles,” the Company adopted theprovisions of SFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity,” as of January 1, 2004.

 

The table belowsummarizes the increase in mandatorily redeemable preferred stock during thethree months ended March 31, 2004.

 
|                                                               |   | **DeCrane  Aircraft  16% Preferred Stock** |   | **DeCrane  Holdings  14% Preferred Stock** |   |
|--------------------------------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------------|--------|
| **(In thousands, except share and per share data)**                |   | **Number  of  Shares**                     |   | **Mandatory  Redemption  Value**           |   | **Unamortized  Issuance  Discount** |   | **Net  Book  Value** |   | **Number  of  Shares** |   | **Mandatory  Redemption  Value** |   | **Total** |   |
|                                                               |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |   |   |
| Balance,  December 31, 2003                                   |   | 432,919                                    |   | $                                          | 43,292 |   | $ | (2,457 | ) | $ | 40,835 |   | 342,417 |   | $ | 71,402 |   | $ | 112,237 |   |
| Preferred stock  dividends                                         |   | 17,317                                     |   | 1,732                                      |   | — |   | 1,732 |   | — |   | 2,499 |   | 4,231 |   |
| Redemption value  accretion                                        |   | —                                     |   | —                                     |   | 117 |   | 117 |   | — |   | — |   | 117 |   |
| Balance, March  31, 2004 (Unaudited)                               |   | 450,236                                    |   | $                                          | 45,024 |   | $ | (2,340 | ) | $ | 42,684 |   | 342,417 |   | $ | 73,901 |   | $ | 116,585 |   |
|                                                               |   |                                       |   |                                       |   |   |   |   |   |   |   |   |   |   |   |   |
| Per share  liquidation value as of March 31, 2004 (Unaudited) |   |                                       |   | $                                          | 100.00 |   |   |   |   |   |   |   | $ | 215.82 |   |   |   |

 

***DeCrane Aircraft16% Mandatorily Redeemable Preferred Stock***

** **

Holders of the preferredstock are entitled to receive, when, as and if declared, dividends at a rateequal to 16% per annum.  Prior to June30, 2005, DeCrane Aircraft may, at its option, pay dividends either in cash orby the issuance of additional shares of preferred stock.  Since the preferred stock issuance date onJune 30, 2000, DeCrane Aircraft has elected to issue additional shares in lieuof cash dividend payments; such shares are reflected as a component of minorityinterest in preferred stock of subsidiary. The preferred stock is mandatorily redeemable in cash on March 31, 2009.

 

10

----

 

***DeCrane Holdings14% Mandatorily Redeemable Preferred Stock***

** **

Holders of the preferredstock are entitled to receive, when, as and if declared, dividends at a rateequal to 14% per annum.  Prior toSeptember 30, 2005, dividends are not paid in cash but instead accrete to theliquidation value of the preferred stock, which, in turn, increases theredemption obligation.  The preferredstock is mandatorily redeemable in cash on September 30, 2009.

 

**Note 8.**          Income Taxes

** **

The components of income(loss) before income taxes and cumulative effect of change in accountingprinciple and the provisions for income tax benefit are as follows:

 
|                                                       |   | **Three  Months Ended  March 31,** |    |
|------------------------------------------------------------|--------|------------------------------------|---------|
| **(In thousands)**                                         |   | **2004**                           |    | **2003** |   |
|                                                       |   | **(Unaudited)**                    |    |
| Pre-tax loss  reported by:                                 |   |                               |    |   |   |
| Continuing  operations                                     |   | $                                  | (11,617 | ) | $ | (7,198 | ) |
| Discontinued  operations                                   |   | —                             |    | (5,688 | ) |
| Consolidated  pre-tax loss                                 |   | $                                  | (11,617 | ) | $ | (12,886 | ) |
|                                                       |   |                               |    |   |   |
| Total provision  for income taxes (benefit):               |   |                               |    |   |   |
| Income tax  benefit based on pre-tax loss                  |   | $                                  | (2,524  | ) | $ | (556 | ) |
| Net deferred tax  asset valuation allowance                |   | 2,554                              |    | — |   |
| Net provision  for income taxes (benefit)                  |   | $                                  | 30      |   | $ | (556 | ) |
|                                                       |   |                               |    |   |   |
| Allocation of  total provision for income taxes (benefit): |   |                               |    |   |   |
| Continuing  operations                                     |   | $                                  | 30      |   | $ | (1,265 | ) |
| Discontinued  operations                                   |   | —                             |    | 709 |   |
| Net provision  for income tax benefit                      |   | $                                  | 30      |   | $ | (556 | ) |

 

For the three monthsended March 31, 2003, the provision for income taxes, based on the reportedconsolidated pre-tax loss, differs from the amount determined by applying theapplicable U.S. statutory federal rate to the pre-tax loss primarily due to theeffects of state and foreign income taxes and non-deductible expenses,principally the non-deductible portion of goodwill impairment charges and DeCraneAircraft’s 16% preferred stock dividends.

 

For the three monthsended March 31, 2004, the provision for income taxes, based on the reportedconsolidated pre-tax loss, differs from the amount determined by applying theapplicable U.S. statutory federal rate to the pre-tax loss primarily due to theeffects of state and foreign income taxes and non-deductible expenses,principally mandatorily redeemable preferred stock dividends due to theadoption of SFAS No. 150 effective January 1, 2004 (Note 1).

 

As more fully describedin Note 11 to the audited financial statements included in the Company’s 2003Form 10-K, the Company had a net deferred tax asset of $19,528,000 fully offsetby a valuation allowance of the same amount as of December 31, 2003.

 

11

----

 

As required by SFAS No.109, the Company evaluated its deferred assets for expected recoverabilitybased on the nature of the item, the associated taxing jurisdictions, theapplicable expiration dates and future taxable income forecasts that wouldimpact utilization.  Since there is noloss carry back potential and the Company does not have any tax planningstrategies to assure recoverability, the only possibility for recovery of thenet deferred assets is future taxable income. Since there have been prior year losses, the Company believes it is notprudent to rely on future income as the means to support the carrying value ofthe net asset.  As a result of theevaluation, the Company recorded a $19,528,000 valuation allowance, eliminatingthe net deferred asset, as of December 31, 2003.  Based upon the results of operations for the three months endedMarch 31, 2004, the Company determined that an additional $2,554,000 valuationallowance was required as of that date.

 

**Note 9.**          Commitments andContingencies

** **

**Litigation**

** **

Raytheon Aircraft Company(“Raytheon”) has filed a complaint against the Company and one of itssubsidiaries in the state court of Kansas with respect to alleged productliability related to certain aircraft seats sold to Raytheon by the Company’ssubsidiary.  The complaint does notspecify the amount of damages claimed by Raytheon, but the amount could bematerial.

 

This action has just beenserved on the Company and no discovery has commenced; accordingly, managementhas not had an opportunity to determine the likely outcome of this claim.  However, based on the allegations in thecomplaint and the facts currently available, management does not know of abasis which would result in this action having a material adverse effect on theCompany’s business, consolidated financial position, results of operations orcash flows.  Further, the Company’ssubsidiary may be indemnified by the entity from which it acquired the seatproduct line.

 

The Company and itssubsidiaries are also involved in other routine legal and administrativeproceedings incident to the normal conduct of business.  Management believes the ultimate dispositionof all such matters will not have a material adverse effect on the Company’s business,consolidated financial position, results of operations or cash flows.

 

12

----

 

**Note 10.****Business Segment Information**

 

The Companysupplies products and services to the business, VIP and head-of-state aircraftmarket within the aerospace industry. The Company’s subsidiaries are organized into two groups, each of whichis a strategic business that develops, manufactures and sells distinct productsand services.  The groups and adescription of their businesses are as follows:

 

•      *Cabin Management –* manufactures interior cabin components,including cabin interior furnishings, cabin management systems, seating andcomposite components;

 

•      *Systems Integration –* manufactures auxiliary fuel systemsand auxiliary power units, provides system integration services, providesaircraft completion and refurbishment services and is a Boeing Business Jetauthorized service center.

 

In prior periods,the Company’s Specialty Avionics Group was a third strategic business for whichsegment information was provided.  As aresult of the sale of the Specialty Avionics Group, this group is reflected asa discontinued operation and segment information for prior periods has beenrestated.

 

Managementutilizes more than one measurement to evaluate group performance and allocateresources; however, management considers Adjusted EBITDA, as defined, to be theprimary measurement of a group’s overall core economic performance and returnon invested capital.  Management alsouses Adjusted EBITDA in the Company’s annual budget and planning process forfuture periods, as one of the decision-making criteria for fundingdiscretionary capital expenditures and product development programs and as themeasure in determining the value of acquisitions and dispositions.  The board of directors uses Adjusted EBITDAas one of the performance metrics for determining the amount of bonuses awardedto pursuant to the Company’s cash incentive bonus plan and as an indicator ofenterprise value used in determining the exercise price of stock optionsgranted and the acceleration of stock option vesting pursuant to the Company’sincentive stock option plan.

 

Management definesAdjusted EBITDA as earnings, determined using program accounting for productdevelopment costs, before interest, income taxes, depreciation andamortization, restructuring, asset impairment and other related charges,acquisition related charges not capitalized and other noncash and nonoperatingcharges.  Management believes thepresentation of this measure is relevant and useful to investors because itallows investors and analysts to view group performance in a manner similar tothe method used by management, helps improve their ability to understand theCompany’s core segment performance, adjusted for items management believes areunusual, and makes it easier to compare the Company’s results with othercompanies that have different financing, capital structures and tax rates.  In addition, management believes thesemeasures are consistent with the manner in which its lenders and investorsmeasure the Company’s overall performance and liquidity, including its abilityto service debt and fund discretionary capital expenditure and productdevelopment programs.

 

The financial measure Adjusted EBITDA, as defined,excludes certain charges reflected in the Company’s financial statements whichare prepared in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”).  However,the Company’s presentation of Adjusted EBITDA is in accordance with the GAAPrequirements of SFAS No. 131, “Disclosures about Segments of an Enterprise andRelated Information,” which requires the Company to report the primary measureof segment performance used by management to evaluate and manage itsbusinesses.  The Company’s method ofcalculating Adjusted EBITDA may not be consistent with that of other companiesand should be viewed in conjunction with measurements that are computed inaccordance GAAP, such as net income (loss), the nearest comparable GAAPfinancial measure.  A reconciliation ofAdjusted EBITDA to net income (loss) is included herein to clarify thedifferences between these financial measures.

 

13

----

 

The accountingpolicies of the groups are substantially the same as those described in thesummary of significant accounting policies Note 1 to the audited financialstatements.  Some transactions arerecorded at the Company’s corporate headquarters and are not allocated to thegroups, such as most of the Company’s cash and cash equivalents, debt andrelated net interest expense, corporate headquarters costs and income taxes.

 

The tables belowsummarize selected financial data by business segment.

 
|                           |   | **Three  Months EndedMarch 31,** |    |
|--------------------------------|--------|----------------------------------|---------|
| **(In thousands)**             |   | **2004**                         |    | **2003** |   |
|                           |   | **(Unaudited)**                  |    |
|                           |   |                             |    |   |   |
| Revenues:                      |   |                             |    |   |   |
| Cabin Management               |   | $                                | 34,338  |   | $ | 30,620 |   |
| Systems  Integration           |   | 14,531                           |    | 12,132 |   |
| Inter-group  elimination (1)   |   | (272                             | )       | (852 | ) |
| Consolidated  totals           |   | $                                | 48,597  |   | $ | 41,900 |   |
|                           |   |                             |    |   |   |
| Adjusted EBITDA  (as defined): |   |                             |    |   |   |
| Cabin Management               |   | $                                | 3,440   |   | $ | 4,550 |   |
| Systems  Integration           |   | 3,029                            |    | 2,157 |   |
| Corporate (2)                  |   | (1,093                           | )       | (2,112 | ) |
| Inter-group  elimination (3)   |   | 3                                |    | 110 |   |
| Consolidated  totals           |   | 5,379                            |    | 4,705 |   |
| Reconciling  items (4)         |   | (17,026                          | )       | (30,799 | ) |
| Net loss                       |   | $                                | (11,647 | ) | $ | (26,094 | ) |

 
| **(In thousands)**                |   | **March 31,  2004** |    | **December 31,  2003** |   |
|-----------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                              |   | **(Unaudited)**          |    |                        |   |
|                              |   |                     |    |                        |   |
| Total assets (as  of period end): |   |                     |    |                        |   |
| Cabin Management                  |   | $                        | 231,888 |                        | $      | 224,116 |   |
| Systems  Integration              |   | 59,315                   |    | 58,395                      |   |
| Corporate (5)                     |   | 16,127                   |    | 21,456                      |   |
| Inter-group  elimination (6)      |   | (93                      | )       | (91                         | )      |
| Consolidated  totals              |   | $                        | 307,237 |                        | $      | 303,876 |   |

 

----

(1)       Inter-group sales areaccounted for at prices comparable to sales to unaffiliated customers, and areeliminated in consolidation.

 

(2)       Reflects the Company’scorporate headquarters costs and expenses not allocated to the groups.

 

(3)       Reflects elimination of theeffect of inter-group profits in inventory.

 

14

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(4)       Adjusted EBITDA (as defined)excludes the following charges reflected in the Company’s financial statementswhich are prepared in accordance with generally accepted accounting principles:

 
|                                                                          |   | **Three  Months EndedMarch 31,** |    |
|-------------------------------------------------------------------------------|--------|----------------------------------|---------|
| **(In thousands)**                                                            |   | **2004**                         |    | **2003** |   |
|                                                                          |   | **(Unaudited)**                  |    |
| Depreciation and  amortization of long-lived assets (a)                       |   | $                                | (2,326  | ) | $ | (2,516 | ) |
| Adjustment to  reflect program costs as research and development expenses (b) |   | (1,616                           | )       | (1,573 | ) |
| Acquisition  related charges not capitalized                                  |   | (9                               | )       | (9 | ) |
| Interest expense                                                              |   | (8,702                           | )       | (5,869 | ) |
| Mandatorily  redeemable preferred stock dividends                             |   | (4,231                           | )       | (1,597 | ) |
| Other expenses,  net                                                          |   | (112                             | )       | (339 | ) |
| Provision for  income (taxes) benefit                                         |   | (30                              | )       | 1,265 |   |
| Income (loss)  from discontinued operations                                   |   | —                           |    | (6,397 | ) |
| Cumulative  effect of change in accounting principle                          |   | —                           |    | (13,764 | ) |
| Total  reconciling items                                                      |   | $                                | (17,026 | ) | $ | (30,799 | ) |

 

----

(a)           Reflects depreciationand amortization of long-lived assets and amortization of deferred financingcosts, which are classified as a component of interest expense, as follows:

 
|                                                |   | **Three  Months EndedMarch 31,** |   |
|-----------------------------------------------------|--------|----------------------------------|--------|
| **(In thousands)**                                  |   | **2004**                         |   | **2003** |   |
|                                                |   | **(Unaudited)**                  |   |
| Depreciation and  amortization of long-lived assets |   | $                                | 2,326  |   | $ | 2,516 |   |
| Amortization of  deferred financing costs           |   | 790                              |   | 695 |   |
| Consolidated  depreciation and amortization         |   | $                                | 3,116  |   | $ | 3,211 |   |

 

(b)           Under programaccounting, which the Company is required to use for determining covenantcompliance under its credit agreements, certain product development costsincurred in connection with specific contracted programs are deferred andcharged to cost of sales as revenues related to the program arerecognized.  For financial reportingpurposes, these costs are charged to research and development expense asincurred.  This adjustment reflects thenet difference between these two methods of accounting.

 

(5)       Reflects the Company’scorporate headquarters assets, excluding investments in and notes receivablefrom subsidiaries.

 

(6)       Reflects elimination ofinter-group receivables and profits in inventory as of period end.

 

15

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**Note 11.****Supplemental CondensedConsolidating Financial Information**

 

In conjunction with the12% subordinated notes described in Note 6, the following condensedconsolidating financial information is presented segregating DeCrane Aircraft,as the issuer, and the guarantor and non-guarantor subsidiaries.  The accompanying financial information inthe guarantor subsidiaries column reflects the financial position, results ofoperations and cash flows for those subsidiaries guaranteeing the notes.  DeCrane Holdings is not a guarantor of thenotes and is therefore reflected in the non-guarantor subsidiary column withDeCrane Aircraft’s non-guarantor subsidiaries. DeCrane Aircraft’s non-guarantor subsidiaries are companies within theSpecialty Avionics Group which was sold in May 2003 and is therefore classifiedas a component of discontinued operations.

 

The guarantorsubsidiaries are wholly-owned subsidiaries of DeCrane Aircraft and theirguarantees are full and unconditional on a joint and several basis.  There are no restrictions on the ability ofthe guarantor subsidiaries to transfer funds to the issuer in the form of cashdividends, loans or advances.  Separatefinancial statements of the guarantor subsidiaries are not presented becausemanagement believes that such financial statements would not be material toinvestors.  Investments in subsidiariesin the following condensed consolidating financial information are accountedfor under the equity method of accounting. Consolidating adjustments include the following:

 

(1)           Eliminationof investments in subsidiaries.

 

(2)           Eliminationof intercompany accounts.

 

(3)           Eliminationof equity in earnings of subsidiaries.

 

16

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**Balance Sheets**

 
|                                                                                                |   | **March 31,  2004 (Unaudited)** |    |
|-----------------------------------------------------------------------------------------------------|--------|---------------------------------|---------|
| **(In thousands)**                                                                                  |   | **Issuer**                      |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                                                                |   |                            |    |   |   |   |   |   |   |   |   |
| **Assets**                                                                                          |   |                            |    |   |   |   |   |   |   |   |   |
|                                                                                                |   |                            |    |   |   |   |   |   |   |   |   |
| Current assets:                                                                                     |   |                            |    |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                          |   | $                               | 2,209   |   | $ | 480 |   | $ | — |   | $ | — |   | $ | 2,689 |   |
| Accounts  receivable, net                                                                           |   | —                          |    | 26,969 |   | — |   | — |   | 26,969 |   |
| Inventories                                                                                         |   | —                          |    | 47,621 |   | — |   | — |   | 47,621 |   |
| Other current  assets                                                                               |   | 122                             |    | 1,037 |   | — |   | — |   | 1,159 |   |
| Total current  assets                                                                               |   | 2,331                           |    | 76,107 |   | — |   | — |   | 78,438 |   |
|                                                                                                |   |                            |    |   |   |   |   |   |   |   |   |
| Property and  equipment, net                                                                        |   | 951                             |    | 29,011 |   | — |   | — |   | 29,962 |   |
| Other assets,  principally goodwill and intangibles, net                                            |   | 12,845                          |    | 185,992 |   | — |   | — |   | 198,837 |   |
| Investments in  subsidiaries                                                                        |   | 83,962                          |    | — |   | (52,793 | ) | (31,169 | )(1) | — |   |
| Intercompany  receivables                                                                           |   | 230,562                         |    | 62,826 |   | — |   | (293,388 | )(2) | — |   |
| Total assets                                                                                        |   | $                               | 330,651 |   | $ | 353,936 |   | $ | (52,793 | ) | $ | (324,557 | ) | $ | 307,237 |   |
|                                                                                                |   |                            |    |   |   |   |   |   |   |   |   |
| **Liabilities  and Stockholders’ Equity (Deficit)**                                            |   |                            |    |   |   |   |   |   |   |   |   |
|                                                                                                |   |                            |    |   |   |   |   |   |   |   |   |
| Current liabilities:                                                                                |   |                            |    |   |   |   |   |   |   |   |   |
| Current portion  of long-term debt                                                                  |   | $                               | 7       |   | $ | 1,264 |   | $ | — |   | $ | — |   | $ | 1,271 |   |
| Other current  liabilities                                                                          |   | 6,111                           |    | 28,826 |   | — |   | — |   | 34,937 |   |
| Total current  liabilities                                                                          |   | 6,118                           |    | 30,090 |   | — |   | — |   | 36,208 |   |
|                                                                                                |   |                            |    |   |   |   |   |   |   |   |   |
| Long-term debt,  less current portion                                                               |   | 270,111                         |    | 7,215 |   | — |   | — |   | 277,326 |   |
| Mandatorily  redeemable preferred stock                                                             |   | 42,684                          |    | — |   | 73,901 |   | — |   | 116,585 |   |
| Intercompany  payables                                                                              |   | 62,826                          |    | 230,562 |   | — |   | (293,388 | )(2) | — |   |
| Other long-term  liabilities                                                                        |   | 2,991                           |    | 2,375 |   | — |   | — |   | 5,366 |   |
|                                                                                                |   |                            |    |   |   |   |   |   |   |   |   |
| Stockholders’  equity (deficit):                                                               |   |                            |    |   |   |   |   |   |   |   |   |
| Paid-in capital                                                                                     |   | 111,701                         |    | 151,492 |   | 61,515 |   | (264,479 | )(1) | 60,229 |   |
| Accumulated  deficit                                                                                |   | (165,780                        | )       | (67,530 | ) | (188,209 | ) | 233,310 |  (1) | (188,209 | ) |
| Accumulated  other comprehensive loss                                                               |   | —                          |    | (268 | ) | — |   | — |   | (268 | ) |
| Total  stockholders’ equity (deficit)                                                          |   | (54,079                         | )       | 83,694 |   | (126,694 | ) | (31,169 | ) | (128,248 | ) |
| Total  liabilities, mandatorily redeemable preferred stock and stockholders’ equity  (deficit) |   | $                               | 330,651 |   | $ | 353,936 |   | $ | (52,793 | ) | $ | (324,557 | ) | $ | 307,237 |   |

 

17

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|                                                                                                |   | **December 31, 2003** |    |
|-----------------------------------------------------------------------------------------------------|--------|-----------------------|---------|
| **(In  thousands)**                                                                                 |   | **Issuer**            |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** | ** ** |
|                                                                                                |   |                  |    |   |   |   |   |   |   |   |   |
| **Assets**                                                                                          |   |                  |    |   |   |   |   |   |   |   |   |
|                                                                                                |   |                  |    |   |   |   |   |   |   |   |   |
| Current assets:                                                                                     |   |                  |    |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                                                          |   | $                     | 6,540   |   | $ | 396 |   | $ | — |   | $ | — |   | $ | 6,936 |   |
| Accounts  receivable, net                                                                           |   | —                |    | 21,455 |   | — |   | — |   | 21,455 |   |
| Inventories                                                                                         |   | —                |    | 42,981 |   | — |   | — |   | 42,981 |   |
| Other current  assets                                                                               |   | 254                   |    | 828 |   | — |   | — |   | 1,082 |   |
| Total current  assets                                                                               |   | 6,794                 |    | 65,660 |   | — |   | — |   | 72,454 |   |
|                                                                                                |   |                  |    |   |   |   |   |   |   |   |   |
| Property and equipment, net                                                                         |   | 1,047                 |    | 29,853 |   | — |   | — |   | 30,900 |   |
| Other assets, principally goodwill                                                                  |   | 13,615                |    | 186,907 |   | — |   | — |   | 200,522 |   |
| Investments in subsidiaries                                                                         |   | 85,668                |    | — |   | (44,913 | ) | (40,755 | )(1) | — |   |
| Intercompany receivables                                                                            |   | 261,631               |    | 100,642 |   | — |   | (362,273 | )(2) | — |   |
| Total assets                                                                                        |   | $                     | 368,755 |   | $ | 383,062 |   | $ | (44,913 | ) | $ | (403,028 | ) | $ | 303,876 |   |
|                                                                                                |   |                  |    |   |   |   |   |   |   |   |   |
| **Liabilities, Mandatorily Redeemable  Preferred Stock and Stockholders’ Equity (Deficit)**    |   |                  |    |   |   |   |   |   |   |   |   |
|                                                                                                |   |                  |    |   |   |   |   |   |   |   |   |
| Current liabilities:                                                                                |   |                  |    |   |   |   |   |   |   |   |   |
| Current portion  of long-term debt                                                                  |   | $                     | 11      |   | $ | 1,187 |   | $ | — |   | $ | — |   | $ | 1,198 |   |
| Other current  liabilities                                                                          |   | 8,532                 |    | 24,820 |   | — |   | — |   | 33,352 |   |
| Total current  liabilities                                                                          |   | 8,543                 |    | 26,007 |   | — |   | — |   | 34,550 |   |
|                                                                                                |   |                  |    |   |   |   |   |   |   |   |   |
| Long-term debt, less current portion                                                                |   | 260,654               |    | 7,554 |   | — |   | — |   | 268,208 |   |
| Intercompany payables                                                                               |   | 100,642               |    | 261,631 |   | — |   | (362,273 | )(2) | — |   |
| Other long-term liabilities                                                                         |   | 2,994                 |    | 2,470 |   | — |   | — |   | 5,464 |   |
|                                                                                                |   |                  |    |   |   |   |   |   |   |   |   |
| Minority  interest in preferred stock of subsidiary                                                 |   | 40,835                |    | — |   | — |   | — |   | 40,835 |   |
| Mandatorily  redeemable 14% preferred stock                                                         |   | —                |    | — |   | 71,402 |   | — |   | 71,402 |   |
|                                                                                                |   |                  |    |   |   |   |   |   |   |   |   |
| Stockholders’ equity (deficit):                                                                |   |                  |    |   |   |   |   |   |   |   |   |
| Paid-in capital                                                                                     |   | 111,719               |    | 151,492 |   | 60,247 |   | (263,211 | )(1) | 60,247 |   |
| Retained  earnings (deficit)                                                                        |   | (156,632              | )       | (65,824 | ) | (176,562 | ) | 222,456 | (1) | (176,562 | ) |
| Accumulated  other comprehensive loss                                                               |   | —                |    | (268 | ) | — |   | — |   | (268 | ) |
| Total  stockholders’ equity                                                                    |   | (44,913               | )       | 85,400 |   | (116,315 | ) | (40,755 | ) | (116,583 | ) |
| Total  liabilities, mandatorily redeemable preferred stock and stockholders’ equity  (deficit) |   | $                     | 368,755 |   | $ | 383,062 |   | $ | (44,913 | ) | $ | (403,028 | ) | $ | 303,876 |   |
|                                                                                                     |        |                       |         |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

18

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**Statements of Operations**

 
|                                              |   | **Three  Months Ended March 31, 2004 (Unaudited)** |   |
|---------------------------------------------------|--------|----------------------------------------------------|--------|
| **(In thousands)**                                |   | **Issuer**                                         |   | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                              |   |                                               |   |   |   |   |   |   |   |   |   |
| Revenues                                          |   | $                                                  | — |   | $ | 48,597 |   | $ | — |   | $ | — |   | $ | 48,597 |   |
| Cost of sales                                     |   | —                                             |   | 36,839 |   | — |   | — |   | 36,839 |   |
| Gross profit                                      |   | —                                             |   | 11,758 |   | — |   | — |   | 11,758 |   |
|                                              |   |                                               |   |   |   |   |   |   |   |   |   |
| Operating and  other expenses (income):           |   |                                               |   |   |   |   |   |   |   |   |   |
| Selling, general  and administrative expenses     |   | 1,198                                              |   | 6,039 |   | — |   | — |   | 7,237 |   |
| Research and  development expenses                |   | —                                             |   | 2,181 |   | — |   | — |   | 2,181 |   |
| Amortization of  intangible assets                |   | —                                             |   | 912 |   | — |   | — |   | 912 |   |
| Interest expense                                  |   | 8,516                                              |   | 186 |   | — |   | — |   | 8,702 |   |
| Mandatorily  redeemable preferred stock dividends |   | 1,732                                              |   | — |   | 2,499 |   | — |   | 4,231 |   |
| Intercompany  charges                             |   | (5,257                                             | )      | 5,257 |   | — |   | — |   | — |   |
| Equity in loss  of subsidiaries                   |   | 1,706                                              |   | — |   | 9,148 |   | (10,854 | )(3) | — |   |
| Other expenses  (income), net                     |   | 118                                                |   | (6 | ) | — |   | — |   | 112 |   |
| Provision for  income taxes (benefit)             |   | 1,135                                              |   | (1,105 | ) | — |   | — |   | 30 |   |
| Net loss                                          |   | $                                                  | (9,148 | ) | $ | (1,706 | ) | $ | (11,647 | ) | $ | 10,854 |   | $ | (11,647 | ) |

 
|                                                 |   | **Three  Months Ended March 31, 2003 (Unaudited)** |    |
|------------------------------------------------------|--------|----------------------------------------------------|---------|
| **(In thousands)**                                   |   | **Issuer**                                         |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                 |   |                                               |    |   |   |   |   |   |   |   |   |
| Revenues                                             |   | $                                                  | —  |   | $ | 41,900 |   | $ | — |   | $ | — |   | $ | 41,900 |   |
| Cost of sales                                        |   | —                                             |    | 28,878 |   | — |   | — |   | 28,878 |   |
| Gross profit                                         |   | —                                             |    | 13,022 |   | — |   | — |   | 13,022 |   |
|                                                 |   |                                               |    |   |   |   |   |   |   |   |   |
| Operating and  other expenses (income):              |   |                                               |    |   |   |   |   |   |   |   |   |
| Selling, general  and administrative expenses        |   | 3,036                                              |    | 6,894 |   | — |   | — |   | 9,930 |   |
| Research and  development expenses                   |   | —                                             |    | 1,573 |   | — |   | — |   | 1,573 |   |
| Amortization of  intangible assets                   |   | —                                             |    | 912 |   | — |   | — |   | 912 |   |
| Interest expense                                     |   | 5,820                                              |    | 49 |   | — |   | — |   | 5,869 |   |
| Mandatorily  redeemable preferred stock dividends    |   | —                                             |    | — |   | 1,597 |   | — |   | 1,597 |   |
| Intercompany  charges                                |   | (6,523                                             | )       | 6,523 |   | — |   | — |   | — |   |
| Equity in loss  of subsidiaries                      |   | 19,748                                             |    | 69 |   | 24,497 |   | (44,314 | )(3) | — |   |
| Other expenses,  net                                 |   | 174                                                |    | 165 |   | — |   | — |   | 339 |   |
| Provision for  income taxes (benefit)                |   | 2,242                                              |    | (3,507 | ) | — |   | — |   | (1,265 | ) |
| Loss from  discontinued operations                   |   | —                                             |    | 6,328 |   | 69 |   | — |   | 6,397 |   |
| Cumulative  effect of change in accounting principle |   | —                                             |    | 13,764 |   | — |   | — |   | 13,764 |   |
| Net loss                                             |   | $                                                  | (24,497 | ) | $ | (19,748 | ) | $ | (26,163 | ) | $ | 44,314 |   | $ | (26,094 | ) |

 

19

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**Statements of Cash Flows**

 
|                                                                   |   | **Three  Months Ended March 30, 2004 (Unaudited)** |   |
|------------------------------------------------------------------------|--------|----------------------------------------------------|--------|
| **(In thousands)**                                                     |   | **Issuer**                                         |   | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                                   |   |                                               |   |   |   |   |   |   |   |   |   |
| **Cash  flows from operating activities:**                             |   |                                               |   |   |   |   |   |   |   |   |   |
| Net loss                                                               |   | $                                                  | (9,148 | ) | $ | (1,706 | ) | $ | (11,647 | ) | $ | 10,854  |  (3) | $ | (11,647 | ) |
| Noncash  adjustments:                                                  |   |                                               |   |   |   |   |   |   |   |   |   |
| Equity in loss  of subsidiaries                                        |   | 1,706                                              |   | — |   | 9,148 |   | (10,854 | )(3) | — |   |
| Other noncash  adjustments                                             |   | 3,322                                              |   | 2,259 |   | 2,499 |   | — |   | 8,080 |   |
| Changes in  working capital                                            |   | (9,058                                             | )      | 297 |   | — |   | — |   | (8,761 | ) |
| Net cash  provided by (used for) operating activities                  |   | (13,178                                            | )      | 850 |   | — |   | — |   | (12,328 | ) |
|                                                                   |   |                                               |   |   |   |   |   |   |   |   |   |
| **Cash  flows from investing activities:**                             |   |                                               |   |   |   |   |   |   |   |   |   |
| Capital  expenditures                                                  |   | —                                             |   | (504 | ) | — |   | — |   | (504 | ) |
| Net cash used  for investing activities                                |   | —                                             |   | (504 | ) | — |   | — |   | (504 | ) |
|                                                                   |   |                                               |   |   |   |   |   |   |   |   |   |
| **Cash  flows from financing activities:**                             |   |                                               |   |   |   |   |   |   |   |   |   |
| Net revolving  line of credit borrowings Other secured long-term debt: |   | 8,850                                              |   | — |   | — |   | — |   | 8,850 |   |
| Borrowings                                                             |   | —                                             |   | 46 |   | — |   | — |   | 46 |   |
| Repayments                                                             |   | (3                                                 | )      | (308 | ) | — |   | — |   | (311 | ) |
| Net cash  provided by (used for) financing activities                  |   | 8,847                                              |   | (262 | ) | — |   | — |   | 8,585 |   |
| Net increase  (decrease) in cash and equivalents                       |   | (4,331                                             | )      | 84 |   | — |   | — |   | (4,247 | ) |
| Cash and  equivalents at beginning of period                           |   | 6,540                                              |   | 396 |   | — |   | — |   | 6,936 |   |
| Cash and  equivalents at end of period                                 |   | $                                                  | 2,209  |   | $ | 480 |   | $ | — |   | $ | — |   | $ | 2,689 |   |

 

20

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|                                                  |   | **Three Months Ended March 31, 2003 (Unaudited)** |    |
|-------------------------------------------------------|--------|--------------------------------------------------------|---------|
| **(In thousands)**                                    |   | **Issuer**                                             |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                  |   |                                                   |    |   |   |   |   |   |   |   |   |
| **Cash  flows from operating activities:**            |   |                                                   |    |   |   |   |   |   |   |   |   |
| Net loss                                              |   | $                                                      | (24,497 | ) | $ | (19,748 | ) | $ | (26,163 | ) | $ | 44,314 |  (3) | $ | (26,094 | ) |
| Noncash adjustments:                                  |   |                                                   |    |   |   |   |   |   |   |   |   |
| Cumulative  effect of change in accounting principle  |   | —                                                 |    | 13,764 |   | — |   | — |   | 13,764 |   |
| Loss from  discontinued operations                    |   | —                                                 |    | 6,328 |   | 69 |   | — |   | 6,397 |   |
| Equity in loss  of subsidiaries                       |   | 19,748                                                 |    | 69 |   | 24,497 |   | (44,314 | )(3) | — |   |
| Other noncash  adjustments                            |   | 237                                                    |    | 1,509 |   | 1,597 |   | — |   | 3,343 |   |
| Changes in  working capital                           |   | (16,438                                                | )       | (3,339 | ) | — |   | — |   | (19,777 | ) |
| Net cash used  for operating activities               |   | (20,950                                                | )       | (1,417 | ) | — |   | — |   | (22,367 | ) |
|                                                  |   |                                                   |    |   |   |   |   |   |   |   |   |
| **Cash  flows from investing activities:**            |   |                                                   |    |   |   |   |   |   |   |   |   |
| Cash paid for  acquisitions, net of cash acquired     |   | (600                                                   | )       | — |   | — |   | — |   | (600 | ) |
| Capital  expenditures                                 |   | (3                                                     | )       | (1,095 | ) | — |   | — |   | (1,098 | ) |
| Net cash used  for investing activities               |   | (603                                                   | )       | (1,095 | ) | — |   | — |   | (1,698 | ) |
|                                                  |   |                                                   |    |   |   |   |   |   |   |   |   |
| **Cash  flows from financing activities:**            |   |                                                   |    |   |   |   |   |   |   |   |   |
| Net revolving  line of credit borrowings              |   | 27,150                                                 |    | — |   | — |   | — |   | 27,150 |   |
| First-lien term  debt repayments                      |   | (3,275                                                 | )       | — |   | — |   | — |   | (3,275 | ) |
| Other secured  long-term debt repayments              |   | (114                                                   | )       | (821 | ) | — |   | — |   | (935 | ) |
| Net cash  provided by (used for) financing activities |   | 23,761                                                 |    | (821 | ) | — |   | — |   | 22,940 |   |
| Net cash  provided by discontinued operations         |   | —                                                 |    | 3,341 |   | — |   | — |   | 3,341 |   |
| Net increase in  cash and equivalents                 |   | 2,208                                                  |    | 8 |   | — |   | — |   | 2,216 |   |
| Cash and  equivalents at beginning of period          |   | 12,343                                                 |    | 78 |   | — |   | — |   | 12,421 |   |
| Cash and  equivalents at end of period                |   | $                                                      | 14,551  |   | $ | 86 |   | $ | — |   | $ | — |   | $ | 14,637 |   |

 

21

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**ITEM 2.****          MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The followingdiscussions should be read in conjunction with our financial statements andaccompanying notes included in this report.

 

**Results of Operations**

** **

### **Performance Measures**

 

The followingdiscussion of our results of operations includes discussions of financialmeasures and operating statistics we use to evaluate the performance of, andtrends in, our businesses.  We believethe presentation of these measures and statistics are relevant and useful toinvestors because it allows them to view performance and trends in a mannersimilar to the methods we use.  Thesemeasures and statistics, and why they are important to us and could be ofinterest to you, are described below.

 

**Adjusted EBITDA.**  Our discussion of the results of operationsincludes discussions of financial measures determined in accordance withaccounting principles generally accepted in the United States of America(“GAAP”) as well as the financial measure Adjusted EBITDA, which excludescertain charges reflected in our GAAP basis financial statements.  Our presentation of Adjusted EBITDA is inaccordance with the GAAP requirements of SFAS No. 131, “Disclosures aboutSegments of an Enterprise and Related Information,” which requires us to reportthe primary measure of segment performance we use to evaluate and manage ourbusinesses.

 

We utilize morethan one measurement to evaluate segment performance and allocate resourcesamong our operating segments; however, we consider Adjusted EBITDA, as definedbelow, to be the primary measurement of overall operating segment core economicperformance and return on invested capital. We also use Adjusted EBITDA in the annual budgeting and planning forfuture periods, as one of the decision-making criteria for fundingdiscretionary capital expenditure and product development programs and as themeasure for determining the value of acquisitions and dispositions.  Our board of directors uses Adjusted EBITDAas one of the performance metrics for determining the amount of bonuses awardedto pursuant to the cash incentive bonus plan and as an indicator of enterprisevalue used in determining the exercise price of stock options granted and theacceleration of stock option vesting pursuant the incentive stock option plan.

 

We define AdjustedEBITDA as earnings, determined using program accounting for product developmentcosts, before interest, income taxes, depreciation and amortization,restructuring, asset impairment and other related charges, acquisition relatedcharges not capitalized and other noncash and nonoperating charges.  We believe the presentation of this measureis relevant and useful to investors because it allows investors and analysts toview group performance in a manner similar to the method we use, helps improvetheir ability to understand our core segment performance, adjusted for items webelieve are unusual, and makes it easier to compare our results with othercompanies that have different financing, capital structures and tax rates.  In addition, we believe these measures areconsistent with the manner in which our lenders and investors measure ouroverall performance and liquidity, including our ability to service debt andfund discretionary capital expenditure and product development programs.

 

Our method ofcalculating Adjusted EBITDA may not be consistent with that of other companiesand should be viewed in conjunction with measurements that are computed inaccordance GAAP, such as net income (loss), the nearest comparable GAAPfinancial measure.  Adjusted EBITDAshould not be viewed as substitutes for or superior to net income (loss), cashflow from operations or other data prepared in accordance with GAAP as ameasure of our profitability or liquidity. The notes to our financial statements include information about our operatingsegments, including Adjusted EBITDA, and should be read in conjunction with thediscussions presented herein.  The notesto our financial statements

 

22

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also include areconciliation of Adjusted EBITDA to net income (loss) to clarify thedifferences between these financial measures.

 

**Bookings and Backlog.**  Bookings and backlog are operatingstatistics we use as leading trend indicators of future demand for our productsand services.  Bookings and backlog arebased upon the value of purchase orders received from our customers, which willresult in revenues, if and when such orders are filled.

 

Bookings represent thetotal invoice value of purchase orders received during the period and backlogrepresents the total invoice value of unfilled purchase orders as of the end ofa period.  Orders may be subject tochange or cancellation by the customer prior to shipment.  The level of unfilled orders at any givendate during the year will be materially affected by the timing of our receiptof orders and the speed with which those orders are filled.

 

### **Changes in Accounting Principles**

 

**Adoption of SFAS No. 150.**  Effective January 1, 2004, we adoptedSFAS No. 150, “Accounting for Certain Financial Instruments with Characteristicsof both Liabilities and Equity.”  SFASNo. 150 establishes standards for the classification and measurement of certainfinancial instruments with characteristics of both liabilities and equity.  SFAS No. 150 requires classification offinancial instruments within its scope as a liability, including financialinstruments issued in the form of shares that are mandatorily redeemable,because those financial instruments are deemed to be, in essence, obligationsof the issuer.  As a result of adoptingof SFAS No. 150 on January 1, 2004, all mandatorily redeemable preferredstock was reclassified as a liability and all quarterly dividends are reflectedas a charge against pre-tax income.  Inperiods prior to January 1, 2004, DeCrane Holdings’ 14% preferred stockdividends were deducted in arriving at the net income or loss applicable to theCompany’s common stockholders; DeCrane Aircraft’s 16% preferred stock dividendswere charged against pre-tax income as minority interest in preferred stock ofsubsidiary.

 

The following tablesummarizes the results of operations for the three months ended March 31,2003 as if SFAS No. 150 had been in effect as of the beginning of 2003.

 
|                             |   | **Three  Months Ended  March 31, 2003** |   |
|----------------------------------|--------|----------------------------------------------|--------|
| **(In millions)**                |   | **As  Reported**                             |   | **Pro Forma** |   |
|                             |   | **(Unaudited)**                              |   |
| Loss  from continuing operations |   | $                                            | (5.9   | ) | $ | (8.1 | ) |
| Net  loss                        |   | (26.1                                        | )      | (28.3 | ) |
|                                  |        |                                              |        |  |  |  |  |

 

The pro forma datareflects $2.2 million of DeCrane Holdings 14% preferred stock dividends as acharge against income during the period.

 

**Change in Accounting for Product Development Costs.**  In addition, and as more fully described in“Note 1—Change in Accounting Principle” to the audited financial statementsincluded in the Company’s 2003 Form 10-K, we elected to discontinue the use ofprogram accounting for the costs of products manufactured for delivery underproduction-type contracts.  As a result,certain deferred program costs are no longer included in inventory commencingJanuary 1, 2003.

 

This change in accountingpolicy was made after concluding the 2003 fiscal year but was appliedretroactively to the beginning of the year, January 1, 2003, as requiredby generally accepted accounting principles. As a result of the change, program-related product development costs arenow classified as a component of research and development expenses in theconsolidated financial statements rather than classified as a component ofinventory cost.  As a result of thechange, we have restated the results of operations for the three months endedMarch 31, 2003 by charging $1,573,000 of previously inventoried

 

23

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costs to research anddevelopment expense and recording a $13,764,000 charge as of January 1,2003 to reflect the cumulative effect of the change in accounting principle.

 

### **Three Months Ended March** 31, 2004 Compared to Three MonthsEnded March 31, 2003

### ** **

**Revenues.* ***Revenuesincreased $6.7 million, or 16.0%, to $48.6 million for the three months endedMarch 31, 2004 from $41.9 million for the three months endedMarch 31, 2003.  By segment,revenues changed as follows:

 
|                                 |   | **Increase  (Decrease)  From 2003** |   |
|--------------------------------------|--------|-------------------------------------|--------|
| **(In millions)**                    |   | **Amount**                          |   | **Percent** |   |
|                                 |   |                                |   |   |   |
| Cabin  Management                    |   | $                                   | 3.7    |   | 12.1 | % |
| Systems  Integration                 |   | 2.4                                 |   | 19.8 |   |
| Decrease  in inter-group elimination |   | 0.6                                 |   |   |   |
| Total                                |   | $                                   | 6.7    |   |   |   |

 

*CabinManagement. *Revenuesincreased by $3.7 million, or 12.1% compared to the prior year due to a highervolume of corporate jet production by aircraft manufacturers.  The increase consisted of the following:

 

•      a$1.1 million increase in aircraft furniture and related products revenues;

 

•      a$1.2 million increase in cabin management and entertainment systems revenues;and

 

•      a$1.5 million increase in seating products revenues; offset by

 

•      a$0.1 million decrease in other product and services revenues.

 

*SystemsIntegration.*  Revenuesincreased by $2.4 million, or 19.8% compared to the prior year, due to:

 

•      thereceipt of $4.2 million for the conversion of a major supply contract forauxiliary fuel systems to a “requirements” only contract from a guaranteed“take-or-pay” contract; and

 

•      a$0.8 million increase in the commercial aircraft systems integrationengineering services; offset by

 

•      a$2.6 million decrease resulting from lower production of auxiliary fuel tanksystems.

 

**Grossprofit.**  Gross profitdecreased $1.3 million, or 9.7%, to $11.7 million for the three months endedMarch 31, 2004 from $13.0 million for the same period in the prioryear.  By segment, gross profit changedas follows:

 
|                 |   | **Increase  (Decrease)  From 2003** |   |
|----------------------|--------|-------------------------------------|--------|
| **(In millions)**    |   | **Amount**                          |   | **Percent** |   |
|                 |   |                                |   |   |   |
| Cabin  Management    |   | $                                   | (0.8   | ) | (8.6 | )% |
| Systems  Integration |   | (0.5                                | )      | (9.5 | ) |
| Total                |   | $                                   | (1.3   | ) |   |   |

 

*CabinManagement.*  Grossprofit decreased by $0.8 million, or 8.6% compared to the prior year, primarilydue to:

 

•      a$1.6 million decrease due to lower margins resulting from the costs associatedwith the start-up of production for new aircraft programs as well as a changein sales mix; offset by

 

•      a$0.8 million increase in gross profit related to higher volume for our cabinmanagement and entertainment systems.

 

24

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*SystemsIntegration.*  Grossprofit decreased by $0.5 million, or 9.5% compared to the prior year, primarilydue to:

 

•      a$2.3 million decrease resulting from lower revenues and a change in productdelivery mix; offset by

 

•      a$1.5 million increase resulting from the conversion of a major supply contractfor auxiliary fuel systems to a “requirements” only contact from a guaranteed“take-or-pay” contract; and

 

•      a$0.3 million increase resulting from the increase in commercial aircraftsystems integration engineering services revenues.

 

Duringthe three months ended March 31, 2004, we received $4.2 million ascompensation for converting the supply contract to a requirements-only contract.  In conjunction with the conversion, wecharged $2.7 million to cost of sales to write-off unamortized design andengineering costs and to reduce excess raw material inventory related to thiscontract to its net realizable value.

 

**Selling,general and administrative expenses.**  Selling, general and administrative expensesdecreased $2.7 million, or 27.1%, to $7.2 million for the three months endedMarch 31, 2004, from $9.9 million for the same period in the prior year.  By segment, SG&A expenses changed asfollows:

 
|                 |   | **Increase  (Decrease)  From 2003** |   |
|----------------------|--------|-------------------------------------|--------|
| **(In millions)**    |   | **Amount**                          |   | **Percent** |   |
|                 |   |                                |   |   |   |
| Cabin  Management    |   | $                                   | (0.2   | ) | (4.4 | )% |
| Systems  Integration |   | (1.4                                | )      | (41.4 | ) |
| Corporate            |   | (1.1                                | )      |   |   |
| Total                |   | $                                   | (2.7   | ) |   |   |

 

*CabinManagement. *SG&Aexpenses decreased by $0.2 million, or 4.4% compared to the prior year, due toongoing cost reduction *measures*.

 

*SystemsIntegration. *SG&Aexpenses decreased by $1.4 million, or 41.4% compared to the prior year, due tolower labor and employee benefit costs resulting from workforce reductions in2003 as well as other cost reduction efforts.

 

*Corporate. *SG&A expensesdecreased by $1.1 million compared to the prior year due principally to lowercosts pursuant to the incentive compensation plan.

 

**Researchand development expenses. **Research and development expenses increased$0.6 million, or 38.6%, to $2.2 million for the three months endedMarch 31, 2004 compared to $1.6 million in the prior year.  By segment, research and developmentexpenses changed as follows:

 
|                 |   | **Increase  (Decrease)  From 2003** |   |
|----------------------|--------|-------------------------------------|--------|
| **(In millions)**    |   | **Amount**                          |   | **Percent** |   |
|                 |   |                                |   |   |   |
| Cabin  Management    |   | $                                   | 0.2    |   | 14.9 | % |
| Systems  Integration |   | 0.4                                 |   | 411.7 |   |
| Total                |   | $                                   | 0.6    |   |   |   |

 

*Cabin Management. *R&Dexpenses increased $0.2 million, or 14.9% compared to the prior year. Theincrease is primarily related to the development of our new single-design seattechnology and design of new interior furnishing components for a majorcustomer’s recently introduced new model of aircraft.

 

*Systems Integration. *R&D expenses increased $0.4 million, or 411.7%compared to the prior year.  Theincrease is principally due to the development of several new products.

 

25

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**Depreciationand amortization of intangibles.**  Depreciation and amortization expense decreased $0.2 million to$2.3 million for the three months ended March 31, 2004 from $2.5 millionfor the same period in the prior year. The decline is attributable to reduced capital expenditures and lowerdepreciable base.  By segment,depreciation and amortization changed as follows.

 
|                                         |   | **Increase  (Decrease)  From 2003** |   |
|----------------------------------------------|--------|-------------------------------------|--------|
| **(In millions)**                            |   | **Amount**                          |   | **Percent** |   |
|                                         |   |                                |   |   |   |
| Depreciation  charged to:                    |   |                                |   |   |   |
| Cost  of sales                               |   | $                                   | (0.1   | ) | (6.9 | )% |
| Selling,  general and administrative expense |   | (0.1                                | )      | (21.0 | ) |
| Amortization  of intangible assets           |   | 0.0                                 |   | 0.0 |   |
| Total                                        |   | $                                   | (0.2   | ) |   |   |

 

**AdjustedEBITDA. **As described above in “—PerformanceMeasures–Adjusted EBITDA,” we use this financial measure to evaluate the coreeconomic performance of our operating segments.  The notes to our financial statements include additionalinformation about Adjusted EBITDA, and should be read in conjunction with thediscussions presented herein.  The notesto our financial statements also include a reconciliation of Adjusted EBITDA tonet income (loss), a GAAP financial measure, to clarify the differences betweenthese two measures.

 

*Cabin Management. *AdjustedEBITDA decreased by $1.2 million, or24.4%, to $3.4 million for the three months ended March 31, 2004 comparedto $4.6 million for the same period in the prior year primarily due to:

 

•      a$1.6 million decrease in gross profit related to our business, VIP andhead-of-state aircraft furniture and seating operations; and

 

•      a$0.4 million unfavorable impact resulting from adjusting for program costs; and

 

•      a$0.2 million increase in research and development expenses; offset by

 

•      a$0.8 million increase in gross profit related our cabin management andentertainment systems; and

 

•      a$0.2 million decrease in SG&A spending.

 

*SystemsIntegration. *AdjustedEBITDA increased by $0.8 million, or 40.4%, to $3.0 million for the threemonths ended March 31, 2004 compared to $2.2 million for the same periodin the prior year due to:

 

•      a$1.4 million decrease in SG&A spending; and

 

•      a$0.3 million favorable impact resulting from adjusting for program costs;offset by

 

•      a$0.5 million decline in gross profit; and

 

•      a$0.4 million increase in research and development expenses.

 

**Operatingincome.**  Operatingincome increased $0.8 million, or 135.3%, to $1.4 million for the three monthsended March 31, 2004, from $0.6 million for the same period in the prioryear.  By segment, operating incomechanged as follows:

 
|                 |   | **Increase  (Decrease)  From 2003** |   |
|----------------------|--------|-------------------------------------|--------|
| **(In millions)**    |   | **Amount**                          |   | **Percent** |   |
|                 |   |                                |   |   |   |
| Cabin  Management    |   | $                                   | (0.7   | ) | (47.9 | )% |
| Systems  Integration |   | 0.5                                 |   | 35.3 |   |
| Corporate            |   | 1.0                                 |   |   |   |
| Total                |   | $                                   | 0.8    |   |   |   |

 

26

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*CabinManagement. *Operatingincome decreased by $0.7 million, or 47.9% compared to the prior year, due to:

 

•      a$1.5 million decrease in gross profit, primarily due to lower revenues relatedto our furniture and seating operations; and

 

•      an$0.2 million increase in research and development expenses; offset by

 

•      a$0.8 million increase in gross profit related to higher volume for our cabinmanagement and entertainment systems; and

 

•      a$0.2 million decrease in expenses resulting from cost reduction measures.

 

*SystemsIntegration.*Operating income increased by $0.5 million, or35.3% compared to the prior year, due to:

 

•      anet $1.5 million increase resulting from the conversion of a major customersupply contract to a requirements-only contract; and

 

•      a$1.4 million decrease in SG&A spending; offset by

 

•      a$1.9 million decrease resulting from reduced gross profit on lower revenues;and

 

•      a$0.4 million increase in research and development expenses.

 

**Interestexpense.**  Interestexpense increased $2.8 million, or 48.3%, to $8.7 million for the three monthsended March 31, 2004 compared to $5.9 million for the same period in theprior year.  The increase isattributable to:

 

•      $3.0million of additional interest expense attributable to $80.0 million ofsecond-lien term debt issued in December 2003; and

 

•      a$0.3 million increase in other interest expense; offset by

 

•      a$0.5 million decrease in our first-lien interest expense due to lower principalbalances outstanding resulting from the partial refinancing with second-liendebt in December, partially offset by a 1.5% increase in interest rate marginscharged by our lenders based on the consolidated debt leverage ratio.

 

**Mandatorily redeemable preferred stock dividends. **Mandatorily redeemablepreferred stock dividends increased $2.6 million to $4.2 million for the threemonths ended March 31, 2004 from $1.6 million for the same period in theprior year as follows:

 
|                                  |   | **Three  Months Ended  March 31,** |   |
|---------------------------------------|--------|-----------------------------------------|--------|
| **(In millions)**                     |   | **2004**                                |   | **2003** |   |
|                                  |   |                                    |   |   |   |
| DeCrane  Holdings 14% preferred stock |   | $                                       | 2.5    |   | $ | — |   |
| DeCrane  Aircraft 16% preferred stock |   | 1.7                                     |   | 1.6 |   |
| Net  income tax benefit               |   | $                                       | 4.2    |   | $ | 1.6 |   |

 

 

As more fully describedin “—Changes in Accounting Principles” above, effective January 1, 2004 weadopted SFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity.”

 

As a result of adoptingof SFAS No. 150, the 14% quarterly preferred stock dividends are reflected as acharge against pre-tax income.  Inperiods prior to January 1, 2004, the 14% preferred stock dividends werededucted in arriving at the net income or loss applicable to DeCrane Holdings’common stockholders and amounted to $2.2 million of the three months endedMarch 31, 2004; DeCrane Aircraft’s 16% preferred stock dividends totaled$1.6 million and were charged against pre-tax income as

 

27

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minority interest inpreferred stock of subsidiary.  Theincrease between periods is attributable to the quarterly compounding of thedividends accrued but not declared and paid.

 

**Provisionfor income tax benefit.** The provision for income taxes is comprised of the following:

 
|                                                 |   | **Three  Months Ended  March 31,** |   |
|------------------------------------------------------|--------|-----------------------------------------|--------|
| **(In millions)**                                    |   | **2004**                                |   | **2003** |   |
|                                                 |   |                                    |   |   |   |
| Income  tax (benefit) based on reported pre-tax loss |   | $                                       | (2.5   | ) | $ | (1.2 | ) |
| Net  deferred tax asset valuation allowance          |   | 2.5                                     |   | — |   |
| Net  income tax benefit                              |   | $                                       | — |   | $ | (1.2 | ) |

 

For the three monthsended March 31, 2003, the provision for income taxes, based on thereported consolidated pre-tax loss, differs from the amount determined byapplying the applicable U.S. statutory federal rate to the pre-tax lossprimarily due to the effects of state and foreign income taxes andnon-deductible expenses, principally the non-deductible portion of goodwillimpairment charges and DeCrane Aircraft’s 16% preferred stock dividends.

 

For the three monthsended March 31, 2004, the provision for income taxes, based on thereported consolidated pre-tax loss, differs from the amount determined byapplying the applicable U.S. statutory federal rate to the pre-tax lossprimarily due to the effects of state and foreign income taxes andnon-deductible expenses, principally mandatorily redeemable preferred stockdividends due to the adoption of SFAS No. 150 effective January 1, 2004described above..

 

As more fully describedin Note 11 to the audited financial statements included in our 2003 Form 10-K,we had a net deferred tax asset of $19.5 million fully offset by a valuationallowance of the same amount as of December 31,2003.

 

As required by SFAS No.109, we evaluated our deferred assets for expected recoverability based on thenature of the item, the associated taxing jurisdictions, the applicableexpiration dates and future taxable income forecasts that would impactutilization.  Since there is no losscarry back potential and there are no tax planning strategies to assure recoverability,the only possibility for recovery of the net deferred assets is future taxableincome.  Since there have been prioryear losses, we believe it is not prudent to rely on future income as the meansto support the carrying value of the net asset.  As a result of the evaluation, we recorded a $19.5 millionvaluation allowance, eliminating the net deferred asset, as ofDecember 31, 2003.  Based upon theresults of operations for the three months ended March 31, 2004, weCompany determined that an additional $2.5 million valuation allowance wasrequired as of that date.

 

**Loss from continuing operations.**  The loss from continuing operationsincreased $5.7 million to a loss of $11.6 million for the three months endedMarch 31, 2004 compared to a loss of $5.9 million for the same period inthe prior year, primarily due to:

 

•      a$2.7 million increase in interest and other expenses (net);

 

•      a$1.3 million decrease in income tax benefit; and

 

•      a$2.6 million increase in preferred stock dividends, principally resulting fromthe adoption of SFAS No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity” as described above; offsetby

 

•      a$0.8 million increase in operating income.

 

**Loss from discontinued operations. **Loss from discontinued operations was $6.4million for the three months ended March 31, 2003 and reflects the resultsof operations of our Specialty Avionics Group which was sold on May 22, 2003.

 

28

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**Cumulative effect of change in accounting principle.**  As more fully described in “—Changes inAccounting Principles” above, the $13.8 million charge during the three monthsended March 31, 2003 was to reflect the cumulative effect of the change inaccounting for product development costs.

 

**Net loss.**  Net loss decreased $14.5 million to a netloss of $11.6 million for the three months ended March 31, 2004 comparedto a net loss of $26.1 million for the same period in the prior year.  The decrease is attributable to:

 

•      anet decrease in cumulative effect of change in accounting principles of $13.8million; and

 

•      adecrease in the loss from discontinued operations of $6.4 million; offset by

 

•      anincrease in loss from continuing operations of $5.7 million.

 

**Net lossapplicable to common stockholders.**  Net loss applicable our common stockholders decreased $16.7million to a net loss of $11.6 million for the three months endedMarch 31, 2004 compared to a net loss of $28.3 million for the same periodin the prior year.  The decrease in thenet loss applicable to our common stockholder is attributable to:

 

•      a$14.5 million decrease in our net loss; and

 

•      a$2.2 million decrease in preferred stock dividends resulting from theJanuary 1, 2004 adoption of SFAS No. 150 which requires preferred stockdividends be deducted from the net income or loss for the period.

 

**Bookings. **Bookings increased $26.8million, or 64.8%, to $68.2 million for the three months ended March 31,2004 compared to $41.4 million for the same period in the prior year.  The increase in bookings for 2004 is due toincreases in orders for all of our business segments.

 

**Backlogat end of period.** Backlog increased $19.6 million to $77.6 million as of March 31,2004 compared to $58.0 million as of March 31, 2003.

 

**Liquidity andCapital Resources**

 

We are a holding companyand have no direct material operations. Our only asset is our ownership of all of the common stock of DeCraneAircraft, and our only material liability is our guarantee of the DeCrane Aircraftfirst-lien credit facility and second-lien term debt.  Our principal liquidity needs are for income taxes and, beginningin 2005, the payment cash dividends on our preferred stock, if declared.

 

Our only source of cashis dividends from DeCrane Aircraft.  Thefirst-lien credit facility, second-lien term debt and subordinated notesdescribed below are obligations of DeCrane Aircraft and impose limitations onits ability to pay dividends to us.  Webelieve that DeCrane Aircraft’s debt instruments will permit it to supply uswith sufficient cash to meet the cash needs referred to above for the nexttwelve months.  However, if that is notthe case, we would not be able to satisfy those needs, because we have no othersource of cash other than dividends from DeCrane Aircraft.  We would then be required to securealternate financing, which may not be available on acceptable terms, or at all.

 

DeCrane Aircraft’sprincipal cash needs are for debt service, working capital, capitalexpenditures and strategic acquisitions, as well as to provide us with cash tofinance our needs.  Its principalsources of liquidity are expected to be cash flow from operations, potentialcapital market transactions and third party borrowings, principally under itsfirst-lien credit facility.

 

29

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**CashFlows During the Three months ended March 31, 2004**

 

Net cash used byoperating activities was $12.3 million for the three months endedMarch 31, 2004 and consisted of $3.5 million of cash used by operationsafter adding back depreciation, amortization, preferred stock dividends,interest accretion and other noncash items and $8.7 million used for workingcapital and a $0.1 million decrease in other liabilities.  The following factors contributed to the$8.7 million working capital increase:

 

•      a$5.5 million increase in accounts receivables due to higher revenues;

 

•      a$4.6 million increase in inventory commensurate with higher revenues; and

 

•      a$0.2 million net increase in other working capital items; offset by

 

•      a$1.5 million increase in accounts payable and accrued expenses (net); and

 

•      a$0.1 million increase in income taxes payable due to lower levels of taxableincome.

 

Net cash used byinvesting activities consisted of capital expenditures of $0.5 million for thethree months ended March 31, 2004. We anticipate *spending*approximately $3.0 to $5.0 million for capital expenditures in 2004.

 

Net cash *provided* by financing activities was $8.6million for the three months ended March 31, 2004 and consisted of:

 

•      $8.9million of debt borrowings, primarily on the revolving line of credit; offsetby

 

•      $0.3million of other secured long-term debt repayments.

 

**Debt Obligations and CapitalResources as of March 31, 2004**

 

As of March 31,2004, first-lien credit facility borrowings and second-lien term debt totaling$99.5 million are at variable interest rates based on defined margins over thecurrent prime rate or LIBOR.  We alsohad $100.0 million of 12% subordinated notes, $70.6 million of 15% second-lienterm debt and other secured indebtedness totaling $8.5 million outstanding asof March 31, 2004.  In addition,our 14% and 16% mandatorily redeemable preferred stock, which hascharacteristics of both liabilities and equity, had an aggregate $118.9 millionmandatorily redemption value as of March 31, 2004.

 

As of March 31,2004, we had $42.2 million of working capital and $14.8 million of borrowingsavailable under our revolving line of credit, which expires in March 2006.

 

**Financial Condition and Liquidity**

 

We believe our expectedoperating cash flows, together with borrowings under our first-lien creditfacility ($14.8 million of which was available as of March 31, 2004, thecommitment for which expires in March 2006), will be sufficient to meetour operating expenses, working capital requirements, capital expenditures anddebt service obligations for the next twelve months.  However, our ability to comply with our debt financial covenants,pay principal or interest and satisfy our other debt obligations will depend onour future operating performance as well as competitive, legislative,regulatory, business and other factors beyond our control.  Although we cannot be certain, we expect tobe in compliance with the revised financial covenants through the end of theyear based on our current operating plan.

 

We continue to explorethe possible restructuring of our other debt and equity instruments that wouldimprove our liquidity and reduce our cash needs.  We have not entered into any definitive documentation to do so andcannot assure you that we will be able to do so in the future.

 

30

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**Disclosure ofContractual Obligations and Commitments**

** **

The following tablesummarizes our known contractual obligations to make future cash payments as ofMarch 31, 2004, as well an estimate of the periods during which thesepayments are expected to be made.

 
|                                         |   |      |   | **Years  Ending December 31,** |   |
|----------------------------------------------|--------|-----------|--------|-------------------------------------|--------|
| **(In millions)**                            |   | **Total** |   | **2004**                            |   | **2005  and  2006** |   | **2007  and  2008** |   | **2009  and  Beyond** |   |
|                                         |   |      |   |                                |   |   |   |   |   |   |   |
| Long-term debt (a):                          |   |      |   |                                |   |   |   |   |   |   |   |
| First-lien  credit facility (b):             |   |      |   |                                |   |   |   |   |   |   |   |
| Term  debt                                   |   | $         | 80.5   |                                | $      | — |   | $ | 15.0 |   | $ | 65.5 |   | $ | — |   |
| Revolving  line of credit                    |   | 8.9       |   | —                              |   | 8.9 |   | — |   | — |   |
| Second-lien  term debt (c)                   |   | 80.7      |   | —                              |   | — |   | 80.7 |   | — |   |
| 12%  subordinated notes (d)                  |   | 100.0     |   | —                              |   | — |   | 100.0 |   | — |   |
| Capital  lease obligations (e)               |   | 3.3       |   | 0.4                                 |   | 0.9 |   | 0.6 |   | 1.4 |   |
| Other  indebtedness (e)                      |   | 5.2       |   | 0.5                                 |   | 1.7 |   | 0.6 |   | 2.4 |   |
| Total  long-term debt                        |   | 278.6     |   | 0.9                                 |   | 26.5 |   | 247.4 |   | 3.8 |   |
|                                         |   |      |   |                                |   |   |   |   |   |   |   |
| Mandatorily  redeemable preferred stock:     |   |      |   |                                |   |   |   |   |   |   |   |
| DeCrane  Aircraft preferred stock (f)        |   | 45.0      |   | —                              |   | — |   | — |   | 45.0 |   |
| DeCrane  Holdings preferred stock (g)        |   | 73.9      |   | —                              |   | — |   | — |   | 73.9 |   |
| Other  long-term liabilities                 |   | 5.4       |   | —                              |   | 3.7 |   | 1.7 |   | — |   |
| Operating  lease obligations                 |   | 14.0      |   | 2.2                                 |   | 5.0 |   | 2.4 |   | 4.4 |   |
| Total  obligations as of March 31, 2004 |   | $         | 416.9  |                                | $      | 3.1 |   | $ | 35.2 |   | $ | 251.5 |   | $ | 127.1 |   |

 

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(a)       Excludes interest payments.

 

(b)       The first-lien creditfacility bears interest at variable rates and therefore the amount of futureinterest payments are uncertain.  Thedebt bears interest based on a margin over, at our option, the prime rate orLIBOR.  As of March 31, 2004, thecurrent prime rate was 4.00% and the current LIBOR was 1.08%.  The margins applicable to portions ofamounts borrowed vary depending on our consolidated debt leverage ratio.  Currently, the applicable margins are 4.00%to 4.75% for prime rate borrowings and 5.25% to 6.00% for LIBORborrowings.  The weighted-averageinterest rate on all first-lien debt was 6.98% as of March 31, 2004.

 

(c)       The second-lien term debtis comprised of $70.0 million of fixed rate debt and $10.0 million of variablerate debt.  The fixed rate debt bearsinterest at 15%; 12% payable quarterly in cash and 3% pay-in-kind or “accreted”interest, payable at maturity.  Thevariable rate debt bears cash interest, at our option, at the prime rate plus7.5% or LIBOR plus 8.5%, plus 3% pay-in-kind interest payable at maturity.  The weighted-average interest rate on allsecond-lien debt was 14.33% as of March 31, 2004.  All of the second-lien debt matures onJune 30, 2008, at which time the cash payment obligation will be $91.7million, including the 3% pay-in-kind interest obligation.

 

(d)       Interest on the 12%subordinated notes is payable semiannually.

 

(e)       Interest is generallypayable monthly.

 

(f)        Dividends accrue quarterlyat a 16% annual rate.  Prior toJune 30, 2005, we may, at our option, pay dividends either in cash or bythe issuance of additional shares of preferred stock.  Since the issuance of the preferred stock in June 2000, wehave elected to issue additional shares in lieu of cash dividend payments andmay continue to do so until June 2005, after which time we are required topay quarterly dividends in cash, if declared. Our debt instruments restrict our ability to make payments on ourpreferred stock.  If we elect tocontinue issuing additional shares until June 2005, our mandatoryredemption obligation on March 31, 2009, the mandatory

 

31

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redemption date, will be$54.8 million and our annual cash dividend payment obligation will be $8.8million, payable quarterly, commencing September 2005, if declared.

 

(g)       Dividends accrue quarterlyat a 14% annual rate.  Prior toSeptember 30, 2005, dividends are not paid in cash but instead accrete tothe liquidation value of the preferred stock. Our debt instruments restrict our ability to make payments on ourpreferred stock.  Our annual cash dividendpayment obligation will be $12.7 million, payable quarterly, commencingDecember 31, 2005, if declared, and our mandatory redemption obligation onSeptember 30, 2009, the mandatory redemption date, will be $90.8 million.

 

**Disclosure AboutOff-Balance Sheet Commitments and Indemnities**

** **

During our normal courseof business, we have entered into agreements containing indemnities pursuant towhich we may be required to make payments in the future.  These indemnities are in connection withfacility leases and liabilities for specified claims arising from investmentbanking services our financial advisors provide to us.  The duration of these indemnities,commitments and guarantees varies, and in certain cases, is indefinite.  Substantially all of these indemnitiesprovide no limitation on the maximum potential future payments we could beobligated to make and is not quantifiable. We have not recorded any liability for these indemnities since no claimshave been asserted to date.

 

In connection with thesale of the Specialty Avionics Group, we made indemnities to the buyer withrespect to a number of customary, and certain other specific, representationsand warranties.  Our indemnities withrespect to some of these matters are limited in terms of duration with themaximum of potential future payments capped at $14.0 million and our indemnitieswith respect to specified environmental matters will expire not later thanOctober 2010 and provides for a maximum liability of $5.0 million, whileothers will have no limitations.

 

As of March 31,2004, we also had irrevocable standby letters of credit in the amount of $0.3million issued and outstanding under our first-lien credit facility.

 

**Recent AccountingPronouncements**

** **

**Accounting Pronouncements AdoptedJanuary 1, 2004**

 

As more fully describedin Note 1 accompanying our financial statements included in this report and“—Changes in Accounting Principles” above, effective January 1, 2004 weadopted the provisions of SFAS No. 150, “Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity.”

 

**Special Note RegardingForward-Looking Statements and Risk Factors**

 

All statements other thanstatements of historical facts included in this report, including statementsabout our future performance and liquidity and future industry performance, areconsidered forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995. These statements are subject to known and unknown risks, uncertaintiesand other factors, which are difficult to predict.  We are vulnerable to a variety of factors that affect manybusinesses, such as:

 

•      fuelprices and general economic conditions that affect demand for aircraft and airtravel, which in turn affect demand for our products and services;

 

•      acts,and ongoing threats, of global terrorism, military conflicts and healthepidemics that affect demand for aircraft and air travel, which in turn affectdemand for our products and services;

 

•      ourreliance on key customers and the adverse effect a significant decline inbusiness from any one of them would have on our business;

 

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•      changesin prevailing interest rates and the availability of financing to fund ourplans for continued growth;

 

•      competitionfrom larger companies;

 

•      FederalAviation Administration prescribed standards and licensing requirements, whichapply to many of the products and services we provide;

 

•      inflation,and other general changes in costs of goods and services;

 

•      priceand availability of raw materials, component parts and electrical energy;

 

•      liabilityand other claims asserted against us that exceeds our insurance coverage;

 

•      theability to attract and retain qualified personnel;

 

•      labordisturbances; and

 

•      changesin operating strategy, or our acquisition and capital expenditure plans.

 

Some of the moresignificant factors listed above are further described in our 2003 AnnualReport on Form 10-K and should be read in conjunction with this report.  Changes in such factors could cause ouractual results to differ materially from those contemplated in suchforward-looking statements.  Although webelieve that the expectations reflected in such forward-looking statements arereasonable, we can give no assurance that such expectations will prove to becorrect.  We undertake no obligation torelease publicly any revisions to these forward-looking statements to reflectevents or circumstances after the date hereof or to reflect the occurrence ofunanticipated events.  You should notrely on our forward-looking statements as if they were certainties.

 

**ITEM 3.**          QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

** **

We are exposed to variousmarket risks, including interest rates and changes in foreign currency exchangerates.  Market risk is the potentialloss arising from adverse changes in prevailing market rates and prices.  From time to time, we use derivativefinancial instruments to manage and reduce risks associated with thesefactors.  We do not enter intoderivatives or other financial instruments for trading or speculative purposes.

 

**Interest Rate Risk.**  A significant portion of our capitalstructure is comprised of long-term variable and fixed-rate debt.

 

Market risk related toour variable-rate debt is estimated as the potential decrease in pre-taxearnings resulting from an increase in interest rates.  The interest rates applicable tovariable-rate debt are, at our option, based on defined margins over thecurrent prime rate or LIBOR.  As ofMarch 31, 2004, the current prime rate was 4.00% and the current LIBOR was1.08%.  Based on $99.5 million ofvariable-rate debt outstanding as of March 31, 2004, a hypothetical onepercent rise in interest rates, to 5.00% for prime rate borrowings and 2.08%for LIBOR borrowings, would reduce our pre-tax earnings by $1.0 million annually.

 

To limit a portion of ourexposure related to rising interest rates, we have entered into an interestrate swap contract to effectively convert our variable-rate industrial revenuebonds to 4.2% fixed-rate debt until maturity in 2008.  The contract is considered to be a hedge against changes in theamount of future cash flows associated with interest payments on this portionof our variable-rate debt.  Market riskrelated to this interest rate swap contract is estimated as the potentialhigher interest expense we will incur if the variable interest rate decreasesbelow the 4.2% fixed rate.  Based on the$3.1 million of variable-rate debt converted to fixed-rate debt outstanding asof March 31 2004, a hypothetical one percent decrease in the variable interestrate to 3.2%, would reduce our pre-tax earnings by less than $0.1 millionannually.

 

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The estimated fair valueof our $100.0 million fixed-rate long-term debt increased $20.0 million, or44.4%, to approximately $65.0 million as of March 31, 2004 from $45.0million as of December 31, 2003. Market risk related to our fixed-rate debt is deemed to be the potentialincrease in fair value resulting from a decrease in interest rates.  For example, a hypothetical ten percentdecrease in the interest rates, from 12.0% to 10.8%, would increase the fairvalue of our fixed-rate debt by approximately $5.0 million.

 

**Foreign Currency Exchange Rate Risk.**  Our foreign customers are located in variousparts of the world, primarily Canada, the Far and Middle East and WesternEurope, and we have a subsidiary with manufacturing facilities in Mexico.  To limit our foreign currency exchange raterisk related to sales to our customers, orders are almost always valued and soldin U.S. dollars.  We have entered intoforward foreign exchange contracts in the past, primarily to limit exposurerelated to foreign inventory procurement and operating costs.  While we have not entered into any suchcontracts since 1998, we may do so in the future depending on the volume ofnon-U.S. dollar denominated transactions and our assessment of future foreignexchange rate trends.

 

**ITEM 4.**          CONTROLSAND PROCEDURES

** **

The management of DeCraneHoldings Co. (the “Company”), under the supervision and with the participationof the Company’s Chief Executive Officer and Chief Financial Officer, conductedan evaluation of the Company’s “disclosure controls and procedures” (as definedin Exchange Act Rules 13a-15(e) or 15d-15(e)) as of the end of the periodcovered by this report.  Based on thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures were effective as of theend of the period covered by this report.

 

There was no change inthe Company’s internal control over financial reporting identified inconnection with the evaluation required by paragraph (d) of Exchange Act Rules13a-15 or 15d-15 that occurred during the Company’s last fiscal quarter thathas materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

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**PART II– OTHER INFORMATION**

 

**ITEM 1.****          LEGAL PROCEEDINGS**

 

See Note 9 to theconsolidated financial statements included in this report.

 

**ITEM6.****          EXHIBITS AND REPORTS ONFORM 8-K**

 

a.         Exhibits

 

18                Letter regardingchange in accounting principle effective January 1, 2003 (1)

 

31.1             Chief ExecutiveOfficer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of2002 *

 

31.2             Chief FinancialOfficer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of2002 *

 

32                Chief ExecutiveOfficer and Chief Financial Officer Certifications Pursuant to Pursuant toSection 906 of the Sarbanes-Oxley Act of 2002 *

 

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*                  Filed herewith

 

(1)               Filed as an exhibitto our Form 10-K dated December 31, 2003 filed with the Commission onMarch 29, 2004

 

b.         Reports on Form 8-K

 

None.

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 
|         | **DECRANE  HOLDINGS CO. (Registrant)** |
|--------------|----------------------------------------|
|         |                                   |   |
|         |                                   |   |
|         |                                   |   |
| May 14, 2004 | By:                                    | /s/  RICHARD J. KAPLAN |   |
|         | Name:                                  | Richard J.  Kaplan |
|         | Title:                                 | Chief Financial  Officer and  Assistant Secretary |

 

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