**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

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

 

For the quarterly periodended **June 30, 2003**

 

**CommissionFile Number 333-70363**

 

**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 check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.

 

ýYes   oNo

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

 

o Yes  ý No

 

The number of shares of Registrant’s Common Stock,$.01 par value, outstanding as of August 1, 2003 was 4,116,627shares.

 

 

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**Table of Contents**

 
| **Part I – Financial  Information** |
|------------------------------------------|
|                                     |   |
| **Item 1.**                              | **Financial Statements  (Unaudited)** |
|                                     | Consolidated Balance Sheets  as of June 30, 2003 and December 31, 2002 |
|                                     | Consolidated  Statements of Operations for the three months and six months ended June 30,  2003 and 2002 |
|                                     | Consolidated  Statements of Stockholders’ Equity (Deficit) for the six months ended June  30, 2003 |
|                                     | Consolidated  Statements of Cash Flows for the six months ended June 30, 2003 and 2002 |
|                                     | Condensed  Notes to Consolidated Financial Statements |
| **Item 2.**                              | **Management’s Discussion and  Analysis of Financial Condition and Results of Operations** |
|                                     | Recent Developments |
|                                     | Industry Overview and  Trends |
|                                     | Results of Operations |
|                                     |   | Performance Measures |
|                                     |   | Three months ended June 30,  2003 |
|                                     |   | Six months ended June 30, 2003 |
|                                     | Restructuring, Asset Impairment and Other  Related Charges |
|                                     | Goodwill Impairment Charges |
|                                     | Liquidity and Capital  Resources |
|                                     | Disclosure  of Contractual Obligations and Commitments |
|                                     | Disclosure  of 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 SUBSIDIARYConsolidated Balance Sheets**

 
| **(In thousands,  except share data)**                                                                                                             |   | **June 30,  2003** |    | **December 31,  2002** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                                                                                                                                               |   | **(Unaudited)**         |    |                        |   |
| **Assets**                                                                                                                                         |   |                    |    |                        |   |
| Current assets:                                                                                                                                    |   |                    |    |                        |   |
| Cash and cash equivalents                                                                                                                          |   | $                       | 3,673   |                        | $      | 12,421 |   |
| Accounts receivable, net                                                                                                                           |   | 20,726                  |    | 26,354                      |   |
| Inventories                                                                                                                                        |   | 63,125                  |    | 59,300                      |   |
| Deferred income taxes                                                                                                                              |   | 172                     |    | 16,430                      |   |
| Prepaid expenses and other current assets                                                                                                          |   | 1,609                   |    | 1,724                       |   |
| Current assets of discontinued operations                                                                                                          |   | —                  |    | 160,741                     |   |
| Total current assets                                                                                                                               |   | 89,305                  |    | 276,970                     |   |
|                                                                                                                                               |   |                    |    |                        |   |
| Property and equipment, net                                                                                                                        |   | 34,801                  |    | 36,139                      |   |
| Goodwill                                                                                                                                           |   | 162,430                 |    | 196,430                     |   |
| Other assets, principally intangibles, net                                                                                                         |   | 36,110                  |    | 39,428                      |   |
| Total assets                                                                                                                                       |   | $                       | 322,646 |                        | $      | 548,967 |   |
|                                                                                                                                               |   |                    |    |                        |   |
| **Liabilities, Mandatorily Redeemable Preferred Stock and Stockholders’  Equity (Deficit)**                                                   |   |                    |    |                        |   |
| Current liabilities:                                                                                                                               |   |                    |    |                        |   |
| Current portion of long-term debt                                                                                                                  |   | $                       | 8,485   |                        | $      | 16,317 |   |
| Accounts payable                                                                                                                                   |   | 9,847                   |    | 13,055                      |   |
| Accrued liabilities                                                                                                                                |   | 20,645                  |    | 31,494                      |   |
| Income taxes payable                                                                                                                               |   | 149                     |    | —                      |   |
| Current liabilities of discontinued  operations                                                                                                    |   | —                  |    | 19,928                      |   |
| Total current liabilities                                                                                                                          |   | 39,126                  |    | 80,794                      |   |
|                                                                                                                                               |   |                    |    |                        |   |
| Long-term debt, less current portion                                                                                                               |   | 251,372                 |    | 364,700                     |   |
| Deferred income taxes                                                                                                                              |   | 387                     |    | 27,077                      |   |
| Other long-term liabilities                                                                                                                        |   | 11,485                  |    | 7,364                       |   |
|                                                                                                                                               |   |                    |    |                        |   |
| Commitments and contingencies (Note 11)                                                                                                            |   |                    |    |                        |   |
|                                                                                                                                               |   |                    |    |                        |   |
| Mandatorily redeemable preferred stock:                                                                                                            |   |                    |    |                        |   |
| Minority interest in 16% preferred stock of  subsidiary                                                                                            |   | 37,335                  |    | 34,081                      |   |
| Mandatorily redeemable 14% preferred stock                                                                                                         |   | 66,654                  |    | 62,222                      |   |
|                                                                                                                                               |   |                    |    |                        |   |
| Stockholders’ equity (deficit):                                                                                                               |   |                    |    |                        |   |
| Undesignated preferred stock, $.01 par value,  1,140,000 shares authorized; None issued and outstanding as of June 30, 2003  and December 31, 2002 |   | —                  |    | —                      |   |
| Common stock, $.01 par value, 10,000,000  shares authorized; 4,116,627 shares issued and outstanding as of June 30,  2003 and December 31, 2002    |   | 41                      |    | 41                          |   |
| Additional paid-in capital                                                                                                                         |   | 67,693                  |    | 72,125                      |   |
| Notes receivable for shares sold                                                                                                                   |   | (2,665                  | )       | (2,591                      | )      |
| Accumulated deficit                                                                                                                                |   | (148,418                | )       | (96,485                     | )      |
| Accumulated other comprehensive loss                                                                                                               |   | (364                    | )       | (361                        | )      |
| Total stockholder’s equity (deficit)                                                                                                          |   | (83,713                 | )       | (27,271                     | )      |
| Total liabilities, mandatorily redeemable  preferred stock and stockholder’s equity (deficit)                                                 |   | $                       | 322,646 |                        | $      | 548,967 |   |

 

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

 

1

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**DECRANE HOLDINGS CO. AND SUBSIDIARYConsolidated Statements ofOperations**

 
|                                                               |   | **Three  Months Ended****June 30,** |    | **Six Months  Ended****June 30,** |   |
|--------------------------------------------------------------------|--------|-------------------------------------|---------|----------------------------------------|--------|
| **(In  thousands)**                                                |   | **2003**                            |    | **2002**                               |   | **2003** |   | **2002** |   |
|                                                               |   | **(Unaudited)**                     |    |
| Revenues                                                           |   | $                                   | 44,113  |                                   | $      | 61,293 |   | $ | 86,013 |   | $ | 122,112 |   |
| Cost of sales                                                      |   | 45,383                              |    | 47,831                                 |   | 76,286 |   | 92,212 |   |
|                                                               |   |                                |    |                                   |   |   |   |   |   |
| Gross profit (loss)                                                |   | (1,270                              | )       | 13,462                                 |   | 9,727 |   | 29,900 |   |
|                                                               |   |                                |    |                                   |   |   |   |   |   |
| Operating expenses:                                                |   |                                |    |                                   |   |   |   |   |   |
| Selling, general and administrative  expenses                      |   | 6,282                               |    | 11,336                                 |   | 13,480 |   | 22,732 |   |
| Impairment of goodwill                                             |   | 34,000                              |    | —                                 |   | 34,000 |   | — |   |
| Amortization of intangible assets                                  |   | 914                                 |    | 874                                    |   | 1,826 |   | 1,717 |   |
| Total operating expenses                                           |   | 41,196                              |    | 12,210                                 |   | 49,306 |   | 24,449 |   |
|                                                               |   |                                |    |                                   |   |   |   |   |   |
| Income (loss) from operations                                      |   | (42,466                             | )       | 1,252                                  |   | (39,579 | ) | 5,451 |   |
|                                                               |   |                                |    |                                   |   |   |   |   |   |
| Other expenses:                                                    |   |                                |    |                                   |   |   |   |   |   |
| Interest expense                                                   |   | 7,614                               |    | 7,997                                  |   | 15,289 |   | 15,756 |   |
| Minority interest in preferred stock of  subsidiary                |   | 1,657                               |    | 1,433                                  |   | 3,254 |   | 2,815 |   |
| Other expenses, net                                                |   | 407                                 |    | 86                                     |   | 746 |   | 199 |   |
|                                                               |   |                                |    |                                   |   |   |   |   |   |
| Loss from continuing operations before  provision for income taxes |   | (52,144                             | )       | (8,264                                 | )      | (58,868 | ) | (13,319 | ) |
| Income tax benefit                                                 |   | 9,702                               |    | 2,487                                  |   | 11,399 |   | 4,040 |   |
|                                                               |   |                                |    |                                   |   |   |   |   |   |
| Loss from continuing operations                                    |   | (42,442                             | )       | (5,777                                 | )      | (47,469 | ) | (9,279 | ) |
|                                                               |   |                                |    |                                   |   |   |   |   |   |
| Discontinued operations and change in  accounting principle:       |   |                                |    |                                   |   |   |   |   |   |
| Income (loss) from discontinued operations,  net of tax            |   | 1,266                               |    | 2,412                                  |   | (4,464 | ) | (34,392 | ) |
| Cumulative effect of change in accounting  principle               |   | —                              |    | —                                 |   | — |   | (17,828 | ) |
|                                                               |   |                                |    |                                   |   |   |   |   |   |
| Net loss                                                           |   | (41,176                             | )       | (3,365                                 | )      | (51,933 | ) | (61,499 | ) |
|                                                               |   |                                |    |                                   |   |   |   |   |   |
| Noncash preferred stock dividend accretion                         |   | (2,254                              | )       | (1,964                                 | )      | (4,432 | ) | (3,862 | ) |
|                                                               |   |                                |    |                                   |   |   |   |   |   |
| Net loss applicable to common stockholders                         |   | $                                   | (43,430 | )                                      | $      | (5,329 | ) | $ | (56,365 | ) | $ | (65,361 | ) |

 

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

 

2

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**DECRANE HOLDINGS CO. AND SUBSIDIARYConsolidated Statement ofStockholders’ Equity (Deficit)**

 
| **(In thousands, except share  data)**          |   | **Common Stock** |       | **Additional  Paid-in  Capital** |       | **Notes  Receivable  For Shares  Sold** |       | **Accumulated  Deficit** |       | **Accumulated  Other  Comprehensive  Loss** |       | **Total** |       |
|-------------------------------------------------|--------|------------------|------------|----------------------------------|------------|-----------------------------------------|------------|--------------------------|------------|---------------------------------------------|------------|-----------|------------|
| **Shares**                                      |   | **Amount**       |       |                             |
|                                            |   |             | ** ** |                             | ** ** |                                    | ** ** |                     | ** ** |                                        | ** ** |      | ** ** |   | ** ** |
| Balance,  December 31, 2002                |   | 4,116,627        |       | $                                | 41         |                                    | $          | 72,125                   |       | $                                           | (2,591     | )         | $          | (96,485 | ) | $ | (361 | ) | $ | (27,271 | ) |
|                                            |   |             |       |                             |       |                                    |       |                     |       |                                        |       |      |       |   |   |
| Comprehensive  income (loss):                   |   |             |       |                             |       |                                    |       |                     |       |                                        |       |      |       |   |   |
| Net loss                                        |   | —           |       | —                           |       | —                                  |       | —                   |       | (51,933                                     | )          | —    |       | (51,933 | ) |
| Unrealized loss  on interest rate swap contract |   | —           |       | —                           |       | —                                  |       | —                   |       | —                                      |       | (3        | )          | (3 | ) |
|                                            |   |             |       |                             |       |                                    |       |                     |       |                                        |       |      |       | (51,936 | ) |
|                                            |   |             |       |                             |       |                                    |       |                     |       |                                        |       |      |       |   |   |
| Noncash dividend  accretion on preferred stock  |   | —           |       | —                           |       | (4,432                                  | )          | —                   |       | —                                      |       | —    |       | (4,432 | ) |
|                                            |   |             |       |                             |       |                                    |       |                     |       |                                        |       |      |       |   |   |
| Notes receivable  interest accrued              |   | —           |       | —                           |       | —                                  |       | (74                      | )          | —                                      |       | —    |       | (74 | ) |
|                                            |   |             |       |                             |       |                                    |       |                     |       |                                        |       |      |       |   |   |
| Balance, June  30, 2003 (Unaudited)             |   | 4,116,627        |       | $                                | 41         |                                    | $          | 67,693                   |       | $                                           | (2,665     | )         | $          | (148,418 | ) | $ | (364 | ) | $ | (83,713 | ) |

 

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**

 
|                                                                               |   | **Six Months Ended  June 30,** |    |
|------------------------------------------------------------------------------------|--------|-------------------------------------|---------|
| **(In thousands)**                                                                 |   | **2003**                            |    | **2002** |   |
|                                                                               |   | **(Unaudited)**                     |    |
| **Cash flows from operating activities:**                                          |   |                                |    |   |   |
| Net loss                                                                           |   | $                                   | (51,933 | ) | $ | (61,499 | ) |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |                                |    |   |   |
| Loss from discontinued operations                                                  |   | 4,464                               |    | 34,392 |   |
| Minority interest in preferred stock of  subsidiary                                |   | 3,254                               |    | 2,815 |   |
| Cumulative effect of change in accounting  principle                               |   | —                              |    | 17,828 |   |
| Depreciation and amortization                                                      |   | 6,342                               |    | 6,743 |   |
| Noncash portion of restructuring, asset  impairment and other related charges      |   | 43,926                              |    | 5,910 |   |
| Deferred income taxes                                                              |   | (11,659                             | )       | (1,008 | ) |
| Other, net                                                                         |   | 295                                 |    | 212 |   |
| Changes in assets and liabilities:                                                 |   |                                |    |   |   |
| Accounts receivable                                                                |   | 4,207                               |    | 7,725 |   |
| Inventories                                                                        |   | (12,705                             | )       | (1,786 | ) |
| Prepaid expenses and other assets                                                  |   | 541                                 |    | (1,540 | ) |
| Accounts payable                                                                   |   | (2,251                              | )       | (1,090 | ) |
| Accrued liabilities                                                                |   | (10,755                             | )       | (14,340 | ) |
| Income taxes payable                                                               |   | 385                                 |    | 30 |   |
| Other long-term liabilities                                                        |   | 4,761                               |    | 448 |   |
| Net cash used for operating activities                                             |   | (21,128                             | )       | (5,160 | ) |
|                                                                               |   |                                |    |   |   |
| **Cash flows from investing activities:**                                          |   |                                |    |   |   |
| Net cash proceeds from sale of Specialty  Avionics Group                           |   | 132,800                             |    | — |   |
| Capital expenditures                                                               |   | (2,002                              | )       | (2,024 | ) |
| Cash paid for acquisition contingent  consideration                                |   | (600                                | )       | (5,890 | ) |
| Net cash provided by (used for) investing  activities                              |   | 130,198                             |    | (7,914 | ) |
|                                                                               |   |                                |    |   |   |
| **Cash flows from financing activities:**                                          |   |                                |    |   |   |
| Principal payments on term debt,  capitalized leases and other debt                |   | (130,448                            | )       | (4,486 | ) |
| Net borrowings under senior revolving  credit facility                             |   | 9,250                               |    | 8,000 |   |
| Deferred financing costs                                                           |   | —                              |    | (1,663 | ) |
| Other, net                                                                         |   | —                              |    | 277 |   |
| Net cash provided by (used for) financing  activities                              |   | (121,198                            | )       | 2,128 |   |
|                                                                               |   |                                |    |   |   |
| Net cash provided by discontinued  operations                                      |   | 3,380                               |    | 10,057 |   |
|                                                                               |   |                                |    |   |   |
| Net decrease in cash and cash equivalents                                          |   | (8,748                              | )       | (889 | ) |
| Cash and cash equivalents at beginning of  period                                  |   | 12,421                              |    | 9,478 |   |
| Cash and cash equivalents at end of period                                         |   | $                                   | 3,673   |   | $ | 8,589 |   |

 

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 ofPresentation**

 

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, 2002 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 inconjunction with Management’s Discussion and Analysis of Financial Conditionand Results of Operations and the audited financial statements and relatednotes included in the Company’s 2002 Form 10-K.

 

Reclassifications havebeen made to prior periods’ financial statements to conform to the 2003presentation, principally to reflect the disposition of the Specialty AvionicsGroup as a discontinued operation (Note 2).

 

As the Company describedin its Form 10-K for the year ended December 31, 2002 and Form 10-Q for thethree months ended March 31, 2003, its failure to consummate the sale of theSpecialty Avionics Group by June 30, 2003 would have been an event of defaultunder the amended senior credit facility. As a result, the Company’s independent accountants qualified theirreport on its audited financial statements, as well as their report on DeCraneAircraft Holdings, Inc. (the Company’s wholly-owned subsidiary), for the yearended December 31, 2002 with respect to their ability to continue as a goingconcern.  Consummation of the sale andrepayment of $130.0 million of borrowings alleviated the independentaccountants doubt about DeCrane Aircraft’s ability to continue as a goingconcern.  As a result, the Company’sindependent accountants issued a revised, unqualified report on DeCraneAircraft’s financial statements was included in a registration statement onForm S-1 regarding DeCrane Aircraft’s 12% Series B Senior Subordinated Notesdue 2008 (Registration No. 333-106381, filed with Securities and ExchangeCommission on June 23, 2003 and amended on August 12, 2003).  In the near future, DeCrane Holdings expectsto file a similar registration statement of Form S-1 regarding its Warrants toPurchase Common Stock (Par Value $0.01 per Share).  Absent any adverse changes in circumstances, DeCrane Holdingsexpects its revised 2002 financial statements will contain an unqualifiedreport as well.

 

**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.

 

5

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|                                                                                                                                           |   | **Three Months Ended  June 30,** |    | **Six Months Ended  June 30,** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|---------|-------------------------------------|--------|
| **(In  thousands)**                                                                                                                            |   | **2003**                         |    | **2002**                            |   | **2003** |   | **2002** |   |
|                                                                                                                                           |   | **(Unaudited)**                  |    |
| Net loss, as reported                                                                                                                          |   | $                                | (41,176 | )                                   | $      | (3,365 | ) | $ | (51,933 | ) | $ | (61,499 | ) |
| Less total stock-based employee  compensation expense determined under the fair value based method for all awards,  net of related tax effects |   | (94                              | )       | (94                                 | )      | (188 | ) | (188 | ) |
| Pro forma net loss                                                                                                                             |   | $                                | (41,270 | )                                   | $      | (3,459 | ) | $ | (52,121 | ) | $ | (61,687 | ) |

 

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.

 

**AccountingPronouncements Adopted January 1, 2003**

 

Effective January 1, 2003the Company adopted the following accounting pronouncements.

 

*SFAS No. 145 –Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS No. 13, and TechnicalCorrections*

 

Among other things, SFASNo. 145 rescinds various pronouncements regarding early extinguishment of debtand allows extraordinary accounting treatment for early extinguishment onlywhen the provisions of Accounting Principles Board Opinion No. 30, “Reportingthe Results of Operations—Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions” are met.  Adoption of thisnew standard did not have an impact on the Company’s consolidated financialposition, or results of operations or cash flow.

 

*SFAS No. 146 –Accounting for Costs Associated with Exit or Disposal Activities*

 

SFAS No. 146 supersedesprevious accounting guidance, principally Emerging Issues Task Force Issue No.94-3, “Liability Recognition for Certain Employee Termination Benefits andOther Costs to Exit an Activity (including Certain Costs Incurred in aRestructuring).”  SFAS No. 146 requiresthat the liability for costs associated with an exit or disposal activity beinitially measured at fair value and recognized when the liability isincurred.  In periods subsequent toinitial measurement, changes to the liability are measured using the credit-adjustedrisk-free rate that was used in the initial measurement of the liabilityrecorded.  The cumulative effect of achange resulting from revisions to either the timing or the amount of estimatedcash flows is recognized as an adjustment to the liability in the period of thechange and charged to the same line items in the statement of operations usedwhen the related costs were initially recognized.  Under EITF No. 94-3, a liability for an exit cost was recognizedat the date of a company’s commitment to an exit plan.

 

The Company believes SFASNo. 146 affects the timing of recognizing restructuring costs, as well as theamounts recognized, depending on the nature of the exit, disposal orrestructuring activity and the timing of the related estimated cash flows.  As required by the provisions of SFAS No.146, the Company applied its provisions to the restructuring activitiesinitiated in June 2003 (Note 3).

 

6

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*FASB Interpretation No. 45 – Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others*

 

FIN No. 45 elaborates onthe disclosures to be made by a guarantor in its interim and annual financialstatements about its obligations under certain guarantees that it hasissued.  The interpretation alsoclarifies that a guarantor is required to recognize, at the inception of aguarantee, a liability for the fair value of the obligation undertaken inissuing the guarantee.  The initialrecognition and initial measurement provisions of FIN No. 45 are applicable tothe Company on a prospective basis to guarantees issued or modified afterDecember 31, 2002.  However, thedisclosure requirements in FIN No. 45 are effective for the Company’s financialstatements for periods ending after December 15, 2002.  The Company is not a party to any agreementin which it is a guarantor of indebtedness of others therefore the adoption ofinterpretation did not have an impact on the Company’s financial position, resultsof operations or cash flows.  The disclosurerequirements of this interpretation were adopted by the Company as of December31, 2002.

 

**Recently IssuedAccounting Pronouncement**

 

*SFAS No. 150 –Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity*

 

Issued in May 2003, 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.  The Company will berequired to reclassify all mandatorily redeemable preferred stock as aliability commencing July 1, 2003 and reflect quarterly dividend accretion onits 14% preferred stock as a charge against pre-tax income in future periods.

 

**Note 2.**          Disposition of SpecialtyAvionics Group

 

During the fourth quarterof fiscal 2002 the Company assessed its long-term business strategies in lightof current aerospace industry conditions. The Company believes that as the aerospace industry recovers, the demandfor its Cabin Management and Systems Integration Groups’ products and servicesfor business, VIP and head-of-state aircraft will return to historical levelsand, accordingly, the Company decided to focus its resources in these marketsegments.  To accomplish this objective,the Company embarked on a plan to sell its Specialty Avionics Group, which ishighly dependent on the commercial airline industry.

 

On March 14, 2003, theCompany entered into a definitive agreement to sell its equity interests in thesubsidiaries comprising its Specialty Avionics Group to Wings Holdings, Inc.,an affiliate of Odyssey Investment Partners, LLC, for $140,000,000 incash.  The sale was consummated on May23, 2003.  The selling price is subjectto a post-closing adjustment related to the amount of working capital at closing.  Proceeds of $130,000,000 from the sale wereused to repay senior credit facility borrowings (Note 8).  The sale of the Specialty Avionics Group isnot expected to affect the operations of the remaining operating groups.

 

7

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Based upon the fair valueof the group implied in the definitive agreement, the Company determined thatthe carrying value of the group’s net assets was not fully recoverable.  As a result, the Company recorded a goodwillimpairment charge of $7,500,000 during the three months endedMarch 31, 2003 to reduce the carrying value to the estimated netrealizable value established by the definitive agreement.  The Company recorded a modest gain on thesale during the second quarter of fiscal 2003, based on the financial positionof the group on the date of sale.  Theultimate gain or loss on the sale is subject to finalizing the post-closingadjustment, which is not expected to be material, if any.

 

As a result of the sale,the Specialty Avionics Group is presented as a discontinued operation in theaccompanying consolidated financial statements.  The financial statements for prior periods have been reclassifiedto segregate the group’s assets and liabilities, results of operations and cashflows for all periods.  The followingtables summarize the financial position, results operations and cash flows ofthe Specialty Avionics Group.

 
| **(In  thousands)**                         |   | **December 31,  2002** |    |
|---------------------------------------------|--------|-----------------------------|---------|
|                                        |   |                        |    |
| Assets:                                     |   |                        |    |
| Current  assets                             |   | $                           | 41,614  |   |
| Property  and equipment, net                |   | 15,744                      |    |
| Other  assets, principally intangibles, net |   | 103,383                     |    |
| Total  assets                               |   | 160,741                     |    |
|                                        |   |                        |    |
| Liabilities:                                |   |                        |    |
| Current  liabilities                        |   | 8,288                       |    |
| Long-term  liabilities                      |   | 11,640                      |    |
| Total  liabilities                          |   | 19,928                      |    |
|                                        |   |                        |    |
| Net  assets of the Specialty Avionics Group |   | $                           | 140,813 |   |

 
|                                                 |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|------------------------------------------------------|--------|----------------------------------|--------|-------------------------------------|--------|
| **(In  thousands)**                                  |   | **2003(a)**                      |   | **2002**                            |   | **2003(a)** |   | **2002** |   |
|                                                 |   | **(Unaudited)**                  |   |
| Results of Operations:                               |   |                             |   |                                |   |   |   |   |   |
| Revenues                                             |   | $                                | 13,125 |                                | $      | 25,038 |   | $ | 36,595 |   | $ | 50,383 |   |
|                                                 |   |                             |   |                                |   |   |   |   |   |
| Operating expenses:                                  |   |                             |   |                                |   |   |   |   |   |
| Costs and expenses                                   |   | 11,867                           |   | 21,028                              |   | 32,426 |   | 41,991 |   |
| Impairment of goodwill                               |   | —                           |   | —                              |   | 7,500 |   | — |   |
| Total operating expenses                             |   | 11,867                           |   | 21,028                              |   | 39,926 |   | 41,991 |   |
|                                                 |   |                             |   |                                |   |   |   |   |   |
| Pre-tax income (loss)                                |   | 1,258                            |   | 4,010                               |   | (3,331 | ) | 8,392 |   |
| Provision for income taxes                           |   | 681                              |   | 1,598                               |   | 1,822 |   | 3,462 |   |
|                                                 |   |                             |   |                                |   |   |   |   |   |
| Income (loss) before change in accounting  principle |   | 577                              |   | 2,412                               |   | (5,153 | ) | 4,930 |   |
| Cumulative effect of change in accounting  principle |   | —                           |   | —                              |   | — |   | (39,322 | ) |
|                                                 |   |                             |   |                                |   |   |   |   |   |
| Income (loss) from operations                        |   | 577                              |   | 2,412                               |   | (5,153 | ) | (34,392 | ) |
| Gain on sale, net of tax                             |   | 689                              |   | —                              |   | 689 |   | — |   |
|                                                 |   |                             |   |                                |   |   |   |   |   |
| Net income (loss) from discontinued  operations      |   | $                                | 1,266  |                                | $      | 2,412 |   | $ | (4,464 | ) | $ | (34,392 | ) |

----

(a)                                  Reflectsthe results of operations through May 23, 2003, the date of sale.

 

8

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|                                                  |   | **Six Months Ended  June 30,** |   |
|-------------------------------------------------------|--------|-------------------------------------|--------|
| **(In thousands)**                                    |   | **2003**                            |   | **2002** |   |
|                                                  |   | **(Unaudited)**                     |   |
| Cash Flows Provided By (Used For):                    |   |                                |   |   |   |
| Operating activities                                  |   | $                                   | 4,946  |   | $ | 10,751 |   |
| Investing activities                                  |   | (902                                | )      | (468 | ) |
| Financing activities                                  |   | (649                                | )      | (180 | ) |
| Net (increase) decrease in cash and cash  equivalents |   | (13                                 | )      | (90 | ) |
| Effect of foreign currency translation on  cash       |   | (2                                  | )      | 44 |   |
| Net cash provided by discontinued  operations         |   | $                                   | 3,380  |   | $ | 10,057 |   |

 

**Note 3.**          Restructuring, AssetImpairment and Other Related Charges

 

During the three monthsand six months ended June 30, 2003 and 2002, the Company recordedrestructuring, asset impairment and other related charges as follows:

 
|                                                                       |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|----------------------------------------------------------------------------|--------|----------------------------------|--------|-------------------------------------|--------|
| **(In  thousands)**                                                        |   | **2003**                         |   | **2002**                            |   | **2003** |   | **2002** |   |
|                                                                       |   | **(Unaudited)**                  |   |
| Nature of charges:                                                         |   |                             |   |                                |   |   |   |   |   |
| Seating Product Line and Furniture  Manufacturing Facilities Restructuring |   | $                                | 13,394 |                                | $      | — |   | $ | 13,394 |   | $ | — |   |
| Seat Manufacturing Facilities Restructuring                                |   | —                           |   | 2,251                               |   | — |   | 6,294 |   |
| Asset Realignment Restructuring                                            |   | —                           |   | 5,415                               |   | — |   | 5,415 |   |
| Goodwill impairment charges                                                |   | 34,000                           |   | —                              |   | 41,500 |   | — |   |
| Total pre-tax charges                                                      |   | $                                | 47,394 |                                | $      | 7,666 |   | $ | 54,894 |   | $ | 11,709 |   |
|                                                                       |   |                             |   |                                |   |   |   |   |   |
| Business segment recording the charges:                                    |   |                             |   |                                |   |   |   |   |   |
| Cabin Management                                                           |   | $                                | 47,394 |                                | $      | 7,666 |   | $ | 47,394 |   | $ | 11,709 |   |
| Systems Integration                                                        |   | —                           |   | —                              |   | — |   | — |   |
| Total continuing operations                                                |   | 47,394                           |   | 7,666                               |   | 47,394 |   | 11,709 |   |
| Discontinued operations (Specialty Avionics)                               |   | —                           |   | —                              |   | 7,500 |   | — |   |
| Total pre-tax charges                                                      |   | $                                | 47,394 |                                | $      | 7,666 |   | $ | 54,894 |   | $ | 11,709 |   |
|                                                                       |   |                             |   |                                |   |   |   |   |   |
| Charged to operations:                                                     |   |                             |   |                                |   |   |   |   |   |
| Cost of sales                                                              |   | $                                | 12,835 |                                | $      | 4,732 |   | $ | 12,835 |   | $ | 5,946 |   |
| Selling, general and administrative  expenses                              |   | 559                              |   | 2,934                               |   | 559 |   | 5,763 |   |
| Impairment of goodwill                                                     |   | 34,000                           |   | —                              |   | 34,000 |   | — |   |
| Discontinued operations (Specialty  Avionics)                              |   | —                           |   | —                              |   | 7,500 |   | — |   |
| Total pre-tax charges                                                      |   | $                                | 47,394 |                                | $      | 7,666 |   | $ | 54,894 |   | $ | 11,709 |   |
|                                                                       |   |                             |   |                                |   |   |   |   |   |
| Components of charges:                                                     |   |                             |   |                                |   |   |   |   |   |
| Continuing operations:                                                     |   |                             |   |                                |   |   |   |   |   |
| Noncash charges                                                            |   | $                                | 43,926 |                                | $      | 2,765 |   | $ | 43,926 |   | $ | 5,910 |   |
| Cash charges                                                               |   | 3,468                            |   | 4,901                               |   | 3,468 |   | 5,799 |   |
| Total continuing operations pre-tax charges                                |   | 47,394                           |   | 7,666                               |   | 47,394 |   | 11,709 |   |
| Discontinued operations (noncash charges)                                  |   | —                           |   | —                              |   | 7,500 |   | — |   |
| Total pre-tax charges                                                      |   | $                                | 47,394 |                                | $      | 7,666 |   | $ | 54,894 |   | $ | 11,709 |   |

 

9

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During the second quarterof fiscal 2003, the Company consolidated its seating product line offerings andadopted a restructuring plan to down-size a furniture manufacturing facility inresponse to continuing weakness in the business, VIP and head-of-state aircraftmarket.  These actions were designed toreduce engineering, production and inventory carrying costs by supporting fewerproduct offerings and achieve profitability at the furniture manufacturingfacility based on its lower production levels. In connection with these actions, the Company recorded pre-tax chargesto operations totaling $13,394,000 during the second quarter of fiscal2003.  The charges are comprised of thefollowing:

 

•                  *Seating Product Line Consolidation. *The curtailment**ofseveral seating product offerings and conversion of seat products whichincorporate a new single-design technology resulted in the write-off of$6,262,000 of inventoried costs related to the discontinued product offerings.

 

•                  *Excess and Obsolete Inventory Write-Downs. *Inventory was written down by $3,073,000 to reflect its net realizablevalue for quantities on hand exceeding current and forecast order backlogrequirements and obsolete inventory related to the curtailed seatingproduct offerings.

 

•                  *Lease Termination and Related Charges. *Lease termination costs related to future estimated rental payments underexisting long-term lease agreements for the facilities permanently vacated inconnection with down-sizing a furniture manufacturing facility.  Future payments have been reduced by theexpected sublease income.  The netfuture payments are based on estimated current market rates and anticipateddates that these facilities will be subleased. If market-rates decrease or should it take longer than expected tosublease these facilities, the actual loss could exceed these estimates.  Other related charges include the write-offof leasehold improvements related to the vacated facilities.

 

•                  *Severance and Other Compensation Costs. *The Company has reduced its total workforce at the down-sized facilityby 49 employees, or 37%, between December 31, 2002 and June 30, 2003.

 

The components of therestructuring, asset impairment and other related charges are as follows:

 
|                                                       |   |               |        |                 |     |   |   | **Balance at  June 30,  2003** |   |
|------------------------------------------------------------|--------|--------------------|-------------|----------------------|----------|--------|--------|-------------------------------------|--------|
|                                                       |   | **Total  Charges** |        | **Amounts Incurred** |     |   |
| **(In  thousands)**                                        |   |               | **Noncash** |                 | **Cash** |   |   |
|                                                       |   | **(Unaudited)**    |        |
| Product  development costs related to curtailed programs   |   | $                  | 6,262       |                 | $        | (6,262 | )      | $                                   | — |   | $ | — |   |
| Excess  and obsolete inventory write-downs                 |   | 3,073              |        | (3,073               | )        | — |   | —                              |   |
| Lease  termination and other related charges               |   | 4,436              |        | (591                 | )        | — |   | 3,845                               |   |
| Severance  and other compensation costs                    |   | 183                |        | —               |     | (183   | )      | —                              |   |
| Total                                                      |   | 13,954             |        | $                    | (9,926   | )      | $      | (183                                | )      | 3,845 |   |
|                                                       |   |               |        |                 |     |   |   |                                |   |
| Present  value discount, using an 8% imputed interest cost |   | (560               | )           |                 |     |   |   | (560                                | )      |
| Total  pre-tax charges                                     |   | $                  | 13,394      |                 |     |   |   |                                | $      | 3,285 |   |

 

10

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As required by SFAS No.146, the charges recorded were discounted by $560,000 to initially measure andreflect the liabilities incurred as a result of the restructuring plan at theirfair value as of June 30, 2003. The cumulative effect of a changes resulting from revisions to eitherthe timing or the amount of estimated cash flows will be recognized as anadjustment to the liability in the period of the change.  Future cash payments will be funded fromexisting cash balances and internally generated cash from operations.

 

**Seat ManufacturingFacilities Restructuring**

 

During the first quarterof fiscal 2002, the Company announced it would consolidate the production offour seating and related manufacturing facilities into two, resulting in thepermanent closure of two facilities. This plan was designed to improve manufacturing efficiencies and tofurther reduce costs and conserve working capital.  In connection with this restructuring plan, the Company recordedpre-tax charges to operations totaling $6,294,000 during 2002 forrestructuring, asset impairment and other related charges.  The charges were comprised of the following:

 

•                  *Inventory and Accounts Receivable Write-Downs.*  Inconnection with the consolidation of all production, the Company discontinuedmanufacturing certain products, principally those which overlap.  Inventory and certain receivables related tothe discontinued products were written down to net realizable value.

 

•                  *Impairment of Long-Lived Assets.*  The restructuring plan resulted in theimpairment of property and equipment and, accordingly, these assets werewritten down to their net realizable value.

 

•                  *Severance and Other Compensation Costs.*  Approximately 115 employees were terminatedin connection with the permanent closure of the manufacturing facilities.

 

•                  *Lease Termination and Other Related Costs.*  Lease termination and other related costsare comprised of the net losses expected to be incurred under existinglong-term lease agreements for the facilities being permanently vacated.  The losses have been reduced by the expectedsublease income.  These expected losseswere based on estimated current market rates and anticipated dates that thesefacilities are subleased.  Ifmarket-rates decrease or should it take longer than expected to sublease thesefacilities, the actual loss could exceed these estimates.

 

•                  *Other Asset Impairment Related Expenses.*  Other expenses pertain to FAA retesting andrecertification of products manufactured at a different facility, moving,transportation and travel costs and shutdown / startup costs.  Such costs were charged to expense asincurred.

 

The components of theamounts incurred were as follows:

 
|                                           |   | **Charges Recorded During the  Year Ended December 31, 2002** |   |
|------------------------------------------------|--------|---------------------------------------------------------------|--------|
| **(In thousands)**                             |   | **1****st****Quarter**                                        |   | **2nd  Quarter** |   | **Total** |   |
|                                           |   | **(Unaudited)**                                               |   |   |   |
| Inventory and  accounts receivable write-downs |   | $                                                             | 1,445  |   | $ | 755 |   | $ | 2,200 |   |
| Impairment of  long-lived assets               |   | 1,700                                                         |   | (326 | ) | 1,374 |   |
| Severance and  other compensation costs        |   | 450                                                           |   | — |   | 450 |   |
| Lease  termination and other related costs     |   | 300                                                           |   | — |   | 300 |   |
| Other  restructuring-related expenses          |   | 148                                                           |   | 1,822 |   | 1,970 |   |
| Total pre-tax  charges                         |   | $                                                             | 4,043  |   | $ | 2,251 |   | $ | 6,294 |   |
|                                                |        |                                                               |        |  |  |  |  |  |  |  |  |

 

This restructuring planwas completed during the second quarter of fiscal 2002.

 

11

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**Asset RealignmentRestructuring**

 

During the second quarterof fiscal 2001, the Company’s Cabin Management Group adopted a restructuringplan to realign production programs between its manufacturing facilities.  In response to the adverse impact on theaerospace industry resulting from the September 11th terroristattack and its aftermath, as well as the weakening of global economicconditions, the Company announced and implemented a further restructuring planin December 2001 designed to reduce costs and conserve working capital.  This plan included permanently closing onemanufacturing facility and idling a second facility for an indefinite period,curtailing several product development programs and instituting workforcereductions.  Due to the ongoing weaknessof the business, VIP and head-of-state aircraft market, the Company decidedduring the second quarter of fiscal 2002 to permanently close the temporarilyidled manufacturing facility.  The restructuring,asset impairment and other related charges recorded during fiscal 2002 werecomprised of the following:

 

•                  *Impairment of Long-Lived Assets.*  The decision to permanently close theadditional manufacturing facility resulted in an additional impairment ofproperty and equipment and, accordingly, these assets were written down totheir estimated net realizable value in 2002. Net realizable values are based on estimated current market values andthe actual losses could exceed these estimates.

 

•                  *Excess Inventory Write-Downs. *Inventory was written down to netrealizable value for quantities on hand exceeding current and forecast orderbacklog requirements.

 

•                  *Other AssetImpairment Related Charges.* Other expenses pertain to provisions for estimated losses on uncompletedlong-term contracts aggregating $2,577,000 and other related charges expensedas incurred.

 

The components of theamounts incurred were as follows:

 
|                                  |   | **Charges Recorded During the  Year Ended December 31, 2002** |   |
|---------------------------------------|--------|---------------------------------------------------------------|--------|
| **(In thousands)**                    |   | **2nd  Quarter**                                              |   | **3****rd****& 4th  Quarters** |   | **Total** |   |
|                                  |   | **(Unaudited)**                                               |   |   |   |
| Impairment of  long-lived assets      |   | $                                                             | 1,756  |   | $ | 801 |   | $ | 2,557 |   |
| Excess inventory  write-downs         |   | 580                                                           |   | 685 |   | 1,265 |   |
| Other  restructuring-related expenses |   | 3,079                                                         |   | — |   | 3,079 |   |
| Total pre-tax  charges                |   | $                                                             | 5,415  |   | $ | 1,486 |   | $ | 6,901 |   |
|                                       |        |                                                               |        |  |  |  |  |  |  |  |  |

 

This restructuring plan was completed during thefourth quarter of fiscal 2002.

 

**Goodwill Impairment Charges**

 

As a result of thecontinuing weakness in the business, VIP and head-of-state aircraft market andthe decision to down-size a furniture manufacturing facility, the goodwillassociated with the furniture manufacturing reporting unit was tested forrecoverability and found to be impaired (Note 5).  As a result, $34,000,000 of goodwill associated with thereporting unit was written off and charged to operations.

 

As described in Note 2,on March 14, 2003, the Company entered into a definitive agreement to sell itsequity interests in the subsidiaries comprising its Specialty Avionics Groupfor $140,000,000 in cash.  Based uponthe fair value of the group implied in the definitive agreement, the Companydetermined that the carrying value of the group’s net assets was not fullyrecoverable.  As a result, the Companyrecorded a goodwill impairment charge of $7,500,000 during the three monthsended March 31, 2003 to reduce the carrying value to estimated netrealizable value.

 

12

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**Note 4.**          Inventories

 

Inventories are comprisedof the following as of June 30, 2003 and December 31, 2002:

 
| **(In  thousands)**                                                          |   | **June 30,  2003** |   | **December 31,  2002** |   |
|------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                                                         |   | **(Unaudited)**         |   |                        |   |
| Raw materials                                                                |   | $                       | 31,470 |                        | $      | 28,911 |   |
| Work-in-process:                                                             |   |                    |   |                        |   |
| Direct and indirect manufacturing costs                                      |   | 7,978                   |   | 6,843                       |   |
| Program costs, principally engineering                                       |   | 12,746                  |   | 14,769                      |   |
| Finished goods                                                               |   | 1,392                   |   | 4,773                       |   |
| Costs and estimated earnings in excess of  billings on uncompleted contracts |   | 9,539                   |   | 4,004                       |   |
| Total inventories                                                            |   | $                       | 63,125 |                        | $      | 59,300 |   |
|                                                                              |        |                         |        |                             |        |  |  |  |

 

Periodic assessments are performed to ensurerecoverability of the program costs and adjustments are made, if necessary, toreduce inventoried costs to estimated realizable value.   In connection with the curtailment ofseveral seating product offerings (Note 3), all inventoried costs related theseprograms, which aggregated $6,262,000, were charged to cost of sales during thethree months ended June 30, 2003.  Inaddition, $3,073,000 of excess and obsolete inventory associated with thecurtailed seating product offerings and down-sizing of a furnituremanufacturing facility was also charged to cost of sales during the threemonths ended June 30, 2003.

 

Total costs and estimated earnings on all uncompletedcontracts as of June 30, 2003 and December 31, 2002 are comprised ofthe following:

 
| **(In  thousands)**                                                           |   | **June 30,  2003** |   | **December 31,  2002** |   |
|-------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                                                          |   | **(Unaudited)**         |   |                        |   |
| Costs incurred on uncompleted contracts                                       |   | $                       | 62,793 |                        | $      | 49,572 |   |
| Estimated earnings recognized                                                 |   | 83,133                  |   | 63,699                      |   |
| Total costs and estimated earnings                                            |   | 145,926                 |   | 113,271                     |   |
| Less billings to date                                                         |   | (136,512                | )      | (109,880                    | )      |
| Net                                                                           |   | $                       | 9,414  |                        | $      | 3,391 |   |
|                                                                          |   |                    |   |                        |   |
| Balance sheet classification:                                                 |   |                    |   |                        |   |
| Asset – Costs and estimated earnings in  excess of billings              |   | $                       | 9,539  |                        | $      | 4,004 |   |
| Liability – Billings in excess of costs and  estimated earnings (Note 7) |   | (125                    | )      | (613                        | )      |
| Net                                                                           |   | $                       | 9,414  |                        | $      | 3,391 |   |
|                                                                               |        |                         |        |                             |        |  |  |  |

 

Revenues and earnings forproducts manufactured under long-term contracts are recognized under thepercentage-of-completion method using total contract price, actual costsincurred to date and an estimate of the completion costs for eachcontract.  Provisions for estimated losseson uncompleted contracts are made in the period in which such losses aredetermined.

 

13

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**Note 5.**          Goodwill

 

Effective January 1,2002, the Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets”and the provisions of SFAS No. 141, “Business Combinations,” which wererequired to be adopted concurrent with the adoption of SFAS No. 142.  During 2002, the Company completed thetransitional impairment testing of goodwill recorded as of January 1, 2002 asrequired under SFAS No. 142.  Fair valueof each reporting unit was determined using a discounted cash flow approachtaking into consideration projections based on the individual characteristicsof the reporting units, historical trends, market multiples for comparablebusinesses and independent appraisals. Unallocated goodwill was allocated to the reporting units for impairmenttesting purposes.

 

The results indicatedthat the carrying value of goodwill was impaired.  The resulting impairment was primarily attributable to a changein the evaluation criteria for goodwill utilized under previous accountingguidance to the fair value approach stipulated in SFAS No. 142.  In accordance with the transitionalprovision of SFAS No. 142, the Company recorded a $17,828,000 noncashwrite-down of goodwill (net of $878,000 income tax benefit) as of January 1,2002 as a cumulative effect of a change in accounting principle.  An additional $39,322,000 noncash write-downof goodwill pertained to the Specialty Avionics Group and is included in theloss from discontinued operations.

 

Changes in the carryingamount of goodwill, by business segment (Note 12), for the six months endedJune 30, 2003 are as follows:

 
|                               |   | **Continuing Operations**    |    | **Discontinued  Specialty  Avionics  Group** |   |
|------------------------------------|--------|------------------------------|---------|----------------------------------------------|--------|
| **(In  thousands)**                |   | **Cabin  Management  Group** |    | **Systems  Integration  Group**              |   | **Corporate** |   | **Total** |   |   |
|                               |   |                         |    |                                         |   |   |   |   |   |   |   |
| Balance, December 31, 2002         |   | $                            | 173,934 |                                         | $      | 20,782 |   | $ | 1,714 |   | $ | 196,430 |   | $ | 80,722 |   |
| Impairment charges                 |   | (34,000                      | )       | —                                       |   | — |   | (34,000 | ) | (7,500 | ) |
| Sale of Specialty Avionics Group   |   | —                       |    | —                                       |   | — |   | — |   | (73,222 | ) |
| Balance, June 30, 2003 (unaudited) |   | $                            | 139,934 |                                         | $      | 20,782 |   | $ | 1,714 |   | $ | 162,430 |   | $ | — |   |

 

As described in Note 2,on March 14, 2003, the Company entered into a definitive agreement to sell itsequity interests in the subsidiaries comprising its Specialty AvionicsGroup.  Based upon the fair value of thegroup implied in the definitive agreement, the Company determined that thecarrying value of the group’s net assets was not fully recoverable.  As a result, the Company recorded a goodwillimpairment charge of $7,500,000 during the three months endedMarch 31, 2003 to reduce the carrying value to estimated netrealizable value.

 

As required by SFAS No.142, the Company tests goodwill for impairment annually, on October 31stof each year, or when events or changes in circumstances indicate the carryingamount may not be recoverable.  Thegoodwill impairment model is a two-step process.  First, it requires a comparison of the book value of net assetsto the fair value of the related reporting units that have goodwill assigned tothem.  If the fair value is determinedto be less than book value, a second step is performed to compute the amount ofthe impairment.  In this process, a fairvalue for goodwill is estimated, based in part on the fair value of thereporting used in the first step, and is compared to its carrying value.  The amount by which carrying value exceedsfair value represents the amount of goodwill impairment.

 

14

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As a result of thecontinuing weakness in the business, VIP and head-of-state aircraft market andthe Company’s decision to down-size a furniture manufacturing facility in thesecond quarter of fiscal 2003, the Company determined that it should reevaluatethe carrying value of its goodwill prior to the annual October 31st testing date.Accordingly, the Company performed a step-one test of goodwill associated withits furniture manufacturing reporting unit for recoverability and found thegoodwill to be impaired.  As a result,the Company recorded a pre-tax charge to operations of $34,000,000 during thethree months ended June 30, 2003 based on a comparison of the estimated bookvalue of the net assets of the reporting unit to its fair value.  The charge was primarily a result of adecrease in fair value caused by using lower cash flow forecasts based on themost recently reduced industry estimates of aircraft deliveries resulting fromoverall industry weakness.  The amountrecorded is an estimate and may be revised during the third quarter of fiscal2003 upon completion of step two of the goodwill impairment model, whichmeasures the amount of impairment.

 

**Note 6.**          Other Assets

 

Other assets arecomprised of the following as of June 30, 2003 and December 31, 2002:

 
| **(In thousands)**                                       |   | **June 30,  2003** |   | **December 31,  2002** |   |
|----------------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                                     |   | **(Unaudited)**         |   |                        |   |
| Identifiable intangible assets with finite  useful lives |   | $                       | 27,281 |                        | $      | 29,105 |   |
| Deferred financing costs                                 |   | 7,793                   |   | 9,168                       |   |
| Other non-amortizable assets                             |   | 1,036                   |   | 1,155                       |   |
| Total other assets                                       |   | $                       | 36,110 |                        | $      | 39,428 |   |
|                                                          |        |                         |        |                             |        |  |  |  |

 

**IdentifiableIntangible Assets with Finite Useful Lives**

 

Identifiable intangibleassets with finite useful lives are comprised of the following as ofJune 30, 2003 and December 31, 2002:

 
|                            |   | **June 30, 2003 (Unaudited)** |   | **December 31, 2002**    |   |
|---------------------------------|--------|------------------------------------|--------|-------------------------------|--------|
| **(In  thousands)**             |   | **Cost**                           |   | **Accumulated  Amortization** |   | **Net** |   | **Cost** |   | **Accumulated  Amortization** |   | **Net** |   |
|                            |   |                               |   |                          |   |   |   |   |   |   |   |   |   |
| FAA  certifications             |   | $                                  | 22,272 |                          | $      | (7,636 | ) | $ | 14,636 |   | $ | 22,272 |   | $ | (4,738 | ) | $ | 17,534 |   |
| Customer  contracts             |   | 8,390                              |   | (2,751                        | )      | 5,639 |   | 8,390 |   | (4,695 | ) | 3,695 |   |
| Engineering  drawings           |   | 7,645                              |   | (2,436                        | )      | 5,209 |   | 7,645 |   | (1,776 | ) | 5,869 |   |
| Other  identifiable intangibles |   | 2,955                              |   | (1,158                        | )      | 1,797 |   | 2,955 |   | (948 | ) | 2,007 |   |
| Total  identifiable intangibles |   | $                                  | 41,262 |                          | $      | (13,981 | ) | $ | 27,281 |   | $ | 41,262 |   | $ | (12,157 | ) | $ | 29,105 |   |

 

Estimated annualamortization expense for all identifiable intangible assets with finite usefullives for the five-year period ending December 31, 2007 is as follows:2003 – $3,644,000; 2004 – $3,644,000; 2005 – $3,477,000; 2006 – $2,275,000; and2007 – $2,175,000.

 

15

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**Note 7.**          Accrued Liabilities

 

Accrued liabilities arecomprised of the following as of June 30, 2003 and December 31, 2002:

 
| **(In  thousands)**                                                          |   | **June 30,  2003** |   | **December 31,  2002** |   |
|------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                                                         |   | **(Unaudited)**         |   |                        |   |
| Salaries,  wages, compensated absences and payroll related taxes             |   | $                       | 8,794  |                        | $      | 9,212 |   |
| Customer  advances and deposits                                              |   | 2,103                   |   | 4,662                       |   |
| Accrued  interest                                                            |   | 4,596                   |   | 7,465                       |   |
| Billings  in excess of costs and estimated earnings on uncompleted contracts |   | 125                     |   | 613                         |   |
| Acquisition  related contingent consideration                                |   | —                  |   | 600                         |   |
| Other  accrued liabilities                                                   |   | 5,027                   |   | 8,942                       |   |
| Total  accrued liabilities                                                   |   | $                       | 20,645 |                        | $      | 31,494 |   |
|                                                                              |        |                         |        |                             |        |  |  |  |

 

**Note 8.**          Long-Term Debt

 

Long-term debt includesthe following amounts as of June 30, 2003 and December 31, 2002:

 
| **(In  thousands)**                                                                   |   | **June 30,  2003** |    | **December 31,  2002** |   |
|---------------------------------------------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                                                                                  |   | **(Unaudited)**         |    |                        |   |
| Senior  credit facility:                                                              |   |                    |    |                        |   |
| Term  loans                                                                           |   | $                       | 134,925 |                        | $      | 264,200 |   |
| Revolving  line of credit                                                             |   | 15,250                  |    | 6,000                       |   |
| 12%  senior subordinated notes                                                        |   | 100,000                 |    | 100,000                     |   |
| Capital  lease obligations and term debt financing, secured by property and equipment |   | 9,682                   |    | 10,331                      |   |
| Other  indebtedness                                                                   |   | —                  |    | 486                         |   |
| Total  long-term debt                                                                 |   | 259,857                 |    | 381,017                     |   |
| Less  current portion                                                                 |   | (8,485                  | )       | (16,317                     | )      |
| Long-term  debt, less current portion                                                 |   | $                       | 251,372 |                        | $      | 364,700 |   |
|                                                                                       |        |                         |         |                             |        |  |  |  |

 

During 2003, the Companyamended its senior credit facility to permit the sale of its Specialty AvionicsGroup.  Upon consummation of the sale onMay 23, 2003, the Company repaid $130,000,000 of senior credit borrowings withthe estimated net proceeds from the sale. The Company may be required to repay additional borrowings upon finaldetermination of the net proceeds from the sale.

 

The amendment alsorevised various financial covenants (which the Company would otherwise have notbeen able to meet), decreases by $10,000,000 the maximum permitted revolvingline of credit borrowings to $40,000,000, increases the prime rate and LIBORinterest margins by 1.5% and permits the issuance of specified types ofadditional indebtedness and the repurchase of up to $20,000,000 of theCompany’s 12% senior subordinated notes with the proceeds from the sale ofjunior securities.

 

16

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**Note 9.**          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  June 30,** |    | **Six Months Ended  June 30,** |   |
|---------------------------------------------|--------|----------------------------------|---------|-------------------------------------|--------|
| **(In  thousands)**                         |   | **2003**                         |    | **2002**                            |   | **2003** |   | **2002** |   |
|                                        |   | **(Unaudited)**                  |    |
| Pre-tax income (loss) reported by:          |   |                             |    |                                |   |   |   |   |   |
| Continuing operations                       |   | $                                | (52,144 | )                                   | $      | (8,264 | ) | $ | (58,868 | ) | $ | (13,319 | ) |
| Discontinued operations                     |   | 1,258                            |    | 4,010                               |   | (3,331 | ) | 8,392 |   |
| Consolidated pre-tax loss                   |   | $                                | (50,886 | )                                   | $      | (4,254 | ) | $ | (62,199 | ) | $ | (4,927 | ) |
|                                        |   |                             |    |                                |   |   |   |   |   |
| Total provision for income taxes (benefit): |   |                             |    |                                |   |   |   |   |   |
| Income tax benefit based on pre-tax loss    |   | $                                | (22,077 | )                                   | $      | (889 | ) | $ | (22,633 | ) | $ | (578 | ) |
| Net deferred tax assets valuation allowance |   | 13,056                           |    | —                              |   | 13,056 |   | — |   |
| Net income tax benefit                      |   | $                                | (9,021  | )                                   | $      | (889 | ) | $ | (9,577 | ) | $ | (578 | ) |
|                                        |   |                             |    |                                |   |   |   |   |   |
| Allocation of total provision:              |   |                             |    |                                |   |   |   |   |   |
| Continuing operations                       |   | $                                | (9,702  | )                                   | $      | (2,487 | ) | $ | (11,399 | ) | $ | (4,040 | ) |
| Discontinued operations                     |   | 681                              |    | 1,598                               |   | 1,822 |   | 3,462 |   |
| Net provision for income tax benefit        |   | $                                | (9,021  | )                                   | $      | (889 | ) | $ | (9,577 | ) | $ | (578 | ) |

 

For the three months andsix months ended June 30, 2003 and 2002, the provision for income taxes,based on the reported consolidated pre-tax loss, differs from the amountdetermined by applying the applicable U.S. statutory federal rate to thepre-tax loss primarily due to the effects of state and foreign income taxes,the non-deductible portion of goodwill impairment charges and minority interestin preferred stock of subsidiary, which is not deductible for income tax purposes.

 

During the three monthsand six months ended June 30, 2003, the Company established a $13,056,000valuation allowance for the net deferred tax assets which may not be realizedin the future.  The Company evaluated itsdeferred assets for expected recoverability based on the nature of the item,the associated taxing jurisdictions, the applicable expiration dates and futuretaxable income forecasts that would impact utilization.  Based on its evaluation, the Companydetermined that recovery was not likely in certain taxing jurisdictions andapplied its judgment in estimating the amount of valuation allowance necessaryunder the circumstances to reduce the assets carrying value to realizablevalue.  The Company will reduce thevaluation allowance in the future for each item at such time when it determinesthat recoverability is more likely than not.

 

17

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**Note 10.**   Capital Structure

 

**MandatorilyRedeemable Preferred Stock**

 

The table belowsummarizes the increase in mandatorily redeemable preferred stock during thesix months ended June 30, 2003.

 
|                                                         |   | **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** |   |
|                                                         |   |                                      |   |                                      |   |   |   |   |   |   |   |   |   |
| Balance,  December 31, 2002                             |   | 370,061                                   |   | $                                         | 37,006 |   | $ | (2,925 | ) | $ | 34,081 |   | 342,417 |   | $ | 62,222 |   |
| Accrued  dividends and redemption value accretion            |   | 30,206                                    |   | 3,020                                     |   | 234 |   | 3,254 |   | — |   | — |   |
| Noncash dividend  accretion                                  |   | —                                    |   | —                                    |   | — |   | — |   | — |   | 4,432 |   |
| Balance, June  30, 2003 (Unaudited)                          |   | 400,267                                   |   | $                                         | 40,026 |   | $ | (2,691 | ) | $ | 37,335 |   | 342,417 |   | $ | 66,654 |   |
|                                                         |   |                                      |   |                                      |   |   |   |   |   |   |   |   |   |
| Per share  liquidation value as of June 30, 2003 (Unaudited) |   |                                      |   | $                                         | 100.00 |   |   |   |   |   |   |   | $ | 194.66 |   |

 

DeCrane Aircraft’s 16%preferred stock is reflected as minority interest in preferred stock ofsubsidiary in the consolidated financial statements.

 

***DeCrane Aircraft 16% 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 dividends; such shares are reflected as a component of minorityinterest in preferred stock of subsidiary.

 

***DeCrane Holdings 14% 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.

 

**Note 11.**   Commitments and Contingencies

 

**Litigation**

 

As part of itsinvestigation of the crash of Swissair Flight 111 off the Canadian coast onSeptember 2, 1998, the Canadian Transportation Safety Board (the“CTSB”) initially notified the Company that it recovered burned wire that wasattached to the in-flight entertainment system installed on some of Swissair’s aircraftby one of the Company’s subsidiaries. The Company’s subsidiary has worked vigorously over the last five yearswith the CTSB investigators in the fact-finding investigation of thiscatastrophic incident.  On March 27,2003, the CTSB released its final report on its investigation.  This report indicated that the CTSB wasunable to conclusively determine the cause of the fire which led to the crashof the aircraft.

 

18

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The Company was adefendant in most, but not all, of the actions brought by the estates of the229 victims of the crash.  The actions,which sought damages and costs in unstated amounts, claimed negligence, strictliability, and breach of warranty. Virtually all of the cases have been settled by Boeing and Swissair’sinsurers and both assignment of the claims against, and releases in favor of,the Company have been obtained by the Boeing and Swissair insurers.

 

Boeing and Swissair havemade a claim (but have not commenced litigation) against the Company tocontribute to the amounts paid to settle the cases.  As there is no litigation pending, no discovery has been taken byeither side as to liability for the crash. The Company believes that it is not responsible for the crash and, inany event, it maintains insurance for such matters.  The Company further believes that any loss it may sustain uponthe ultimate resolution of this matter, if any, will not exceed the amount ofinsurance coverage maintained. Accordingly, no accrual for loss has been recorded.

 

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’sbusiness, consolidated financial position, results of operations or cash flows.

 

**Note 12.**   Business Segment Information

 

The Company suppliesproducts and services to the business, VIP and head-of-state aircraft market withinthe aerospace industry.  The Company’ssubsidiaries are organized into two groups, each of which is a strategicbusiness that develops, manufactures and sells distinct products and services.  The groups and a description of theirbusinesses are as follows:

 

•                  *Cabin Management –* manufactures interiorcabin components, including cabin interior furnishings, cabin managementsystems, seating and composite components;

 

•                  *Systems Integration –* manufacturesauxiliary fuel systems and auxiliary power units, provides system integrationservices, provides aircraft completion and refurbishment services and is aBoeing Business Jet authorized service center.

 

In prior periods, the Company’s Specialty AvionicsGroup was a third strategic business for which segment information wasprovided.  As a result of the sale ofthe Specialty Avionics Group, this group is reflected as a discontinuedoperation and segment information for prior periods has been restated.

 

Management utilizes more than one measurement toevaluate group performance and allocate resources; however, managementconsiders Adjusted EBITDA, as defined, to be the primary measurement of agroup’s overall core economic performance and return on invested capital.  Management also uses Adjusted EBITDA in theCompany’s annual budget and planning process for future periods, as one of thedecision-making criteria for funding discretionary capital expenditures andproduct development programs and as the measure in determining the value ofacquisitions and dispositions.  Theboard of directors uses Adjusted EBITDA as one of the performance metrics fordetermining the amount of bonuses awarded to pursuant to the Company’s cashincentive bonus plan and as an indicator of enterprise value used indetermining the exercise price of stock options granted and the acceleration ofstock option vesting pursuant to the Company’s incentive stock option plan.

 

19

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Management definesAdjusted EBITDA as earnings 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 the presentationof this measure is relevant and useful to investors because it allows investorsand analysts to view group performance in a manner similar to the method usedby management, helps improve their ability to understand the Company’s coresegment performance, adjusted for items management believes are unusual, andmakes it easier to compare the Company’s results with other companies that havedifferent 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 measureAdjusted EBITDA, as defined, excludes certain charges reflected in theCompany’s financial statements which are prepared in accordance with accountingprinciples generally accepted in the United States of America (“GAAP”).  However, the Company’s presentation ofAdjusted EBITDA is in accordance with the GAAP requirements of SFAS No. 131,“Disclosures about Segments of an Enterprise and Related Information,” whichrequires the Company to report the primary measure of segment performance usedby management to evaluate and manage its businesses.  The Company’s method of calculating Adjusted EBITDA may not beconsistent with that of other companies and should be viewed in conjunctionwith measurements that are computed in accordance GAAP, such as net income(loss), the nearest comparable GAAP financial measure.  A reconciliation of Adjusted EBITDA to netincome (loss) is included herein to clarify the differences between thesefinancial measures.

 

The accounting policiesof the groups are substantially the same as those described in the summary ofsignificant 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 Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|-------------------------------|--------|----------------------------------|--------|-------------------------------------|--------|
| **(In  thousands)**           |   | **2003**                         |   | **2002**                            |   | **2003** |   | **2002** |   |
|                          |   | **(Unaudited)**                  |   |
| Revenues:                     |   |                             |   |                                |   |   |   |   |   |
| Cabin Management              |   | $                                | 29,635 |                                | $      | 48,232 |   | $ | 60,255 |   | $ | 94,099 |   |
| Systems Integration           |   | 14,718                           |   | 13,223                              |   | 26,850 |   | 28,300 |   |
| Inter-group elimination (1)   |   | (240                             | )      | (162                                | )      | (1,092 | ) | (287 | ) |
| Consolidated totals           |   | $                                | 44,113 |                                | $      | 61,293 |   | $ | 86,013 |   | $ | 122,112 |   |
|                          |   |                             |   |                                |   |   |   |   |   |
| Adjusted EBITDA (as defined): |   |                             |   |                                |   |   |   |   |   |
| Cabin Management              |   | $                                | 4,310  |                                | $      | 9,042 |   | $ | 8,860 |   | $ | 16,503 |   |
| Systems Integration           |   | 4,180                            |   | 4,096                               |   | 6,337 |   | 8,392 |   |
| Corporate (2)                 |   | (1,395                           | )      | (1,629                              | )      | (3,507 | ) | (3,187 | ) |
| Inter-group elimination (3)   |   | 2                                |   | (111                                | )      | 112 |   | — |   |
| Consolidated totals (4)       |   | $                                | 7,097  |                                | $      | 11,398 |   | $ | 11,802 |   | $ | 21,708 |   |

 

20

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|                                          |   | **June 30,** |    |
|-----------------------------------------------|--------|-------------------|---------|
| **(In  thousands)**                           |   | **2003**          |    | **2002** |   |
|                                          |   | **(Unaudited)**   |    |
| Total assets (as of period end):              |   |              |    |   |   |
| Cabin Management                              |   | $                 | 236,941 |   | $ | 288,543 |   |
| Systems Integration                           |   | 69,049            |    | 68,242 |   |
| Corporate (5)                                 |   | 17,094            |    | 29,072 |   |
| Inter-group elimination (6)                   |   | (438              | )       | (122 | ) |
| Continuing operations                         |   | 322,646           |    | 385,735 |   |
| Discontinued operations (Specialty  Avionics) |   | —            |    | 177,191 |   |
| Consolidated totals                           |   | $                 | 322,646 |   | $ | 562,926\ |   |

 

----

(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 ofthe effect of inter-group profits in inventory.

(4)          The table belowreconciles the financial measure Adjusted EBITDA, as defined, to net loss.

 
|                                                       |   | **Three Months Ended  June 30,** |    | **Six Months Ended  June 30,** |   |
|------------------------------------------------------------|--------|----------------------------------|---------|-------------------------------------|--------|
| **(In  thousands)**                                        |   | **2003**                         |    | **2002**                            |   | **2003** |   | **2002** |   |
|                                                       |   | **(Unaudited)**                  |    |
| Consolidated Adjusted EBITDA (as defined)                  |   | $                                | 7,097   |                                | $      | 11,398 |   | $ | 11,802 |   | $ | 21,708 |   |
| Restructuring, asset impairment and other  related charges |   | (47,394                          | )       | (7,666                              | )      | (47,394 | ) | (11,709 | ) |
| Depreciation and amortization of long-lived  assets (a)    |   | (2,451                           | )       | (2,680                              | )      | (4,967 | ) | (5,447 | ) |
| Acquisition related charges not capitalized                |   | (8                               | )       | (468                                | )      | (17 | ) | (478 | ) |
| Other noncash charges                                      |   | —                           |    | (84                                 | )      | — |   | (138 | ) |
| Corporate overhead charged to discontinued  operations     |   | 290                              |    | 752                                 |   | 997 |   | 1,515 |   |
| Interest expense                                           |   | (7,614                           | )       | (7,997                              | )      | (15,289 | ) | (15,756 | ) |
| Minority interest in preferred stock of  subsidiary        |   | (1,657                           | )       | (1,433                              | )      | (3,254 | ) | (2,815 | ) |
| Other expenses, net                                        |   | (407                             | )       | (86                                 | )      | (746 | ) | (199 | ) |
| Income tax benefit                                         |   | 9,702                            |    | 2,487                               |   | 11,399 |   | 4,040 |   |
| Income (loss) from discontinued operations                 |   | 1,266                            |    | 2,412                               |   | (4,464 | ) | (34,392 | ) |
| Cumulative effect of change in accounting  principle       |   | —                           |    | —                              |   | — |   | (17,828 | ) |
| Net loss                                                   |   | $                                | (41,176 | )                                   | $      | (3,365 | ) | $ | (51,933 | ) | $ | (61,499 | ) |

 

----

 

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

 

21

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|                                                |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|-----------------------------------------------------|--------|----------------------------------|--------|-------------------------------------|--------|
| **(In  thousands)**                                 |   | **2003**                         |   | **2002**                            |   | **2003** |   | **2002** |   |
|                                                |   | **(Unaudited)**                  |   |
| Depreciation and amortization of long-lived  assets |   | $                                | 2,451  |                                | $      | 2,680 |   | $ | 4,967 |   | $ | 5,447 |   |
| Amortization of deferred financing costs            |   | 680                              |   | 707                                 |   | 1,375 |   | 1,296 |   |
| Consolidated depreciation and amortization          |   | $                                | 3,131  |                                | $      | 3,387 |   | $ | 6,342 |   | $ | 6,743 |   |

 

----

(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.

 

**Note 13.**   Supplemental Condensed Consolidating FinancialInformation

 

In conjunction with 12%senior subordinated notes described in Note 8, the following condensedconsolidating financial information is presented segregating DeCrane Aircraft,as the issuer, and 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 senior creditfacility and the notes.  DeCraneHoldings is not a guarantor of the notes and is therefore reflected in thenon-guarantor subsidiary column with DeCrane Aircraft’s non-guarantor subsidiaries.

 

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)          Elimination ofinvestments in subsidiaries.

(2)          Elimination ofintercompany accounts.

(3)          Elimination of equity inearnings of subsidiaries.

 

22

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**Balance Sheets**

 
|                                                                                             |   | **June 30, 2003 (Unaudited)** |    |
|--------------------------------------------------------------------------------------------------|--------|-------------------------------|---------|
| **(In  thousands)**                                                                              |   | **Issuer**                    |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                                                             |   |                          |    |   |   |   |   |   |   |   |   |
| **Assets**                                                                                       |   |                          |    |   |   |   |   |   |   |   |   |
|                                                                                             |   |                          |    |   |   |   |   |   |   |   |   |
| Current assets:                                                                                  |   |                          |    |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                                                        |   | $                             | 3,571   |   | $ | 102 |   | $ | — |   | $ | — |   | $ | 3,673 |   |
| Accounts receivable, net                                                                         |   | —                        |    | 20,726 |   | — |   | — |   | 20,726 |   |
| Inventories                                                                                      |   | —                        |    | 63,125 |   | — |   | — |   | 63,125 |   |
| Other current assets                                                                             |   | 1,190                         |    | 591 |   | — |   | — |   | 1,781 |   |
| Assets of discontinued operations                                                                |   | —                        |    | — |   | — |   | — |   | — |   |
| Total current assets                                                                             |   | 4,761                         |    | 84,544 |   | — |   | — |   | 89,305 |   |
|                                                                                             |   |                          |    |   |   |   |   |   |   |   |   |
| Property and equipment, net                                                                      |   | 2,105                         |    | 32,696 |   | — |   | — |   | 34,801 |   |
| Goodwill                                                                                         |   | 10,224                        |    | 152,206 |   | — |   | — |   | 162,430 |   |
| Other assets, principally intangibles, net                                                       |   | —                        |    | 36,110 |   | — |   | — |   | 36,110 |   |
| Investments in subsidiaries                                                                      |   | 290,404                       |    | — |   | (16,695 | ) | (273,709 | )(1) | — |   |
| Intercompany receivables                                                                         |   | 55,073                        |    | 74,846 |   | — |   | (129,919 | )(2) | — |   |
| Total assets                                                                                     |   | $                             | 362,567 |   | $ | 380,402 |   | $ | (16,695 | ) | $ | (403,628 | ) | $ | 322,646 |   |
|                                                                                             |   |                          |    |   |   |   |   |   |   |   |   |
| **Liabilities, Mandatorily Redeemable  Preferred Stock and Stockholders’ Equity (Deficit)** |   |                          |    |   |   |   |   |   |   |   |   |
|                                                                                             |   |                          |    |   |   |   |   |   |   |   |   |
| Current liabilities:                                                                             |   |                          |    |   |   |   |   |   |   |   |   |
| Current portion of long-term debt                                                                |   | $                             | 7,336   |   | $ | 1,149 |   | $ | — |   | $ | — |   | $ | 8,485 |   |
| Other current liabilities                                                                        |   | 10,477                        |    | 20,164 |   | — |   | — |   | 30,641 |   |
| Liabilities of discontinued operations                                                           |   | —                        |    | — |   | — |   | — |   | — |   |
| Total current liabilities                                                                        |   | 17,813                        |    | 21,313 |   | — |   | — |   | 39,126 |   |
|                                                                                             |   |                          |    |   |   |   |   |   |   |   |   |
| Long-term debt, less current portion                                                             |   | 242,936                       |    | 8,436 |   | — |   | — |   | 251,372 |   |
| Intercompany payables                                                                            |   | 74,846                        |    | 55,073 |   | — |   | (129,919 | )(2) | — |   |
| Other long-term liabilities                                                                      |   | 6,332                         |    | 5,540 |   | — |   | — |   | 11,872 |   |
|                                                                                             |   |                          |    |   |   |   |   |   |   |   |   |
| Minority interest in preferred stock of subsidiary                                               |   | 37,335                        |    | — |   | — |   | — |   | 37,335 |   |
| Mandatorily redeemable 14% preferred stock                                                       |   | —                        |    | — |   | 66,654 |   | — |   | 66,654 |   |
|                                                                                             |   |                          |    |   |   |   |   |   |   |   |   |
| Stockholders’ equity (deficit):                                                             |   |                          |    |   |   |   |   |   |   |   |   |
| Paid-in capital                                                                                  |   | 115,293                       |    | 337,592 |   | 65,069 |   | (452,885 | )(1) | 65,069 |   |
| Retained earnings deficit                                                                        |   | (131,988                      | )       | (47,188 | ) | (148,418 | ) | 179,716 | (1) | (148,418 | ) |
| Accumulated other comprehensive loss                                                             |   | —                        |    | (364 | ) | — |   | — |   | (364 | ) |
| Total stockholders’ equity (deficit)                                                        |   | (16,695                       | )       | 290,040 |   | (83,349 | ) | (273,709 | ) | (83,713 | ) |
| Total liabilities, mandatorily redeemable preferred stock and  stockholders’ equity         |   | $                             | 362,567 |   | $ | 380,402 |   | $ | (16,695 | ) | $ | (403,628 | ) | $ | 322,646 |   |

 

23

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|                                                                                               |   | **December 31, 2002** |    |
|----------------------------------------------------------------------------------------------------|--------|----------------------------|---------|
| **(In thousands)**                                                                                 |   | **Issuer**                 |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                                                               |   |                       |    |   |   |   |   |   |   |   |   |
| **Assets**                                                                                         |   |                       |    |   |   |   |   |   |   |   |   |
|                                                                                               |   |                       |    |   |   |   |   |   |   |   |   |
| Current assets:                                                                                    |   |                       |    |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                                                          |   | $                          | 12,343  |   | $ | 78 |   | $ | — |   | $ | — |   | $ | 12,421 |   |
| Accounts receivable, net                                                                           |   | —                     |    | 26,354 |   | — |   | — |   | 26,354 |   |
| Inventories                                                                                        |   | —                     |    | 59,300 |   | — |   | — |   | 59,300 |   |
| Other current assets                                                                               |   | 17,711                     |    | 443 |   | — |   | — |   | 18,154 |   |
| Assets of discontinued operations                                                                  |   | —                     |    | 166,507 |   | 5,197 |   | (10,963 | )(1) | 160,741 |   |
| Total current assets                                                                               |   | 30,054                     |    | 252,682 |   | 5,197 |   | (10,963 | ) | 276,970 |   |
|                                                                                               |   |                       |    |   |   |   |   |   |   |   |   |
| Property and equipment, net                                                                        |   | 2,485                      |    | 33,654 |   | — |   | — |   | 36,139 |   |
| Other assets, principally intangibles, net                                                         |   | 11,708                     |    | 224,150 |   | — |   | — |   | 235,858 |   |
| Investments in subsidiaries                                                                        |   | 351,502                    |    | — |   | 34,137 |   | (385,639 | )(1) | — |   |
| Intercompany receivables                                                                           |   | 273,178                    |    | 172,389 |   | 5,740 |   | (451,307 | )(2) | — |   |
| Total assets                                                                                       |   | $                          | 668,927 |   | $ | 682,875 |   | $ | 45,074 |   | $ | (847,909 | ) | $ | 548,967 |   |
|                                                                                               |   |                       |    |   |   |   |   |   |   |   |   |
| **Liabilities, Mandatorily Redeemable  Preferred Stock and Stockholders’ Equity (Deficit)**   |   |                       |    |   |   |   |   |   |   |   |   |
|                                                                                               |   |                       |    |   |   |   |   |   |   |   |   |
| Current liabilities:                                                                               |   |                       |    |   |   |   |   |   |   |   |   |
| Current portion of long-term debt                                                                  |   | $                          | 15,337  |   | $ | 980 |   | $ | — |   | $ | — |   | $ | 16,317 |   |
| Other current liabilities                                                                          |   | 16,786                     |    | 27,763 |   | — |   | — |   | 44,549 |   |
| Liabilities of discontinued operations                                                             |   | —                     |    | 19,954 |   | (26 | ) | — |   | 19,928 |   |
| Total current liabilities                                                                          |   | 32,123                     |    | 48,697 |   | (26 | ) | — |   | 80,794 |   |
|                                                                                               |   |                       |    |   |   |   |   |   |   |   |   |
| Long-term debt, less current portion                                                               |   | 355,568                    |    | 9,132 |   | — |   | — |   | 364,700 |   |
| Intercompany payables                                                                              |   | 178,242                    |    | 273,065 |   | — |   | (451,307 | )(2) | — |   |
| Other long-term liabilities                                                                        |   | 33,601                     |    | 840 |   | — |   | — |   | 34,441 |   |
|                                                                                               |   |                       |    |   |   |   |   |   |   |   |   |
| Minority interest in preferred stock of subsidiary                                                 |   | 34,081                     |    | — |   | — |   | — |   | 34,081 |   |
| Mandatorily redeemable 14% preferred stock                                                         |   | —                     |    | — |   | 62,222 |   | — |   | 62,222 |   |
|                                                                                               |   |                       |    |   |   |   |   |   |   |   |   |
| Stockholders’ equity (deficit):                                                               |   |                       |    |   |   |   |   |   |   |   |   |
| Paid-in capital                                                                                    |   | 118,621                    |    | 337,592 |   | 83,840 |   | (470,478 | )(1) | 69,575 |   |
| Retained earnings (deficit)                                                                        |   | (83,309                    | )       | 13,910 |   | (100,962 | ) | (73,876 | )(1) | (96,485 | ) |
| Accumulated other  comprehensive loss                                                              |   | —                     |    | (361 | ) | — |   | — |   | (361 | ) |
| Total stockholders’ equity (deficit)                                                          |   | 35,312                     |    | 351,141 |   | (17,122 | ) | (396,602 | ) | (27,271 | ) |
| Total liabilities, mandatorily redeemable preferred stock and  stockholders’ equity (deficit) |   | $                          | 668,927 |   | $ | 682,875 |   | $ | 45,074 |   | $ | (847,909 | ) | $ | 548,967 |   |

 

24

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**Statementsof Operations**

 
|                                               |   | **Six Months Ended June 30, 2003 (Unaudited)** |    |
|----------------------------------------------------|--------|------------------------------------------------|---------|
| **(In thousands)**                                 |   | **Issuer**                                     |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                               |   |                                           |    |   |   |   |   |   |   |   |   |
| Revenues                                           |   | $                                              | —  |   | $ | 86,013 |   | $ | — |   | $ | — |   | $ | 86,013 |   |
| Cost of sales                                      |   | —                                         |    | 76,286 |   | — |   | — |   | 76,286 |   |
|                                               |   |                                           |    |   |   |   |   |   |   |   |   |
| Gross profit                                       |   | —                                         |    | 9,727 |   | — |   | — |   | 9,727 |   |
|                                               |   |                                           |    |   |   |   |   |   |   |   |   |
| Selling, general and administrative expenses       |   | 3,907                                          |    | 9,573 |   | — |   | — |   | 13,480 |   |
| Impairment of goodwill                             |   | —                                         |    | 34,000 |   | — |   | — |   | 34,000 |   |
| Amortization of intangible assets                  |   | —                                         |    | 1,826 |   | — |   | — |   | 1,826 |   |
| Interest expense                                   |   | 15,068                                         |    | 221 |   | — |   | — |   | 15,289 |   |
| Minority interest in preferred stock of subsidiary |   | —                                         |    | — |   | 3,254 |   | — |   | 3,254 |   |
| Intercompany charges                               |   | (11,575                                        | )       | 11,575 |   | — |   | — |   | — |   |
| Equity in loss of subsidiaries                     |   | 33,429                                         |    | 218 |   | 48,679 |   | (82,326 | )(3) | — |   |
| Other expenses (income), net                       |   | 586                                            |    | 160 |   | — |   | — |   | 746 |   |
| Income tax benefit                                 |   | (7,264                                         | )       | (18,663 | ) | — |   | — |   | (11,399 | ) |
| Loss from discontinued operations                  |   | —                                         |    | 4,246 |   | 218 |   | — |   | 4,464 |   |
| Net loss                                           |   | $                                              | (48,679 | ) | $ | (34,429 | ) | $ | (52,151 | ) | $ | 82,326 |   | $ | (51,933 | ) |

 
|                                                |   | **Six Months Ended June 30, 2002 (Unaudited)** |    |
|-----------------------------------------------------|--------|------------------------------------------------|---------|
| **(In  thousands)**                                 |   | **Issuer**                                     |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                |   |                                           |    |   |   |   |   |   |   |   |   |
| Revenues                                            |   | $                                              | —  |   | $ | 122,112 |   | $ | — |   | $ | — |   | $ | 122,112 |   |
| Cost of sales                                       |   | —                                         |    | 92,212 |   | — |   | — |   | 92,212 |   |
|                                                |   |                                           |    |   |   |   |   |   |   |   |   |
| Gross profit                                        |   | —                                         |    | 29,900 |   | — |   | — |   | 29,900 |   |
|                                                |   |                                           |    |   |   |   |   |   |   |   |   |
| Selling, general and administrative expenses        |   | 4,273                                          |    | 18,459 |   | — |   | — |   | 22,732 |   |
| Amortization of intangible assets                   |   | —                                         |    | 1,717 |   | — |   | — |   | 1,717 |   |
| Interest expense                                    |   | 15,682                                         |    | 74 |   | — |   | — |   | 15,756 |   |
| Minority interest in preferred stock of subsidiary  |   | —                                         |    | — |   | 2,815 |   | — |   | 2,815 |   |
| Intercompany charges                                |   | (14,310                                        | )       | 14,310 |   | — |   | — |   | — |   |
| Equity in loss of subsidiaries                      |   | 52,977                                         |    | 9,510 |   | 58,684 |   | (121,171 | )(3) | — |   |
| Other expenses, net                                 |   | 174                                            |    | 25 |   | — |   | — |   | 199 |   |
| Income tax benefit                                  |   | (1,596                                         | )       | (2,444 | ) | — |   | — |   | (4,040 | ) |
| Loss from discontinued operations                   |   | —                                         |    | 24,882 |   | 9,510 |   | — |   | 34,392 |   |
| Cumulative effect of change in accounting principle |   | 1,484                                          |    | 16,344 |   | — |   | — |   | 17,828 |   |
| Net loss                                            |   | $                                              | (58,684 | ) | $ | (52,977 | ) | $ | (71,009 | ) | $ | 121,171 |   | $ | (61,499 | ) |

 

25

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**Statementsof Cash Flows**

 
|                                                 |   | **Six Months Ended June 30, 2003 (Unaudited)** |    |
|------------------------------------------------------|--------|------------------------------------------------|---------|
| **(In thousands)**                                   |   | **Issuer**                                     |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                 |   |                                           |    |   |   |   |   |   |   |   |   |
| **Cash flows from operating  activities:**           |   |                                           |    |   |   |   |   |   |   |   |   |
| Net loss                                             |   | $                                              | (48,679 | ) | $ | (33,429 | ) | $ | (52,151 | ) | $ | 82,326 | (3) | $ | (51,933 | ) |
| Loss from discontinued operations                    |   | —                                         |    | 4,246 |   | 218 |   | — |   | 4,464 |   |
| Noncash adjustments:                                 |   |                                           |    |   |   |   |   |   |   |   |   |
| Equity in loss of subsidiaries                       |   | 33,429                                         |    | 218 |   | 48,679 |   | (82,326 | )(3) | — |   |
| Other noncash adjustments                            |   | (21,973                                        | )       | 61,060 |   | 3,254 |   | — |   | 42,341 |   |
| Changes in working capital                           |   | (16,951                                        | )       | (32,591 | ) | — |   | — |   | (16,000 | ) |
| Net cash used for operating activities               |   | (20,272                                        | )       | (856 | ) | — |   | — |   | (21,128 | ) |
| **Cash flows from investing  activities:**           |   |                                           |    |   |   |   |   |   |   |   |   |
| Net proceeds from sale of Specialty Avionics Group   |   | 132,800                                        |    | — |   | — |   | — |   | 132,800 |   |
| Capital expenditures                                 |   | (26                                            | )       | (1,976 | ) | — |   | — |   | (2,002 | ) |
| Cash paid for acquisitions                           |   | (600                                           | )       | — |   | — |   | — |   | (600 | ) |
| Net cash provided by (used for) investing activities |   | 132,174                                        |    | (1,976 | ) | — |   | — |   | 130,198 |   |
| **Cash flows from financing  activities:**           |   |                                           |    |   |   |   |   |   |   |   |   |
| Principal payments on long-term debt and leases      |   | (129,924                                       | )       | (524 | ) | — |   | — |   | (130,448 | ) |
| Net senior revolving credit facility borrowings      |   | 9,250                                          |    | — |   | — |   | — |   | 9,250 |   |
| Net cash provided by financing activities            |   | (120,674                                       | )       | (524 | ) | — |   | — |   | (121,198 | ) |
|                                                 |   |                                           |    |   |   |   |   |   |   |   |   |
| Net cash provided by discontinued operations         |   | —                                         |    | 3,380 |   | — |   | — |   | 3,380 |   |
| Net increase (decrease) in cash and equivalents      |   | (8,772                                         | )       | 24 |   | — |   | — |   | (8,748 | ) |
| Cash and equivalents at beginning of period          |   | 12,343                                         |    | 78 |   | — |   | — |   | 12,421 |   |
| Cash and equivalents at end of period                |   | $                                              | 3,571   |   | $ | 102 |   | $ | — |   | $ | — |   | $ | 3,673 |   |

 

26

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|                                                 |   | **Six Months Ended June 30, 2002 (Unaudited)** |    |
|------------------------------------------------------|--------|------------------------------------------------|---------|
| **(In thousands)**                                   |   | **Issuer**                                     |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                 |   |                                           |    |   |   |   |   |   |   |   |   |
| **Cash flows from operating  activities:**           |   |                                           |    |   |   |   |   |   |   |   |   |
| Net loss                                             |   | $                                              | (58,684 | ) | $ | (52,977 | ) | $ | (71,009 | ) | $ | 121,171 | (3) | $ | (61,499 | ) |
| Loss from discontinued operations                    |   | —                                         |    | 24,882 |   | 9,510 |   | — |   | 34,392 |   |
| Noncash adjustments:                                 |   |                                           |    |   |   |   |   |   |   |   |   |
| Equity in loss of subsidiaries                       |   | 52,977                                         |    | 9,510 |   | 58,684 |   | (121,171 | )(3) | — |   |
| Other noncash adjustments                            |   | 2,318                                          |    | 27,367 |   | — |   | — |   | 29,685 |   |
| Changes in working capital                           |   | 4,974                                          |    | (18,342 | ) | 2,815 |   | — |   | (10,553 | ) |
| Net cash provided by (used for) operating activities |   | 1,585                                          |    | (9,560 | ) | — |   | — |   | (7,975 | ) |
| **Cash flows from investing  activities:**           |   |                                           |    |   |   |   |   |   |   |   |   |
| Cash paid for acquisitions                           |   | (5,890                                         | )       | — |   | — |   | — |   | (5,890 | ) |
| Capital expenditures                                 |   | (46                                            | )       | (1,978 | ) |   |   | — |   | (2,024 | ) |
| Other, net                                           |   | —                                         |    | — |   | 268 |   | (268 | )(1) | — |   |
| Net cash used for investing activities               |   | (5,936                                         | )       | (1,978 | ) | 268 |   | (268 | ) | (7,914 | ) |
|                                                 |   |                                           |    |   |   |   |   |   |   |   |   |
| **Cash flows from financing  activities:**           |   |                                           |    |   |   |   |   |   |   |   |   |
| Net senior revolving credit facility borrowings      |   | 8,000                                          |    | — |   | — |   | — |   | 8,000 |   |
| Principal payments on long-term debt and leases      |   | (2,863                                         | )       | (1,623 | ) | — |   | — |   | (4,486 | ) |
| Deferred financing costs                             |   | (1,663                                         | )       | — |   | — |   | — |   | (1,663 | ) |
| Other, net                                           |   | (268                                           | )       | (545 | ) | 268 |   | 268 | (1) | 277 |   |
| Net cash provided by (used for) financing activities |   | 3,206                                          |    | (1,078 | ) | 268 |   | 268 |   | 2,128 |   |
|                                                 |   |                                           |    |   |   |   |   |   |   |   |   |
| Net cash provided by discontinued operations         |   | —                                         |    | 12,872 |   | — |   | — |   | 12,872 |   |
| Net increase (decrease) in cash and equivalents      |   | (1,145                                         | )       | 256 |   | — |   | — |   | (889 | ) |
| Cash and equivalents at beginning of period          |   | 9,641                                          |    | (163 | ) | — |   | — |   | 9,478 |   |
| Cash and equivalents at end of period                |   | $                                              | 8,496   |   | $ | 93 |   | $ | — |   | $ | — |   | $ | 8,589 |   |

 

 

27

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**ITEM 2****.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The following discussions should be read inconjunction with our financial statements and accompanying notes included inthis report.

 

**Recent Developments**

 

On May 23, 2003, we consummated the sale of our equityinterests in the subsidiaries comprising the Specialty Avionics Group to WingsHoldings, Inc., an affiliate of Odyssey Investment Partners, LLC, for $140.0million in cash.  Proceeds of $130.0million from the sale were used to repay senior credit facility borrowings, inaccordance with the facility’s terms which were amended to permit the sale.

 

As we described in our Form 10-K for the year endedDecember 31, 2002 and Form 10-Q for the three months ended March 31, 2003, ourfailure to consummate the sale of the Specialty Avionics Group by June 30, 2003would have been an event of default under the amended senior creditfacility.  As a result, our independentaccountants qualified their report on our audited financial statements, as wellas their report on DeCrane Aircraft Holdings, Inc. (our wholly-ownedsubsidiary), for the year ended December 31, 2002 with respect to our abilityto continue as a going concern. Consummation of the sale and repayment of $130.0 million of borrowingsalleviated our independent accountants doubt about DeCrane Aircrafts’ abilityto continue as a going concern.  As aresult, our independent accountants issued a revised, unqualified report onDeCrane Aircraft’s financial statements we included in a registration statementon Form S-1 regarding DeCrane Aircraft’s 12% Series B Senior Subordinated Notesdue 2008 (Registration No. 333-106381, filed with Securities and ExchangeCommission on June 23, 2003 and amended on August 12, 2003).  In the near future, we expect to file asimilar registration statement of Form S-1 regarding DeCrane Holdings’ Warrantsto Purchase Common Stock (Par Value $0.01 per Share).  Absent any adverse changes in circumstances, we expect DeCraneHoldings’ revised 2002 financial statements will contain an unqualified reportas well.    See “—Liquidity and CapitalResources—Recent Developments Affecting Financial Condition and Liquidity”below for additional information.

 

The sale of the Specialty Avionics Group is notexpected to affect the operations of the remaining operating groups.  As a result of the sale, the SpecialtyAvionics Group is presented as a discontinued operation in our consolidatedfinancial statements and our discussion below of our results of operationsreflects only continuing operations for all periods.

 

**Industry Overviewand Trends**

 

We compete in the aircraft products and servicesmarket of the aerospace industry.  Themarket for our products and services is largely driven by demand in the threecivil aircraft markets: business, VIP and head-of-state aircraft and, to alesser extent, commercial and regional aircraft.  The September 11, 2001 terrorist attack on the United States,ongoing concerns about global terrorism, the current Middle-Eastern militaryconflicts, the Severe Acute Respiratory Syndrome (SARS) epidemic and weak globaleconomic conditions are all adversely impacting travel and, in turn, theaerospace industry and our business.  Inresponse to certain of these adverse conditions, we announced and implemented aseries of restructuring activities designed to reduce expenses and conserveworking capital.  See “—Restructuring,Asset Impairment and Other Related Charges” below for additional information.

 

The business, VIP and head-of-state aircraft portionof our business experienced weakness during 2002 and will continue toexperience weakness throughout 2003 as evidenced by various manufacturers’announced plans to temporarily suspend production at various times throughoutthe year in response to the weak demand for new aircraft.  However, we believe business, VIP andhead-of-state aircraft deliveries may reflect a modest recovery in 2004 andreflect continuing recovery thereafter. The commercial aircraft portion of our business, which subsequent to thesale of the Specialty Avionics Group accounts for less than 5% of consolidatedrevenues, also experienced significant weakness in 2002 and the first half of2003 and we believe this condition will continue through 2003 and 2004, withpotential recovery not expected to occur until at least 2005.  Our beliefs are based on the assumptionsthat we will experience economic recovery and there are no further negativegeo-political developments affecting our industry.

 

**Results of Operations**

 

### **Performance Measures**

 

The following discussion of our results of operationsincludes discussions of financial measures and operating statistics we use toevaluate the performance of, and trends in, our businesses.  We believe the presentation of thesemeasures and statistics are relevant and useful to investors because it allowsthem to view performance and trends in a manner similar to the methods weuse.  These measures and statistics, andwhy they are important to us and could be of interest to you, are describedbelow.

 

 

28

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**Adjusted EBITDA.**  Our discussion of the results of operations includes discussionsof financial measures determined in accordance with accounting principlegenerally accepted in the United States of America (“GAAP”) as well as thefinancial measure Adjusted EBITDA, which excludes certain charges reflected inour GAAP basis financial statements. Our presentation of Adjusted EBITDA is in accordance with the GAAPrequirements of SFAS No. 131, “Disclosures about Segments of an Enterprise andRelated Information,” which requires us to report the primary measure ofsegment performance we use to evaluate and manage our businesses.

 

We utilize more than one measurement to evaluate segmentperformance and allocate resources among our operating segments; however, weconsider Adjusted EBITDA, as defined below, to be the primary measurement ofoverall operating segment core economic performance and return on investedcapital.  We also use Adjusted EBITDA inthe annual budgeting and planning for future periods, as one of thedecision-making criteria for funding discretionary capital expenditure andproduct development programs and as the measure for determining the value ofacquisitions and dispositions.  Ourboard of directors uses Adjusted EBITDA as one of the performance metrics fordetermining the amount of bonuses awarded to pursuant to the cash incentivebonus plan and as an indicator of enterprise value used in determining theexercise price of stock options granted and the acceleration of stock optionvesting pursuant the incentive stock option plan.

 

We define Adjusted EBITDA as earnings before interest,income taxes, depreciation and amortization, restructuring, asset impairmentand other related charges, acquisition related charges not capitalized andother noncash and nonoperating charges. We believe the presentation of this measure is relevant and useful toinvestors because it allows investors and analysts to view segment performancein a manner similar to the method we use, helps improve their ability tounderstand our core segment performance, adjusted for items we believe areunusual, and makes it easier to compare our results with other companies thathave 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 of calculating Adjusted EBITDA may not beconsistent with that of other companies and should be viewed in conjunctionwith measurements that are computed in accordance GAAP, such as net income(loss), the nearest comparable GAAP financial measure.  Adjusted EBITDA should not be viewed assubstitutes for or superior to net income (loss), cash flow from operations orother data prepared in accordance with GAAP as a measure of our profitabilityor liquidity.  The notes to ourfinancial statements include information about our operating segments,including 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) to clarify the differences 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 the total invoice value of purchaseorders received during the period and backlog represents the total invoicevalue of unfilled purchase orders as of the end of a period.  Orders may be subject to change orcancellation by the customer prior to shipment.  The level of unfilled orders at any given date during the yearwill be materially affected by the timing of our receipt of orders and thespeed with which those orders are filled.

 

29

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### **Three Months Ended June **30, 2003 Compared to Three Months EndedJune 30, 2002

 

Our results of operations have been affected byrestructuring, asset impairment and other related charges relating to a seriesof restructuring activities and goodwill impairment charges.  These charges, which affect the comparabilityof our reported results of operations between periods, are more fully describedin “—Restructuring, Asset Impairment and Other Related Charges” and “—GoodwillImpairment Charges” below.

 

**Revenues.* ***Revenuesdecreased $17.2 million, or 28.1%, to $44.1 million for the three months endedJune 30, 2003 from $61.3 million for the three months ended June 30, 2002.  By segment, revenues changed as follows:

 
|                     |   | **Increase (Decrease)  From 2002** |   |
|--------------------------|--------|------------------------------------|--------|
| **(In millions)**        |   | **Amount**                         |   | **Percent** |   |
|                     |   |                               |   |   |   |
| Cabin Management         |   | $                                  | (18.6  | ) | (38.6 | )% |
| Systems  Integration     |   | 1.5                                |   | 11.3 |   |
| Inter-group  elimination |   | (0.1                               | )      |   |   |
| Total                    |   | $                                  | (17.2  | ) |   |   |

 

*CabinManagement. *Revenuesdecreased by $18.6 million, or 38.6% compared to the prior year.  The decrease, which is across all of ourproduct and services categories, is caused by the ongoing adverse impact ofweak global economic conditions which reduces the affordability of business,VIP and head-of-state aircraft and therefore demand for the products andservices we provide.  The 2003 decreaseconsists of:

 

•      a $18.0 million decrease in aircraftfurniture and related products revenues; and

 

•      a $1.2 million decrease in cabinmanagement and entertainment systems revenues;

 

•      a $0.2 million decrease in seatingproducts revenues; offset by,

 

•      a $0.8 million increase in other productand services revenues.

 

The revenue decrease wascaused by lower order volume from our customers.  Revenues from Textron and Bombardier, our principal customers,decreased $14.1 million compared to the prior year as a result of the decreasein orders and resulting lower production of aircraft they are experiencing dueto the economic downturn.  We alsoexperienced similar volume decreases from our other customers during theperiod.

 

*SystemsIntegration.*  Revenuesincreased by $1.5 million, or 11.3% compared to the prior year, due to:

 

•      a $2.1 million increase resulting fromrevenue recognized pursuant to the “take-or-pay” provisions of a major supplycontract; offset by,

 

•      a $0.6 million decrease in the commercialaircraft systems integration engineering services provided in the aftermath ofSeptember 11th and resulting down-turn in the commercial airlineindustry; the airline industry’s corresponding reduction in the size of itsoperating fleet and the delay or postponement of retrofit and refurbishmentprograms for the remaining operational fleet reduced demand for our integrationand engineering services.

 

30

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**Grossprofit. **Gross profit decreased $14.8 million to aloss of $1.3 million for the three months ended June 30, 2003 from $13.5million for the same period last year. By segment, gross profit changed as follows:

 
|                 |   | **Increase (Decrease)  From 2002** |   |
|----------------------|--------|------------------------------------|--------|
| **(In millions)**    |   | **Amount**                         |   | **Percent** |   |
|                 |   |                               |   |   |   |
| Cabin Management     |   | $                                  | (13.8  | ) | (182.5 | )% |
| Systems  Integration |   | (1.0                               | )      | (17.7 | ) |
| Total                |   | $                                  | (14.8  | ) |   |   |

 

*CabinManagement.*  Grossprofit decreased by $13.8 million, or 182.5% compared to the prior year,primarily due to:

 

•      a $5.9 million decrease in profit marginsdue to lower volume for our business, VIP and head-of-state aircraft furnitureand seating products; and

 

•      a $0.6 million decrease in gross profitrelated to lower volume for our cabin management and entertainment systems; and

 

•      a $8.1 million decrease caused byrestructuring charges incurred in 2003 as compared to those recorded in 2002related to the consolidation of our seating and related manufacturingoperations; offset by

 

•      a $0.8 million increase in revenues forother products and services.

 

*SystemsIntegration.*  Grossprofit decreased by $1.0 million, or 17.7% compared to the prior year,primarily due to:

 

•      a $0.5 million decrease resulting fromlower revenues and unfavorable overhead absorption as a result of lowerproduction and a change in product delivery mix; and

 

•      a $0.5 million decrease in the commercialaircraft systems integration engineering services provided.

 

**Selling,general and administrative expenses.**  Selling, general and administrative expensesdecreased $5.0 million, or 44.2%, to $6.3 million for the three months endedJune 30, 2003, from $11.3 million for the same period last year.  By segment, SG&A expenses changed asfollows:

 
|                 |   | **Increase (Decrease)  From 2002** |   |
|----------------------|--------|------------------------------------|--------|
| **(In millions)**    |   | **Amount**                         |   | **Percent** |   |
|                 |   |                               |   |   |   |
| Cabin Management     |   | $                                  | (4.0   | ) | (49.5 | )% |
| Systems  Integration |   | (1.2                               | )      | (56.7 | ) |
| Corporate            |   | 0.2                                |   |   |   |
| Total                |   | $                                  | (5.0   | ) |   |   |

 

*CabinManagement. *SG&Aexpenses decreased by $4.0 million, or 49.5% compared to the prior year, dueto:

 

•      a $2.4 million reduction resulting fromrestructuring charges recorded in 2003 as compared to those recorded in 2002related to the consolidation of our seating and related manufacturingoperations; and

 

•      a $1.6 million decrease in expensesresulting from cost reduction measures implemented in response to lower salesvolume resulting from the weak global economic conditions.

 

31

----

 

*SystemsIntegration. *SG&Aexpenses decreased by $1.2 million, or 56.7% compared to the prior year, due tolower labor and employee benefit costs resulting from workforce reductions in2003.

 

**Impairment of goodwill. **During the three monthsended June 30, 2003, a $34.0 million charge was recorded to reflect theadditional impairment of goodwill in connection with the impairment testingprovision of SFAS No. 142, “Goodwill and Other Intangible Assets.”  The additional impairment results fromcontinued weak global economic conditions, which reduces the affordability ofbusiness, VIP and head-of-state aircraft and therefore demand for the productsand services we provide.  The impairmentcharge pertains to our furniture manufacturing reporting unit within our CabinManagement Group.  See “—GoodwillImpairment Charges” below for additional information.

 

**Depreciationand amortization of intangibles.**  Depreciation and amortization expense decreased $0.2 million to $2.5million for the three months ended June 30, 2003 from $2.7 million for the sameperiod last year, primarily resulting from reduced capital expenditures and alower depreciable base resulting from impairment charges recorded during 2002as follows:

 
|                                         |   | **Increase (Decrease)  From 2002** |   |
|----------------------------------------------|--------|------------------------------------|--------|
| **(In millions)**                            |   | **Amount**                         |   | **Percent** |   |
|                                         |   |                               |   |   |   |
| Depreciation  charged to:                    |   |                               |   |   |   |
| Cost of sales                                |   | $                                  | (0.1   | ) | (8.1 | )% |
| Selling, general  and administrative expense |   | (0.2                               | )      | (25.1 | ) |
| Amortization of  intangible assets           |   | 0.1                                |   | 8.2 |   |
| 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 additional informationabout Adjusted EBITDA, and should be read in conjunction with the discussionspresented herein.  The notes to ourfinancial statements also include a reconciliation of Adjusted EBITDA to netincome (loss), a GAAP financial measure, to clarify the differences betweenthese two measures.

 

*Cabin Management. *Adjusted EBITDA decreased by $4.7 million, or 52.3%compared to the prior year primarily due to:

 

•      a $5.3 million decrease in gross profitrelated to our business/VIP aircraft furniture and seating operations; and

 

•      a $0.6 million decrease in gross profitrelated our cabin management and entertainment systems; offset by,

 

•      a $1.2 million increase in gross profitrelated to our other products and services.

 

*SystemsIntegration. *AdjustedEBITDA increased by $0.1 million, or 2.1% over the prior year, due to reducedSG&A spending resulting from workforce reductions.

 

**Operatingincome.**  Operatingincome decreased $43.7 million to a loss of $42.5 million for the three monthsended June 30, 2003, from income of $1.3 million for the same period lastyear.  By segment, operating incomechanged as follows:

 

32

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|                 |   | **Increase (Decrease)  From 2002** |   |
|----------------------|--------|------------------------------------|--------|
| **(In millions)**    |   | **Amount**                         |   | **Percent** |   |
|                 |   |                               |   |   |   |
| Cabin Management     |   | $                                  | (43.8  | ) | (4380.0 | )% |
| Systems  Integration |   | 0.2                                |   | 4.7 |   |
| Corporate            |   | (0.1                               | )      |   |   |
| Total                |   | $                                  | (43.7  | ) |   |   |

 

*CabinManagement. *Operatingincome decreased by $43.8 million, or 4380.0% compared to the prior year, dueto:

 

•      a $4.1 million decrease in gross profit,principally related to lower revenues in our business, VIP and head-of-stateaircraft furniture and seating operations;

 

•      a $34.0 million increase in goodwillimpairment charges; and

 

•      a $5.7 million increase in restructuringcharges recorded in 2003 as compared to those recorded in 2002 related to theconsolidation of our seating and related manufacturing operations.

 

*SystemsIntegration.*Operating income increased by $0.2 million, or4.7% compared to the prior year, due to reduced SG&A spending resultingfrom workforce reductions in 2003.

 

**Interestexpense.**  Interestexpense decreased $0.4 million, or 4.8%, to $7.6 million for the three monthsended June 30, 2003 compared to $8.0 million for the same period lastyear.  The decrease is attributable tolower outstanding debt balances for a portion of the quarter in the currentyear.

 

**Minorityinterest in preferred stock of subsidiary. **Minority interest increased $0.2 million to $1.6million for the three months ended June 30, 2003 compared to $1.4 million forthe same period last year.  Minorityinterest reflects the accrued dividends, which are compounded quarterly, andredemption value accretion during the periods on DeCrane Aircrafts’ 16%preferred stock.

 

**Provisionfor income taxes.**  Theprovision for income taxes, based on the reported consolidated pre-tax loss,differs from the amount determined by applying the applicable U.S. statutoryfederal rate to the pre-tax loss primarily due to the effects of state andforeign income taxes, the non-deductible portion of goodwill impairment chargesand minority interest in preferred stock of subsidiary, which is not deductiblefor income tax purposes.

 

During the three months ended June 30, 2003, weestablished a $13.1 million valuation allowance for the net deferred tax assetswhich may not be realized in the future. We evaluated our deferred assets for expected recoverability based onthe nature of the item, the associated taxing jurisdictions, the applicableexpiration dates and future taxable income forecasts that would impactutilization.  Based on our evaluation,we determined that recovery was not likely in certain taxing jurisdictions andapplied our judgment in estimating the amount of valuation allowance necessaryunder the circumstances to reduce the assets carrying value to realizablevalue.  We will reduce the valuationallowance in the future for each item at such time when we determine thatrecoverability is more likely than not.

 

**Loss from continuing operations.**  The loss from continuing operationsincreased $36.6 million to a loss of $42.4 million for the three months endedJune 30, 2003 compared to a loss of $5.8 million for the same period last year,primarily due to:

 

•      a $43.7 million decrease in operatingincome resulting, in part, from a $34.0 million goodwill impairment charge; and

 

•      a $0.2 million increase in minorityinterest in preferred stock of subsidiary; offset by

 

33

----

 

•      a $7.2 million increase in the provisionfor income tax benefit.

 

**Income from discontinued operations.**  Income from discontinued operationsdecreased $1.1 million to $1.3 million for the three months ended June 30, 2003compared to $2.4 million for the same period last year primarily the result ofthe disposition of the Specialty Avionics Group on May 22, 2003 as compared toa full quarter of results included in the prior year.

 

**Netloss.**  Net lossincreased $37.8 million to a net loss of $41.2 million for the three monthsended June 30, 2003 compared to a net loss of $3.4 million for the same periodlast year.  The increase is attributableto an increases in the loss from continuing operations of $36.6 million and adecrease in the income from discontinued operations of $1.1 million.

 

**Net lossapplicable to common stockholders.**  Net loss applicable to our common stockholders increased $38.1million to a net loss of $43.4 million for the three months ended June 30, 2003compared to a net loss of $5.3 million for the same period last year.  The increase in the net loss applicable toour common stockholder is attributable to:

 

•      a $37.8 million increase in our net loss;and

 

•      a $0.3 million increase in noncashpreferred stock dividend accretion on our 14% mandatorily redeemable preferredstock.

 

**Bookings. **Bookings decreased $23.4million, or 31.1%, to $51.9 million for the three months ended June 30, 2003compared to $75.3 million for the same period last year.  The decrease in bookings for 2003 is due todecreases in orders for all of our business segments.

 

**Backlogat end of period.**  Backlogincreased $7.3 million to $74.1 million as of June 30, 2003 compared to $66.8million as of December 30, 2002.

 

As described in “—Industry Overview and Trends,” theacts and ongoing threats of global terrorism, the current military conflicts,SARS epidemic and weak global economic conditions are having an adverse impacton our business, resulting in the decrease in bookings during 2003 and relatedbacklog at the end of the period.  Inaddition, we believe that some of our customers have substantially reducedtheir order lead times which may have adversely affected bookings during theperiod.

 

We are not able to predict the continuing impact theseevents will have on bookings and backlog in future periods.  However, given the magnitude of these events,the adverse impact could be material.

 

### **Six Months Ended June** 30, 2003 Compared to Six MonthsEnded June 30, 2002

 

**Revenues.* ***Revenuesdecreased $36.1 million, or 29.6%, to $86.0 million for the six months endedJune 30, 2003 from $122.1 million for the six months ended June 30, 2002.  By segment, revenues changed as follows:

 
|                     |   | **Increase (Decrease)  From 2002** |   |
|--------------------------|--------|------------------------------------|--------|
| **(In millions)**        |   | **Amount**                         |   | **Percent** |   |
|                     |   |                               |   |   |   |
| Cabin Management         |   | $                                  | (33.8  | ) | (36.0 | )% |
| Systems  Integration     |   | (1.5                               | )      | (5.1 | ) |
| Inter-group  elimination |   | (0.8                               | )      |   |   |
| Total                    |   | $                                  | (36.1  | ) |   |   |

 

34

----

 

*CabinManagement. *Revenuesdecreased by $33.8 million, or 36.0% compared to the prior year.  The decrease, which is across all of ourproduct and services categories, is caused by the ongoing adverse impact ofweak global economic conditions which reduces the affordability of business,VIP and head-of-state aircraft and therefore demand for the products andservices we provide.  The 2003 decreaseconsists of:

 

•      a $29.5 million decrease in aircraftfurniture and related products revenues;

 

•      a $2.8 million decrease in cabinmanagement and entertainment systems revenues;

 

•      a $1.8 million decrease in seatingproducts revenues; offset by,

 

•      a $0.3 million increase in other product andservices revenues.

 

The revenue decrease wascaused by lower order volume from our customers.  Revenues from Textron and Bombardier, our principal customers,decreased $24.4 million compared to the prior year as a result of the decreasein orders and resulting lower production of aircraft they are experiencing dueto the economic downturn.  We alsoexperienced similar volume decreases from our other customers during theperiod.

 

*SystemsIntegration.*  Revenuesdecreased by $1.5 million, or 5.1% compared to the prior year, due to:

 

•      a $1.3 million decrease in the commercialaircraft systems integration engineering services provided in the aftermath ofSeptember 11th and resulting down-turn in the commercial airlineindustry; the airline industry’s corresponding reduction in the size of itsoperating fleet and the delay or postponement of retrofit and refurbishmentprograms for the remaining operational fleet reduced demand for our integrationand engineering services; and

 

•      a $2.3 million decrease resulting fromreduced production and delivery of business, VIP and head-of-state aircraftproducts and services due to the adverse impact weak global economic conditionsare having on the demand for those types of aircraft; offset by

 

•      a $2.1 million increase resulting fromrevenue pursuant to the “take-or-pay” provisions of a major supply contract.

 

**Grossprofit.**  Gross profitdecreased $20.2 million, or 67.5%, to $9.7 million for the six months endedJune 30, 2003 from $29.9 million for the same period last year.  By segment, gross profit changed as follows:

 
|                 |   | **Increase (Decrease)  From 2002** |   |
|----------------------|--------|------------------------------------|--------|
| **(In millions)**    |   | **Amount**                         |   | **Percent** |   |
|                 |   |                               |   |   |   |
| Cabin Management     |   | $                                  | (16.3  | ) | (93.1 | )% |
| Systems  Integration |   | (3.9                               | )      | (32.3 | ) |
| Total                |   | $                                  | (20.2  | ) |   |   |

 

*CabinManagement.*  Grossprofit decreased by $16.3 million, or 93.1% compared to the prior year,primarily due to:

 

•      a $9.8 million decrease in profit marginsdue to lower volume for our business, VIP and head-of-state aircraft furnitureand seating products; and

 

•      a $1.0 million decrease in gross profitrelated to lower volume for our cabin management and entertainment systems; and

 

•      a $6.9 million increase caused byrestructuring charges incurred in 2003 as compared to those recorded in 2002related to the consolidation of our seating and related manufacturingoperations; offset by

 

35

----

 

•      a $1.4 million increase in other productsand services.  $0.2 million of theincrease is the result of an increase in revenues and the remaining increase of$1.2 million is due to a $2.1 million decrease in materials costs, offset by a$0.9 million increase in direct labor and overhead costs.

 

*SystemsIntegration.*  Grossprofit decreased by $3.9 million, or 32.3% compared to the prior year,primarily due to:

 

•      a $3.0 million decrease resulting fromlower revenues and unfavorable overhead absorption as a result of lowerproduction and a change in product delivery mix; and

 

•      a $0.9 million decrease in the commercialaircraft systems integration engineering services provided.

 

**Selling,general and administrative expenses.**  Selling, general and administrative expensesdecreased $9.3 million, or 40.7%, to $13.5 million for the six months endedJune 30, 2003, from $22.7 million for the same period last year.  By segment, SG&A expenses changed asfollows:

 
|                 |   | **Increase (Decrease)  From 2002** |   |
|----------------------|--------|------------------------------------|--------|
| **(In millions)**    |   | **Amount**                         |   | **Percent** |   |
|                 |   |                               |   |   |   |
| Cabin Management     |   | $                                  | (7.5   | ) | (47.5 | )% |
| Systems  Integration |   | (2.0                               | )      | (47.2 | ) |
| Corporate            |   | 0.2                                |   |   |   |
| Total                |   | $                                  | (9.3   | ) |   |   |

 

*CabinManagement. *SG&Aexpenses decreased by $7.5 million, or 47.5% compared to the prior year, dueto:

 

•      a $5.3 million reduction caused byrestructuring charges incurred in 2003 as compared to those recorded in 2002related to the consolidation of our seating and related manufacturingoperations; and

 

•      a $2.2 million decrease in expensesresulting from cost reduction measures implemented in response to lower salesvolume resulting from the weak global economic conditions.

 

*SystemsIntegration. *SG&Aexpenses decreased by $2.0 million, or 47.2% compared to the prior year, due tolower labor and employee benefit costs resulting from workforce reductions in2003.

 

**Impairment of goodwill. **During the six monthsended June 30, 2003, a $34.0 million charge was recorded to reflect theadditional impairment of goodwill in connection with the impairment testingprovision of SFAS No. 142, “Goodwill and Other Intangible Assets.”  The additional impairment results fromcontinued weak global economic conditions which reduces the affordability ofbusiness, VIP and head-of-state aircraft and therefore demand for the productsand services we provide.  The impairmentcharge pertains to our furniture manufacturing reporting unit within our CabinManagement Group.  See “—GoodwillImpairment Charges” below for additional information.

 

**Depreciationand amortization of intangibles.**  Depreciation and amortization expense decreased $0.5 million to$5.0 million for the six months ended June 30, 2003 from $5.5 million for thesame period last year, primarily resulting from reduced capital expendituresand a lower depreciable base resulting from impairment charges recorded during2002 as follows.

 

36

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|                                         |   | **Increase (Decrease)  From 2002** |   |
|----------------------------------------------|--------|------------------------------------|--------|
| **(In millions)**                            |   | **Amount**                         |   | **Percent** |   |
|                                         |   |                               |   |   |   |
| Depreciation  charged to:                    |   |                               |   |   |   |
| Cost of sales                                |   | $                                  | (0.3   | ) | (11.9 | )% |
| Selling, general  and administrative expense |   | (0.3                               | )      | (21.4 | ) |
| Amortization of  intangible assets           |   | 0.1                                |   | 6.3 |   |
| Total                                        |   | $                                  | (0.5   | ) |   |   |

 

**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.

 

*CabinManagement. *Adjusted EBITDA decreased by $7.6 million,or 46.3% compared to the prior year primarily due to:

 

•      a $7.7 million decrease in gross profitrelated to our business/VIP aircraft furniture and seating operations; and

 

•      a $1.0 million decrease in gross profitrelated our cabin management and entertainment systems; offset by,

 

•      a $1.4 million increase in gross profitrelated to our other products and services.

 

*SystemsIntegration. *AdjustedEBITDA decreased by $2.1 million, or 24.5% over the prior year, due to lowersales volume partially offset by reduced SG&A spending resulting fromworkforce reductions.

 

**Operatingincome.**  Operatingincome decreased $45.1 million to a loss of $39.6 million for the six monthsended June 30, 2003, from $5.5 million for the same period last year.  By segment, operating income changed asfollows:

 
|                 |   | **Increase (Decrease)  From 2002** |   |
|----------------------|--------|------------------------------------|--------|
| **(In millions)**    |   | **Amount**                         |   | **Percent** |   |
|                 |   |                               |   |   |   |
| Cabin Management     |   | $                                  | (43.2  | ) | 792.5 | % |
| Systems  Integration |   | (1.9                               | )      | (27.8 | ) |
| Total                |   | $                                  | (45.1  | ) |   |   |

 

*CabinManagement. *Operatingincome decreased by $43.2 million, or 792.5% compared to the prior year, dueto:

 

•      a $1.6 million increase in restructuringcharges incurred in 2003 as compared to those recorded in 2002 related to theconsolidation of our seating and related manufacturing operations; and

 

•      a $34.0 million increase in goodwillimpairment charges; and

 

•      a $9.8 million decrease in gross profit,primarily due to lower revenues related to our furniture and seatingoperations; offset by

 

•      a $2.2 million decrease in expensesresulting from cost reduction measures implemented in response to lower salesvolume resulting from the weak global economic conditions;

 

37

----

 

*SystemsIntegration.*Operating income decreased by $1.9 million, or27.8% compared to the prior year, due primarily to lower revenues, offset byreduced SG&A spending.

 

**Interestexpense.**  Interestexpense decreased $0.5 million, or 2.9%, to $15.3 million for the six monthsended June 30, 2003 compared to $15.8 million for the same period lastyear.  We expect interest expense todecrease in 2003 as a resulting of lower debt outstanding, partially offset byhigher interest rates charged by our lenders as a result of the amendment toour senior credit facility.

 

**Minorityinterest in preferred stock of subsidiary. **Minority interest increased $0.4 million to $3.2million for the six months ended June 30, 2003 compared to $2.8 million for thesame period last year.  Minorityinterest reflects the accrued dividends, which are compounded quarterly, andredemption value accretion during the periods on DeCrane Aircrafts’ 16%preferred stock.

 

**Provisionfor income taxes.**  Theprovision for income taxes, based on the reported consolidated pre-tax loss,differs from the amount determined by applying the applicable U.S. statutoryfederal rate to the pre-tax loss primarily due to the effects of state andforeign income taxes, the non-deductible portion of goodwill impairment chargesand minority interest in preferred stock of subsidiary, which is not deductiblefor income tax purposes.

 

During the six months ended June 30, 2003, weestablished a $13.1 million valuation allowance for the net deferred tax assetswhich may not be realized in the future. We evaluated our deferred assets for expected recoverability based onthe nature of the item, the associated taxing jurisdictions, the applicableexpiration dates and future taxable income forecasts that would impactutilization.  Based on our evaluation,we determined that recovery was not likely in certain taxing jurisdictions andapplied our judgment in estimating the amount of valuation allowance necessaryunder the circumstances to reduce the assets carrying value to realizablevalue.  We will reduce the valuation allowancein the future for each item at such time when we determine that recoverabilityis more likely than not.

 

**Loss from continuing operations.**  The loss from continuing operationsincreased $38.2 million to a loss of $47.5 million for the six months endedJune 30, 2003 compared to a loss of $9.3 million for the same period last year,primarily due to:

 

•      a $45.1 million decrease in operatingincome resulting, in part, from a $34.0 million goodwill impairment charge; and

 

•      a $0.4 million increase in minorityinterest in preferred stock of subsidiary; offset by

 

•      a $7.3 million increase in the provisionfor income tax benefit

 

**Loss from discontinued operations.**  Loss from discontinued operations decreased$29.9 million, to a loss of $4.5 million for the six months ended June 30, 2003compared to a loss of $34.4 million for the same period last year.  The decrease is primarily due to:

 

•      a $39.4 million charge in 2002 to reflectthe cumulative effect on discontinued operations of the change in accounting principleassociated with initial adoption of SFAS No. 142, “Goodwill and OtherIntangible Assets” as described below; offset by

 

•      a $7.5 million charge in 2003 to theimpairment of goodwill to reduce the carrying value of assets sold to theirestimated net realizable value; and

 

•      the result of the disposition of theSpecialty Avionics Group on May 22, 2003 as compared to a full six months ofresults included in the prior year.

 

38

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**Cumulative effect of change in accounting principle.**  The$17.8 million charge in 2002 to reflect the cumulative effect on continuingoperations of the change in accounting principle was a result of transitionalgoodwill impairment charges recognized upon initial adoption of SFAS No. 142,“Goodwill and Other Intangible Assets.” Including the $39.4 million charged to discontinued operations, thetotal charge to reflect the cumulative effect of the change in accountingprinciple was $57.2 million.

 

**Netloss.**  Net lossdecreased $9.6 million to a net loss of $51.9 million for the six months endedJune 30, 2003 compared to a net loss of $61.5 million for the same period lastyear.  The decrease is attributable to:

 

•      an increase in loss from continuingoperations of $38.2 million; offset by

 

•      a decrease in loss from discontinuedoperations of $29.9 million; and

 

•      a decrease in cumulative effect of changein accounting principle of $17.8 million

 

**Net lossapplicable to common stockholders.**  Net loss applicable to our common stockholders, our commonstockholder, decreased $9.0 million to a net loss of $56.4 million for the sixmonths ended June 30, 2003 compared to a net loss of $65.4 million for the sameperiod last year.  The decrease in thenet loss applicable to our common stockholder is attributable to:

 

•      a $9.6 million decrease in our net loss;offset by

 

•      a $0.6 million increase in noncashpreferred stock dividend accretion on our 14% mandatorily redeemable preferredstock.

 

**Bookings. **Bookings decreased $15.9million, or 14.6 %, to $93.3 million for the six months ended June 30, 2003compared to $109.2 million for the same period last year.  The decrease in bookings for 2003 is due todecreases in orders for all of our business segments.

 

39

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**Restructuring**,Asset Impairment and Other Related Charges

** **

The following discussion should be read in conjunctionwith Note 3 accompanying our financial statements included in this report.

 

During the three months and six months ended June 30,2003, we recorded restructuring, asset impairment and other related pre-taxcharges related to a series of restructuring activities.  These charges, and the effect these chargeshad on our reported results of operations, are summarized below.

 
|                                                                       |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|----------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
| **(In millions)**                                                          |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                                                       |   |                             |   |                           |   |   |   |   |   |
| Nature of charges:                                                         |   |                             |   |                           |   |   |   |   |   |
| Seating Product Line and Furniture Manufacturing Facilities  Restructuring |   | $                                | 13.4   |                           | $      | — |   | $ | 13.4 |   | $ | — |   |
| Seat Manufacturing Facilities Restructuring                                |   | —                           |   | 2.3                            |   | — |   | 6.3 |   |
| Asset Realignment Restructuring                                            |   | —                           |   | 5.4                            |   | — |   | 5.4 |   |
| Goodwill impairment charges                                                |   | 34.0                             |   | —                         |   | 41.5 |   | — |   |
| Total pre-tax charges                                                      |   | $                                | 47.4   |                           | $      | 7.7 |   | $ | 54.9 |   | $ | 11.7 |   |
|                                                                       |   |                             |   |                           |   |   |   |   |   |
| Business segment recording the charges:                                    |   |                             |   |                           |   |   |   |   |   |
| Cabin Management                                                           |   | $                                | 47.4   |                           | $      | 7.7 |   | $ | 47.4 |   | $ | 11.7 |   |
| Systems Integration                                                        |   | —                           |   | —                         |   | — |   | — |   |
| Total charged to continuing operations                                     |   | 47.4                             |   | 7.7                            |   | 47.4 |   | 11.7 |   |
| Specialty Avionics (discontinued operations)                               |   | —                           |   | —                         |   | 7.5 |   | — |   |
| Total pre-tax charges                                                      |   | $                                | 47.4   |                           | $      | 7.7 |   | $ | 54.9 |   | $ | 11.7 |   |
|                                                                       |   |                             |   |                           |   |   |   |   |   |
| Charged to operations:                                                     |   |                             |   |                           |   |   |   |   |   |
| Cost of sales                                                              |   | $                                | 12.8   |                           | $      | 4.7 |   | $ | 12.8 |   | $ | 5.9 |   |
| Selling, general and administrative expenses                               |   | 0.6                              |   | 3.0                            |   | 0.6 |   | 5.8 |   |
| Impairment of goodwill                                                     |   | 34.0                             |   | —                         |   | 34.0 |   | — |   |
| Total charged to continuing operations                                     |   | 47.4                             |   | 7.7                            |   | 47.4 |   | 11.7 |   |
| Charged to discontinued operations                                         |   | —                           |   | —                         |   | 7.5 |   | — |   |
| Total pre-tax charges                                                      |   | $                                | 47.4   |                           | $      | 7.7 |   | $ | 54.9 |   | $ | 11.7 |   |
|                                                                       |   |                             |   |                           |   |   |   |   |   |
| Components of charges:                                                     |   |                             |   |                           |   |   |   |   |   |
| Noncash charges                                                            |   | $                                | 43.9   |                           | $      | 2.8 |   | $ | 43.9 |   | $ | 5.9 |   |
| Cash charges                                                               |   | 3.5                              |   | 4.9                            |   | 3.5 |   | 5.8 |   |
| Total charged to continuing operations                                     |   | 47.4                             |   | 7.7                            |   | 47.4 |   | 11.7 |   |
| Charged to discontinued operations                                         |   | —                           |   | —                         |   | 7.5 |   | — |   |
| Total pre-tax charges                                                      |   | $                                | 47.4   |                           | $      | 7.7 |   | $ | 54.9 |   | $ | 11.7 |   |

 

 

40

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**Seating Product Line and FurnitureManufacturing Facilities Restructuring**

 

During the second quarter of fiscal 2003, weconsolidated our seating product line offerings and adopted a restructuringplan to down-size a furniture manufacturing facility in response to continuingweakness in the business, VIP and head-of-state aircraft market.  These actions were designed to reduceengineering, production and inventory carrying costs by supporting fewerproduct offerings and achieve profitability at the furniture manufacturingfacility based on its lower production levels. In connection with these actions, we recorded pre-tax charges tooperations totaling $13,394,000 during the second quarter of fiscal 2003.  The charges are comprised of the following:

** **

•                  *Seating Product Line Consolidation. *The curtailment**ofseveral seating product offerings and conversion of seat products whichincorporate a new single-design technology resulted in the write-off of $6.3million of inventoried costs related to the discontinued product offerings.

** **

•                  *Excess and Obsolete Inventory*Write*-Downs. *Inventory was written down by $3.1 millionto reflect its net realizable value for quantities on hand exceeding currentand forecast order backlog requirements and obsolete inventory related to the curtailedseating product offerings.

** **

•                  *LeaseTermination and Related Charges. *Leasetermination costs related to future estimated rental payments under existinglong-term lease agreements for the facilities permanently vacated in connectionwith down-sizing a furniture manufacturing facility.  Future payments have been reduced by the expected subleaseincome.  The net future payments arebased on estimated current market rates and anticipated dates that thesefacilities will be subleased.  Ifmarket-rates decrease or should it take longer than expected to sublease thesefacilities, the actual loss could exceed these estimates.  Other related charges include the write-offof leasehold improvements related to the vacated facilities.

** **

•                  *Severanceand Other Compensation Costs.*  We have reduced our total workforce at thedown-sized facility by 49 employees, or 37%, between December 31, 2002 and June30, 2003.

** **

During 2003, we paid $0.2 million of costs related tothis restructuring in cash and a $3.3 million restructuring reserve remained asof June 30, 2003 solely for the remaining lease termination and otherrelated costs.  Future cash paymentswill be funded from existing cash balances and internally generated cash fromoperations.

** **

**Asset RealignmentRestructuring**

** **

During the second quarter of fiscal 2001, we adopted arestructuring plan to realign aircraft furniture production programs among ourmanufacturing facilities.  In addition,and in response to the adverse impact on the aerospace industry resulting fromthe September 11th terrorist attack and its aftermath, as well asthe weakening of global economic conditions, we announced and implemented afurther restructuring plan in December 2001 designed to reduce costs andconserve working capital.  This planincluded permanently closing one manufacturing facility and idling a secondfacility for an indefinite period, curtailing several product developmentprograms and instituting workforce reductions.

 

Due to the ongoing weakness of the business, VIP andhead-of-state aircraft market, we decided during the second quarter of fiscal2002 to permanently close the temporarily idled manufacturing facility.  In connection with this decision, we recordedadditional pre-tax charges to operations totaling $6.9 million during the yearended December 31, 2002, of which $3.8 million were noncash charges, foradditional impairment of long-lived assets, current asset write-downs and otherrelated expenses.

 

This restructuring plan was completed during thefourth quarter of fiscal 2002.

 

**Seat ManufacturingFacilities Restructuring**

** **

During the first quarter of fiscal 2002, we announcedwe would consolidate the production of four seating and related manufacturingfacilities into two, resulting in the permanent closure of two facilities.  This plan was designed to improvemanufacturing efficiencies and to further reduce costs and conserve workingcapital.  In connection with thisrestructuring plan, we recorded pre-tax charges to operations

 

41

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totaling $6.3 millionduring the year ended December 31, 2002, of which $3.6 million were noncashcharges, for restructuring, asset impairment and other related restructuringcharges.

 

The restructuring, asset impairment and other relatedexpenses are comprised of charges for current asset write-downs, the impairmentof long-lived assets, severance and lease termination costs and otherrestructuring-related expenses pertaining to FAA retesting and recertification,moving, transportation and travel costs and shutdown and startup costs.

 

This restructuring plan was completed during thesecond quarter of fiscal 2002.

 

**Goodwill Impairment Charges**

 

As a result of the continuing weakness in thebusiness, VIP and head-of-state aircraft market and the decision to down-size afurniture manufacturing facility, the goodwill associated with the furnituremanufacturing reporting unit was tested for recoverability and found to beimpaired.  As a result, $34,000,000 ofgoodwill associated with the reporting unit was written off and charged tooperations.

 

During the first quarter of fiscal 2003, we enteredinto a definitive agreement to sell our Specialty Avionics Group.  Based upon the fair value of the groupimplied in the definitive agreement, we determined that the carrying value ofone of the reporting unit’s net assets was not fully recoverable.  As a result, we recorded a goodwillimpairment charge of $7.5 million during the three months endedMarch 31, 2003 to reduce the carrying value to the estimated netrealizable value established by the definitive agreement.

 

See “—Goodwill Impairment Charges” below foradditional information.

 

## **GoodwillImpairment Charges**

## ** **

The following discussion should be read in conjunctionwith the Notes 3 and 5 accompanying our financial statements.

 

Our results of operations for the three months and sixmonths ended June 30, 2003 and 2002 have been affected by the adoption of SFASNo. 142, “Goodwill and Other Intangible Assets,” and goodwill impairmentcharges.

 

Effective January 1, 2002, we adopted SFAS No. 142,“Goodwill and Other Intangible Assets” and the provisions of SFAS No. 141,“Business Combinations,” which were required to be adopted concurrent with theadoption of SFAS No. 142.  Adoption ofthese accounting pronouncements resulted in the following:

 

•      *Reclassification of Intangible Assets.*  Intangible assets relating to acquiredassembled workforce intangibles not meeting the criteria for recognition apartfrom goodwill were reclassified to goodwill, net of deferred income taxes.

 

•      *Discontinuance of Goodwill Amortization.*  Goodwill is deemed to be an indefinite-livedasset.  As a result, and in accordancewith SFAS No. 142, the recording of periodic goodwill amortization charges wasdiscontinued effective January 1, 2002.

 

•      *Annual Testing for Goodwill Impairment.*  In lieu of periodic goodwill amortizationcharges, SFAS No. 142 requires goodwill to be tested annual for impairment, orwhen events or changes in circumstances indicate the carrying value may not berecoverable.

 

During 2002, we completed the transitional impairmenttesting of goodwill recorded as of January 1, 2002 as required under SFASNo. 142.  Fair value of each reportingunit was determined using a discounted cash flow approach taking intoconsideration projections based on the individual characteristics of thereporting units, historical trends, market multiples for comparable businessesand independent appraisals.  Our CabinManagement Group consists of three reporting units, our Systems IntegrationGroup consists of two and the Specialty Avionics consists of three.  Unallocated goodwill was allocated to thereporting units for impairment testing purposes.  The results indicated that the carrying value of goodwill wasimpaired at one of the reporting units within each of our operatinggroups.  The resulting impairment wasprimarily attributable to a change in the evaluation criteria for goodwillutilized

 

42

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under previous accounting guidance to the fair value approachstipulated in SFAS No. 142.  Inaccordance with the transitional provision of SFAS No. 142, we recorded a $17.8million noncash write-down of goodwill (net of $0.9 million income tax benefit)as of January 1, 2002 as a cumulative effect of a change in accountingprinciple.  An additional $39.4 millionnoncash write-down of goodwill pertained to the Specialty Avionics Group and isincluded in the loss from discontinued operations.

 

Changes in the carrying amount of goodwill, bybusiness segment, for the six months ended June 30, 2003 are as follows:

 
|                             |   | **Continuing Operations**    |   | **Discontinued  Operations**    |   |
|----------------------------------|--------|------------------------------|--------|---------------------------------|--------|
| **(In millions)**                |   | **Cabin  Management  Group** |   | **Systems  Integration  Group** |   | **Corporate** |   | **Total** |   | **Specialty  Avionics  Group** |   |
|                             |   |                         |   |                            |   |   |   |   |   |   |   |
| Balance, December 31, 2002       |   | $                            | 173.9  |                            | $      | 20.8 |   | $ | 1.7 |   | $ | 196.4 |   | $ | 80.7 |   |
| Impairment charges               |   | (34.0                        | )      | —                          |   | — |   | (34.0 | ) | (7.5 | ) |
| Sale of Specialty Avionics Group |   | —                       |   | —                          |   | — |   | — |   | (73.2 | ) |
| Balance, June 30, 2003           |   | $                            | 139.9  |                            | $      | 20.8 |   | $ | 1.7 |   | $ | 162.4 |   | $ | — |   |

 

During the first quarter of fiscal 2003, we enteredinto a definitive agreement to sell our Specialty Avionics Group.  Based upon the fair value of the groupimplied in the definitive agreement, we determined that the carrying value ofthe group’s net assets was not fully recoverable.  As a result, we recorded a goodwill impairment charge of$7,500,000 during the three months ended March 31, 2003 to reduce thecarrying value to the estimated net realizable value established by thedefinitive agreement.  We recorded amodest gain on the sale during the second quarter of fiscal 2003, based on thefinancial position of the group on the date of sale.  The ultimate gain or loss on the sale is subject to finalizingthe post-closing adjustment, which is not expected to be material, if any.

 

As required by SFAS No. 142, we test goodwill forimpairment annually, on October 31st of each year, or when events orchanges in circumstances indicate the carrying amount may not be recoverable.  The goodwill impairment model is a two-stepprocess.  First, it requires acomparison of the book value of net assets to the fair value of the relatedreporting units that have goodwill assigned to them.  If the fair value is determined to be less than book value, asecond step is performed to compute the amount of the impairment.  In this process, a fair value for goodwillis estimated, based in part on the fair value of the reporting used in thefirst step, and is compared to its carrying value.  The amount by which carrying value exceeds fair value representsthe amount of goodwill impairment.

 

As a result of the continuing weakness in thebusiness, VIP and head-of-state aircraft market and our decision to down-size afurniture manufacturing facility in the second quarter of fiscal 2003, wedetermined that we should reevaluate the carrying value of our goodwill priorto the annual October 31st testing date. Accordingly, weperformed a step-one test of goodwill associated with our furniture manufacturingreporting unit for recoverability and found the goodwill to be impaired.  As a result, we recorded a pre-tax charge tooperations of $34,000,000 during the three months ended June 30, 2003 based ona comparison of the estimated book value of the net assets of the reportingunit to its fair value.  The charge wasprimarily a result of a decrease in fair value caused by using lower cash flowforecasts based on the most recently reduced industry estimates of aircraftdeliveries resulting from overall industry weakness.  The amount recorded is an estimate and may be revised during thethird quarter of fiscal 2003 upon completion of step two of the goodwillimpairment model, which measures the amount of impairment.

 

43

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**Liquidity andCapital Resources**

** **

We are a holding company and have no direct materialoperations. Our only asset is our ownership of all of the common stock ofDeCrane Aircraft, and our only material liability is our guarantee of the DeCraneAircraft senior credit facility.  Ourprincipal liquidity needs are for income taxes and, beginning in 2005, thepayment cash dividends on our preferred stock.

 

Our only source of cash is dividends from DeCraneAircraft.  The senior credit facilityand senior subordinated notes described below are obligations of DeCraneAircraft and impose limitations on its ability to pay dividends to us.  We believe that DeCrane Aircrafts’ debtinstruments will permit it to supply us with sufficient cash to meet the cashneeds referred to above for several years. However, if that is not the case, we would not be able to satisfy thoseneeds, because we have no other source of cash other than dividends fromDeCrane Aircraft.  We would then berequired to secure alternate financing, which may not be available onacceptable terms, or at all.

 

### **DeCrane Aircrafts’ principal cash needs are for debtservice, working capital, capital expenditures and strategic acquisitions, aswell as to provide us with cash to finance our needs.  Its principal sources of liquidity are expected to be cash flowfrom operations, potential capital market transactions and third partyborrowings, principally under its senior credit facility.**

### ** **

**Cash Flows during the Six MonthsEnded June 30, 2003**

 

Net cash used by operating activities was $21.1million for the six months ended June 30, 2003 and consisted of $5.3 million ofcash used by operations after adding back depreciation, amortization, thenoncash portion of our restructuring and asset impairment charges and othernoncash items and $21.0 million used for working capital, offset by a $5.1million increase in other liabilities. The following factors contributed to the $21.0 million working capitalincrease:

 

•      a $12.7 million inventory increase principallyrelated to long-term contracts;

 

•      a $13.0 million decrease in accountspayable and accrued expenses, primarily resulting from reduced purchasingcommensurate with lower revenues; offset by,

 

•      a $0.5 million decrease in prepaidexpenses and other assets; and

 

•      a $4.2 million decrease in accountsreceivables.

 

We expect working capital increases, if any, tomoderate during the remainder of 2003.

 

Net cash provided by investing activities was $130.2million for the six months ended June 30, 2003 and consisted of:

 

•      $132.8 million of net proceeds from thesale of the Specialty Avionics Group; offset by,

 

•      $2.0 million used for capitalexpenditures; and

 

•      $0.6 million used for the payment ofcontingent acquisition consideration.

 

We anticipate spending approximately $4.0 to $4.5million for capital expenditures in 2003. As of June 30, 2003, there are no remaining acquisition contingentconsideration payment obligations.

 

Net cash used by financing activities was $121.2million for the six months ended June 30, 2003.  Cash of $9.3 million was provided by revolving line of creditborrowings under our senior credit facility. Cash of $130.5 million was used for principal payments on our seniorterm debt, capitalized lease obligations and other debt.

 

44

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**Capital Resources and DebtObligations at June 30, 2003**

 

At June 30, 2003, we had $50.2 million of workingcapital, compared to $55.4 million as of December 31, 2002, excluding assetsand liabilities of the discontinued operations we sold in 2003.  At June 30, 2003, we also had $24.4 millionof borrowings available under our revolving line of credit, as amended inMarch 2003 and described below, compared to $43.6 million available as ofDecember 31, 2002.  Our revolving lineof credit expires in September 2004.  Wemay not be able to replace it on commerically acceptable terms, or at all.  At June 30, 2003, our senior credit facilityborrowings totaling $150.2 million are at variable interest rates based on definedmargins over the current prime rate or LIBOR, compared to $270.2 million as ofDecember 31, 2002.  We also had $100.0million of 12% senior subordinated notes at June 30, 2003 and December 31, 2002and other indebtedness totaling $9.7 million outstanding at June 30, 2003compared to $10.8 million as of December 31, 2002.

 

The senior credit facility and senior subordinatednotes indenture impose restrictive and financial covenants on us.  In the first quarter of fiscal 2003, termsand financial covenants contained in our senior credit facility were amendedto, among other things, permit the sale of the Specialty Avionics Group whichwas consummated on May 23, 2003. As required by the amendment, we repaid $130.0 million of senior creditfacility borrowings with the proceeds from the sale.  See “—Recent Developments Affecting Financial Condition andLiquidity” below for additional information.

 

**Recent Developments AffectingFinancial Condition and Liquidity**

 

As more fully described in “—Industry Overview andTrends,” the acts and ongoing threats of global terrorism, the current militaryconflicts, SARS epidemic and weak global economic conditions are all adverselyimpacting our business.  In response, wehave implemented a series of restructuring activities as described in“—Restructuring, Asset Impairment and Other Related Charges,” designed toreduce costs and conserve working capital.

 

During the fourth quarter of fiscal 2002, we furtherassessed our long-term business strategies in light of current aerospaceindustry conditions.  In addition, wesubsequently determined that we would likely not be in compliance with oursenior credit facility’s financial covenants in 2003.  We believe that when the aerospace industry recovers, the demandfor our Cabin Management and Systems Integration groups’ products and servicesfor business, VIP and head-of-state aircraft will return to historical levelsand, accordingly, we decided to focus our resources in these marketsegments.  To accomplish this objective,we embarked on a plan to sell the Specialty Avionics Group, which is highlydependent on the commercial airline industry.

 

We consummated the sale of our Specialty AvionicsGroup on May 23, 2003 and, as required by the senior credit facility amendment,used $130.0 million of the proceeds from the sale to repay senior creditfacility borrowings.  The senior creditfacility amendment also relaxes various financial covenants for 2003 andbeyond, decreases by $10.0 million the maximum permitted revolving line of creditborrowings to $40.0 million, increases the prime rate and LIBOR interestmargins by 1.5% and permits the issuance of specified types of additionalindebtedness and the repurchase of up to $20.0 million aggregate principalamount of our 12% senior subordinated notes with the proceeds from the sale ofjunior securities.  Junior securitiesmeans: (i) senior subordinated notes issued by us that are unsecured and do notprovide for any scheduled redemptions or prepayments or any sinking fundinstallment payments or maturities prior to the termination of the seniorcredit facility, or other indebtedness subordinated in right of payment to ourobligations under the senior credit facility, and whose material terms aresatisfactory to the lenders; and (ii) equity securities issued by us.

 

We believe our expected operating cash flows, togetherwith borrowings under our senior credit facility ($24.4 million of which wasavailable as of June 30, 2003 the commitment for which expires in September2004), will be sufficient to meet our future short- and long-term operatingexpenses, working capital requirements, capital expenditures and debt serviceobligations for the next twelve months. However, our ability to comply with our debt financial covenants, payprincipal or interest and satisfy our

 

45

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other debt obligations will depend on our future operating performanceas well as competitive, legislative, regulatory, business and other factorsbeyond our control.  Although we cannotbe certain, we expect to be in compliance with the revised financial covenantsthrough the end of the year based on our current operating plan.

 

In addition, we are continually consideringacquisitions that complement or expand our existing businesses or that mayenable us to expand into new markets, some of which may be material.  Future acquisitions may require additionaldebt, equity financing or both.  We maynot be able to obtain any additional financing on acceptable terms.  We are not currently party to any definitiveacquisition agreements.

 

**Disclosure ofContractual Obligations and Commitments**

** **

The following table summarizes our known obligationsto make future cash payments as of June 30, 2003, as well an estimate ofthe periods during which these payments are expected to be made.

 
|                                                           |   |      |   | **Years Ending December 31,** |   |
|----------------------------------------------------------------|--------|-----------|--------|-------------------------------|--------|
| **(In millions)**                                              |   | **Total** |   | **2003**                      |   | **2004  and  2005** |   | **2006  and  2007** |   | **2008  and  Beyond** |   |
| Long-term debt (a):                                            |   |      |   |                          |   |   |   |   |   |   |   |
| Senior credit facility                                         |   | $         | 150.2  |                          | $      | — |   | $ | 89.8 |   | $ | 60.5 |   | $ | — |   |
| 12% senior subordinated notes                                  |   | 100.0     |   | —                        |   | — |   | — |   | 100.0 |   |
| Capital lease obligations and other indebtedness               |   | 9.7       |   | 0.5                           |   | 2.3 |   | 1.6 |   | 5.3 |   |
| Total long-term debt                                           |   | 259.9     |   | 0.5                           |   | 92.1 |   | 62.1 |   | 105.3 |   |
|                                                           |   |      |   |                          |   |   |   |   |   |   |   |
| Operating lease obligations                                    |   | 14.6      |   | 1.0                           |   | 3.2 |   | 3.9 |   | 6.5 |   |
| Mandatorily redeemable preferred stock redemption obligations: |   |      |   |                          |   |   |   |   |   |   |   |
| DeCrane Aircraft preferred stock (b)                           |   | 40.0      |   | —                        |   | — |   | — |   | 40.0 |   |
| DeCrane Holdings preferred stock (c)                           |   | 66.7      |   | —                        |   | — |   | — |   | 66.7 |   |
| Total obligations at June 30, 2003                             |   | $         | 381.2  |                          | $      | 1.5 |   | $ | 95.3 |   | $ | 66.0 |   | $ | 218.5 |   |

 

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(a)       Excludes interest payments.  Interest on the 12% senior subordinatednotes is payable semiannually.  Thesenior credit facility bears interest at a variable rate and therefore theamount of future interest payments are uncertain.

 

(b)       Dividends accrue quarterly at the annualrate of 16% and are payable, at our option, either in cash or by the issuanceof additional shares of preferred stock. Since the issuance of the preferred stock in June 2000, we have electedto issue additional shares in lieu of cash dividend payments and may continueto do so until June 2005, after which time we are required to pay quarterlydividends in cash.  If we elect to continueissuing additional shares until June 2005, our mandatory redemption obligationon March 30, 2009, the mandatory redemption date, will be $54.8 million and ourannual cash dividend payment obligation will be $8.8 million, payablequarterly, commencing September 2005.

 

(c)       Dividends accrue quarterly at a 14%annual rate.  Prior to September 30,2005, dividends are not paid in cash but instead accrete to the liquidationvalue of the preferred stock.  Ourannual cash dividend payment obligation will be $12.7 million, payablequarterly, commencing December 31, 2005 and our mandatory redemption obligationon September 30, 2009, the mandatory redemption date, will be $90.8 million.

 

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

** **

During our normal course of business, we have enteredinto agreements containing indemnities pursuant to which we may be required tomake payments in the future.  Theseindemnities are in connection with facility leases and liabilities forspecified claims arising from investment banking services our financialadvisors provide to us.  The duration ofthese indemnities, commitments and guarantees varies, and in certain cases, isindefinite.  Substantially all of theseindemnities provide no limitation on the maximum potential future payments wecould be obligated to make and is not quantifiable.  We have not recorded any liability for these indemnities since noclaims have been asserted to date.

 

In connection with the sale of the Specialty AvionicsGroup, we made indemnities to the buyer with respect to a number of customary,and certain other specific, representations and warranties.  Our indemnities with respect to some ofthese matters are limited in terms of duration with the maximum of potentialfuture payments capped at $14.0 million and our indemnities with respect tospecified environmental matters will expire not later than October 2010 andprovides for a maximum liability of $5.0 million, while others will have nolimitations.  In addition, the $140.0million selling price is subject to a potential post-closing adjustment relatedto the amount of working capital at closing.

 

As of June 30, 2003, we also had an irrevocablestandby letter of credit in the amount of $0.4 million issued and outstandingunder our senior credit facility.

 

**Recent AccountingPronouncements**

** **

**Accounting Pronouncements AdoptedJanuary 1, 2003**

 

As more fully described in Note 1 accompanying ourfinancial statements included in this report, we adopted the provisions of thefollowing accounting pronouncements effective January 1, 2003:

 

•      SFAS No. 145, “Rescission ofSFAS Nos. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections;”

 

•      SFAS No. 146, “Accounting forCosts Associated with Exit or Disposal Activities;”

 

•      SFAS No. 148, “Accounting forStock-Based Compensation—Transition and Disclosure;” and

 

•      FASB Interpretation No. 45, “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Other.”

 

**Recently IssuedAccounting Pronouncement**

** **

*SFAS No. 150 —Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity*

* *

Issued in May 2003, SFAS No. 150 establishes standardsfor the classification 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.  We will be required to reclassify allmandatorily redeemable preferred stock as a liability commencing July 1, 2003and reflect quarterly dividend accretion on our 14% preferred stock as a chargeagainst pre-tax income in future periods.

 

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**Special NoteRegarding Forward-Looking Statements and Risk Factors**

** **

All statements other than statements of historicalfacts included in this report are considered forward-looking statements withinthe meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements are subjectto known and unknown risks, uncertainties and other factors, which are difficultto predict.  We are vulnerable to avariety of factors that affect many businesses, such as:

 

•      fuel prices and general economicconditions that affect demand for aircraft and air travel, which in turn affectdemand for our products and services;

 

•      acts, and ongoing threats, of globalterrorism, military conflicts and health epidemics that affect demand foraircraft and air travel, which in turn affect demand for our products andservices;

 

•      our reliance on key customers and theadverse effect a significant decline in business from any one of them wouldhave on our business;

 

•      changes in prevailing interest rates andthe availability of financing to fund our plans for continued growth;

 

•      competition from larger companies;

 

•      Federal Aviation Administration prescribedstandards and licensing requirements, which apply to many of the products andservices we provide;

 

•      inflation, and other general changes incosts of goods and services;

 

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

 

•      liability and other claims assertedagainst us that exceeds our insurance coverage;

 

•      the ability to attract and retainqualified personnel;

 

•      labor disturbances; and

 

•      changes in operating strategy, or ouracquisition and capital expenditure plans.

 

Some of the more significant factors listed above arefurther described in our Annual Report on Form 10-K and should be read inconjunction with this report.  Changesin such factors could cause our actual results to differ materially from thosecontemplated in such forward-looking statements.  Although we believe that the expectations reflected in suchforward-looking statements are reasonable, we can give no assurance that suchexpectations will prove to be correct. We undertake no obligation to release publicly any revisions to theseforward-looking statements to reflect events or circumstances after the datehereof or to reflect the occurrence of unanticipated events.  You should not rely on our forward-lookingstatements as if they were certainties.

 

**ITEM3.              QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK**

** **

We are exposed to various market risks, includinginterest rates and changes in foreign currency exchange rates.  Market risk is the potential loss arisingfrom 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 to our variable-rate debt isestimated as the potential decrease in pre-tax earnings resulting from anincrease in interest rates.  Theinterest rates applicable to variable-rate debt are,

 

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at our option, based on defined margins over the current prime rate orLIBOR.  At June 30, 2003, the current primerate was 4.00% and the current LIBOR was 1.12%.  Based on $150.2 million of variable-rate debt outstanding as ofJune 30, 2003, a hypothetical one percent rise in interest rates, to 5.00% forprime rate borrowings and 2.12% for LIBOR borrowings, would reduce our pre-taxearnings by $1.5 million annually.

 

To limit a portion of our exposure related to risinginterest rates, we have entered into an interest rate swap contract toeffectively convert $4.5 million of variable-rate industrial revenue bonds to4.2% fixed-rate debt until maturity in 2008. The contract is considered to be a hedge against changes in the amountof future cash flows associated with interest payments on this portion of ourvariable-rate debt.  Market risk relatedto this interest rate swap contract is estimated as the potential higherinterest expense we will incur if the variable interest rate decreases belowthe 4.2% fixed rate.  Based on the $4.5million of variable-rate debt converted to fixed-rate debt outstanding as ofJune 30, 2003, a hypothetical one percent decrease in the variable interestrate to 3.2%, would reduce our pre-tax earnings by less than $0.1 millionannually.

 

The estimated fair value of our $100.0 millionfixed-rate long-term debt increased $7.0 million, or 17.5%, to approximately$47.0 million at June 30, 2003 from $40.0 million at December 31, 2002.  Although we cannot be certain, we believethe increase may have been a result of the sale of our Specialty Avionics Group.  Market risk related to our fixed-rate debtis deemed to be the potential increase in fair value resulting from a decreasein interest rates.  For example, ahypothetical ten percent decrease in the interest rates, from 12.0% to 10.8%,would increase the fair value of our fixed-rate debt by approximately $7.0million.

 

**Foreign Currency Exchange Rate Risk.**  Our foreign customers are located in variousparts of the world, primarily Western Europe, the Far East and Canada, and wehave subsidiaries with manufacturing facilities in Mexico.  To limit our foreign currency exchange raterisk related to sales to our customers, orders are primarily valued and sold inU.S. dollars.

 

**ITEM 4.              CONTROLS AND PROCEDURES**

** **

The management of DeCrane Holdings Co. (the“Company”), under the supervision and with the participation of the Company’sChief Executive Officer and Chief Financial Officer, conducted an evaluation ofthe Company’s “disclosure controls and procedures” (as defined in Exchange ActRules 13a-15(e) or l5d-15(e)) as of the end of the period covered by thisreport.  Based on that evaluation, theChief Executive Officer and Chief Financial Officer concluded that theCompany’s disclosure controls and procedures were effective as of the end ofthe period covered by this report.

 

There was no change in the Company’s internal controlover financial reporting identified in connection with the evaluation requiredby paragraph (d) of Exchange Act Rules 13a-15 or l5d-I5 that occurred duringthe Company’s last fiscal quarter that has materially affected, or is reasonablylikely to materially affect, the Company’s internal control over financialreporting.

 

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**PART II – OTHER INFORMATION**

 

**ITEM 1.          LEGAL PROCEEDINGS**

 

As part of its investigation of the crash of SwissairFlight 111 off the Canadian coast on September 2, 1998, the CanadianTransportation Safety Board (the “CTSB”) initially notified us that itrecovered burned wire that was attached to the in-flight entertainment systeminstalled on some of Swissair’s aircraft by one of our subsidiaries.  Our subsidiary has worked vigorously overthe last five years with the CTSB investigators in the fact-findinginvestigation of this catastrophic incident. On March 27, 2003, the CTSB released its final report on its investigation.  This report indicated that the CTSB wasunable to conclusively determine the cause of the fire which led to the crashof the aircraft.

 

We were a defendant in most, but not all, of theactions brought by the estates of the 229 victims of the crash.  The actions, which sought damages and costsin unstated amounts, claimed negligence, strict liability, and breach ofwarranty.  Virtually all of the caseshave been settled by Boeing and Swissair’s insurers and both assignment of theclaims against, and releases in favor, of us have been obtained by the Boeingand Swissair insurers.

 

Boeing and Swissair have made a claim (but have notcommenced litigation) against us to contribute to the amounts paid to settlethe cases.  As there is no litigation pending,no discovery has been taken by either side as to liability for the crash.  We believe that our subsidiary is notresponsible for the crash and, in any event, we maintain insurance for suchmatters.  We further believe that anyloss we may sustain upon the ultimate resolution of this matter, if any, willnot exceed the amount of insurance coverage maintained.  Accordingly, no accrual for loss has beenrecorded in our financial statements.

 

We are also involved in other routine legal andadministrative proceedings incident to the normal conduct of business.  We believe the ultimate disposition of allsuch matters will not have a material adverse effect on our business,consolidated financial position, results of operations or cash flows.

 

**ITEM 6.          EXHIBITS AND REPORTS ON FORM 8-K**

 

a.         Exhibits

 

31.1             Chief Executive OfficerCertification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *

 

31.2             Chief Financial OfficersCertification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *

 

32                Chief Executive Officer and Chief Financial OfficerCertifications Pursuant to Pursuant to Section 906 of the Sarbanes-Oxley Act of2002 *

 

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*                  Filed herewith

 

b.         Reports on Form8-K

 

On March 17, 2003, we filed a Form 8-K Current Reportregarding DeCrane Aircraft entering into a definitive agreement to sell itsSpecialty Avionics Group.  The text ofthe press release is contained in the filing.

 

On May 23, 2003, we filed a Form 8-K Current Reportregarding DeCrane Aircraft consummating the sale of its Specialty AvionicsGroup.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 

 
|            | **DECRANE  HOLDINGS, CO. (Registrant)** |
|-----------------|-----------------------------------------|
|            |                                    |   |
| August 14, 2003 | By:                                     | /s/  Richard J. Kaplan |
|            | Name:                                   | Richard J. Kaplan |
|            | Title:                                  | Chief Financial  Officer, Assistant Secretary and  Director |

 

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