**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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** **

**FORM 10-Q**

 

**QUARTERLY REPORT PURSUANT TO SECTION13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended June 30, 2004**

 

**Commission File Number 333-70363**

 

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**DECRANEHOLDINGS CO.**

 (Exact name of registrant as 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 MerchantBanking Partners II, L.P.Eleven Madison Avenue, New York, NY 10010**

(Address,including zip code, of principal executive offices)

 

**(212) 325-2000**

(Registrant’stelephone number, including area code)

 

**(NotApplicable)**

(Former address and telephone number of principalexecutive offices, if changed since last report)

 

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

 

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

 

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The number of shares of Registrant’s Common Stock, $.01 par value,outstanding as of August 9, 2004 was 4,358,242 shares.

 

 

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**Tableof Contents**

** **
| **Part I – Financial Information** |                                                                                                    |
|-----------------------------------------|---------------------------------------------------------------------------------------------------------|
|                                    |                                                                                                    |   |
| **Item 1.**                             | **Financial Statements (Unaudited)**                                                                    |   |
|                                    |                                                                                                    |   |
|                                    | Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003                                   |   |
|                                    |                                                                                                    |   |
|                                    | Consolidated Statements of Operations for  the three months and six months ended June 30, 2004 and 2003 |   |
|                                    |                                                                                                    |   |
|                                    | Consolidated Statements of Stockholders’  Equity (Deficit) for the six months ended June 30, 2004  |   |
|                                    |                                                                                                    |   |
|                                    | Consolidated Statements of Cash Flows for  the six months ended June 30, 2004 and 2003                  |   |
|                                    |                                                                                                    |   |
|                                    | Condensed Notes to Consolidated Financial  Statements                                                   |   |
|                                    |                                                                                                    |   |
| **Item 2.**                             | **Management’s Discussion and Analysis of  Financial Condition and Results of Operations**         |   |
|                                    |                                                                                                    |   |
|                                    | Results of Operations                                                                                   |   |
|                                    |                                                                                                    |   |
|                                    | Performance Measures                                                                                    |   |
|                                    |                                                                                                    |   |
|                                    | Changes in Accounting Principles                                                                        |   |
|                                    |                                                                                                    |   |
|                                    | Three months ended June 30 2004                                                                         |   |
|                                    |                                                                                                    |   |
|                                    | Six months ended June 30, 2004                                                                          |   |
|                                    |                                                                                                    |   |
|                                    | Restructuring, Asset Impairment and Other  Related Charges                                              |   |
|                                    |                                                                                                    |   |
|                                    | Liquidity and Capital Resources                                                                         |   |
|                                    |                                                                                                    |   |
|                                    | Disclosure of Contractual Obligations and  Commitments                                                  |   |
|                                    |                                                                                                    |   |
|                                    | Disclosure About Off-Balance Sheet  Commitments and Indemnities                                         |   |
|                                    |                                                                                                    |   |
|                                    | Recent Accounting Pronouncements                                                                        |   |
|                                    |                                                                                                    |   |
|                                    | Special Note Regarding Forward Looking Statements  and Risk Factors                                     |   |
|                                    |                                                                                                    |   |
| **Item 3.**                             | **Quantitative and Qualitative Disclosure  About Market Risk**                                          |   |
|                                    |                                                                                                    |   |
| **Item 4.**                             | **Controls and Procedures**                                                                             |   |
|                                    |                                                                                                    |   |
| **Part II – Other Information**    |                                                                                                    |
|                                    |                                                                                                    |   |
| **Item 1.**                             | **Legal Proceedings**                                                                                   |   |
|                                    |                                                                                                    |   |
| **Item 6.**                             | **Exhibits and Reports on Form 8-K**                                                                    |   |
|                                    |                                                                                                    |   |
|                                    | Exhibits                                                                                                |   |
|                                    |                                                                                                    |   |
|                                    | Reports on Form 8-K                                                                                     |   |
|                                    |                                                                                                    |   |
| **Signatures**                          |                                                                                                    |

 

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**PART I – FINANCIALINFORMATION**

 

**ITEM 1****.****                          FINANCIALSTATEMENTS**

 

**DECRANEHOLDINGS CO. AND SUBSIDIARY**

 

**Consolidated BalanceSheets**

 
| **(In thousands, except share data)**                                                                                                              |   | **June 30,  2004** |    | **December 31,  2003** |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                                                                                                                                               |   | **(Unaudited)**         |    |                        |   |
| **Assets**                                                                                                                                         |   |                    |    |                        |   |
|                                                                                                                                               |   |                    |    |                        |   |
| Current assets:                                                                                                                                    |   |                    |    |                        |   |
| Cash and cash equivalents                                                                                                                          |   | $                       | 2,362   |                        | $      | 6,936 |   |
| Accounts receivable, net                                                                                                                           |   | 27,322                  |    | 21,455                      |   |
| Inventories                                                                                                                                        |   | 52,314                  |    | 42,981                      |   |
| Prepaid expenses and other current assets                                                                                                          |   | 1,176                   |    | 1,082                       |   |
| Total current assets                                                                                                                               |   | 83,174                  |    | 72,454                      |   |
|                                                                                                                                               |   |                    |    |                        |   |
| Property and equipment, net                                                                                                                        |   | 29,798                  |    | 30,900                      |   |
| Goodwill                                                                                                                                           |   | 162,430                 |    | 162,430                     |   |
| Other assets, principally intangibles, net                                                                                                         |   | 34,764                  |    | 38,092                      |   |
| Total assets                                                                                                                                       |   | $                       | 310,166 |                        | $      | 303,876 |   |
|                                                                                                                                               |   |                    |    |                        |   |
| **Liabilities, Mandatorily Redeemable Preferred Stock and Stockholders’  Equity (Deficit)**                                                   |   |                    |    |                        |   |
|                                                                                                                                               |   |                    |    |                        |   |
| Current liabilities:                                                                                                                               |   |                    |    |                        |   |
| Current portion of long-term debt                                                                                                                  |   | $                       | 1,319   |                        | $      | 1,198 |   |
| Accounts payable                                                                                                                                   |   | 17,377                  |    | 15,462                      |   |
| Accrued liabilities                                                                                                                                |   | 23,387                  |    | 17,890                      |   |
| Income taxes payable                                                                                                                               |   | 64                      |    | —                      |   |
| Total current liabilities                                                                                                                          |   | 42,147                  |    | 34,550                      |   |
|                                                                                                                                               |   |                    |    |                        |   |
| Long-term debt                                                                                                                                     |   | 283,821                 |    | 268,208                     |   |
| Mandatorily redeemable preferred stock                                                                                                             |   | 121,089                 |    | —                      |   |
| Other long-term liabilities                                                                                                                        |   | 7,836                   |    | 5,464                       |   |
|                                                                                                                                               |   |                    |    |                        |   |
| Commitments and contingencies (Note 10)                                                                                                            |   |                    |    |                        |   |
|                                                                                                                                               |   |                    |    |                        |   |
| Mandatorily redeemable preferred stock                                                                                                             |   | —                  |    | 112,237                     |   |
|                                                                                                                                               |   |                    |    |                        |   |
| Stockholders’ equity (deficit):                                                                                                               |   |                    |    |                        |   |
| Undesignated preferred stock, $.01 par  value, 1,140,000 shares authorized; None issued and outstanding as of June  30, 2004 and December 31, 2003 |   | —                  |    | —                      |   |
| Common stock, $.01 par value, 10,000,000  shares authorized; 4,009,297 shares issued and outstanding as of June 30,  2004 and December 31, 2003    |   | 40                      |    | 40                          |   |
| Additional paid-in capital                                                                                                                         |   | 61,475                  |    | 61,475                      |   |
| Notes receivable for shares sold                                                                                                                   |   | (1,305                  | )       | (1,268                      | )      |
| Accumulated deficit                                                                                                                                |   | (204,669                | )       | (176,562                    | )      |
| Accumulated other comprehensive loss                                                                                                               |   | (268                    | )       | (268                        | )      |
| Total stockholders’ equity (deficit)                                                                                                          |   | (144,727                | )       | (116,583                    | )      |
| Total liabilities, mandatorily redeemable  preferred stock and stockholders’ equity (deficit)                                                 |   | $                       | 310,166 |                        | $      | 303,876 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

1

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**DECRANEHOLDINGS CO. AND SUBSIDIARY**

 

**ConsolidatedStatements of Operations**

 
|                                                               |   | **Three  Months Ended  June 30,** |    | **Six Months  Ended  June 30,** |   |
|--------------------------------------------------------------------|--------|-----------------------------------|---------|--------------------------------------|--------|
| **(In thousands)**                                                 |   | **2004**                          |    | **2003**                             |   | **2004** |   | **2003** |   |
|                                                               |   | **(Unaudited)**                   |    |
| Revenues                                                           |   | $                                 | 54,817  |                                 | $      | 44,113 |   | $ | 103,414 |   | $ | 86,013 |   |
| Cost of sales                                                      |   | 47,317                            |    | 38,714                               |   | 84,156 |   | 67,592 |   |
|                                                               |   |                              |    |                                 |   |   |   |   |   |
| Gross profit                                                       |   | 7,500                             |    | 5,399                                |   | 19,258 |   | 18,421 |   |
|                                                               |   |                              |    |                                 |   |   |   |   |   |
| Operating expenses:                                                |   |                              |    |                                 |   |   |   |   |   |
| Selling, general and administrative  expenses                      |   | 7,788                             |    | 6,979                                |   | 15,025 |   | 16,909 |   |
| Research and development expenses                                  |   | 2,001                             |    | 3,278                                |   | 4,182 |   | 4,851 |   |
| Impairment of goodwill                                             |   | —                            |    | 34,000                               |   | — |   | 34,000 |   |
| Amortization of intangible assets                                  |   | 913                               |    | 914                                  |   | 1,825 |   | 1,826 |   |
| Total operating expenses                                           |   | 10,702                            |    | 45,171                               |   | 21,032 |   | 57,586 |   |
|                                                               |   |                              |    |                                 |   |   |   |   |   |
| Loss from operations                                               |   | (3,202                            | )       | (39,772                              | )      | (1,774 | ) | (39,165 | ) |
|                                                               |   |                              |    |                                 |   |   |   |   |   |
| Other expenses:                                                    |   |                              |    |                                 |   |   |   |   |   |
| Interest expense                                                   |   | 8,750                             |    | 6,468                                |   | 17,452 |   | 12,337 |   |
| Mandatorily redeemable preferred stock  dividends                  |   | 4,387                             |    | 1,657                                |   | 8,618 |   | 3,254 |   |
| Other expenses, net                                                |   | 91                                |    | 407                                  |   | 203 |   | 746 |   |
|                                                               |   |                              |    |                                 |   |   |   |   |   |
| Loss from continuing operations before  provision for income taxes |   | (16,430                           | )       | (48,304                              | )      | (28,047 | ) | (55,502 | ) |
| Provision for income (taxes) benefit                               |   | (30                               | )       | 9,365                                |   | (60 | ) | 10,630 |   |
|                                                               |   |                              |    |                                 |   |   |   |   |   |
| Loss from continuing operations                                    |   | (16,460                           | )       | (38,939                              | )      | (28,107 | ) | (44,872 | ) |
|                                                               |   |                              |    |                                 |   |   |   |   |   |
| Discontinued operations and change in  accounting principle:       |   |                              |    |                                 |   |   |   |   |   |
| Income (loss) from discontinued operations,  net of tax            |   | —                            |    | 747                                  |   | — |   | (5,650 | ) |
| Cumulative effect of change in accounting  principle               |   | —                            |    | —                               |   | — |   | (13,764 | ) |
|                                                               |   |                              |    |                                 |   |   |   |   |   |
| Net loss                                                           |   | (16,460                           | )       | (38,192                              | )      | (28,107 | ) | (64,286 | ) |
|                                                               |   |                              |    |                                 |   |   |   |   |   |
| Noncash preferred stock dividend accretion                         |   | —                            |    | (2,254                               | )      | — |   | (4,432 | ) |
|                                                               |   |                              |    |                                 |   |   |   |   |   |
| Net loss applicable to common stockholders                         |   | $                                 | (16,460 | )                                    | $      | (40,446 | ) | $ | (28,107 | ) | $ | (68,718 | ) |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

2

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**DECRANEHOLDINGS CO. AND SUBSIDIARY**

 

**ConsolidatedStatement of Stockholders’ Equity (Deficit)**

 
| **(In thousands, except share  data)** |       | **Common  Stock** |       | **Additional  Paid-in** |        | **Notes  Receivable  For Shares** |     | **Accumulated** |        | **Accumulated  Other  Comprehensive** |     |   |      |
|----------------------------------------|------------|-------------------|------------|-------------------------|-------------|-----------------------------------|----------|-----------------|-------------|---------------------------------------|----------|--------|-----------|
|                                   | **Shares** |              | **Amount** |                    | **Capital** |                              | **Sold** |            | **Deficit** |                                  | **Loss** |   | **Total** |   |
|                                   |       |              |       |                    |        |                              |     |            |        |                                  |     |   |      |   |   |
| Balance, December 31, 2003        |       | 4,009,297         |       | $                       | 40          |                              | $        | 61,475          |        | $                                     | (1,268   | )      | $         | (176,562 | ) | $ | (268 | ) | $ | (116,583 | ) |
|                                   |       |              |       |                    |        |                              |     |            |        |                                  |     |   |      |   |   |
| Comprehensive loss:                    |       |              |       |                    |        |                              |     |            |        |                                  |     |   |      |   |   |
| Net loss                               |       | —            |       | —                  |        | —                            |     | —          |        | (28,107                               | )        | — |      | (28,107 | ) |
|                                   |       |              |       |                    |        |                              |     |            |        |                                  |     |   |      |   |   |
| Notes receivable interest accrued      |       | —            |       | —                  |        | —                            |     | (37             | )           | —                                |     | — |      | (37 | ) |
|                                   |       |              |       |                    |        |                              |     |            |        |                                  |     |   |      |   |   |
| Balance, June 30, 2004 (Unaudited)     |       | 4,009,297         |       | $                       | 40          |                              | $        | 61,475          |        | $                                     | (1,305   | )      | $         | (204,669 | ) | $ | (268 | ) | $ | (144,727 | ) |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

3

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**DECRANEHOLDINGS CO. AND SUBSIDIARY**

 

**ConsolidatedStatements of Cash Flows**

 
|                                                                                        |   | **Six Months  Ended  June 30,** |    |
|---------------------------------------------------------------------------------------------|--------|---------------------------------|---------|
| **(In thousands)**                                                                          |   | **2004**                        |    | **2003** |   |
|                                                                                        |   | **(Unaudited)**                 |    |
| **Cash flows from operating activities:**                                                   |   |                            |    |   |   |
| Net loss                                                                                    |   | $                               | (28,107 | ) | $ | (64,286 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used for) operating activities: |   |                            |    |   |   |
| Cumulative effect of change in accounting  principles                                       |   | —                          |    | 13,764 |   |
| Loss from discontinued operations                                                           |   | —                          |    | 5,650 |   |
| Depreciation and amortization                                                               |   | 6,184                           |    | 6,342 |   |
| Mandatorily redeemable preferred stock  dividends                                           |   | 8,618                           |    | 3,254 |   |
| Noncash portion of restructuring, asset  impairment and other related charges               |   | 2,978                           |    | 37,664 |   |
| Interest accretion on second-lien term debt                                                 |   | 1,213                           |    | — |   |
| Preferred stock redemption value accretion                                                  |   | 234                             |    | — |   |
| Deferred income taxes                                                                       |   | —                          |    | (11,659 | ) |
| Other, net                                                                                  |   | (13                             | )       | 295 |   |
| Changes in assets and liabilities:                                                          |   |                            |    |   |   |
| Accounts receivable                                                                         |   | (5,867                          | )       | 4,207 |   |
| Inventories                                                                                 |   | (12,144                         | )       | (7,854 | ) |
| Prepaid expenses and other assets                                                           |   | (270                            | )       | 541 |   |
| Accounts payable                                                                            |   | 1,915                           |    | (2,251 | ) |
| Accrued liabilities                                                                         |   | 5,432                           |    | (10,755 | ) |
| Income taxes payable                                                                        |   | 162                             |    | 385 |   |
| Other long-term liabilities                                                                 |   | 2,372                           |    | 4,761 |   |
| Net cash used for operating activities                                                      |   | (17,293                         | )       | (19,942 | ) |
|                                                                                        |   |                            |    |   |   |
| **Cash flows from investing activities:**                                                   |   |                            |    |   |   |
| Net proceeds from sale of Specialty  Avionics Group                                         |   | —                          |    | 132,800 |   |
| Capital expenditures                                                                        |   | (1,767                          | )       | (2,002 | ) |
| Cash paid for acquisition contingent  consideration                                         |   | —                          |    | (600 | ) |
| Net cash provided by (used for) investing  activities                                       |   | (1,767                          | )       | 130,198 |   |
|                                                                                        |   |                            |    |   |   |
| **Cash flows from financing activities:**                                                   |   |                            |    |   |   |
| Debt borrowings:                                                                            |   |                            |    |   |   |
| Revolving line of credit, net                                                               |   | 15,050                          |    | 9,250 |   |
| Other secured long-term                                                                     |   | 46                              |    | — |   |
| Debt repayments:                                                                            |   |                            |    |   |   |
| First-lien term debt                                                                        |   | —                          |    | (129,275 | ) |
| Other secured long-term debt                                                                |   | (610                            | )       | (1,173 | ) |
| Net cash provided by (used for) financing  activities                                       |   | 14,486                          |    | (121,198 | ) |
|                                                                                        |   |                            |    |   |   |
| Net cash provided by discontinued  operations                                               |   | —                          |    | 2,194 |   |
|                                                                                        |   |                            |    |   |   |
| Net decrease in cash and cash equivalents                                                   |   | (4,574                          | )       | (8,748 | ) |
| Cash and cash equivalents at beginning of  period                                           |   | 6,936                           |    | 12,421 |   |
| Cash and cash equivalents at end of period                                                  |   | $                               | 2,362   |   | $ | 3,673 |   |

 

The accompanying notes are an integral partof the consolidated financial statements.

 

4

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**DECRANEHOLDINGS CO. AND SUBSIDIARY**

** **

**CondensedNotes to Consolidated Financial Statements**

**(Unaudited)**

 

**Note1.           Summary of SignificantAccounting Policies**

 

**Basis of Presentation**

 

Theseconsolidated interim financial statements are unaudited.  The Company believes the interim financialstatements are presented on a basis consistent with the audited financialstatements and include all adjustments necessary for a fair presentation of thefinancial condition, results of operations and cash flows for such interimperiods.  All of these adjustments arenormal recurring adjustments.

 

Preparation ofthese consolidated financial statements in conformity with accountingprinciples generally accepted in the United States of America requires theCompany to make estimates and judgments that affect the reported amounts ofassets, liabilities and disclosure of contingent assets and liabilities at the dateof the consolidated financial statements and the reported amounts of revenuesand expenses during the reporting periods. Actual results could differ from those estimates.

 

The results ofoperations for interim periods do not necessarily predict the operating resultsfor any other interim period or for the full year.  The consolidated balance sheet as of December 31, 2003 has beenderived from audited financial statements but does not include all disclosuresrequired by accounting principles generally accepted in the United States ofAmerica as permitted by interim reporting requirements.  These consolidated interim financialstatements should be read in conjunction with Management’s Discussion andAnalysis of Financial Condition and Results of Operations and the auditedfinancial statements and related notes included in the Company’s 2003 Form10-K.  Reclassifications have been madeto the financial statements for prior periods to conform to the current yearpresentation.

 

**Changes in Accounting Principles**

*** ***

*SFAS No. 150 Adopted January 1, 2004*

 

EffectiveJanuary 1, 2004, the Company adopted SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Liabilities andEquity.”  SFAS No. 150 establishesstandards for the classification and measurement of certain financialinstruments with characteristics of both liabilities and equity.  SFAS No. 150 requires classification offinancial instruments within its scope as a liability, including financialinstruments issued in the form of shares that are mandatorily redeemable,because those financial instruments are deemed to be, in essence, obligationsof the issuer.  As a result of adoptingSFAS No. 150 on January 1, 2004, all mandatorily redeemable preferred stock wasreclassified as a liability and all quarterly dividends are reflected as acharge against pre-tax income.  Inperiods prior to January 1, 2004, DeCrane Holdings’ 14% preferred stockdividends were deducted in arriving at the net income or loss applicable to theCompany’s common stockholders; DeCrane Aircraft’s 16% preferred stock dividendswere charged against pre-tax income as minority interest in preferred stock ofsubsidiary.

 

The followingtable summarizes the results of operations for the three months and six monthsended June 30, 2003 as if SFAS No. 150 had been in effect as of the beginningof 2003.

 

5

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|                            |   | **Three  Months Ended  June 30, 2003** |    | **Six Months  Ended  June 30, 2003** |   |
|---------------------------------|--------|----------------------------------------|---------|-------------------------------------------|--------|
| **(In thousands)**              |   | **As  Reported**                       |    | **Pro Forma**                             |   | **As Reported** |   | **Pro Forma** |   |
|                            |   | **(Unaudited)**                        |    |
| Loss from continuing operations |   | $                                      | (38,939 | )                                         | $      | (41,193 | ) | $ | (44,872 | ) | $ | (49,304 | ) |
| Net loss                        |   | (38,192                                | )       | (40,446                                   | )      | (64,286 | ) | (68,718 | ) |
|                                 |        |                                        |         |                                           |        |  |  |  |  |  |  |  |  |

 

The pro formadata reflects DeCrane Holdings 14% preferred stock dividends of $2,254,000 forthe three months ended June 30, 2003 and $4,432,000 for the six months endedJune 30, 2003 as charges against income during the periods.

 

*Discontinued Use of Program AccountingCommencing January 1, 2003*

 

As more fullydescribed in “Note 1—Change in Accounting Principle” to the audited financialstatements included in the Company’s 2003 Form 10-K, the Company elected todiscontinue the use of program accounting for the costs of productsmanufactured for delivery under production-type contracts.  As a result, certain deferred program costsare no longer included in inventory commencing January 1, 2003.

 

This change inaccounting policy was made after concluding the 2003 fiscal year but wasapplied retroactively to the beginning of the year, January 1, 2003, asrequired by generally accepted accounting principles.  As a result of the change, program-related product developmentcosts are now classified as a component of research and development expenses inthe consolidated financial statements rather than classified as a component ofinventory cost.  The Company hasrestated its results of operations by charging previously inventoried coststotaling $3,278,000 and $4,851,000 for the three months and six months endedJune 30, 2003, respectively, to research and development expense andrecording a $13,764,000 charge as of January 1, 2003 to reflect thecumulative effect of the change in accounting principle.

 

**StockOption Plan**

 

The Companyhas one stock-based employee compensation plan, which is more fully describedin the notes 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 followingtable illustrates the effect on net income if the Company had applied the fairvalue recognition provisions of SFAS No. 123 to stock-based employee compensation.

 
|                                                                                                                                           |   | **Three  Months Ended  June 30,** |    | **Six Months  Ended  June 30,** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|---------|--------------------------------------|--------|
| **(In thousands)**                                                                                                                             |   | **2004**                          |    | **2003**                             |   | **2004** |   | **2003** |   |
|                                                                                                                                           |   | **(Unaudited)**                   |    |
| Net loss, as reported                                                                                                                          |   | $                                 | (16,460 | )                                    | $      | (38,192 | ) | $ | (28,107 | ) | $ | (64,286 | ) |
| Less total stock-based employee  compensation expense determined under the fair value based method for all  awards, net of related tax effects |   | (81                               | )       | (94                                  | )      | (162 | ) | (188 | ) |
| Pro forma net loss                                                                                                                             |   | $                                 | (16,541 | )                                    | $      | (38,286 | ) | $ | (28,269 | ) | $ | (64,474 | ) |

 

6

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The effect ofapplying SFAS No. 123 may not be representative of the pro forma effect infuture years since additional options may be granted during those future years.

 

**Note2.           Restructuring, AssetImpairment and Other Related Charges**

 

During thethree months and six months ended June 30, 2004 and 2003, the Company recordedrestructuring, asset impairment and other related charges as follows:

 
|                                                                       |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|----------------------------------------------------------------------------|--------|-----------------------------------|--------|--------------------------------------|--------|
| **(In thousands)**                                                         |   | **2004**                          |   | **2003**                             |   | **2004** |   | **2003** |   |
|                                                                       |   | **(Unaudited)**                   |   |
| Nature of charges:                                                         |   |                              |   |                                 |   |   |   |   |   |
| Operational Realignment and Facilities  Restructuring                      |   | $                                 | 6,901  |                                 | $      | — |   | $ | 6,901 |   | $ | — |   |
| Seating Product Line and Furniture  Manufacturing Facilities Restructuring |   | —                            |   | 7,132                                |   | — |   | 7,132 |   |
| Goodwill impairment charges                                                |   | —                            |   | 34,000                               |   | — |   | 41,500 |   |
| Total pre-tax charges                                                      |   | $                                 | 6,901  |                                 | $      | 41,132 |   | $ | 6,901 |   | $ | 48,632 |   |
|                                                                       |   |                              |   |                                 |   |   |   |   |   |
| Business segment recording the charges:                                    |   |                              |   |                                 |   |   |   |   |   |
| Cabin Management                                                           |   | $                                 | 1,628  |                                 | $      | 41,132 |   | $ | 1,628 |   | $ | 41,132 |   |
| Systems Integration                                                        |   | 5,273                             |   | —                               |   | 5,273 |   | — |   |
| Total continuing operations                                                |   | 6,901                             |   | 41,132                               |   | 6,901 |   | 41,132 |   |
| Discontinued operations (Specialty  Avionics)                              |   | —                            |   | —                               |   | — |   | 7,500 |   |
| Total pre-tax charges                                                      |   | $                                 | 6,901  |                                 | $      | 41,132 |   | $ | 6,901 |   | $ | 48,632 |   |
|                                                                       |   |                              |   |                                 |   |   |   |   |   |
| Charged to operations:                                                     |   |                              |   |                                 |   |   |   |   |   |
| Cost of sales                                                              |   | $                                 | 6,083  |                                 | $      | 6,573 |   | $ | 6,083 |   | $ | 6,573 |   |
| Selling, general and administrative  expenses                              |   | 818                               |   | 559                                  |   | 818 |   | 559 |   |
| Impairment of goodwill                                                     |   | —                            |   | 34,000                               |   | — |   | 34,000 |   |
| Discontinued operations (Specialty  Avionics)                              |   | —                            |   | —                               |   | — |   | 7,500 |   |
| Total pre-tax charges                                                      |   | $                                 | 6,901  |                                 | $      | 41,132 |   | $ | 6,901 |   | $ | 48,632 |   |
|                                                                       |   |                              |   |                                 |   |   |   |   |   |
| Components of charges:                                                     |   |                              |   |                                 |   |   |   |   |   |
| Continuing operations:                                                     |   |                              |   |                                 |   |   |   |   |   |
| Noncash charges                                                            |   | $                                 | 2,978  |                                 | $      | 37,664 |   | $ | 2,978 |   | $ | 37,664 |   |
| Cash charges                                                               |   | 3,923                             |   | 3,468                                |   | 3,923 |   | 3,468 |   |
| Total continuing operations pre-tax charges                                |   | 6,901                             |   | 41,132                               |   | 6,901 |   | 41,132 |   |
| Discontinued operations (noncash charges)                                  |   | —                            |   | —                               |   | — |   | 7,500 |   |
| Total pre-tax charges                                                      |   | $                                 | 6,901  |                                 | $      | 41,132 |   | $ | 6,901 |   | $ | 48,632 |   |

 

7

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**Operational Realignment and FacilitiesConsolidation**

 

During thesecond quarter of fiscal 2004, the Company adopted plans to restructure theoperations of its Cabin Management and Systems Integration groups.  The restructuring plan for Cabin Managementinvolves the realignment of production between its manufacturing facilities andthe relocation and consolidation of the group’s headquarters to Wichita,Kansas.  The plan for SystemsIntegration involves combining the manufacturing activities of two facilitiesinto a single facility and eliminating some product offerings and servicecapabilities resulting in a partial downsizing of certain operations.  These actions are designed to reduceengineering, production and inventory carrying costs by supporting fewermanufacturing locations and product offerings. In connection with these actions, the Company recorded pre-tax chargesto operations totaling $6,901,000, comprised of the following:

 

•                  *Lease Termination and Related Charges. *Lease termination and otherrelated charges are comprised of the net losses expected to be incurred underthe existing long-term lease agreements for facilities permanentlyvacated.  The losses have been reducedby the expected sublease income.  Theseexpected losses were based on estimated current market rates and anticipateddates that these facilities are subleased. If market rates decrease or should it take longer than expected tosublease these facilities, the actual loss could exceed these estimates.  Otherrelated charges include the write-off of leasehold improvements related to thevacated facilities.

 

•                  *Write-Down of Surplus Inventory. *Inventory was written down to reflect its net realizable value forquantities on hand exceeding current and forecast order backlog requirementsrelated to the curtailed product offerings.

 

•                  *Severance and Other Compensation Costs. *The Company’s total workforce will be reduced by 25 employees, or 2%from December 31, 2003 levels, when the restructuring is completed during thethird quarter of fiscal 2004.

 

•                  *Other Restructuring Charges.*  Other charges pertain to legal, travel andrelocation costs.

 

The Companyexpects to incur additional restructuring-related expenses of approximately$1,900,000 during the last half of fiscal 2004 to complete the restructuringplans.  These expenses, which areprimarily relocation and travel costs, will be expensed as incurred.

 

The componentsof the restructuring, asset impairment and other related charges are asfollows:

 
|                                                |   | **Total**   |   | **Amounts  Incurred** |   | **Balance at  June 30,** |   |
|-----------------------------------------------------|--------|-------------|--------|-----------------------|--------|-------------------------------|--------|
| **(In  thousands)**                                 |   | **Charges** |   | **Noncash**           |   | **Cash**                      |   | **2004** |   |
|                                                |   |        |   | **(Unaudited)**       |   |                          |   |
| Lease termination and other related charges         |   | $           | 2,992  |                  | $      | (102                          | )      | $ | — |   | $ | 2,890 |   |
| Excess inventory write-downs                        |   | 2,811       |   | (2,811                | )      | —                        |   | — |   |
| Severance and other compensation costs              |   | 538         |   | —                |   | (20                           | )      | 518 |   |
| Other restructuring charges                         |   | 560         |   | (65                   | )      | (183                          | )      | 312 |   |
| Total                                               |   | 6,901       |   | $                     | (2,978 | )                             | $      | (203 | ) | $ | 3,720 |   |
|                                                |   |        |   |                  |   |                          |   |   |   |
| Other restructuring-related charges to be  incurred |   | 1,900       |   |                  |   |                          |   |   |   |
| Total expected restructuring charges                |   | $           | 8,801  |                  |   |                          |   |   |   |   |

 

Future cashpayments will be funded from existing cash balances and internally generatedcash from operations.

 

8

----

 

**Seating Product Line and FurnitureManufacturing Facilities Restructuring**

 

During thesecond quarter of fiscal 2003, the Company consolidated its seating productline offerings and adopted a restructuring plan to down-size a furnituremanufacturing facility in response to continuing weakness in the business, VIPand head-of-state aircraft market. These actions were designed to reduce engineering, production andinventory carrying costs by supporting fewer product offerings and achieveprofitability at the furniture manufacturing facility based on its lowerproduction levels.  In connection withthese actions, the Company recorded pre-tax charges to operations totaling$7,132,000, comprised of the following:

 

•                  *Lease Termination and Related Charges. *Lease termination charges reflect lease cancellation costs for thefacilities vacated and possession returned to the lessor in connection withdown-sizing a furniture manufacturing facility.  Other related charges include the write-off of leaseholdimprovements related to the vacated facilities.

 

•                  *Excess 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 related to the curtailed seating product offerings.

 

•                  *Severance and Other Compensation Costs. *The Company reduced its total workforce at the down-sized facility by49 employees, or 37%, from December 31, 2002 levels.

 

The componentsof the restructuring, asset impairment and other related charges are asfollows:

 
|                                        |   | **Total**   |   | **Amounts  Incurred** |   | **Balance at  December 31,** |   |
|---------------------------------------------|--------|-------------|--------|-----------------------|--------|-----------------------------------|--------|
| **(In  thousands)**                         |   | **Charges** |   | **Noncash**           |   | **Cash**                          |   | **2003** |   |
|                                        |   |        |   |                  |   |                              |   |   |   |
| Lease termination and other related charges |   | $           | 3,876  |                  | $      | (591                              | )      | $ | (3,285 | ) | $ | — |   |
| Excess inventory write-downs                |   | 3,073       |   | (3,073                | )      | —                            |   | — |   |
| Severance and other compensation costs      |   | 183         |   | —                |   | (183                              | )      | — |   |
| Total                                       |   | $           | 7,132  |                  | $      | (3,664                            | )      | $ | (3,468 | ) | $ | — |   |

 

Therestructuring activities were completed during 2003.

 

**Goodwill ImpairmentCharges**

 

As a result ofthe continuing weakness in the business, VIP and head-of-state aircraft marketand the decision to down-size a furniture manufacturing facility, the goodwillassociated with the furniture manufacturing reporting unit was tested forrecoverability in June 2003 and found to be impaired.  As a result, $34,000,000 of goodwill associated with thereporting unit was written off and charged to operations during the threemonths ended June 30, 2003.

 

As describedin Note 3, on March 14, 2003, the Company entered into a definitive agreementto sell its equity interests in the subsidiaries comprising its SpecialtyAvionics Group for $140,000,000 in cash. Based upon the fair value of the group implied in the definitiveagreement, the Company determined that the carrying value of the group’s netassets was not fully recoverable.  As aresult, the Company recorded a goodwill impairment charge of $7,500,000 duringthe three months ended March 31, 2003 to reduce the carrying value toestimated net realizable value.

 

9

----

 

**Note3.           Disposition of SpecialtyAvionics Group**

 

On May 23,2003, the Company consummated the sale of the subsidiaries comprising itsSpecialty Avionics Group for $140,000,000 in cash.  Based upon the fair value of the group implied in the definitiveagreement which was signed during the first quarter of fiscal 2003, the Companydetermined that the carrying value of the group’s net assets was not fullyrecoverable.  As required by SFAS No.142, the Company recorded a goodwill impairment charge of $7,500,000 during thefirst quarter of fiscal 2003 to reduce the carrying value to the estimated netrealizable value established by the definitive agreement.  The Company recorded a modest gain on thesale, based on the actual financial position of the group on the date of sale.  As a result of the sale, the SpecialtyAvionics Group is presented as a discontinued operation in the accompanyingconsolidated financial statements.

 

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

 

The followingtables summarize the results operations and cash flows of the SpecialtyAvionics Group for the two months and five months ended May 23, 2003, the dateof sale.

 
|                                                |   | **May 23,  2003** |   |
|-----------------------------------------------------|--------|-------------------|--------|
| **(In thousands)**                                  |   | **Two  Months**   |   | **Five  Months** |   |
|                                                |   | **(Unaudited)**   |   |
| Revenues                                            |   | $                 | 13,125 |   | $ | 36,595 |   |
|                                                |   |              |   |   |   |
| Operating expenses:                                 |   |              |   |   |   |
| Costs and expenses                                  |   | 11,136            |   | 30,128 |   |
| Impairment of goodwill                              |   | —            |   | 7,500 |   |
| Amortization of intangible assets                   |   | 321               |   | 878 |   |
| Total operating expenses                            |   | 11,457            |   | 38,506 |   |
|                                                |   |              |   |   |   |
| Income (loss) from operations                       |   | 1,668             |   | (1,911 | ) |
|                                                |   |              |   |   |   |
| Other expenses:                                     |   |              |   |   |   |
| Interest expense:                                   |   |              |   |   |   |
| Debt required to be repaid with proceeds  from sale |   | 1,146             |   | 2,952 |   |
| Debt obligations assumed by the buyer               |   | 68                |   | 270 |   |
| Other expenses, net                                 |   | 52                |   | 153 |   |
|                                                |   |              |   |   |   |
| Pre-tax income (loss)                               |   | 402               |   | (5,286 | ) |
| Provision for income taxes                          |   | 344               |   | 1,053 |   |
|                                                |   |              |   |   |   |
| Income (loss) from operations                       |   | 58                |   | (6,339 | ) |
| Gain on sale, net of tax                            |   | 689               |   | 689 |   |
|                                                |   |              |   |   |   |
| Net income (loss) from discontinued  operations     |   | $                 | 747    |   | $ | (5,650 | ) |

 

10

----

 
| **(In thousands)**                              |   | **Five  Months Ended  May 23,  2003** |   |
|-------------------------------------------------|--------|---------------------------------------|--------|
|                                            |   | **(Unaudited)**                       |   |
| Cash Flows Provided By (Used For):              |   |                                  |   |
| Operating activities                            |   | $                                     | 3,760  |   |
| Investing activities                            |   | (902                                  | )      |
| Financing activities                            |   | (649                                  | )      |
| Net increase in cash and cash equivalents       |   | (13                                   | )      |
| Effect of foreign currency translation on  cash |   | (2                                    | )      |
| Net cash provided by discontinued  operations   |   | $                                     | 2,194  |   |

 

**Note4.           Inventories**

 

Inventoriesare comprised of the following as of June 30, 2004 and December 31,2003:

 
| **(In thousands)**                                                           |   | **June 30,  2004** |   | **December 31,  2003** |   |
|------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                                                         |   | **(Unaudited)**         |   |                        |   |
| Raw materials                                                                |   | $                       | 28,483 |                        | $      | 30,414 |   |
| Work-in-process                                                              |   | 15,216                  |   | 6,817                       |   |
| Finished goods                                                               |   | 1,860                   |   | 1,693                       |   |
| Costs and estimated earnings in excess of  billings on uncompleted contracts |   | 6,755                   |   | 4,057                       |   |
| Total inventories                                                            |   | $                       | 52,314 |                        | $      | 42,981 |   |

 

Total costsand estimated earnings on all uncompleted contracts as of June 30, 2004and December 31, 2004 are comprised of the following:

 
| **(In thousands)**                                                            |   | **June 30,  2004** |   | **December 31,  2003** |   |
|-------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                                                          |   | **(Unaudited)**         |   |                        |   |
| Costs incurred on uncompleted contracts                                       |   | $                       | 79,663 |                        | $      | 71,824 |   |
| Estimated earnings recognized                                                 |   | 76,605                  |   | 77,782                      |   |
| Total costs and estimated earnings                                            |   | 156,268                 |   | 149,606                     |   |
| Less billings to date                                                         |   | (152,771                | )      | (145,661                    | )      |
| Net                                                                           |   | $                       | 3,497  |                        | $      | 3,945 |   |
|                                                                          |   |                    |   |                        |   |
| Balance sheet classification:                                                 |   |                    |   |                        |   |
| Asset – Costs and estimated earnings in  excess of billings              |   | $                       | 6,755  |                        | $      | 4,057 |   |
| Liability – Billings in excess of costs and  estimated earnings (Note 6) |   | (3,258                  | )      | (112                        | )      |
| Net                                                                           |   | $                       | 3,497  |                        | $      | 3,945 |   |

 

11

----

 

**Note5.           Other Assets, PrincipallyIntangibles**

 

Other assets arecomprised of the following as of June 30, 2004 and December 31, 2003:

 
| **(In thousands)**                                       |   | **June 30,  2004** |   | **December 31,  2003** |   |
|----------------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                                     |   | **(Unaudited)**         |   |                        |   |
| Identifiable intangible assets with finite  useful lives |   | $                       | 23,630 |                        | $      | 25,455 |   |
| Deferred financing costs                                 |   | 10,231                  |   | 11,812                      |   |
| Other non-amortizable assets                             |   | 903                     |   | 825                         |   |
| Total other assets                                       |   | $                       | 34,764 |                        | $      | 38,092 |   |

 

**Identifiable Intangible Assets with FiniteUseful Lives**

 

Identifiableintangible assets with finite useful lives are comprised of the following as ofJune 30, 2004 and December 31, 2003:

 
|                           |   | **June 30,  2004 (Unaudited)** |   | **December 31,  2003**   |   |
|--------------------------------|--------|--------------------------------|--------|-------------------------------|--------|
| **(In  thousands)**            |   | **Cost**                       |   | **Accumulated  Amortization** |   | **Net** |   | **Cost** |   | **Accumulated  Amortization** |   | **Net** |   |
|                           |   |                           |   |                          |   |   |   |   |   |   |   |   |   |
| FAA certifications             |   | $                              | 22,272 |                          | $      | (6,965 | ) | $ | 15,307 |   | $ | 22,272 |   | $ | (6,222 | ) | $ | 16,050 |   |
| Engineering drawings           |   | 7,645                          |   | (2,540                        | )      | 5,105 |   | 7,645 |   | (2,286 | ) | 5,359 |   |
| Other identifiable intangibles |   | 11,345                         |   | (8,127                        | )      | 3,218 |   | 11,345 |   | (7,299 | ) | 4,046 |   |
| Total identifiable intangibles |   | $                              | 41,262 |                          | $      | (17,632 | ) | $ | 23,630 |   | $ | 41,262 |   | $ | (15,807 | ) | $ | 25,455 |   |

 

Estimatedannual amortization expense for all identifiable intangible assets with finiteuseful lives for the five-year period ending December 31, 2008 is asfollows: 2004 – $3,644,000; 2005 – $3,477,000; 2006 – $2,275,000; 2007 –$2,175,000; and 2008 – $2,171,000.

 

**Note6.           Accrued Liabilities**

 

Accruedliabilities are comprised of the following as of June 30, 2004 andDecember 31, 2003:

 
| **(In thousands)**                                                           |   | **June 30,  2004** |   | **December 31,  2003** |   |
|------------------------------------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                                                         |   | **(Unaudited)**         |   |                        |   |
| Salaries, wages, compensated absences and  payroll related taxes             |   | $                       | 4,700  |                        | $      | 4,017 |   |
| Billings in excess of costs and estimated  earnings on uncompleted contracts |   | 3,258                   |   | 112                         |   |
| Accrued interest                                                             |   | 6,439                   |   | 4,969                       |   |
| Customer advances and deposits                                               |   | 2,439                   |   | 3,147                       |   |
| Current portion of accrued product warranty  obligations                     |   | 2,164                   |   | 2,064                       |   |
| Other accrued liabilities                                                    |   | 4,387                   |   | 3,581                       |   |
| Total accrued liabilities                                                    |   | $                       | 23,387 |                        | $      | 17,890 |   |

 

12

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**Note7.           Long-Term Debt**

 

Long-term debtincludes the following amounts as of June 30, 2004 and December 31,2003:

 
| **(In thousands)**                                                           |   | **June 30,  2004** |    | **December 31,  2003** |   |
|------------------------------------------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                                                                         |   | **(Unaudited)**         |    |                        |   |
| First-lien credit facility:                                                  |   |                    |    |                        |   |
| Term debt                                                                    |   | $                       | 80,521  |                        | $      | 80,521 |   |
| Revolving line of credit                                                     |   | 15,050                  |    | —                      |   |
| Second-lien term debt                                                        |   | 81,280                  |    | 80,067                      |   |
| Capital lease obligations and other debt,  secured by property and equipment |   | 8,289                   |    | 8,818                       |   |
| 12% subordinated notes                                                       |   | 100,000                 |    | 100,000                     |   |
| Total long-term debt                                                         |   | 285,140                 |    | 269,406                     |   |
| Less current portion                                                         |   | (1,319                  | )       | (1,198                      | )      |
| Long-term debt, less current portion                                         |   | $                       | 283,821 |                        | $      | 268,208 |   |

 

A portion ofthe interest charged on the second-lien term debt is pay-in-kind or “accreted”interest, payable at maturity.  Anadditional $1,213,000 of pay-in-kind interest accreted to the initial principalbalance of the term debt during the six months ended June 30, 2004 and $607,000during the three months ended June 30, 2004.

 

As of June 30,2004, the Company had irrevocable standby letters of credit in the amount of$318,000 issued and outstanding under the first-lien credit facility, whichreduces borrowings available under the $24,000,000 revolving line of credit.

 

Subsequent toJune 30, 2004, some of the holders of the 12% subordinated notes elected toexchange their notes for new 17% senior discount notes (Note 13).

 

**Note8.           Mandatorily RedeemablePreferred Stock**

 

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

 

The tablebelow summarizes the increase in mandatorily redeemable preferred stock duringthe six months ended June 30, 2004.

 
|                                                         |   | **DeCrane  Aircraft  16% Preferred Stock** |   | **DeCrane  Holdings  14% Preferred Stock** |   |                                |   |
|--------------------------------------------------------------|--------|--------------------------------------------|--------|--------------------------------------------|--------|-------------------------------------|--------|
| **(In thousands, except share and  per share data)**         |   | **Number  of  Shares**                     |   | **Mandatory  Redemption  Value**           |   | **Unamortized  Issuance  Discount** |   | **Net  Book  Value** |   | **Number  of  Shares** |   | **Mandatory  Redemption  Value** |   | **Total** |   |
|                                                         |   |                                       |   |                                       |   |                                |   |   |   |   |   |   |   |   |   |
| Balance, December 31, 2003                              |   | 432,919                                    |   | $                                          | 43,292 |                                | $      | (2,457 | ) | $ | 40,835 |   | 342,417 |   | $ | 71,402 |   | $ | 112,237 |   |
| Preferred stock dividends                                    |   | 35,326                                     |   | 3,533                                      |   | —                              |   | 3,533 |   | — |   | 5,085 |   | 8,618 |   |
| Redemption value accretion                                   |   | —                                     |   | —                                     |   | 234                                 |   | 234 |   | — |   | — |   | 234 |   |
| Balance, June 30, 2004 (Unaudited)                           |   | 468,245                                    |   | $                                          | 46,825 |                                | $      | (2,223 | ) | $ | 44,602 |   | 342,417 |   | $ | 76,487 |   | $ | 121,089 |   |
|                                                         |   |                                       |   |                                       |   |                                |   |   |   |   |   |   |   |   |   |
| Per share liquidation value as of June 30,  2004 (Unaudited) |   |                                       |   | $                                          | 100.00 |                                |   |   |   |   |   |   | $ | 223.37 |   |   |   |

 

13

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*DeCrane Aircraft 16% Mandatorily RedeemablePreferred Stock*

 

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

 

*DeCrane Holdings 14% Mandatorily RedeemablePreferred Stock*

 

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

 

Subsequent toJune 30, 2004, the Company amended the terms of both the 16% and 14% preferredstock to eliminate the dividends unless the Company achieves defined leverageratios (Note 13).

 

**Note9.           Income Taxes**

 

The componentsof income (loss) before income taxes and cumulative effect of change inaccounting principle and the provisions for income tax benefit are as follows:

 
|                                        |   | **Three  Months Ended  June 30,** |    | **Six Months  Ended  June 30,** |   |
|---------------------------------------------|--------|-----------------------------------|---------|--------------------------------------|--------|
| **(In thousands)**                          |   | **2004**                          |    | **2003**                             |   | **2004** |   | **2003** |   |
|                                        |   | **(Unaudited)**                   |    |
| Pre-tax income (loss) reported by:          |   |                              |    |                                 |   |   |   |   |   |
| Continuing operations                       |   | $                                 | (16,430 | )                                    | $      | (48,304 | ) | $ | (28,047 | ) | $ | (55,502 | ) |
| Discontinued operations                     |   | —                            |    | 402                                  |   | — |   | (5,286 | ) |
| Consolidated pre-tax loss                   |   | $                                 | (16,430 | )                                    | $      | (47,902 | ) | $ | (28,047 | ) | $ | (60,788 | ) |
|                                        |   |                              |    |                                 |   |   |   |   |   |
| Total provision for income taxes (benefit): |   |                              |    |                                 |   |   |   |   |   |
| Income tax benefit based on pre-tax loss    |   | $                                 | (4,619  | )                                    | $      | (22,077 | ) | $ | (7,143 | ) | $ | (22,633 | ) |
| Net deferred tax assets valuation allowance |   | 4,649                             |    | 13,056                               |   | 7,203 |   | 13,056 |   |
| Net provision for income taxes (benefit)    |   | $                                 | 30      |                                 | $      | (9,021 | ) | $ | 60 |   | $ | (9,577 | ) |
|                                        |   |                              |    |                                 |   |   |   |   |   |
| Allocation of total provision:              |   |                              |    |                                 |   |   |   |   |   |
| Continuing operations                       |   | $                                 | 30      |                                 | $      | (9,365 | ) | $ | 60 |   | $ | (10,630 | ) |
| Discontinued operations                     |   | —                            |    | 344                                  |   | — |   | 1,053 |   |
| Net provision for income taxes (benefit)    |   | $                                 | 30      |                                 | $      | (9,021 | ) | $ | 60 |   | $ | (9,577 | ) |

 

For the threemonths and six months ended June 30, 2004, 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 andnon-deductible expenses, principally mandatorily redeemable preferred stock dividendsdue to the adoption of SFAS No. 150 effective January 1, 2004 (Note 1).

 

14

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For the threemonths and six months ended June 30, 2003, 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 andnon-deductible expenses, principally the non-deductible portion of goodwillimpairment charges and DeCrane Aircraft’s 16% preferred stock dividends.

 

As of June 30,2003, the Company had net deferred tax assets of $12,841,000, prior torecording the valuation allowance in June 2003, as opposed to net deferred taxliabilities in prior periods.  Thechange to a net asset position was primarily caused by the $34,000,000 goodwillimpairment charge recorded during the second quarter of fiscal 2003.  SFAS No. 109, “Accounting for Income Taxes,”requires the recognition of a deferred tax asset for the future income taxbenefit of the goodwill deductions that will be taken for income tax purposes(i.e. the goodwill that has been written off in the financial statements forbook purposes will continue to be amortized and deducted for tax purposes andaccordingly represents a new deferred tax asset).

 

As required bySFAS No. 109, the Company evaluated its deferred tax assets for expectedrecoverability based on the nature of the item, the associated taxingjurisdictions, the applicable expiration dates and future taxable incomeforecasts that would impact utilization. Since there is no loss carry back potential and the Company does nothave any tax planning strategies to assure recoverability, the only possibilityfor recovery of the net deferred assets is future taxable income.  Since there have been prior year losses, theCompany believes it was not prudent to rely on future taxable income as themeans to support the carrying value of the net deferred tax assets.  As a result of the evaluation, the Companyrecorded a $13,056,000 valuation allowance, eliminating the net deferred asset,as of June 30, 2003.

 

As more fullydescribed in Note 11 to the audited financial statements included in theCompany’s 2003 Form 10-K, the Company had a net deferred tax asset of$19,528,000 fully offset by a valuation allowance of the same amount as ofDecember 31, 2003.  Based upon theresults of operations for the six months ended June 30, 2004, the Company determinedthat an additional $7,203,000 valuation allowance was required as of that date,$4,649,000 of which is applicable to the three-month period.

 

**Note10.         Commitments and Contingencies**

 

**Litigation**

 

RaytheonAircraft Company (“Raytheon”) has filed a complaint against the Company and oneof its subsidiaries in the state court of Kansas with respect to allegedproduct liability related to certain aircraft seats sold to Raytheon by theCompany’s subsidiary.  The complaintdoes not specify the amount of damages claimed by Raytheon, but the amount couldbe material.

 

This actionhas just been served on the Company and no discovery has commenced;accordingly, management has not had an opportunity to determine the likelyoutcome of this claim.  However, basedon the allegations in the complaint and the facts currently available,management does not know of a basis which would result in this action having amaterial adverse effect on the Company’s business, consolidated financialposition, results of operations or cash flows. Further, the Company’s subsidiary may be indemnified by the entity fromwhich it acquired the seat product line.

 

The Companyand its subsidiaries are also involved in other routine legal andadministrative proceedings 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.

 

15

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**Note11.         Business Segment Information**

 

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

 

•                  *Cabin Management –* manufactures 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 priorperiods, the Company’s Specialty Avionics Group was a third strategic businessfor which segment information was provided. As a result of the sale of the Specialty Avionics Group, this group isreflected as a discontinued operation and segment information for prior periodshas been restated.

 

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

 

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

 

The financialmeasure Adjusted 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.

 

16

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

 

The tablesbelow summarize selected financial data by business segment.

 
|                          |   | **Three  Months Ended  June 30,** |    | **Six Months  Ended  June 30,** |   |
|-------------------------------|--------|-----------------------------------|---------|--------------------------------------|--------|
| **(In thousands)**            |   | **2004**                          |    | **2003**                             |   | **2004** |   | **2003** |   |
|                          |   | **(Unaudited)**                   |    |
| Revenues:                     |   |                              |    |                                 |   |   |   |   |   |
| Cabin Management              |   | $                                 | 40,990  |                                 | $      | 29,635 |   | $ | 75,328 |   | $ | 60,255 |   |
| Systems Integration           |   | 15,380                            |    | 14,718                               |   | 29,911 |   | 26,850 |   |
| Inter-group elimination (1)   |   | (1,553                            | )       | (240                                 | )      | (1,825 | ) | (1,092 | ) |
| Consolidated totals           |   | $                                 | 54,817  |                                 | $      | 44,113 |   | $ | 103,414 |   | $ | 86,013 |   |
|                          |   |                              |    |                                 |   |   |   |   |   |
| Adjusted EBITDA (as defined): |   |                              |    |                                 |   |   |   |   |   |
| Cabin Management              |   | $                                 | 6,182   |                                 | $      | 4,310 |   | $ | 9,622 |   | $ | 8,860 |   |
| Systems Integration           |   | 2,399                             |    | 4,180                                |   | 5,428 |   | 6,337 |   |
| Corporate (2)                 |   | (1,113                            | )       | (1,395                               | )      | (2,206 | ) | (3,507 | ) |
| Inter-group elimination (3)   |   | (2                                | )       | 2                                    |   | 1 |   | 112 |   |
| Consolidated totals           |   | 7,466                             |    | 7,097                                |   | 12,845 |   | 11,802 |   |
| Reconciling items (4)         |   | (23,926                           | )       | (45,289                              | )      | (40,952 | ) | (76,088 | ) |
| Net loss                      |   | $                                 | (16,460 | )                                    | $      | (38,192 | ) | $ | (28,107 | ) | $ | (64,286 | ) |

 
| **(In thousands)**               |   | **June 30,  2004** |    | **December 31,  2003** |   |
|----------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                             |   | **(Unaudited)**         |    |                        |   |
| Total assets (as of period end): |   |                    |    |                        |   |
| Cabin Management                 |   | $                       | 241,077 |                        | $      | 224,116 |   |
| Systems Integration              |   | 54,269                  |    | 58,395                      |   |
| Corporate (5)                    |   | 14,831                  |    | 21,456                      |   |
| Inter-group elimination (6)      |   | (11                     | )       | (91                         | )      |
| Consolidated totals              |   | $                       | 310,166 |                        | $      | 303,876 |   |

 

----

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

 

(2)                                  Reflects theCompany’s corporate headquarters costs and expenses not allocated to thegroups.

 

(3)                                  Reflects eliminationof the effect of inter-group profits in inventory.

 

17

----

 

(4)                                  Adjusted EBITDA (asdefined) excludes the following charges reflected in the Company’s financialstatements which are prepared in accordance with generally accepted accountingprinciples:

 
|                                                                          |   | **Three  Months Ended  June 30,** |    | **Six Months  Ended  June 30,** |   |
|-------------------------------------------------------------------------------|--------|-----------------------------------|---------|--------------------------------------|--------|
| **(In thousands)**                                                            |   | **2004**                          |    | **2003**                             |   | **2004** |   | **2003** |   |
|                                                                          |   | **(Unaudited)**                   |    |
| Depreciation and amortization of long-  lived assets (a)                      |   | $                                 | (2,277  | )                                    | $      | (2,451 | ) | $ | (4,603 | ) | $ | (4,967 | ) |
| Adjustment to reflect program costs as research  and development expenses (b) |   | (1,481                            | )       | (3,278                               | )      | (3,097 | ) | (4,851 | ) |
| Restructuring, asset impairment and other  related charges                    |   | (6,901                            | )       | (41,132                              | )      | (6,901 | ) | (41,132 | ) |
| Acquisition related charges not capitalized                                   |   | (9                                | )       | (8                                   | )      | (18 | ) | (17 | ) |
| Interest expense                                                              |   | (8,750                            | )       | (6,468                               | )      | (17,452 | ) | (12,337 | ) |
| Mandatorily redeemable preferred stock  dividends                             |   | (4,387                            | )       | (1,657                               | )      | (8,618 | ) | (3,254 | ) |
| Other expenses, net                                                           |   | (91                               | )       | (407                                 | )      | (203 | ) | (746 | ) |
| Provision for income (taxes) benefit                                          |   | (30                               | )       | 9,365                                |   | (60 | ) | 10,630 |   |
| Income (loss) from discontinued operations                                    |   | —                            |    | 747                                  |   | — |   | (5,650 | ) |
| Cumulative effect of change in accounting  principle                          |   | —                            |    | —                               |   | — |   | (13,764 | ) |
| Total reconciling items                                                       |   | $                                 | (23,926 | )                                    | $      | (45,289 | ) | $ | (40,952 | ) | $ | (76,088 | ) |

 

----

(a)                                  Reflects depreciationand amortization of long-lived assets but excludes amortization of deferredfinancing costs, which are classified as a component of interest expense, asfollows:

 
|                                                 |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|------------------------------------------------------|--------|-----------------------------------|--------|--------------------------------------|--------|
| **(In thousands)**                                   |   | **2004**                          |   | **2003**                             |   | **2004** |   | **2003** |   |
|                                                 |   | **(Unaudited)**                   |   |
| Depreciation and amortization of long-  lived assets |   | $                                 | 2,277  |                                 | $      | 2,451 |   | $ | 4,603 |   | $ | 4,967 |   |
| Amortization of deferred financing costs             |   | 791                               |   | 680                                  |   | 1,581 |   | 1,375 |   |
| Consolidated depreciation and amortization           |   | $                                 | 3,068  |                                 | $      | 3,131 |   | $ | 6,184 |   | $ | 6,342 |   |

 

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

 

(5)                                  Reflects theCompany’s corporate headquarters assets, excluding investments in and notesreceivable from subsidiaries.

 

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

 

18

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**Note12.         Supplemental CondensedConsolidating Financial Information**

 

In conjunctionwith the 12% subordinated notes described in Note 7, the following condensedconsolidating financial information is presented segregating DeCrane Aircraft,as the issuer, and the guarantor and non-guarantor subsidiaries.  The accompanying financial information inthe guarantor subsidiaries column reflects the financial position, results ofoperations and cash flows for those subsidiaries guaranteeing the notes.  DeCrane Holdings is not a guarantor of thenotes and is therefore reflected in the non-guarantor subsidiary column withDeCrane Aircraft’s non-guarantor subsidiaries. DeCrane Aircraft’s non-guarantor subsidiaries are companies within theSpecialty Avionics Group which was sold in May 2003 and is therefore classifiedas a component of discontinued operations.

 

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

 

(1)                                  Elimination ofinvestments in subsidiaries.

 

(2)                                  Elimination ofintercompany accounts.

 

(3)                                  Elimination of equityin earnings of subsidiaries.

 

19

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**Balance Sheets**

 
|                                                       |   | **June 30,  2004 (Unaudited)** |    |
|------------------------------------------------------------|--------|--------------------------------|---------|
| **(In  thousands)**                                        |   | **Issuer**                     |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                       |   |                           |    |   |   |   |   |   |   |   |   |
| **Assets**                                                 |   |                           |    |   |   |   |   |   |   |   |   |
|                                                       |   |                           |    |   |   |   |   |   |   |   |   |
| Current assets:                                            |   |                           |    |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                  |   | $                              | 1,710   |   | $ | 652 |   | $ | — |   | $ | — |   | $ | 2,362 |   |
| Accounts receivable, net                                   |   | —                         |    | 27,322 |   | — |   | — |   | 27,322 |   |
| Inventories                                                |   | —                         |    | 52,314 |   | — |   | — |   | 52,314 |   |
| Other current assets                                       |   | 88                             |    | 1,088 |   | — |   | — |   | 1,176 |   |
| Total current assets                                       |   | 1,798                          |    | 81,376 |   | — |   | — |   | 83,174 |   |
|                                                       |   |                           |    |   |   |   |   |   |   |   |   |
| Property and equipment, net                                |   | 890                            |    | 28,908 |   | — |   | — |   | 29,798 |   |
| Other assets, principally goodwill                         |   | 12,143                         |    | 185,051 |   | — |   | — |   | 197,194 |   |
| Investments in subsidiaries                                |   | 79,245                         |    | — |   | (66,667 | ) | (12,578 | )(1) | — |   |
| Intercompany receivables                                   |   | 228,891                        |    | 56,857 |   | — |   | (285,748 | )(2) | — |   |
| Total assets                                               |   | $                              | 322,967 |   | $ | 352,192 |   | $ | (66,667 | ) | $ | (298,326 | ) | $ | 310,166 |   |
|                                                       |   |                           |    |   |   |   |   |   |   |   |   |
| **Liabilities and Stockholders’ Equity  (Deficit)**   |   |                           |    |   |   |   |   |   |   |   |   |
|                                                       |   |                           |    |   |   |   |   |   |   |   |   |
| Current liabilities:                                       |   |                           |    |   |   |   |   |   |   |   |   |
| Current portion of long-term debt                          |   | $                              | 46      |   | $ | 1,273 |   | $ | — |   | $ | — |   | $ | 1,319 |   |
| Other current liabilities                                  |   | 8,852                          |    | 31,976 |   | — |   | — |   | 40,828 |   |
| Total current liabilities                                  |   | 8,898                          |    | 33,249 |   | — |   | — |   | 42,147 |   |
|                                                       |   |                           |    |   |   |   |   |   |   |   |   |
| Long-term debt, less current portion                       |   | 276,921                        |    | 6,900 |   | — |   | — |   | 283,821 |   |
| Mandatorily redeemable preferred stock                     |   | 44,602                         |    | — |   | 76,487 |   | — |   | 121,089 |   |
| Intercompany payables                                      |   | 56,857                         |    | 228,891 |   | — |   | (285,748 | )(2) | — |   |
| Other long-term liabilities                                |   | 3,661                          |    | 4,175 |   | — |   | — |   | 7,836 |   |
|                                                       |   |                           |    |   |   |   |   |   |   |   |   |
| Stockholders’ equity (deficit):                       |   |                           |    |   |   |   |   |   |   |   |   |
| Paid-in capital                                            |   | 111,682                        |    | 151,492 |   | 61,515 |   | (264,479 | )(1) | 60,210 |   |
| Retained earnings (deficit)                                |   | (179,654                       | )       | (72,247 | ) | (204,669 | ) | 251,901 | (1) | (204,669 | ) |
| Accumulated other comprehensive loss                       |   | —                         |    | (268 | ) | — |   | — |   | (268 | ) |
| Total stockholders’ equity (deficit)                  |   | (67,972                        | )       | 78,977 |   | (143,154 | ) | (12,578 | ) | (144,727 | ) |
| Total liabilities and stockholders’ equity  (deficit) |   | $                              | 322,967 |   | $ | 352,192 |   | $ | (66,667 | ) | $ | (298,326 | ) | $ | 310,166 |   |

 

20

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

 

21

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**Statements of Operations**

 
|                                              |   | **Six Months  Ended June 30, 2004 (Unaudited)** |    |
|---------------------------------------------------|--------|-------------------------------------------------|---------|
| **(In  thousands)**                               |   | **Issuer**                                      |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                              |   |                                            |    |   |   |   |   |   |   |   |   |
| Revenues                                          |   | $                                               | —  |   | $ | 103,414 |   | $ | — |   | $ | — |   | $ | 103,414 |   |
| Cost of sales                                     |   | —                                          |    | 84,156 |   | — |   | — |   | 84,156 |   |
|                                              |   |                                            |    |   |   |   |   |   |   |   |   |
| Gross profit                                      |   | —                                          |    | 19,258 |   | — |   | — |   | 19,258 |   |
|                                              |   |                                            |    |   |   |   |   |   |   |   |   |
| Operating and other expenses (income):            |   |                                            |    |   |   |   |   |   |   |   |   |
| Selling, general and administrative  expenses     |   | 2,422                                           |    | 12,603 |   | — |   | — |   | 15,025 |   |
| Research and development expenses                 |   | —                                          |    | 4,182 |   | — |   | — |   | 4,182 |   |
| Amortization of intangible assets                 |   | —                                          |    | 1,825 |   | — |   | — |   | 1,825 |   |
| Interest expense                                  |   | 17,091                                          |    | 361 |   | — |   | — |   | 17,452 |   |
| Mandatorily redeemable preferred stock  dividends |   | 3,533                                           |    | — |   | 5,085 |   | — |   | 8,618 |   |
| Intercompany charges                              |   | (10,879                                         | )       | 10,879 |   | — |   | — |   | — |   |
| Equity in loss of subsidiaries                    |   | 6,423                                           |    | — |   | 23,022 |   | (29,445 | )(3) | — |   |
| Other expenses (income), net                      |   | 214                                             |    | (11 | ) | — |   | — |   | 203 |   |
| Provision for income taxes (benefit)              |   | 4,218                                           |    | (4,158 | ) | — |   | — |   | 60 |   |
|                                              |   |                                            |    |   |   |   |   |   |   |   |   |
| Net loss                                          |   | $                                               | (23,022 | ) | $ | (6,423 | ) | $ | (28,107 | ) | $ | 29,445 |   | $ | (28,107 | ) |

 
|                                                 |   | **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                                        |   | —                                          |    | 67,592 |   | — |   | — |   | 67,592 |   |
|                                                 |   |                                            |    |   |   |   |   |   |   |   |   |
| Gross profit                                         |   | —                                          |    | 18,421 |   | — |   | — |   | 18,421 |   |
|                                                 |   |                                            |    |   |   |   |   |   |   |   |   |
| Operating and other expenses (income):               |   |                                            |    |   |   |   |   |   |   |   |   |
| Selling, general and administrative expenses         |   | 4,904                                           |    | 12,005 |   | — |   | — |   | 16,909 |   |
| Research and development expenses                    |   | —                                          |    | 4,851 |   | — |   | — |   | 4,851 |   |
| Impairment of goodwill                               |   | —                                          |    | 34,000 |   | — |   | — |   | 34,000 |   |
| Amortization of intangible assets                    |   | —                                          |    | 1,826 |   | — |   | — |   | 1,826 |   |
| Interest expense                                     |   | 12,116                                          |    | 221 |   | — |   | — |   | 12,337 |   |
| Mandatorily redeemable preferred stock  dividends    |   | —                                          |    | — |   | 3,254 |   | — |   | 3,254 |   |
| Intercompany charges                                 |   | (11,575                                         | )       | 11,575 |   | — |   | — |   | — |   |
| Equity in loss of subsidiaries                       |   | 46,968                                          |    | 218 |   | 61,032 |   | (108,218 | )(3) | — |   |
| Other expenses, net                                  |   | 586                                             |    | 160 |   | — |   | — |   | 746 |   |
| Provision for income taxes (benefit)                 |   | 8,033                                           |    | (18,663 | ) | — |   | — |   | (10,630 | ) |
| Loss from discontinued operations                    |   | —                                          |    | 5,432 |   | 218 |   | — |   | 5,650 |   |
| Cumulative effect of change in accounting  principle |   | —                                          |    | 13,764 |   | — |   | — |   | 13,764 |   |
|                                                 |   |                                            |    |   |   |   |   |   |   |   |   |
| Net loss                                             |   | $                                               | (61,032 | ) | $ | (46,968 | ) | $ | (64,504 | ) | $ | 108,218 |   | $ | (64,286 | ) |

 

22

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**Statements of Cash Flows**

 
|                                                  |   | **Six Months  Ended June 30, 2004 (Unaudited)** |    |
|-------------------------------------------------------|--------|-------------------------------------------------|---------|
| **(In  thousands)**                                   |   | **Issuer**                                      |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                  |   |                                            |    |   |   |   |   |   |   |   |   |
| **Cash flows from operating activities:**             |   |                                            |    |   |   |   |   |   |   |   |   |
| Net loss                                              |   | $                                               | (23,022 | ) | $ | (6,423 | ) | $ | (28,107 | ) | $ | 29,445 |   | $ | (28,107 | ) |
| Noncash adjustments:                                  |   |                                            |    |   |   |   |   |   |   |   |   |
| Equity in loss of subsidiaries                        |   | 6,423                                           |    | — |   | 23,022 |   | (29,445 | )(3) | — |   |
| Other noncash adjustments                             |   | 6,717                                           |    | 7,412 |   | 5,085 |   | — |   | 19,214 |   |
| Changes in working capital                            |   | (9,992                                          | )       | 1,592 |   | — |   | — |   | (8,400 | ) |
| Net cash provided by (used for) operating  activities |   | (19,874                                         | )       | 2,581 |   | — |   | — |   | (17,293 | ) |
|                                                  |   |                                            |    |   |   |   |   |   |   |   |   |
| **Cash flows from investing activities:**             |   |                                            |    |   |   |   |   |   |   |   |   |
| Capital expenditures                                  |   | —                                          |    | (1,767 | ) | — |   | — |   | (1,767 | ) |
| Net cash used for investing activities                |   | —                                          |    | (1,767 | ) | — |   | — |   | (1,767 | ) |
|                                                  |   |                                            |    |   |   |   |   |   |   |   |   |
| **Cash flows from financing activities:**             |   |                                            |    |   |   |   |   |   |   |   |   |
| Net revolving line of credit borrowings               |   | 15,050                                          |    | — |   | — |   | — |   | 15,050 |   |
| Other secured long-term borrowings                    |   | —                                          |    | 46 |   | — |   | — |   | 46 |   |
| Other secured long-term debt repayments               |   | (6                                              | )       | (604 | ) | — |   | — |   | (610 | ) |
| Net cash provided by (used for) financing  activities |   | 15,044                                          |    | (558 | ) | — |   | — |   | 14,486 |   |
|                                                  |   |                                            |    |   |   |   |   |   |   |   |   |
| Net increase (decrease) in cash and  equivalents      |   | (4,830                                          | )       | 256 |   | — |   | — |   | (4,574 | ) |
| Cash and equivalents at beginning of period           |   | 6,540                                           |    | 396 |   | — |   | — |   | 6,936 |   |
|                                                  |   |                                            |    |   |   |   |   |   |   |   |   |
| Cash and equivalents at end of period                 |   | $                                               | 1,710   |   | $ | 652 |   | $ | — |   | $ | — |   | $ | 2,362 |   |

 

23

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|                                                  |   | **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                                              |   | $                                                    | (61,032 | ) | $ | (46,968 | ) | $ | (64,504 | ) | $ | 108,218 | (3) | $ | (64,286 | ) |
| Noncash adjustments:                                  |   |                                                 |    |   |   |   |   |   |   |   |   |
| Cumulative effect of change in accounting  principle  |   | —                                               |    | 13,764 |   | — |   | — |   | 13,764 |   |
| Loss from discontinued operations                     |   | —                                               |    | 5,432 |   | 218 |   | — |   | 5,650 |   |
| Equity in loss of subsidiaries                        |   | 46,968                                               |    | 218 |   | 61,032 |   | (108,218 | )(3) | — |   |
| Other noncash adjustments                             |   | (21,973                                              | )       | 54,615 |   | 3,254 |   | — |   | 35,896 |   |
| Changes in working capital                            |   | 15,765                                               |    | (26,731 | ) | — |   | — |   | (10,966 | ) |
| Net cash used for operating activities                |   | (20,272                                              | )       | 330 |   | — |   | — |   | (19,942 | ) |
|                                                  |   |                                                 |    |   |   |   |   |   |   |   |   |
| **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, net of cash  acquired     |   | (600                                                 | )       | — |   | — |   | — |   | (600 | ) |
| Net cash provided by (used for) investing  activities |   | 132,174                                              |    | (1,976 | ) | — |   | — |   | 130,198 |   |
|                                                  |   |                                                 |    |   |   |   |   |   |   |   |   |
| **Cash flows from financing activities:**             |   |                                                 |    |   |   |   |   |   |   |   |   |
| Net revolving line of credit borrowings               |   | 9,250                                                |    | — |   | — |   | — |   | 9,250 |   |
| First-lien term debt repayments                       |   | (129,275                                             | )       | — |   | — |   | — |   | (129,275 | ) |
| Other secured long-term debt repayments               |   | (649                                                 | )       | (524 | ) | — |   | — |   | (1,173 | ) |
| Net cash provided by (used for) financing  activities |   | (120,674                                             | )       | (524 | ) | — |   | — |   | (121,198 | ) |
|                                                  |   |                                                 |    |   |   |   |   |   |   |   |   |
| Net cash provided by discontinued  operations         |   | —                                               |    | 2,194 |   | — |   | — |   | 2,194 |   |
|                                                  |   |                                                 |    |   |   |   |   |   |   |   |   |
| 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 |   |

 

24

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** **

**Note 13.         Subsequent Event**

 

On July 23, 2004, holders of $64,485,000 of DeCrane Aircraft’s 12%senior subordinated notes due September 30, 2008 (the “existing notes”)exchanged their notes for new 17% senior discount notes due September 30, 2008(the “new notes”).  The new notes do notbear cash interest and have an initial accreted value equal to the principalamount of the notes exchanged.  The newnotes accrete in value at a 17% annual rate and will have a $127,771,000aggregate accreted principal value at maturity.  The new notes are senior unsecured obligations of DeCraneAircraft and are guaranteed by its subsidiaries.  Except for the changes in the interest rate and payment andranking described above, the new notes have terms substantially identical tothose contained in the existing notes, although covenants limiting theincurrence of indebtedness, the granting of liens and the making of restrictedpayments are more restrictive.

 

Concurrent with the note exchange, DeCrane Aircraft amended the terms ofits 16% senior preferred stock and DeCrane Holdings also amended the terms ofits 14% preferred stock as well.  Theamended terms provide that further dividends do not accrue on the preferredstock, except if a leverage ratio (as defined) falls below certain specifiedlevels or if certain triggering events occur, such as failure to discharge anymandatory redemption obligations, and the like.  Depending upon the future leverage ratio achieved, dividends willresume at various dividend rates.  Alldividends accrued through the amendment date and future dividends, if any, arenot payable until redemption.  Theamendment for the 16% preferred stock accelerates the mandatory redemption datefrom March 31, 2009 to December 31, 2008 while the September 30, 2009 mandatoryredemption date for the 14% preferred stock remained unchanged.  The amendment to the 16% preferred stockalso adds several restrictive covenants. The holders of the 16% preferred stock were issued 348,945 shares ofDeCrane Holdings common stock in connection with the amendment.

 

25

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**ITEM2.****         MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The following discussions should be read in conjunction with our financialstatements and accompanying notes included in this report.

 

**Results of Operations**

 

### **Performance Measures**

 

The following discussion of our results of operations includesdiscussions of financial measures and operating statistics we use to evaluatethe performance of, and trends in, our businesses.  We believe the presentation of these measures and statistics arerelevant and useful to investors because it allows them to view performance andtrends in a manner similar to the methods we use.  These measures and statistics, and why they are important to usand could be of interest to you, are described below.

 

**AdjustedEBITDA.**  Ourdiscussion of the results of operations includes discussions of financialmeasures determined in accordance with accounting principles generally acceptedin the United States of America (“GAAP”) as well as the financial measureAdjusted EBITDA, which excludes certain charges reflected in our GAAP basisfinancial statements.  Our presentationof Adjusted EBITDA is in accordance with the GAAP requirements of SFAS No. 131,“Disclosures about Segments of an Enterprise and Related Information,” whichrequires us to report the primary measure of segment performance we use toevaluate and manage our businesses.

 

We utilize more than one measurement to evaluate segment performanceand allocate resources among our operating segments; however, we considerAdjusted EBITDA, as defined below, to be the primary measurement of overalloperating 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, determined using programaccounting for product development costs, before interest, income taxes,depreciation and amortization, restructuring, asset impairment and otherrelated charges, acquisition related charges not capitalized and other noncashand nonoperating charges.  We believethe presentation of this measure is relevant and useful to investors because itallows investors and analysts to view group performance in a manner similar tothe method we use, helps improve their ability to understand our core segmentperformance, adjusted for items we believe are unusual, and makes it easier tocompare our results with other companies that have different financing, capitalstructures and tax rates.  In addition,we believe these measures are consistent with the manner in which our lendersand investors measure our overall performance and liquidity, including ourability to service debt and fund discretionary capital expenditure and productdevelopment programs.

 

Our method of calculating Adjusted EBITDA may not be consistent withthat of other companies and should be viewed in conjunction with measurementsthat are computed in accordance GAAP, such as net income (loss), the nearestcomparable GAAP financial measure. Adjusted EBITDA should not be viewed as substitutes for or superior tonet income (loss), cash flow from operations or other data prepared inaccordance with GAAP as a measure of our profitability or liquidity.  The notes to our financial statementsinclude information about our operating segments, including Adjusted EBITDA,and should be read in conjunction with the discussions presented herein.  The notes to our financial statements

 

26

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also include a reconciliationof Adjusted EBITDA to net income (loss) to clarify the differences betweenthese financial measures.

 

**Bookingsand Backlog.** Bookings and backlog are operating statistics we use as leading trendindicators of future demand for our products and services.  Bookings and backlog are based upon the valueof purchase orders received from our customers, which will result in revenues,if and when such orders are filled.

 

Bookings represent the total invoice value of purchase orders receivedduring the period and backlog represents the total invoice value of unfilledpurchase orders as of the end of a period. Orders may be subject to change or cancellation by the customer prior toshipment.  The level of unfilled ordersat any given date during the year will be materially affected by the timing ofour receipt of orders and the speed with which those orders are filled.

 

### **Changes in AccountingPrinciples**

 

**Adoptionof SFAS No. 150.** Effective January 1, 2004, we adopted SFAS No. 150, “Accounting forCertain Financial Instruments with Characteristics of both Liabilities andEquity.”  SFAS No. 150 establishesstandards for the classification and measurement of certain financialinstruments with characteristics of both liabilities and equity.  SFAS No. 150 requires classification offinancial instruments within its scope as a liability, including financialinstruments issued in the form of shares that are mandatorily redeemable,because those financial instruments are deemed to be, in essence, obligationsof the issuer.  As a result of adoptingSFAS No. 150 on January 1, 2004, all mandatorily redeemable preferred stock wasreclassified as a liability and all quarterly dividends are reflected as acharge against pre-tax income.  Inperiods prior to January 1, 2004, DeCrane Holdings’ 14% preferred stockdividends were deducted in arriving at the net income or loss applicable to ourcommon stockholders; DeCrane Aircraft’s 16% preferred stock dividends werecharged against pre-tax income as minority interest in preferred stock ofsubsidiary.

 

The following table summarizes the results of operations for the threemonths and six months ended June 30, 2003 as if SFAS No. 150 had been in effectas of the beginning of 2003.

 
|                            |   | **Three  Months Ended  June 30, 2003** |   | **Six Months  Ended  June 30, 2003** |   |
|---------------------------------|--------|----------------------------------------|--------|-------------------------------------------|--------|
| **(In millions)**               |   | **As  Reported**                       |   | **Pro Forma**                             |   | **As  Reported** |   | **Pro Forma** |   |
|                            |   |                                   |   |                                      |   |   |   |   |   |
| Loss from continuing operations |   | $                                      | (39.0  | )                                         | $      | (41.3 | ) | $ | (44.9 | ) | $ | (49.3 | ) |
| Net loss                        |   | (38.2                                  | )      | (40.5                                     | )      | (64.3 | ) | (68.7 | ) |
|                                 |        |                                        |        |                                           |        |  |  |  |  |  |  |  |  |

 

The pro formadata reflects DeCrane Holdings 14% preferred stock dividends of $2.3 millionfor the three months ended June 30, 2003 and $4.4 million for the six monthsended June 30, 2003 as charges against income during the periods.

** **

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

 

This change inaccounting policy was made after concluding the 2003 fiscal year but wasapplied retroactively to the beginning of the year, January 1, 2003, asrequired by generally accepted accounting principles.  As a result of the change, program-related product developmentcosts are now classified as a component of research and development expenses inthe consolidated financial statements rather than classified as a component ofinventory cost.  We have restated the resultsof operations by charging 

 

27

----

 

previously inventoried coststotaling $3.3 million and $4.9 million for the three months and six monthsended June 30, 2003, respectively, to research and development expense andrecording a $13.8 million charge as of January 1, 2003 to reflect thecumulative effect of the change in accounting principle.

### ** **

### **Restructuring, Asset Impairment and Other RelatedCharges**

 

Our results ofoperations for 2003 and 2004 have been affected by restructuring, impairmentand other related charges pertaining to a series of restructuringactivities.  These charges, which affectthe comparability of our reported results of operations between periods, aremore fully described in “—Restructuring, Asset Impairment and Other RelatedCharges” below.

### ** **

### **Three Months Ende**d June 30, 2004 Compared to ThreeMonths Ended June 30, 2003

** **

**Revenues.* ***Revenuesincreased $10.7 million, or 24.3%, to $54.8 million for the three months endedJune 30, 2004 from $44.1 million for the three months ended June 30, 2003.  By segment, revenues changed as follows:

** **
|                                |   | **Increase  (Decrease)  From 2003** |   |
|-------------------------------------|--------|-------------------------------------|--------|
| **(In millions)**                   |   | **Amount**                          |   | **Percent** |   |
|                                |   |                                |   |   |   |
| Cabin Management                    |   | $                                   | 11.4   |   | 38.3 | % |
| Systems Integration                 |   | 0.7                                 |   | 4.5 |   |
| Increase in inter-group elimination |   | (1.4                                | )      |   |   |
| Total                               |   | $                                   | 10.7   |   |   |   |

 

*Cabin Management. *Revenues increased by $11.4 million, or38.3% compared to the prior year due to a higher volume of corporate jetproduction by aircraft manufacturers. The increase consisted of the following:

 

•                  a $10.8 millionincrease in aircraft furniture and related products revenues;

 

•                  a $1.1 millionincrease in cabin management and entertainment systems revenues; and

 

•                  a $0.3 millionincrease in seating products revenues; offset by

 

•                  a $0.8 milliondecrease in other product and services revenues.

* *

*Systems Integration.*  Revenues increased by $0.7 million, or 4.5%compared to the prior year, due to:

 

•                  a $2.5 millionincrease in completion and service center revenues; and

 

•                  a $1.0 millionincrease in commercial aircraft systems integration engineering services;offset by

 

•                  a $2.8 milliondecrease resulting from lower production of auxiliary fuel systems pursuant toour supply contract with Boeing Business Jet.

 

BBJ has exercised its option to convert the supply contract to a“requirements” contract, from a guaranteed “take-or-pay” contract, commencingJanuary 1, 2005.  Production under the“take-or-pay” portion of the contract for 2004 was completed during the secondquarter of fiscal 2004 and no new orders have been placed pursuant to the new“requirements” contract.  Based upon thenumber of auxiliary fuel systems BBJ has in its inventory, we believe we maynot receive any orders for additional systems until late in fiscal 2005.  During the three months ended June 30, 2004,auxiliary fuel systems revenues were $3.3 million compared to $6.1 million forthe same period last year.

 

28

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**Gross profit.**  Gross profit increased $2.1 million, or38.9%, to $7.5 million for the three months ended June 30, 2004 from $5.4million for the same period in the prior year. By segment, gross profit changed as follows:

 
|                |   | **Increase  (Decrease)  From 2003** |   |
|---------------------|--------|-------------------------------------|--------|
| **(In millions)**   |   | **Amount**                          |   | **Percent** |   |
|                |   |                                |   |   |   |
| Cabin Management    |   | $                                   | 8.5    |   | 121.9 | % |
| Systems Integration |   | (6.4                                | )      | (121.4 | ) |
| Total               |   | $                                   | 2.1    |   |   |   |

 

*Cabin Management.*  Gross profit increased by $8.5 millioncompared to the prior year, primarily due to:

 

•                  a $5.8 milliondecrease in restructuring charges incurred in 2004 compared to those incurredduring the same period in 2003 related to our furniture and seating operations;

 

•                  a $2.4 millionincrease related to higher volume in aircraft furniture and related productsrevenues; and

 

•                  a $0.6 millionincrease in gross profit related to higher volume for our cabin management andentertainment systems; offset by

 

•                  a $0.3 milliondecrease in gross profit related to other products.

 

*Systems Integration.*  Gross profit decreased by $6.4 million, or121.4% compared to the prior year, primarily due to:

 

•                  $5.3 million ofrestructuring charges incurred in 2004 related to the reorganization of ourmanufacturing operations; and

 

•                  a $1.6 milliondecrease resulting from lower revenues from auxiliary fuel systems and a changein product delivery mix; offset by

 

•                  a $0.5 millionincrease resulting from the increase in commercial aircraft systems integrationengineering services revenues.

 

**Selling, general and administrative expenses.**  Selling, general and administrative expensesincreased $0.8 million, or 11.6%, to $7.8 million for the three months endedJune 30, 2004, from $7.0 million for the same period in the prior year.  By segment, SG&A expenses changed asfollows:

 
|                |   | **Increase  (Decrease)  From 2003** |   |
|---------------------|--------|-------------------------------------|--------|
| **(In millions)**   |   | **Amount**                          |   | **Percent** |   |
|                |   |                                |   |   |   |
| Cabin Management    |   | $                                   | 0.5    |   | 13.1 | % |
| Systems Integration |   | 0.6                                 |   | 47.6 |   |
| Corporate           |   | (0.3                                | )      |   |   |
| Total               |   | $                                   | 0.8    |   |   |   |

* *

*Cabin Management. *SG&A expenses increased by $0.5million, or 13.1% compared to the prior year, primarily as a result ofrestructuring charges.

* *

*Systems Integration. *SG&A expensesincreased by $0.6 million, or 47.6% compared to the prior year, primarily as aresult of higher sales and marketing activities associated with the aircraftcompletion portion of our business.

* *

*Corporate. *SG&A expenses decreased by $0.3 millioncompared to the prior year due principally to lower costs pursuant to theincentive compensation plan.

 

29

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**Research and development expenses. **Research and development expenses decreased$1.3 million, or 38.9%, to $2.0 million for the three months ended June 30,2004 compared to $3.3 million in the prior year.  By segment, research and development expenses changed asfollows:

** **
|                |   | **Increase  (Decrease)  From 2003** |   |
|---------------------|--------|-------------------------------------|--------|
| **(In millions)**   |   | **Amount**                          |   | **Percent** |   |
|                |   |                                |   |   |   |
| Cabin Management    |   | $                                   | (1.8   | ) | (60.5 | )% |
| Systems Integration |   | 0.5                                 |   | 219.8 |   |
| Total               |   | $                                   | (1.3   | ) |   |   |

 

*Cabin Management. *R&D expenses decreased $1.8 million,or 60.5% compared to the prior year. The decrease is primarily related to the near completed development ofour new single-design seat technology and design of new interior furnishingcomponents for a major customer’s recently introduced new model of aircraft.

* *

*Systems Integration. *R&D expensesincreased $0.5 million, or 219.8% compared to the prior year.  The increase is principally due to theongoing development of our video surveillance system for different models ofcommercial aircraft and a design modification to an existing product.

** **

**Depreciation and amortization of intangibles.**  Depreciation and amortization expensedecreased $0.2 million to $2.3 million for the three months ended June 30, 2004from $2.5 million for the same period in the prior year.  The decline is attributable to reducedcapital expenditures and a lower depreciable base.  Depreciation and amortization changed as follows:

** **
|                                        |   | **Increase  (Decrease)  From 2003** |   |
|---------------------------------------------|--------|-------------------------------------|--------|
| **(In millions)**                           |   | **Amount**                          |   | **Percent** |   |
|                                        |   |                                |   |   |   |
| Depreciation charged to:                    |   |                                |   |   |   |
| Cost of sales                               |   | $                                   | (0.1   | ) | (6.4 | )% |
| Selling, general and administrative expense |   | (0.1                                | )      | (20.2 | ) |
| Amortization of intangible assets           |   | 0.0                                 |   |   |   |
| Total                                       |   | $                                   | (0.2   | ) |   |   |

 

**Adjusted EBITDA. **Asdescribed above in “—Performance Measures—Adjusted EBITDA,” we use thisfinancial measure to evaluate the core economic performance of our operatingsegments.  The notes to our financialstatements include additional information about Adjusted EBITDA, and should beread in conjunction with the discussions presented herein.  The notes to our financial statements alsoinclude a reconciliation of Adjusted EBITDA to net income (loss), a GAAPfinancial measure, to clarify the differences between these two measures.

* *

*Cabin Management. *Adjusted EBITDA increased by $1.9 million, or 43.5%, to $6.2 million for thethree months ended June 30, 2004 compared to $4.3 million for the same periodin the prior year primarily due to:

 

•                  a $2.4 millionincrease in gross profit related to our business, VIP and head-of-stateaircraft furniture and seating operations, excluding the effect ofrestructuring charges;

 

•                  a $0.6 millionincrease in gross profit related to our cabin management and entertainmentsystems;

 

•                  a $1.8 milliondecrease in research and development spending; offset by

 

•                  a $2.4 millionunfavorable impact resulting from adjusting for program costs;

 

•                  a $0.3 milliondecrease in gross profit related to other products; and

 

30

----

 

•                  a $0.2 millionincrease in SG&A spending.

 

*Systems Integration. *Adjusted EBITDAdecreased by $1.8 million, or 42.6%, to $2.4 million for the three months endedJune 30, 2004 compared to $4.2 million for the same period in the prior yeardue to:

 

•                  a $1.2 milliondecline in gross profit, excluding the effect of restructuring charges; and

 

•                  a $0.6 millionincrease in SG&A spending.

 

**Impairment of goodwill.**During the three months ended June 30, 2003,a $34.0 million charge was recorded to reflect the impairment of goodwill inconnection with the impairment testing provision of SFAS No. 142, “Goodwill andOther Intangible Assets.”  See“—Restructuring, Asset Impairment and Other Related Charges.”

** **

**Operating income (loss).**  The operating loss decreased $36.6 million,or 91.9%, to a loss of $3.2 million for the three months ended June 30, 2004,from a loss of $39.8 million for the same period in the prior year.  By segment, the operating loss changed asfollows:

** **
|                |   | **Increase  (Decrease)  From 2003** |   |
|---------------------|--------|-------------------------------------|--------|
| **(In millions)**   |   | **Amount**                          |   | **Percent** |   |
|                |   |                                |   |   |   |
| Cabin Management    |   | $                                   | (43.8  | ) | (105.8 | )% |
| Systems Integration |   | 7.6                                 |   | 234.5 |   |
| Corporate           |   | (0.4                                | )      |   |   |
| Total               |   | $                                   | (36.6  | ) |   |   |

 

*Cabin Management. *Theoperating loss decreased by $43.8 million, or 105.8% compared to theprior year, due to:

 

•                  a $34.0 milliondecrease in impairment charges;

 

•                  a $5.5 milliondecrease in restructuring charges incurred in 2004 as compared to 2003;

 

•                  a $2.4 millionincrease in gross profit, primarily due to lower revenues related to ourfurniture and seating operations;

 

•                  a $0.6 millionincrease in gross profit related to higher volume for our cabin management andentertainment systems; and

 

•                  a $1.8 milliondecrease in research and development expenses; offset by

 

•                  a $0.3 milliondecrease in gross profit related to other products; and

 

•                  a $0.2 millionincrease in SG&A spending.

 

*Systems Integration. *The operating lossincreased by $7.6 million, or 234.5% compared to the prior year, due to:

 

•                  $5.3 million ofrestructuring charges incurred in 2004;

 

•                  a $0.6 millionincrease in SG&A spending;

 

•                  a $1.1 milliondecrease resulting from reduced gross profit on lower revenues; and

 

•                  a $0.6 millionincrease in research and development expenses.

 

31

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**Interest expense.**  Interest expense increased $2.3 million, or35.3%, to $8.8 million for the three months ended June 30, 2004 compared to$6.5 million for the same period in the prior year.  The increase is attributable to:

 

•                  $3.0 million ofadditional interest expense attributable to $80.0 million of second-lien termdebt issued in December 2003; and

 

•                  a $0.3 millionincrease in other interest expense; offset by

 

•                  a $1.0 milliondecrease in our first-lien interest expense due to lower principal balancesoutstanding resulting from the partial refinancing with second-lien debt inDecember, offset, in part, by a 1.5% increase in interest rate margins chargedby our lenders based on our consolidated debt leverage ratio.

** **

**Mandatorilyredeemable preferred stock dividends. **Mandatorilyredeemable preferred stock dividends increased $2.7 million to $4.4 million forthe three months ended June 30, 2004 from $1.7 million for the same period inthe prior year as follows:

 
|                                 |   | **Three  Months Ended  June 30,** |   |
|--------------------------------------|--------|-----------------------------------|--------|
| **(In millions)**                    |   | **2004**                          |   | **2003** |   |
|                                 |   |                              |   |   |   |
| DeCrane Holdings 14% preferred stock |   | $                                 | 2.6    |   | $ | — |   |
| DeCrane Aircraft 16% preferred stock |   | 1.8                               |   | 1.7 |   |
| Total dividends                      |   | $                                 | 4.4    |   | $ | 1.7 |   |

 

As more fullydescribed in “—Changes in Accounting Principles” above, effective January 1,2004 we adopted SFAS No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity.”  As a result of adopting of SFAS No. 150, the 14% quarterlypreferred stock dividends are reflected as a charge against pre-taxincome.  In periods prior to January 1,2004, the 14% preferred stock dividends were deducted in arriving at the netincome or loss applicable to DeCrane Holdings’ common stockholders and amountedto $2.3 million for the three months ended June 30, 2003; DeCrane Aircraft’s16% preferred stock dividends totaled $1.7 million and were charged againstpre-tax income as minority interest in preferred stock of subsidiary.  The increase between periods is attributableto the quarterly compounding of the dividends accrued but not declared andpaid.

** **

**Provision for income tax benefit.**  The provision for income taxes is comprisedof the following:

 
|                                                 |   | **Three  Months Ended  June 30,** |   |
|------------------------------------------------------|--------|-----------------------------------|--------|
| **(In millions)**                                    |   | **2004**                          |   | **2003** |   |
|                                                 |   |                              |   |   |   |
| Income tax (benefit) based on reported  pre-tax loss |   | $                                 | (4.6   | ) | $ | (22.5 | ) |
| Net deferred tax asset valuation allowance           |   | 4.6                               |   | 13.1 |   |
| Net income tax benefit                               |   | $                                 | — |   | $ | (9.4 | ) |

 

For the threemonths ended June 30, 2003, the provision for income taxes, based on thereported consolidated pre-tax loss, differs from the amount determined byapplying the applicable U.S. statutory federal rate to the pre-tax lossprimarily due to the effects of state and foreign income taxes and non-deductibleexpenses, principally the non-deductible portion of goodwill impairment chargesand DeCrane Aircraft’s 16% preferred stock dividends.

 

For the threemonths ended June 30, 2004, the provision for income taxes, based on thereported consolidated pre-tax loss, differs from the amount determined byapplying the applicable U.S. statutory federal rate to the pre-tax lossprimarily due to the effects of state and foreign income taxes andnon-deductible expenses, principally mandatorily redeemable preferred stockdividends due to the adoption of SFAS No. 150 effective January 1, 2004described above.

 

32

----

 

As of June 30,2003, there were net deferred tax assets of $12.8 million, prior to recordingthe valuation allowance in June 2003, as opposed to net deferred taxliabilities in prior periods.  Thechange to a net asset position was primarily caused by the $34.0 milliongoodwill impairment charge recorded during the second quarter of fiscal2003.  SFAS No. 109, “Accounting forIncome Taxes,” requires the recognition of a deferred tax asset for the futureincome tax benefit of the goodwill deductions that will be taken for income taxpurposes (i.e. the goodwill that has been written off in the financial statementsfor book purposes will continue to be amortized and deducted for tax purposesand accordingly represents a new deferred tax asset).

 

As required bySFAS No. 109, we evaluated the deferred tax assets for expected recoverabilitybased on the nature of the item, the associated taxing jurisdictions, theapplicable expiration dates and future taxable income forecasts that wouldimpact utilization.  Since there is noloss carry back potential and we do not have any tax planning strategies toassure recoverability, the only possibility for recovery of the net deferredassets is future taxable income.  Sincethere have been prior year losses, we believe it was not prudent to rely onfuture taxable income as the means to support the carrying value of the net deferredtax assets.  As a result of theevaluation, we recorded a $13.1 million valuation allowance, eliminating thenet deferred asset, as of June 30, 2003.

 

As more fullydescribed in Note 11 to the audited financial statements included in theCompany’s 2003 Form 10-K, there were net deferred tax asset of $19.5 millionfully offset by a valuation allowance of the same amount as of December 31,2003.  Based upon the results ofoperations for the six months ended June 30, 2004, we determined that an additional$7.2 million valuation allowance was required as of that date, $4.6 million ofwhich is applicable to the three-month period.

** **

**Loss from continuingoperations.** The loss from continuing operations decreased $22.4 million to a loss of$16.5 million for the three months ended June 30, 2004 compared to a loss of$38.9 million for the same period in the prior year, primarily due to:

 

•                  a $36.6 millionoperating loss decrease; offset by

 

•                  a $2.1 millionincrease in interest and other expenses (net);

 

•                  a $9.4 milliondecrease in income tax benefit; and

 

•                  a $2.7 millionincrease in preferred stock dividends, principally resulting from the adoptionof SFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity” as described above.

** **

**Income fromdiscontinued operations. **Incomefrom discontinued operations was $0.7 million for the three months ended June30, 2003 and reflects the results of operations of our Specialty Avionics Groupwhich was sold on May 22, 2003.

** **

**Net loss.**  Net loss decreased $21.7 million to a netloss of $16.5 million for the three months ended June 30, 2004 compared to anet loss of $38.2 million for the same period in the prior year.  The decrease is attributable to:

 

•                  a decrease inloss from continuing operations of $22.4 million; offset by

 

•                  a decrease inthe income from discontinued operations of $0.7 million.

 

**Net loss applicable to common stockholders.**  Net loss applicable our common stockholdersdecreased $23.9 million to a net loss of $16.5 million for the three monthsended June 30, 2004 compared to a net loss of $40.4 million for the same periodin the prior year.  The decrease in thenet loss applicable to our common stockholder is attributable to:

 

•                  a $21.7 milliondecrease in our net loss; and

 

33

----

 

•                  a $2.2 milliondecrease in preferred stock dividends resulting from the January 1, 2004adoption of SFAS No. 150 which requires preferred stock dividends be deductedfrom the net income or loss for the period.

** **

**Bookings and Backlog. **Bookings decreased$1.4 million, or 2.8%, to $50.5 million for the three months ended June 30,2004 compared to $51.9 million for the same period in the prior year.  Backlog increased $15.2 million to $73.2million as of June 30, 2004 compared to $58.0 million as of December 31,2003.  By segment, bookings and backlogchanged as follows:

 
|                |   | **Increase  (Decrease)  From 2003** |   |
|---------------------|--------|-------------------------------------|--------|
| **(In millions)**   |   | **Amount**                          |   | **Percent** |   |
|                |   |                                |   |   |   |
| Bookings:           |   |                                |   |   |   |
| Cabin Management    |   | $                                   | 16.9   |   | 63.9 | % |
| Systems Integration |   | (18.3                               | )      | (71.8 | ) |
| Total               |   | $                                   | (1.4   | ) |   |   |
|                |   |                                |   |   |   |
| Backlog:            |   |                                |   |   |   |
| Cabin Management    |   | $                                   | 14.1   |   | 41.7 | % |
| Systems Integration |   | 1.1                                 |   | 4.5 |   |
| Total               |   | $                                   | 15.2   |   |   |   |

 

CabinManagement’s bookings and backlog increased as a result of the increase in ourcustomer’s aircraft production schedules during the period.  Systems Integration’s bookings decreaseresulted from a $24.0 million decrease in orders for auxiliary fuel systemsoffset by an increase in bookings for other products and services.

 

**Six Months Ende****d June 30, 2004 Compared to Six Months EndedJune 30, 2003**

 

**Revenues.* ***Revenuesincreased $17.4 million, or 20.2%, to $103.4 million for the six months endedJune 30, 2004 from $86.0 million for the three months ended June 30, 2003.  By segment, revenues changed as follows:

 
|                                |   | **Increase  (Decrease)  From 2003** |   |
|-------------------------------------|--------|-------------------------------------|--------|
| **(In millions)**                   |   | **Amount**                          |   | **Percent** |   |
|                                |   |                                |   |   |   |
| Cabin Management                    |   | $                                   | 15.1   |   | 25.0 | % |
| Systems Integration                 |   | 3.1                                 |   | 11.4 |   |
| Increase in inter-group elimination |   | (0.8                                | )      |   |   |
| Total                               |   | $                                   | 17.4   |   |   |   |

* *

*Cabin Management. *Revenues increased by $15.1 million, or25.0% compared to the prior year due to a higher volume of corporate jetproduction by aircraft manufacturers. The increase consisted of the following:

 

•                  an $11.9 millionincrease in aircraft furniture and related products revenues;

 

•                  a $2.3 millionincrease in cabin management and entertainment systems revenues; and

 

•                  a $1.7 millionincrease in seating products revenues; offset by

 

•                  a $0.8 milliondecrease in other product and services revenues.

* *

*Systems Integration.*  Revenues increased by $3.1 million, or 11.4%compared to the prior year, due to:

 

•                  a $3.3 millionincrease in completion and service center revenues; and

 

34

----

 

•                  a $2.0 millionincrease in commercial aircraft systems integration engineering services;offset by

 

•                  a $2.2 milliondecrease resulting from lower production of auxiliary fuel systems pursuant toour supply contract with Boeing Business Jet.

 

BBJ has exercised its option to convert the supply contract to a“requirements” contract, from a guaranteed “take-or-pay” contract, commencingJanuary 1, 2005.  Production under the“take-or-pay” portion of the contract for 2004 is complete and no new ordershave been placed pursuant to the new “requirements” contract.  Based upon the number of auxiliary fuelsystems BBJ has in its inventory, we believe we may not receive any orders foradditional systems until late in fiscal 2005. During the six months ended June 30, 2004, auxiliary fuel systemsrevenues were $11.8 million compared to $14.0 million for the same period lastyear.  During the year ended December31, 2003, BBJ auxiliary fuel systems provided approximately $26.4 million, or15.5%, of our consolidated revenues.

 

**Gross profit.**  Gross profit increased $0.8 million, or4.5%, to $19.2 million for the six months ended June 30, 2004 from $18.4million for the same period in the prior year. By segment, gross profit changed as follows:

 
|                |   | **Increase  (Decrease)  From 2003** |   |
|---------------------|--------|-------------------------------------|--------|
| **(In millions)**   |   | **Amount**                          |   | **Percent** |   |
|                |   |                                |   |   |   |
| Cabin Management    |   | $                                   | 7.8    |   | 101.6 | % |
| Systems Integration |   | (7.0                                | )      | (65.6 | ) |
| Total               |   | $                                   | 0.8    |   |   |   |

* *

*Cabin Management.*  Gross profit increased by $7.8 million, or101.6% compared to the prior year, primarily due to:

 

•                  a $5.8 milliondecrease in restructuring charges incurred in 2004 compared to those incurredduring the same period in 2003 related to our furniture and seating operations;

 

•                  a $0.9 millionincrease related to higher volume in aircraft furniture and related productsrevenues; and

 

•                  a $1.4 millionincrease in gross profit related to higher volume for our cabin management andentertainment systems; offset by

 

•                  a $0.3 milliondecrease in gross profit related to other products.

 

*Systems Integration.*  Gross profit decreased by $7.0 million, or65.6% compared to the prior year, primarily due to:

 

•                  $5.3 million ofrestructuring charges incurred in 2004 related to the reorganization of ourmanufacturing operations;

 

•                  a $1.3 milliondecrease resulting from reduced auxiliary fuel system revenues; and

 

•                  a $1.0 milliondecrease resulting from the change in product delivery mix; offset by

 

•                  a $0.6 millionincrease resulting from the increase in commercial aircraft systems integrationengineering services revenues.

 

**Selling, general and administrative expenses.**  Selling, general and administrative expensesdecreased $1.9 million, or 11.1%, to $15.0 million for the six months endedJune 30, 2004, from $16.9 million for the same period in the prior year.  By segment, SG&A expenses changed asfollows:

 

35

----

 
|                |   | **Increase  (Decrease)  From 2003** |   |
|---------------------|--------|-------------------------------------|--------|
| **(In millions)**   |   | **Amount**                          |   | **Percent** |   |
|                |   |                                |   |   |   |
| Cabin Management    |   | $                                   | 0.3    |   | 4.1 | % |
| Systems Integration |   | (0.8                                | )      | (16.0 | ) |
| Corporate           |   | (1.4                                | )      |   |   |
| Total               |   | $                                   | (1.9   | ) |   |   |

* *

*Cabin Management. *SG&A expenses increased by $0.3million, or 4.1% compared to the prior year, primarily as a result ofrestructuring charges.

* *

*Systems Integration. *SG&A expensesdecreased by $0.8 million, or 16.0% compared to the prior year, due to lower laborand employee benefit costs resulting from workforce reductions as well as othercost reduction efforts offset by an increase in sales and marketing activitiesassociated with the aircraft completion portion of our business.

* *

*Corporate. *SG&A expenses decreased by $1.4 millioncompared to the prior year due principally to lower costs pursuant to theincentive compensation plan.

** **

**Research and development expenses. **Research and development expenses decreased$0.7 million, or 13.8%, to $4.2 million for the six months ended June 30, 2004compared to $4.9 million in the prior year. By segment, research and development expenses changed as follows:

 
|                |   | **Increase  (Decrease)  From 2003** |   |
|---------------------|--------|-------------------------------------|--------|
| **(In millions)**   |   | **Amount**                          |   | **Percent** |   |
|                |   |                                |   |   |   |
| Cabin Management    |   | $                                   | (1.6   | ) | 35.8 | % |
| Systems Integration |   | 0.9                                 |   | 271.8 |   |
| Total               |   | $                                   | (0.7   | ) |   |   |

* *

*Cabin Management. *R&D expenses decreased $1.6 million,or 35.8% compared to the prior year. The increase is primarily related to the near completed development ofour new single-design seat technology and design of new interior furnishingcomponents for a major customer’s recently introduced new model of aircraft.

* *

*Systems Integration. *R&D expensesincreased $0.9 million, or 271.8% compared to the prior year.  The increase is principally due to theongoing development of our video surveillance system for different models ofcommercial aircraft and a design modification to an existing product.

** **

**Depreciation and amortization of intangibles.**  Depreciation and amortization expensedecreased $0.4 million to $4.6 million for the six months ended June 30, 2004from $5.0 million for the same period in the prior year.  The decline is attributable to reducedcapital expenditures and a lower depreciable base.  Depreciation and amortization changed as follows:

 
|                                        |   | **Increase  (Decrease)  From 2003** |   |
|---------------------------------------------|--------|-------------------------------------|--------|
| **(In millions)**                           |   | **Amount**                          |   | **Percent** |   |
|                                        |   |                                |   |   |   |
| Depreciation charged to:                    |   |                                |   |   |   |
| Cost of sales                               |   | $                                   | (0.2   | ) | (6.7 | )% |
| Selling, general and administrative expense |   | (0.2                                | )      | (20.3 | ) |
| Amortization of intangible assets           |   | 0.0                                 |   |   |   |
| Total                                       |   | $                                   | (0.4   | ) |   |   |

 

36

----

 

**Adjusted EBITDA. **Asdescribed above in “—Performance Measures—Adjusted EBITDA,” we use thisfinancial measure to evaluate the core economic performance of our operatingsegments.  The notes to our financialstatements include additional information about Adjusted EBITDA, and should beread in conjunction with the discussions presented herein.  The notes to our financial statements alsoinclude a reconciliation of Adjusted EBITDA to net income (loss), a GAAPfinancial measure, to clarify the differences between these two measures.

* *

*Cabin Management. *Adjusted EBITDA increased by $0.7 million, or 8.6%, to $9.6 million for the sixmonths ended June 30, 2004 compared to $8.9 million for the same period in theprior year primarily due to:

 

•                  a $0.9 millionincrease in gross profit related to our business, VIP and head-of-stateaircraft furniture and seating operations, excluding the effect ofrestructuring charges;

 

•                  a $1.4 millionincrease in gross profit related to our cabin management and entertainmentsystems;

 

•                  a $1.6 milliondecrease in research and development spending; offset by

 

•                  a $2.8 millionunfavorable impact resulting from adjusting for program costs;

 

•                  a $0.3 milliondecrease in gross profit related to other products; and

 

•                  a $0.1 millionincrease in SG&A spending.

* *

*Systems Integration. *Adjusted EBITDAdecreased by $0.9 million, or 14.4%, to $5.4 million for the six months endedJune 30, 2004 compared to $6.3 million for the same period in the prior yeardue to:

 

•                  a $1.7 milliondecline in gross profit, excluding the effect of restructuring charges; offsetby

 

•                  a $0.8 milliondecrease in SG&A spending.

 

**Impairment of goodwill.**During the six months ended June 30, 2003, a$34.0 million charge was recorded to reflect the impairment of goodwill inconnection with the impairment testing provision of SFAS No. 142, “Goodwill andOther Intangible Assets.”  See“—Restructuring, Asset Impairment and Other Related Charges.”

** **

**Operating income (loss).**  The operating loss decreased $37.4 million,or 95.5%, to a loss of $1.8 million for the six months ended June 30, 2004,from a loss of $39.2 million for the same period in the prior year.  By segment, the operating loss changed asfollows:

 
|                |   | **Increase  (Decrease)  From 2003** |   |
|---------------------|--------|-------------------------------------|--------|
| **(In millions)**   |   | **Amount**                          |   | **Percent** |   |
|                |   |                                |   |   |   |
| Cabin Management    |   | $                                   | (43.1  | ) | (107.8 | )% |
| Systems Integration |   | 7.1                                 |   | 153.8 |   |
| Corporate           |   | (1.4                                | )      |   |   |
| Total               |   | $                                   | (37.4  | ) |   |   |

* *

*Cabin Management. *The operating loss decreased by $43.1million, or 107.8% compared to the prior year, due to:

 

•                  a $34.0 milliondecrease in impairment charges;

 

•                  a $5.5 milliondecrease in restructuring charges incurred in 2004 as compared to 2003;

 

•                  a $0.9 millionincrease in gross profit, primarily due to lower revenues related to ourfurniture and seating operations;

 

•                  a $1.6 millionincrease in gross profit related to higher volume for our cabin management andentertainment systems; and

 

37

----

 

•                  an $1.6 milliondecrease in research and development expenses; offset by

 

•                  a $0.3 milliondecrease in gross profit related to other products; and

 

•                  a $0.2 millionincrease in SG&A spending.

 

*Systems Integration. *The operating lossincreased by $7.1 million, or 153.8% compared to the prior year, due to:

 

•                  $5.3 million ofrestructuring charges incurred in 2004;

 

•                  a $3.2 milliondecrease resulting from reduced gross profit on lower revenues; and

 

•                  a $0.9 millionincrease in research and development expenses; offset by

 

•                  a net $1.5million increase resulting from the conversion of a major customer supplycontract to a requirements-only contract;

 

•                  a $0.8 milliondecrease in SG&A spending.

 

**Interest expense.**  Interest expense increased $5.2 million, or41.5%, to $17.5 million for the six months ended June 30, 2004 compared to$12.3 million for the same period in the prior year.  The increase is attributable to:

 

•                  $5.9 million ofadditional interest expense attributable to $80.0 million of second-lien termdebt issued in December 2003; and

 

•                  a $0.6 millionincrease in other interest expense; offset by

 

•                  a $1.3 milliondecrease in our first-lien interest expense due to lower principal balancesoutstanding resulting from the partial refinancing with second-lien debt inDecember, offset, in part, by a 1.5% increase in interest rate margins chargedby our lenders based on our consolidated debt leverage ratio.

** **

**Mandatorilyredeemable preferred stock dividends. **Mandatorilyredeemable preferred stock dividends increased $5.3 million to $8.6 million forthe six months ended June 30, 2004 from $3.3 million for the same period in theprior year as follows:

 
|                                 |   | **Six Months  Ended  June 30,** |   |
|--------------------------------------|--------|---------------------------------|--------|
| **(In millions)**                    |   | **2004**                        |   | **2003** |   |
|                                 |   |                            |   |   |   |
| DeCrane Holdings 14% preferred stock |   | $                               | 5.1    |   | $ | — |   |
| DeCrane Aircraft 16% preferred stock |   | 3.5                             |   | 3.3 |   |
| Net income tax benefit               |   | $                               | 8.6    |   | $ | 3.3 |   |

 

As more fullydescribed in “—Changes in Accounting Principles” above, effective January 1,2004 we adopted SFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity.”  As a result of adopting of SFAS No. 150, the 14% quarterlypreferred stock dividends are reflected as a charge against pre-tax income.  In periods prior to January 1, 2004, the 14%preferred stock dividends were deducted in arriving at the net income or lossapplicable to DeCrane Holdings’ common stockholders and amounted to $4.4million for the six months ended June 30, 2003; DeCrane Aircraft’s 16%preferred stock dividends totaled $3.3 million and were charged against pre-taxincome as minority interest in preferred stock of subsidiary.  The increase between periods is attributableto the quarterly compounding of the dividends accrued but not declared andpaid.

 

38

----

 

**Provision for income tax benefit.**  The provision for income taxes is comprisedof the following:

 
|                                                 |   | **Six Months  Ended  June 30,** |   |
|------------------------------------------------------|--------|---------------------------------|--------|
| **(In millions)**                                    |   | **2004**                        |   | **2003** |   |
|                                                 |   |                            |   |   |   |
| Income tax (benefit) based on reported  pre-tax loss |   | $                               | (7.1   | ) | $ | (23.7 | ) |
| Net deferred tax asset valuation allowance           |   | 7.2                             |   | 13.1 |   |
| Net provision for income tax (benefit)               |   | $                               | 0.1    |   | $ | (10.6 | ) |

 

For the sixmonths ended June 30, 2003, the provision for income taxes, based on thereported consolidated pre-tax loss, differs from the amount determined byapplying the applicable U.S. statutory federal rate to the pre-tax lossprimarily due to the effects of state and foreign income taxes andnon-deductible expenses, principally the non-deductible portion of goodwillimpairment charges and DeCrane Aircraft’s 16% preferred stock dividends.

 

For the sixmonths ended June 30, 2004, the provision for income taxes, based on thereported consolidated pre-tax loss, differs from the amount determined byapplying the applicable U.S. statutory federal rate to the pre-tax lossprimarily due to the effects of state and foreign income taxes andnon-deductible expenses, principally mandatorily redeemable preferred stockdividends due to the adoption of SFAS No. 150 effective January 1, 2004described above.

 

As of June 30,2003, there were net deferred tax assets of $12.8 million, prior to recordingthe valuation allowance in June 2003, as opposed to net deferred taxliabilities in prior periods.  Thechange to a net asset position was primarily caused by the $34.0 milliongoodwill impairment charge recorded during the second quarter of fiscal2003.  SFAS No. 109, “Accounting forIncome Taxes,” requires the recognition of a deferred tax asset for the futureincome tax benefit of the goodwill deductions that will be taken for income taxpurposes (i.e. the goodwill that has been written off in the financialstatements for book purposes will continue to be amortized and deducted for taxpurposes and accordingly represents a new deferred tax asset).

 

As required bySFAS No. 109, we evaluated the deferred tax assets for expected recoverabilitybased on the nature of the item, the associated taxing jurisdictions, theapplicable expiration dates and future taxable income forecasts that wouldimpact utilization.  Since there is noloss carry back potential and we do not have any tax planning strategies toassure recoverability, the only possibility for recovery of the net deferredassets is future taxable income.  Sincethere have been prior year losses, we believe it was not prudent to rely onfuture taxable income as the means to support the carrying value of the netdeferred tax assets.  As a result of theevaluation, we recorded a $13.1 million valuation allowance, eliminating thenet deferred asset, as of June 30, 2003.

 

As more fullydescribed in Note 11 to the audited financial statements included in theCompany’s 2003 Form 10-K, there were net deferred tax asset of $19.5 millionfully offset by a valuation allowance of the same amount as of December 31,2003.  Based upon the results ofoperations for the six months ended June 30, 2004, we determined that anadditional $7.2 million valuation allowance was required as of that date.

** **

**Loss from continuingoperations.** The loss from continuing operations decreased $16.8 million to a loss of$28.1 million for the six months ended June 30, 2004 compared to a loss of$44.9 million for the same period in the prior year, primarily due to:

 

•                  a $37.4 millionoperating loss decrease; offset by

 

•                  a $4.6 millionincrease in interest and other expenses (net);

 

•                  a $10.7 milliondecrease in income tax benefit; and

 

39

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•                  a $5.3 millionincrease in preferred stock dividends, principally resulting from the adoptionof SFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity” as described above.

** **

**Loss fromdiscontinued operations. **Lossfrom discontinued operations was $5.6 million for the six months ended June 30,2003 and reflects the results of operations of our Specialty Avionics Groupwhich was sold on May 22, 2003.

** **

**Cumulative effect ofchange in accounting principle.**  As more fully described in “—Changes inAccounting Principles” above, the $13.8 million charge during the six monthsended June 30, 2003 was to reflect the cumulative effect of the change inaccounting for product development costs.

** **

**Net loss.**  Net loss decreased $36.2 million to a netloss of $28.1 million for the six months ended June 30, 2004 compared to a netloss of $64.3 million for the same period in the prior year.  The decrease is attributable to:

 

•                  an increase inloss from continuing operations of $16.8 million;

 

•                  a net decreasein cumulative effect of change in accounting principles of $13.8 million; and

 

•                  a decrease inthe loss from discontinued operations of $5.6 million.

 

**Net loss applicable to common stockholders.**  Net loss applicable our common stockholdersdecreased $40.6 million to a net loss of $28.1 million for the six months endedJune 30, 2004 compared to a net loss of $68.7 million for the same period inthe prior year.  The decrease in the netloss applicable to our common stockholder is attributable to:

 

•                  a $36.2 milliondecrease in our net loss; and

 

•                  a $4.4 milliondecrease in preferred stock dividends resulting from the January 1, 2004adoption of SFAS No. 150 which requires preferred stock dividends be deductedfrom the net income or loss for the period.

** **

**Bookings. **Bookings increased $25.3 million, or 27.2%, to$118.6 million for the six months ended June 30, 2004 compared to $93.3 millionfor the same period in the prior year. By segment, bookings changed as follows:

 
|                |   | **Increase  (Decrease)  From 2003** |   |
|---------------------|--------|-------------------------------------|--------|
| **(In millions)**   |   | **Amount**                          |   | **Percent** |   |
|                |   |                                |   |   |   |
| Cabin Management    |   | $                                   | 25.7   |   | 41.9 | % |
| Systems Integration |   | (0.4                                | )      |   |   |
| Total               |   | $                                   | 25.3   |   |   |   |

 

CabinManagement’s bookings increased as a result of the increase in our customer’saircraft production schedules during the period.

 

**Restructuring, Asset Impairment and OtherRelated Charges**

** **

The followingdiscussion should be read in conjunction with Note 2 accompanying our financialstatements included in this report.

 

During thethree months and six months ended June 30, 2003, we recorded restructuring,asset impairment and other related pre-tax charges related to a series ofrestructuring activities.  Thesecharges, and the effect these charges had on our reported results ofoperations, are summarized below.

 

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|                                                                       |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|----------------------------------------------------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
| **(In millions)**                                                          |   | **2004**                          |   | **2003**                        |   | **2004** |   | **2003** |   |
|                                                                       |   |                              |   |                            |   |   |   |   |   |
| Nature of charges:                                                         |   |                              |   |                            |   |   |   |   |   |
| Operational Realignment and Facilities  Restructuring                      |   | $                                 | 6.9    |                            | $      | — |   | $ | 6.9 |   | $ | — |   |
| Seating Product Line and Furniture  Manufacturing Facilities Restructuring |   | —                            |   | 7.1                             |   | — |   | 7.1 |   |
| Goodwill impairment charges                                                |   | —                            |   | 34.0                            |   | — |   | 41.5 |   |
| Total pre-tax charges                                                      |   | $                                 | 6.9    |                            | $      | 41.1 |   | $ | 6.9 |   | $ | 48.6 |   |
|                                                                       |   |                              |   |                            |   |   |   |   |   |
| Business segment recording the charges:                                    |   |                              |   |                            |   |   |   |   |   |
| Cabin Management                                                           |   | $                                 | 1.6    |                            | $      | 41.1 |   | $ | 1.6 |   | $ | 41.1 |   |
| Systems Integration                                                        |   | 5.3                               |   | —                          |   | 5.3 |   | — |   |
| Total charged to continuing operations                                     |   | 6.9                               |   | 41.1                            |   | 6.9 |   | 41.1 |   |
| Specialty Avionics (discontinued  operations)                              |   | —                            |   | —                          |   | — |   | 7.5 |   |
| Total pre-tax charges                                                      |   | $                                 | 6.9    |                            | $      | 41.1 |   | $ | 6.9 |   | $ | 48.6 |   |
|                                                                       |   |                              |   |                            |   |   |   |   |   |
| Charged to operations:                                                     |   |                              |   |                            |   |   |   |   |   |
| Cost of sales                                                              |   | $                                 | 6.1    |                            | $      | 6.5 |   | $ | 6.1 |   | $ | 6.5 |   |
| Selling, general and administrative  expenses                              |   | 0.8                               |   | 0.6                             |   | 0.8 |   | 0.6 |   |
| Impairment of goodwill                                                     |   | —                            |   | 34.0                            |   | — |   | 34.0 |   |
| Total charged to continuing operations                                     |   | 6.9                               |   | 41.1                            |   | 6.9 |   | 41.1 |   |
| Charged to discontinued operations                                         |   | —                            |   | —                          |   | — |   | 7.5 |   |
| Total pre-tax charges                                                      |   | $                                 | 6.9    |                            | $      | 41.1 |   | $ | 6.9 |   | $ | 48.6 |   |
|                                                                       |   |                              |   |                            |   |   |   |   |   |
| Components of charges:                                                     |   |                              |   |                            |   |   |   |   |   |
| Noncash charges                                                            |   | $                                 | 3.0    |                            | $      | 37.6 |   | $ | 3.0 |   | $ | 37.6 |   |
| Cash charges                                                               |   | 3.9                               |   | 3.5                             |   | 3.9 |   | 3.5 |   |
| Total charged to continuing operations                                     |   | 6.9                               |   | 41.1                            |   | 6.9 |   | 41.1 |   |
| Charged to discontinued operations                                         |   | —                            |   | —                          |   | — |   | 7.5 |   |
| Total pre-tax charges                                                      |   | $                                 | 6.9    |                            | $      | 41.1 |   | $ | 6.9 |   | $ | 48.6 |   |

 

**OperationalRealignment and Facilities Restructuring**

 

During thesecond quarter of fiscal 2004, we adopted plans to restructure the operationsof our Cabin Management and Systems Integration groups.  The restructuring plan for Cabin Managementinvolves the realignment of production between its manufacturing facilities andthe relocation and consolidation of the group’s headquarters to Wichita,Kansas.  The plan for SystemsIntegration involves combining the manufacturing activities of two facilitiesinto a single facility and eliminating some product offerings and servicecapabilities resulting in a partial downsizing of certain operations.  These actions are designed to reduceengineering, production and inventory carrying costs by supporting fewermanufacturing locations and product offerings. In connection with these actions, we recorded pre-tax charges tooperations totaling $6.9 million during the second quarter of fiscal 2004, ofwhich $3.0 million were noncash charges.

 

The chargesare comprised of the write-down of surplus inventory, lease termination andrelated charges, and severance and other compensation costs.  We also expect to incur additionalrestructuring-related expenses of approximately $1.9 million during the lasthalf of fiscal 2004 to complete the restructuring plans.  These expenses, which are primarilyrelocation and travel costs, will be expensed as incurred.  Future cash payments, which will aggregateapproximately $5.6 million, will be funded from existing cash balances andinternally generated cash from operations.

 

41

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**Seating Product Lineand Furniture Manufacturing Facilities Restructuring**

 

During thesecond quarter of fiscal 2003, we consolidated our seating product lineofferings and adopted a restructuring plan to down-size a furnituremanufacturing facility in response to continuing weakness in the business, VIPand head-of-state aircraft market. These actions were designed to reduce engineering, production andinventory carrying costs by supporting fewer product offerings and achieveprofitability at the furniture manufacturing facility based on its lowerproduction levels.  In connection withthese actions, we recorded pre-tax charges to operations totaling $7.1 millionduring the second quarter of fiscal 2003, of which $3.6 million were noncashcharges.  The charges are comprised ofthe write-off of excess and obsolete inventory costs related to thediscontinued product offerings, lease termination and related charges, andseverance and other compensation costs. These restructuring activities were completed by the end of fiscal 2003.

 

**Goodwill Impairment Charges**

 

As a result ofthe continuing weakness in the business, VIP and head-of-state aircraft marketand the decision to down-size a furniture manufacturing facility, the goodwillassociated with the furniture manufacturing reporting unit was tested forrecoverability in June 2003 and found to be impaired.  As a result, $34.0 million of goodwill associated with thereporting unit was written off and charged to operations during the threemonths ended June 30, 2003.

 

On March 14,2003, we entered into a definitive agreement to sell our equity interests inthe subsidiaries comprising the Specialty Avionics Group for $140.0 million incash.  Based upon the fair value of thegroup implied in the definitive agreement, we determined that the carryingvalue of the group’s net assets was not fully recoverable.  As a result, we recorded a goodwillimpairment charge of $7.5 million during the three months ended March 31, 2003to reduce the carrying value to estimated net realizable value.

 

**Liquidity and Capital Resources**

 

We are aholding company and have no direct material operations.  Our only asset is our ownership of all ofthe common stock of DeCrane Aircraft, and our only material liability is ourguarantee of the DeCrane Aircraft first-lien credit facility and second-lienterm debt.  Our principal liquidityneeds are for income taxes and the payment of cash dividends on our preferredstock, if declared.

 

Our onlysource of cash is dividends from DeCrane Aircraft.  The first-lien credit facility, second-lien term debt andsubordinated notes described below are obligations of DeCrane Aircraft andimpose limitations on its ability to pay dividends to us.  We believe that DeCrane Aircraft’s debtinstruments will permit it to supply us with sufficient cash to meet the cashneeds referred to above for the next twelve months.  However, if that is not the case, we would not be able to satisfythose needs, 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.

 

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

 

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**Cash Flows During the Six Months Ended June30, 2004**

 

Net cash usedfor operating activities was $17.3 million for the six months ended June 30,2004 and consisted of $8.9 million of cash used by operations after adding backdepreciation, amortization, preferred stock dividends, noncash restructuringcharges, interest accretion and other noncash items, $10.8 million used forworking capital and a $2.4 million increase in other liabilities.  The following factors contributed to the$10.8 million working capital increase:

 

•                  a $5.8 millionincrease in accounts receivables due to higher revenues;

 

•                  a $12.1 millionincrease in inventory commensurate with higher revenues and order backlog; and

 

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

 

•                  a $7.3 millionincrease in accounts payable and accrued expenses.

 

Net cash used for investing activities consisted of capitalexpenditures of $1.8 million for the six months ended June 30, 2004.  We anticipate spending approximately $3.0 to$5.0 million for capital expenditures in 2004.

 

Net cash provided by financing activities was $14.5 million for the sixmonths ended June 30, 2004 and consisted of:

 

•                  $15.1 million ofdebt borrowings, primarily on the revolving line of credit; offset by

 

•                  $0.6 million ofother secured long-term debt repayments.

 

**Debt Obligations andCapital Resources as of June 30, 2004**

 

As of June 30,2004, first-lien credit facility borrowings and second-lien term debt totaling$105.6 million are at variable interest rates based on defined margins over thecurrent prime rate or LIBOR.  We alsohad $100.0 million of 12% subordinated notes, $71.3 million of 15% second-lienterm debt and other secured indebtedness totaling $8.2 million outstanding asof June 30, 2004.  In addition, our 16%mandatorily redeemable preferred stock, which has characteristics of both aliability and equity, had a $46.8 million mandatorily redemption value as ofJune 30, 2004.

 

As of June 30,2004, we had $41.0 million of working capital and $8.6 million of borrowingsavailable under our $24.0 million revolving line of credit, which expires inMarch 2006.

** **

**Recent DevelopmentsAffecting Debt Obligations and Preferred Stock Dividends**

 

On July 23,2004, holders of $64.5 million of DeCrane Aircraft’s 12% senior subordinatednotes due September 30, 2008 (the “existing notes”) exchanged their notes fornew 17% senior discount notes due September 30, 2008 (the “new notes”).  The new notes do not bear cash interest andhave an initial accreted value equal to the principal amount of the notesexchanged.  The new notes accrete invalue at a 17% annual rate and will have a $127.8 million aggregate accretedprincipal value at maturity.  The newnotes are senior unsecured obligations of DeCrane Aircraft and are guaranteedby its subsidiaries.  Except for thechanges in the interest rate and payment and ranking described above, the newnotes have terms substantially identical to those contained in the existing notes,although covenants limiting the incurrence of indebtedness, the granting ofliens and the making of restricted payments are more restrictive.  The exchange will help conserve workingcapital by reducing DeCrane Aircraft’s cash interest expense by $7.7 millionannually through September 2008.

 

Concurrentwith the note exchange, DeCrane Aircraft amended the terms of its 16% seniorpreferred stock and we also amended the terms of our 14% preferred stock aswell.  The amended terms provide thatfurther dividends do not accrue on the preferred stock, except if a leverageratio (as defined)

 

43

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falls below certain specifiedlevels or if certain triggering events occur, such as failure to discharge anymandatory redemption obligations, and the like.  Depending upon the future leverage ratio achieved, dividends willresume at various dividend rates.  Alldividends accrued through the amendment date and future dividends, if any, arenot payable until redemption.  Theamendment for the 16% preferred stock accelerates the mandatory redemption datefrom March 31, 2009 to December 31, 2008 while the September 30, 2009 mandatoryredemption date for the 14% preferred stock remained unchanged.  The amendment to the 16% preferred stockalso adds several restrictive covenants. The holders of the 16% preferred stock were issued 348,945 shares ofDeCrane Holdings common stock in connection with the amendment.

 

We continue toexplore transactions that would improve our liquidity and reduce our cashneeds.  We have not entered into anycommitments to do so and cannot assure you that we will be able to do so in thefuture.  For example, as disclosed in aCurrent Report on Form 8-K date July 20, 2004, we are engaged in discussionswith some of the holders of the remaining 12% senior subordinated notes thatdid not participate in exchange for the 17% notes.  We are proposing that such holders exchange their existing 12%senior subordinated notes for new senior notes that would bear interest at anannual rate of 2% in cash and 10% in kind. No letters of intent or definitive agreements with respect to suchproposal have been executed, and any such transaction would require negotiationand execution of definitive documentation and the consent of our other lenders,including the holders who participated in the 17% note exchange.  As a result, any such exchange transactionmay not occur.

** **

**Financial Conditionand Liquidity**

 

We believe ourexpected operating cash flows, together with borrowings under our first-liencredit facility ($8.6 million of which was available as of June 30, 2004, thecommitment for which expires in March 2006), will be sufficient to meet ouroperating expenses, working capital requirements, capital expenditures and debtservice obligations for the next twelve months.  However, our working capital needs generally increase as ourorder backlog and revenues increase, particularly with respect to orders wherewe must incur development costs and build inventory but we may not receive fullpayment until delivery.  Any significantdelay in payments could increase our working capital needs beyond ourexpectations.  Further, our ability tocomply with our debt financial covenants, pay principal or interest and satisfysuch cash obligations will depend on our future operating performance as wellas competitive, legislative, regulatory, business and other factors beyond ourcontrol.  Although we cannot be certain,we expect to be in compliance with the revised financial covenants through theend of the year based on our current operating plan.  See “Special Note Regarding Forward-Looking Statements and RiskFactors.”

 

**Disclosure of Contractual Obligations andCommitments**

 

The followingtable summarizes our known contractual obligations to make future cash paymentsas of June 30, 2004, as well an estimate of the periods during which thesepayments are expected to be made.  Theinformation presented in the table reflects the changes resulting from the July2004 events previously described in “Liquidity and Capital Resources—RecentDevelopments Affecting Debt Obligations and Preferred Stock Dividends.”

 

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|                                    |   |      |   | **Years  Ending December 31,** |   |
|-----------------------------------------|--------|-----------|--------|--------------------------------|--------|
| **(In millions)**                       |   | **Total** |   | **2004**                       |   | **2005  and  2006** |   | **2007  and  2008** |   | **2009  and  Beyond** |   |
|                                    |   |      |   |                           |   |   |   |   |   |   |   |
| Long-term debt (a):                     |   |      |   |                           |   |   |   |   |   |   |   |
| First-lien credit facility (b):         |   |      |   |                           |   |   |   |   |   |   |   |
| Term debt                               |   | $         | 80.5   |                           | $      | — |   | $ | 15.0 |   | $ | 65.5 |   | $ | — |   |
| Revolving line of credit                |   | 15.0      |   | —                         |   | 15.0 |   | — |   | — |   |
| Second-lien term debt (c)               |   | 81.3      |   | —                         |   | — |   | 81.3 |   | — |   |
| 17% senior discount notes (d)           |   | 64.5      |   | —                         |   | — |   | 64.5 |   | — |   |
| 12% subordinated notes (e)              |   | 35.5      |   | —                         |   | — |   | 35.5 |   | — |   |
| Capital lease obligations (f)           |   | 3.2       |   | 0.3                            |   | 0.9 |   | 0.6 |   | 1.4 |   |
| Other indebtedness (f)                  |   | 5.1       |   | 0.4                            |   | 1.7 |   | 0.6 |   | 2.4 |   |
| Total long-term debt                    |   | 285.1     |   | 0.7                            |   | 32.6 |   | 248.0 |   | 3.8 |   |
|                                    |   |      |   |                           |   |   |   |   |   |   |   |
| Mandatorily redeemable preferred stock: |   |      |   |                           |   |   |   |   |   |   |   |
| DeCrane Aircraft preferred stock (g)    |   | 46.8      |   | —                         |   | — |   | 46.8 |   | — |   |
| DeCrane Holdings preferred stock (h)    |   | 76.5      |   | —                         |   | — |   | — |   | 76.5 |   |
| Other long-term liabilities             |   | 7.8       |   | —                         |   | 5.3 |   | 2.1 |   | 0.4 |   |
| Operating lease obligations             |   | 13.3      |   | 1.5                            |   | 5.0 |   | 2.4 |   | 4.4 |   |
| Total obligations as of June 30, 2004   |   | $         | 429.5  |                           | $      | 2.2 |   | $ | 42.9 |   | $ | 299.3 |   | $ | 85.1 |   |

 

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(a)                      Excludes interest payments, whichare described in the following notes.

 

(b)                     The first-lien credit facilitybears interest at variable rates and therefore the amount of future interestpayments are uncertain.  The debt bearsinterest based on a margin over, at our option, the prime rate or LIBOR.  As of June 30, 2004, the current prime ratewas 4.00% and the current LIBOR was 1.08%. The margins applicable to portions of amounts borrowed vary depending onour consolidated debt leverage ratio. Currently, the applicable margins are 4.00% to 4.75% for prime rateborrowings and 5.25% to 6.00% for LIBOR borrowings.  The weighted-average interest rate on all first-lien debt was6.92% as of June 30, 2004.

 

(c)                      The second-lien term debt iscomprised of $70.0 million of fixed rate debt and $10.0 million of variablerate debt.  The fixed rate debt bearsinterest at 15%; 12% payable quarterly in cash and 3% pay-in-kind or “accreted”interest, payable at maturity.  The variablerate debt bears cash interest, at our option, at the prime rate plus 7.5% orLIBOR plus 8.5%, plus 3% pay-in-kind interest payable at maturity.  The weighted-average interest rate on allsecond-lien debt was 14.33% as of June 30, 2004.  All of the second-lien debt matures on June 30, 2008, at whichtime the cash payment obligation will be $91.7 million, including the 3%pay-in-kind interest obligation.

 

(d)                     The 17% senior discount notes donot bear cash interest expense but instead accrete in value at a 17% annualrate until maturity on September 30, 2008. The notes will have a $127.8 million aggregate accreted principal valueat maturity.

 

(e)                      Interest on the 12% subordinatednotes is payable semiannually.

 

(f)                        Interest is generally payablemonthly.

 

(g)                     Dividends do not accrue on thepreferred stock unless a leverage ratio (as defined) falls below certainspecified levels.  Depending on thefuture leverage ratio achieved, dividends may accrue at either a 4% or 16%annual rate.  Future dividends, in any,are not payable until redemption.  Themandatory redemption date is December 31, 2008.  Our debt instruments restrict our ability to make payments on ourpreferred stock.

 

45

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(h)                     Dividends do not accrue on thepreferred stock unless a leverage ratio (as defined) falls below certainspecified levels.  Depending on thefuture leverage ratio achieved, dividends may accrue at either a 3.5% or 14%annual rate.  Future dividends, in any,are not payable until redemption.  Themandatory redemption date is September 30, 2009.

 

**Disclosure About Off-Balance SheetCommitments and Indemnities**

 

During ournormal course of business, we have entered into agreements containingindemnities pursuant to which we may be required to make payments in thefuture.  These indemnities are inconnection with facility leases and liabilities for specified claims arisingfrom investment banking services our financial advisors provide to us.  The duration of these indemnities,commitments and guarantees varies, and in certain cases, is indefinite.  Substantially all of these indemnitiesprovide no limitation on the maximum potential future payments we could beobligated to make and is not quantifiable. We have not recorded any liability for these indemnities since no claimshave been asserted to date.

 

In connectionwith the sale of the Specialty Avionics Group, we made indemnities to the buyerwith respect to a number of customary, and certain other specific,representations and warranties.  Ourindemnities with respect to some of these matters are limited in terms ofduration with the maximum of potential future payments capped at $14.0 millionand our indemnities with respect to specified environmental matters will expirenot later than October 2010 and provides for a maximum liability of $5.0million, while others will have no limitations.

 

As of June 30,2004, we also had irrevocable standby letters of credit in the amount of $0.3million issued and outstanding under our first-lien credit facility.

 

**Recent Accounting Pronouncements**

** **

**AccountingPronouncements Adopted January 1, 2004**

 

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

 

**Special Note Regarding Forward-LookingStatements and Risk Factors**

 

All statementsother than statements of historical facts included in this report, includingstatements about our future performance and liquidity and future industryperformance, are considered forward-looking statements within the meaning ofthe Private Securities Litigation Reform Act of 1995.  These statements are subject to known and unknown risks, uncertaintiesand other factors, which are difficult to predict.  We are vulnerable to a variety of factors that affect manybusinesses, such as:

 

•                  fuel prices andgeneral economic conditions that affect demand for aircraft and air travel,which in turn affect demand for our products and services;

 

•                  acts, andongoing threats, of global terrorism, military conflicts and health epidemicsthat affect demand for aircraft and air travel, which in turn affect demand forour products and services;

 

•                  our reliance onkey customers and the adverse effect a significant decline in business from anyone of them would have on our business;

 

•                  our reliance onlarge projects, where unanticipated needs to incur development costs andacquire inventory or delays in payment could increase our working capitalneeds;

 

46

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•                  changes inprevailing interest rates and the availability of financing to fund our plansfor continued growth;

 

•                  competition fromlarger companies;

 

•                  Federal AviationAdministration prescribed standards and licensing requirements, which apply tomany of the products and services we provide;

 

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

 

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

 

•                  liability andother claims asserted against us that exceeds our insurance coverage;

 

•                  the ability toattract and retain qualified personnel;

 

•                  labordisturbances; and

 

•                  changes inoperating strategy, or our acquisition and capital expenditure plans.

 

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

 

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

 

We are exposedto various market risks, including interest rates and changes in foreigncurrency exchange rates.  Market risk isthe potential loss arising from adverse changes in prevailing market rates andprices.  From time to time, we usederivative financial instruments to manage and reduce risks associated withthese factors.  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 riskrelated to our variable-rate debt is estimated as the potential decrease inpre-tax earnings resulting from an increase in interest rates.  The interest rates applicable tovariable-rate debt are, at our option, based on defined margins over thecurrent prime rate or LIBOR.  As of June30, 2004, the current prime rate was 4.0% and the current LIBOR was 1.08%.  Based on $105.6 million of variable-ratedebt outstanding as of June 30, 2004, a hypothetical one percent rise ininterest rates, to 5.00% for prime rate borrowings and 2.08% for LIBORborrowings, would reduce our pre-tax earnings by $1.0 million annually.

 

To limit aportion of our exposure related to rising interest rates, we have entered intoan interest rate swap contract to effectively convert our variable-rateindustrial revenue bonds to 4.2% fixed-rate debt until maturity in 2008.  The contract is considered to be a hedgeagainst changes in the amount of future cash flows associated with interestpayments on this portion of our variable-rate debt.  Market risk related to this interest rate swap contract isestimated as the potential higher interest expense we will incur if thevariable interest rate decreases below the 4.2% fixed rate.  Based on the $3.0 million of variable-ratedebt converted to fixed-rate debt outstanding as of June 30 2004, a hypotheticalone percent decrease in the variable interest rate to 3.2%, would reduce ourpre-tax earnings by less than $0.1 million annually.

 

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The estimatedfair value of our $100.0 million fixed-rate long-term debt increased $20.0million, or 44.4%, to approximately $65.0 million as of June 30, 2004 from$45.0 million as of December 31, 2003. Market risk related to our fixed-rate debt is deemed to be the potentialincrease in fair value resulting from a decrease in interest rates.  For example, a hypothetical ten percentdecrease in the interest rates, from 12.0% to 10.8%, would increase the fairvalue of our fixed-rate debt by approximately $5.0 million.

** **

**Foreign CurrencyExchange Rate Risk.** Our foreign customers are located in various parts of the world,primarily Canada, the Far and Middle East and Western Europe, and we have asubsidiary with manufacturing facilities in Mexico.  To limit our foreign currency exchange rate risk related to salesto our customers, orders are almost always valued and sold in U.S.dollars.  We have entered into forwardforeign exchange contracts in the past, primarily to limit exposure related toforeign inventory procurement and operating costs.  While we have not entered into any such contracts since 1998, wemay do so in the future depending on the volume of non-U.S. dollar denominatedtransactions and our assessment of future foreign exchange rate trends.

 

**ITEM 4.****                             CONTROLSAND PROCEDURES**

 

The managementof DeCrane Aircraft Holdings, Inc. (the “Company”), under the supervision andwith the participation of the Company’s Chief Executive Officer and ChiefFinancial Officer, conducted an evaluation of the Company’s “disclosurecontrols and procedures” (as defined in Exchange Act Rules 13a-15(e) or15d-15(e)) as of the end of the period covered by this report.  Based on that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures were effective as of the end of the periodcovered by this report.

 

There was nochange in the Company’s internal control over financial reporting identified inconnection with the evaluation required by paragraph (d) of Exchange Act Rules13a-15 or 15d-15 that occurred during the Company’s last fiscal quarter thathas materially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

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**PART II – OTHER INFORMATION**

 

**ITEM 1.****                             LEGALPROCEEDINGS**

 

See Note 10 tothe consolidated financial statements included in this report.

 

**ITEM 6.****                             EXHIBITSAND REPORTS ON FORM 8-K**

 

a.                                       Exhibits

 

31.1                                       Chief ExecutiveOfficer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*

 

31.2                                       Chief FinancialOfficer Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*

 

32                                                ChiefExecutive Officer and Chief Financial Officer Certifications Pursuant toPursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *

 

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*                                                     Filedherewith

 

b.                                      Reports on Form 8-K

 

On June 2,2004 we filed a Form 8-K Current Report. Under Item 9 we disclosed entering into non-binding letters of intentwith several holders of our 12% senior subordinated notes to exchange theirnotes aggregating approximately $65 million for new 17% senior discount notes,which bear no cash interest but instead accrete in value at a 17% annual rateuntil maturity, and the holders of our 16% and 14% preferred stock to amend theterms of the preferred stock.

 

On July 20,2004 we filed a Form 8-K Current Report. Under Item 9 we disclosed we are in discussion with certain holders ofour 12% senior subordinated notes not participating in the exchange describedin our June 2, 2004 Form 8-K Current Report to exchange their notes for newnotes bearing interest at a rate of 2% in cash and 10% in kind at maturity.

 

On July 23,2004 we filed a Form 8-K Current Report. Under Item 9 we disclosed we had completed the exchange of notes andamended the terms of our 16% preferred stock as we had described in our June 2,2004 Form 8-K Current Report.  We alsodisclosed we had obtained waivers of certain rights from the holders of morethat 99% of our 14% preferred stock.

 

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**SIGNATURES**

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

 
|            | **DECRANE HOLDINGS CO. (Registrant)** |
|-----------------|---------------------------------------|
|            |                                  |
|            |                                  |
| August 16, 2004 | By:                                   | /s/  RICHARD J. KAPLAN |
|            | Name:                                 | Richard J. Kaplan |
|            | Title:                                | Chief Financial Officer and |
|            |                                  | Assistant Secretary |

 

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