**UNITED STATES********SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

----

 

**FORM 10-Q**

 

**QUARTERLY REPORT PURSUANT TO SECTION 13 OR15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended September 30, 2004**

 

**CommissionFile Number 333-70363**

 

----

 

**DECRANE HOLDINGS CO.**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                                                     | ** ** | ** ** | ** ** | **13-4019703**                         |
|------------------------------------------------------------------|------------|------------|------------|----------------------------------------|
| (State or  other jurisdiction of  incorporation or organization) |       |       |       | (I.R.S.  Employer  Identification No.) |

 

**c/o CreditSuisse First Boston / DLJ Merchant Banking Partners II, L.P.Eleven Madison Avenue, New York, NY 10010**

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

 

**(212)325-2000**

(Registrant’s telephone number,including area code)

 

**(NotApplicable)**

(Former name, former addressand former fiscal year, if changed since last report)

 

----

 

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

 

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

 

----

 

The number of shares of Registrant’s CommonStock, $.01 par value, outstanding as of November 8, 2004 was4,358,242 shares.

 

 

----

 

**Table ofContents**

 
| **Part I – Financial Information** |
|-----------------------------------------|
|                                    |   |   |
| **Item 1.**                             | **Financial Statements (Unaudited)** |   |
| ** **                              | ** ** |   |
|                                    | Consolidated Balance Sheets as of September 30, 2004 and December 31,  2003 |   |
|                                    |   |   |
|                                    | Consolidated Statements of Operations for  the three months and nine months ended September 30, 2004 and 2003 |   |
|                                    |   |   |
|                                    | Consolidated Statements of Stockholders’  Equity (Deficit) for the nine months ended September 30, 2004 |   |
|                                    |   |   |
|                                    | Consolidated Statements of Cash Flows for  the nine months ended September 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 September 30, 2004 |   |
|                                    |   |   |
|                                    | Nine  months ended September 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 2.**                             | **Unregistered Sales of Equity Securities and  Use of Proceeds** |   |
| ** **                              | ** ** |   |
| **Item 6.**                             | **Exhibits** |   |
| ** **                              | ** ** |   |
| **Signatures**                          |   |

 

----

 

**PART I – FINANCIAL INFORMATION**

 

**ITEM 1.  FINANCIALSTATEMENTS**

 

**DECRANEHOLDINGS CO. AND SUBSIDIARY**

 

**Consolidated Balance Sheets**

 
| **(In thousands, except share data)**                                                                                                                                                       | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                  | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| **Assets**                                                                                                                                                                                  | ** ** | ** **                   | ** ** | ** **                  | ** ** |
|                                                                                                                                                                                        |       |                         |       |                        |       |
| Current  assets:                                                                                                                                                                            |       |                         |       |                        |       |
| Cash and  cash equivalents                                                                                                                                                                  |       | $                            | 2,774      |                        | $          | 6,936 |   |
| Accounts  receivable, net                                                                                                                                                                   |       | 21,842                       |       | 21,455                      |       |
| Inventories                                                                                                                                                                                 |       | 55,699                       |       | 42,981                      |       |
| Prepaid  expenses and other current assets                                                                                                                                                  |       | 1,254                        |       | 1,082                       |       |
| Total  current assets                                                                                                                                                                       |       | 81,569                       |       | 72,454                      |       |
|                                                                                                                                                                                        |       |                         |       |                        |       |
| Property and  equipment, net                                                                                                                                                                |       | 29,420                       |       | 30,900                      |       |
| Goodwill                                                                                                                                                                                    |       | 162,430                      |       | 162,430                     |       |
| Other  assets, principally intangibles, net                                                                                                                                                 |       | 33,172                       |       | 38,092                      |       |
| Total assets                                                                                                                                                                                |       | $                            | 306,591    |                        | $          | 303,876 |   |
|                                                                                                                                                                                        |       |                         |       |                        |       |
| **Liabilities,  Mandatorily Redeemable Preferred Stock and Stockholders’ Equity (Deficit)**                                                                                            |       |                         |       |                        |       |
|                                                                                                                                                                                        |       |                         |       |                        |       |
| Current  liabilities:                                                                                                                                                                       |       |                         |       |                        |       |
| Short-term  borrowings and current portion of long-term debt                                                                                                                                |       | $                            | 6,339      |                        | $          | 1,198 |   |
| Accounts  payable                                                                                                                                                                           |       | 17,147                       |       | 15,462                      |       |
| Accrued  liabilities                                                                                                                                                                        |       | 18,132                       |       | 17,890                      |       |
| Income taxes  payable                                                                                                                                                                       |       | 63                           |       | —                      |       |
| Total  current liabilities                                                                                                                                                                  |       | 41,681                       |       | 34,550                      |       |
|                                                                                                                                                                                        |       |                         |       |                        |       |
| Long-term  debt                                                                                                                                                                             |       | 288,890                      |       | 268,208                     |       |
| Mandatorily  redeemable preferred stock                                                                                                                                                     |       | 124,475                      |       | —                      |       |
| Other  long-term liabilities                                                                                                                                                                |       | 8,346                        |       | 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 September 30, 2004 and December 31, 2003                           |       | —                       |       | —                      |       |
| Common  stock, $.01 par value, 10,000,000 shares authorized; 4,358,242 and 4,009,297  shares issued and outstanding as of September 30, 2004 and December 31,  2003, respectively |       | 44                           |       | 40                          |       |
| Additional paid-in  capital                                                                                                                                                                 |       | 61,475                       |       | 61,475                      |       |
| Notes  receivable for shares sold                                                                                                                                                           |       | (1,321                       | )          | (1,268                      | )          |
| Accumulated  deficit                                                                                                                                                                        |       | (216,863                     | )          | (176,562                    | )          |
| Accumulated  other comprehensive loss                                                                                                                                                       |       | (136                         | )          | (268                        | )          |
| Total  stockholders’ equity (deficit)                                                                                                                                                  |       | (156,801                     | )          | (116,583                    | )          |
| Total liabilities,  mandatorily redeemable preferred stock and stockholders’ equity (deficit)                                                                                          |       | $                            | 306,591    |                        | $          | 303,876 |   |

 

The accompanying notes are anintegral part of the consolidated financial statements.

 

1

----

 

**DECRANEHOLDINGS CO. AND SUBSIDIARY**

 

**ConsolidatedStatements of Operations**

 
| ** **                                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **(In thousands)**                                                 | ** ** | **2004**                                   | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                         |       | **(Unaudited)**                            |       |
| Revenues                                                           |       | $                                          | 50,645     |                                      | $          | 44,273 |   | $ | 154,059 |   | $ | 130,286 |   |
| Cost of  sales                                                     |       | 37,645                                     |       | 34,494                                    |       | 121,801 |   | 102,086 |   |
|                                                               |       |                                       |       |                                      |       |   |   |   |   |
| Gross profit                                                       |       | 13,000                                     |       | 9,779                                     |       | 32,258 |   | 28,200 |   |
|                                                               |       |                                       |       |                                      |       |   |   |   |   |
| Operating  expenses:                                               |       |                                       |       |                                      |       |   |   |   |   |
| Selling,  general and administrative expenses                      |       | 7,811                                      |       | 4,787                                     |       | 22,836 |   | 21,696 |   |
| Research and  development expenses                                 |       | 1,681                                      |       | 2,211                                     |       | 5,863 |   | 7,062 |   |
| Impairment  of goodwill                                            |       | —                                     |       | —                                    |       | — |   | 34,000 |   |
| Amortization  of intangible assets                                 |       | 913                                        |       | 912                                       |       | 2,738 |   | 2,738 |   |
| Total  operating expenses                                          |       | 10,405                                     |       | 7,910                                     |       | 31,437 |   | 65,496 |   |
|                                                               |       |                                       |       |                                      |       |   |   |   |   |
| Income (loss)  from operations                                     |       | 2,595                                      |       | 1,869                                     |       | 821 |   | (37,296 | ) |
|                                                               |       |                                       |       |                                      |       |   |   |   |   |
| Other  expenses:                                                   |       |                                       |       |                                      |       |   |   |   |   |
| Interest  expense                                                  |       | 9,555                                      |       | 6,546                                     |       | 27,007 |   | 18,883 |   |
| Mandatorily  redeemable preferred stock dividends                  |       | 1,163                                      |       | 1,718                                     |       | 9,781 |   | 4,972 |   |
| Loss on debt  and preferred stock restructuring                    |       | 3,898                                      |       | —                                    |       | 3,898 |   | — |   |
| Other  expenses, net                                               |       | 143                                        |       | 134                                       |       | 346 |   | 880 |   |
|                                                               |       |                                       |       |                                      |       |   |   |   |   |
| Loss from  continuing operations before provision for income taxes |       | (12,164                                    | )          | (6,529                                    | )          | (40,211 | ) | (62,031 | ) |
| Provision  for income (taxes) benefit                              |       | (30                                        | )          | (143                                      | )          | (90 | ) | 10,487 |   |
|                                                               |       |                                       |       |                                      |       |   |   |   |   |
| Loss from  continuing operations                                   |       | (12,194                                    | )          | (6,672                                    | )          | (40,301 | ) | (51,544 | ) |
|                                                               |       |                                       |       |                                      |       |   |   |   |   |
| Discontinued  operations and change in accounting principle:       |       |                                       |       |                                      |       |   |   |   |   |
| Loss from  discontinued operations, net of tax                     |       | —                                     |       | —                                    |       | — |   | (5,650 | ) |
| Cumulative  effect of change in accounting principle               |       | —                                     |       | —                                    |       | — |   | (13,764 | ) |
|                                                               |       |                                       |       |                                      |       |   |   |   |   |
| Net loss                                                           |       | (12,194                                    | )          | (6,672                                    | )          | (40,301 | ) | (70,958 | ) |
|                                                               |       |                                       |       |                                      |       |   |   |   |   |
| Noncash  preferred stock dividend accretion                        |       | —                                     |       | (2,333                                    | )          | — |   | (6,765 | ) |
|                                                               |       |                                       |       |                                      |       |   |   |   |   |
| Net loss  applicable to common stockholders                        |       | $                                          | (12,194    | )                                         | $          | (9,005 | ) | $ | (40,301 | ) | $ | (77,723 | ) |

 

The accompanying notes are anintegral part of the consolidated financial statements.

 

2

----

 

**DECRANEHOLDINGS CO. AND SUBSIDIARY**

 

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

 
| ** **                                         |       | ** **       |       | **Additional  Paid-in  Capital** |   | **Notes  Receivable  For Shares  Sold** |   | **Accumulated  Deficit** |   | **Accumulated  Other  Comprehensive  Loss** |   | **Total** |   |
|----------------------------------------------------|------------|------------------|------------|----------------------------------|--------|-----------------------------------------|--------|--------------------------|--------|---------------------------------------------|--------|-----------|--------|
| ** **                                         |       | ** **       |       | ** **                       |
| **(In thousands, except share data)**              |       | **Common Stock** |
|                                               | **Shares** |             | **Amount** |
|                                               |       |             |       |                             |   |                                    |   |                     |   |                                        |   |      |   |   |   |
| Balance, December 31,  2003                   |       | 4,009,297        |       | $                                | 40     |                                    | $      | 61,475                   |   | $                                           | (1,268 | )         | $      | (176,562 | ) | $ | (268 | ) | $ | (116,583 | ) |
|                                               |       |             |       |                             |   |                                    |   |                     |   |                                        |   |      |   |   |   |
| Comprehensive  income (loss):                      |       |             |       |                             |   |                                    |   |                     |   |                                        |   |      |   |   |   |
| Net loss                                           |       | —           |       | —                           |   | —                                  |   | —                   |   | (40,301                                     | )      | —    |   | (40,301 | ) |
| Unrealized  gain on interest rate swap contract    |       | —           |       | —                           |   | —                                  |   | —                   |   | —                                      |   | 132       |   | 132 |   |
|                                               |       |             |       |                             |   |                                    |   |                     |   |                                        |   |      |   | (40,169 | ) |
|                                               |       |             |       |                             |   |                                    |   |                     |   |                                        |   |      |   |   |   |
| Common stock  issued for preferred stock amendment |       | 348,945          |       | 4                                |   | —                                  |   | —                   |   | —                                      |   | —    |   | 4 |   |
|                                               |       |             |       |                             |   |                                    |   |                     |   |                                        |   |      |   |   |   |
| Notes  receivable interest accrued                 |       | —           |       | —                           |   | —                                  |   | (53                      | )      | —                                      |   | —    |   | (53 | ) |
|                                               |       |             |       |                             |   |                                    |   |                     |   |                                        |   |      |   |   |   |
| Balance, September 30,  2004 (Unaudited)      |       | 4,358,242        |       | $                                | 44     |                                    | $      | 61,475                   |   | $                                           | (1,321 | )         | $      | (216,863 | ) | $ | (136 | ) | $ | (156,801 | ) |

 

The accompanying notes are anintegral part of the consolidated financial statements.

 

3

----

 

**DECRANEHOLDINGS CO. AND SUBSIDIARY**

 

**ConsolidatedStatements of Cash Flows**

 
| ** **                                                                    | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| **(In thousands)**                                                            | ** ** | **2004**                                  | ** ** | **2003** | ** ** |
| ** **                                                                    | ** ** | **(Unaudited)**                           | ** ** |
| **Cash  flows from operating activities:**                                    |       |                                      |       |   |   |
| Net loss                                                                      |       | $                                         | (40,301    | ) | $ | (70,958 | ) |
| Adjustments  to reconcile net loss to net cash used for operating activities: |       |                                      |       |   |   |
| Cumulative  effect of change in accounting principles                         |       | —                                    |       | 13,764 |   |
| Loss from  discontinued operations                                            |       | —                                    |       | 5,650 |   |
| Depreciation  and amortization                                                |       | 9,188                                     |       | 9,401 |   |
| Mandatorily  redeemable preferred stock dividends                             |       | 9,781                                     |       | 4,972 |   |
| Loss on debt  and preferred stock restructuring                               |       | 3,898                                     |       | — |   |
| Long-term  debt interest accretion                                            |       | 3,880                                     |       | — |   |
| Noncash  portion of restructuring, asset impairment and other related charges |       | 3,073                                     |       | 37,664 |   |
| Preferred  stock redemption value accretion                                   |       | 264                                       |       | — |   |
| Deferred  income taxes                                                        |       | —                                    |       | (11,654 | ) |
| Other, net                                                                    |       | (12                                       | )          | 228 |   |
| Changes in  assets and liabilities:                                           |       |                                      |       |   |   |
| Accounts  receivable                                                          |       | (387                                      | )          | 950 |   |
| Inventories                                                                   |       | (15,669                                   | )          | (6,961 | ) |
| Prepaid  expenses and other assets                                            |       | (10                                       | )          | (734 | ) |
| Accounts  payable                                                             |       | 1,685                                     |       | 1,159 |   |
| Accrued  liabilities                                                          |       | 374                                       |       | (14,902 | ) |
| Income taxes  payable                                                         |       | 161                                       |       | 276 |   |
| Other  long-term liabilities                                                  |       | 2,882                                     |       | 3,620 |   |
| Net cash  used for operating activities                                       |       | (21,193                                   | )          | (27,525 | ) |
|                                                                          |       |                                      |       |   |   |
| **Cash  flows from investing activities:**                                    |       |                                      |       |   |   |
| Net proceeds  from sale of Specialty Avionics Group                           |       | —                                    |       | 132,800 |   |
| Capital  expenditures                                                         |       | (2,740                                    | )          | (3,090 | ) |
| Cash paid  for acquisition contingent consideration                           |       | —                                    |       | (600 | ) |
| Net cash  provided by (used for) investing activities                         |       | (2,740                                    | )          | 129,110 |   |
|                                                                          |       |                                      |       |   |   |
| **Cash  flows from financing activities:**                                    |       |                                      |       |   |   |
| Debt  borrowings:                                                             |       |                                      |       |   |   |
| Revolving  line of credit, net                                                |       | 17,800                                    |       | 17,400 |   |
| Short-term  promissory notes                                                  |       | 5,000                                     |       | — |   |
| Debt  repayments:                                                             |       |                                      |       |   |   |
| First-lien  term debt                                                         |       | —                                    |       | (129,275 | ) |
| Other  secured long-term debt                                                 |       | (892                                      | )          | (1,600 | ) |
| Deferred  financing costs                                                     |       | (2,137                                    | )          | — |   |
| Net cash  provided by (used for) financing activities                         |       | 19,771                                    |       | (113,475 | ) |
|                                                                          |       |                                      |       |   |   |
| Net cash  provided by discontinued operations                                 |       | —                                    |       | 2,194 |   |
|                                                                          |       |                                      |       |   |   |
| Net decrease  in cash and cash equivalents                                    |       | (4,162                                    | )          | (9,696 | ) |
| Cash and  cash equivalents at beginning of period                             |       | 6,936                                     |       | 12,421 |   |
| Cash and  cash equivalents at end of period                                   |       | $                                         | 2,774      |   | $ | 2,725 |   |

 

The accompanying notes are anintegral part of the consolidated financial statements.

 

4

----

 

**DECRANEHOLDINGS CO. AND SUBSIDIARY**

 

**CondensedNotes to Consolidated Financial Statements**

**(Unaudited)**

 

**Note1.**                                  Summary of Significant AccountingPolicies

** **

**Basisof Presentation**

 

These consolidated interim financial statements areunaudited.  The Company believes theinterim financial statements are presented on a basis consistent with theaudited financial statements and include all adjustments necessary for a fairpresentation of the financial condition, results of operations and cash flowsfor such interim periods.  All of theseadjustments are normal recurring adjustments.

 

Preparation of these consolidated financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America requires the Company to make estimates and judgments thataffect the reported amounts of assets, liabilities and disclosure of contingentassets and liabilities at the date of the consolidated financial statements andthe reported amounts of revenues and expenses during the reportingperiods.  Actual results could differfrom those estimates.

 

The results of operations for interim periods do notnecessarily predict the operating results for any other interim period or forthe full year.  The consolidated balancesheet as of December 31, 2003 has been derived from audited financialstatements but does not include all disclosures required by accountingprinciples generally accepted in the United States of America as permitted byinterim reporting requirements.  Theseconsolidated interim financial statements should be read in conjunction withManagement’s Discussion and Analysis of Financial Condition and Results ofOperations and the audited financial statements and related notes included inthe Company’s 2003 Form 10-K. Reclassifications have been made to the financial statements for priorperiods to conform to the current year presentation.

** **

**Changesin Accounting Principles**

** **

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

 

Effective January 1, 2004, the Company adoptedSFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity.”  SFAS No. 150 establishes standards for theclassification and measurement of certain financial instruments withcharacteristics of both liabilities and equity. SFAS No. 150 requires classification of financial instruments within itsscope as a liability, including financial instruments issued in the form ofshares that are mandatorily redeemable, because those financial instruments aredeemed to be, in essence, obligations of the issuer.  As a result of adopting SFAS No. 150 on January 1,2004, all mandatorily redeemable preferred stock was reclassified as aliability and all quarterly dividends are reflected as a charge against pre-taxincome.  In periods prior to January 1,2004, DeCrane Holdings’ 14% preferred stock dividends were deducted in arrivingat the net income or loss applicable to the Company’s common stockholders;DeCrane Aircraft’s 16% preferred stock dividends were charged against pre-taxincome as minority interest in preferred stock of subsidiary.

 

The following table summarizes the results ofoperations for the three months and nine months ended September 30, 2003as if SFAS No. 150 had been in effect as of the beginning of 2003.

 
| ** **                       | ** ** | **Three Months Ended  September 30, 2003** | ** ** | **Nine Months Ended  September 30, 2003** | ** ** |
|----------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| **(In thousands)**               | ** ** | **As Reported**                                 | ** ** | **Pro Forma**                                  | ** ** | **As Reported** | ** ** | **Pro Forma** | ** ** |
| ** **                       | ** ** | **(Unaudited)**                                 | ** ** |
| Loss from  continuing operations |       | $                                               | (6,672     | )                                              | $          | (9,005 | ) | $ | (51,544 | ) | $ | (58,309 | ) |
| Net loss                         |       | (6,672                                          | )          | (9,005                                         | )          | (70,958 | ) | (77,723 | ) |
|                                  |            |                                                 |            |                                                |            |  |  |  |  |  |  |  |  |

** **

**5**

----

** **

The pro forma data reflects DeCrane Holdings 14%preferred stock dividends of $2,333,000 for the three months ended September 30,2003 and $6,765,000 for the nine months ended September 30, 2003 ascharges against income during the periods.

** **

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

 

As more fully described in “Note 1—Change inAccounting Principle” to the audited financial statements included in theCompany’s 2003 Form 10-K, the Company 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 commencing January 1, 2003.

 

This change in accounting policy was made afterconcluding the 2003 fiscal year but was applied retroactively to the beginningof the year, January 1, 2003, as required by generally accepted accountingprinciples.  As a result of the change,program-related product development costs are now classified as a component ofresearch and development expenses in the consolidated financial statementsrather than classified as a component of inventory cost.  The Company restated its results ofoperations by charging previously inventoried costs totaling $2,211,000 and$7,062,000 for the three months and nine months ended September 30, 2003,respectively, to research and development expense and recording a $13,764,000charge as of January 1, 2003 to reflect the cumulative effect of thechange in accounting principle.

** **

**StockOption Plan**

 

The Company has one stock-based employee compensationplan, which is more fully described in the notes to its audited financialstatements.  As permitted under SFAS No.123, “Accounting for Stock-Based Compensation,” the Company measurescompensation expense related to the employee stock option plan utilizing theintrinsic value method as prescribed by Accounting Principles Board Opinion No.25, “Accounting for Stock Issued to Employees,” and relatedinterpretations.  No stock-based employeecompensation cost is reflected in net income (loss), as all options grantedunder the plan had an exercise price equal to the value of the underlyingcommon stock on the date of grant.

 

The following table illustrates the effect on net lossif the Company had applied the fair value recognition provisions of SFAS No.123 to stock-based employee compensation.

 
| ** **                                                                                                                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **(In thousands)**                                                                                                                             | ** ** | **2004**                                   | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                                     | ** ** | **(Unaudited)**                            | ** ** |
| Net loss, as  reported                                                                                                                         |       | $                                          | (12,194    | )                                         | $          | (6,672 | ) | $ | (40,301 | ) | $ | (70,958 | ) |
| Less total  stock-based employee compensation expense determined under the fair value  based method for all awards, net of related tax effects |       | (81                                        | )          | (94                                       | )          | (243 | ) | (282 | ) |
| Pro forma  net loss                                                                                                                            |       | $                                          | (12,275    | )                                         | $          | (6,766 | ) | $ | (40,544 | ) | $ | (71,240 | ) |

 

The effect of applying SFAS No. 123 may not berepresentative of the pro forma effect in future years since additional optionsmay be granted during those future years.

 

6

----

 

**Note 2.   Restructuring,Asset Impairment and Other Related Charges**

 

During the three months and nine months ended September 30,2004 and 2003, the Company recorded restructuring, asset impairment and otherrelated charges as follows:

 
| ** **                                                                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **(In thousands)**                                                         | ** ** | **2004**                                   | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                 |       | **(Unaudited)**                            |       |
| Nature of  charges:                                                        |       |                                       |       |                                      |       |   |   |   |   |
| Operational  Realignment and Facilities Restructuring                      |       | $                                          | 405        |                                      | $          | — |   | $ | 7,306 |   | $ | — |   |
| Seating  Product Line and Furniture Manufacturing Facilities Restructuring |       | —                                     |       | —                                    |       | — |   | 7,132 |   |
| Goodwill  impairment charges                                               |       | —                                     |       | —                                    |       | — |   | 41,500 |   |
| Total  pre-tax charges                                                     |       | $                                          | 405        |                                      | $          | — |   | $ | 7,306 |   | $ | 48,632 |   |
|                                                                       |       |                                       |       |                                      |       |   |   |   |   |
| Business  segment recording the charges:                                   |       |                                       |       |                                      |       |   |   |   |   |
| Cabin  Management                                                          |       | $                                          | 73         |                                      | $          | — |   | $ | 1,701 |   | $ | 41,132 |   |
| Systems  Integration                                                       |       | 75                                         |       | —                                    |       | 5,348 |   | — |   |
| Corporate                                                                  |       | 257                                        |       | —                                    |       | 257 |   | — |   |
| Total  charged to continuing operations                                    |       | 405                                        |       | —                                    |       | 7,306 |   | 41,132 |   |
| Specialty  Avionics (discontinued operations)                              |       | —                                     |       | —                                    |       | — |   | 7,500 |   |
| Total  pre-tax charges                                                     |       | $                                          | 405        |                                      | $          | — |   | $ | 7,306 |   | $ | 48,632 |   |
|                                                                       |       |                                       |       |                                      |       |   |   |   |   |
| Charged to  operations:                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Cost of  sales                                                             |       | $                                          | 147        |                                      | $          | — |   | $ | 6,230 |   | $ | 6,573 |   |
| Selling,  general and administrative expenses                              |       | 258                                        |       | —                                    |       | 1,076 |   | 559 |   |
| Impairment  of goodwill                                                    |       | —                                     |       | —                                    |       | — |   | 34,000 |   |
| Total  charged to continuing operations                                    |       | 405                                        |       | —                                    |       | 7,306 |   | 41,132 |   |
| Charged to  discontinued operations                                        |       | —                                     |       | —                                    |       | — |   | 7,500 |   |
| Total  pre-tax charges                                                     |       | $                                          | 405        |                                      | $          | — |   | $ | 7,306 |   | $ | 48,632 |   |
|                                                                       |       |                                       |       |                                      |       |   |   |   |   |
| Components  of charges:                                                    |       |                                       |       |                                      |       |   |   |   |   |
| Noncash  charges                                                           |       | $                                          | 95         |                                      | $          | — |   | $ | 3,073 |   | $ | 37,664 |   |
| Cash charges                                                               |       | 310                                        |       | —                                    |       | 4,233 |   | 3,468 |   |
| Total  charged to continuing operations                                    |       | 405                                        |       | —                                    |       | 7,306 |   | 41,132 |   |
| Charged to  discontinued operations (noncash)                              |       | —                                     |       | —                                    |       | — |   | 7,500 |   |
| Total  pre-tax charges                                                     |       | $                                          | 405        |                                      | $          | — |   | $ | 7,306 |   | $ | 48,632 |   |

 

7

----

 

**OperationalRealignment and Facilities Consolidation**

 

During the second quarter of fiscal 2004, the Companyadopted plans to restructure the operations of its Cabin Management and SystemsIntegration groups.  The restructuringplan for Cabin Management involves the realignment of production between itsmanufacturing facilities and the relocation and consolidation of the group’sheadquarters to Wichita, Kansas.  Theplan for Systems Integration involves combining the manufacturing activities oftwo facilities into a single facility and eliminating some product offeringsand service capabilities resulting in a partial downsizing of certainoperations.  These actions are designedto reduce engineering, production and inventory carrying costs by supportingfewer manufacturing locations and product offerings.  In connection with these actions, the Companyrecorded pre-tax charges to operations totaling $7,306,000 through September 30,2004, including $405,000 during the third quarter, comprised of the following:

 

•      *Lease Termination andRelated Charges. *Lease termination and other relatedcharges are comprised of the net losses expected to be incurred under theexisting long-term lease agreements for facilities permanently vacated.  The losses have been reduced by the expectedsublease income.  These expected losseswere based on estimated current market rates and anticipated dates that thesefacilities are subleased.  If marketrates decrease or should it take longer than expected to sublease thesefacilities, the actual loss could exceed these estimates.  Otherrelated charges include the write-off of leasehold improvements related to thevacated facilities.

 

•      *Write-Down of SurplusInventory. *Inventory waswritten down to reflect its net realizable value for quantities on handexceeding current and forecast order backlog requirements related to the curtailed product offerings.

 

•      *Severance and Other CompensationCosts. *The Company’s totalworkforce will be reduced by 25 employees, or 2%, from December 31, 2003levels when the restructuring is completed during the fourth quarter of fiscal2004.

 

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

 

The Company expects to incur additionalrestructuring-related expenses of approximately $1,600,000 during the fourthquarter of fiscal 2004 to complete the restructuring plans.  These expenses, which are primarilyrelocation and travel costs, will be expensed as incurred.

 

The components of the restructuring, asset impairmentand other related charges are as follows:

 
| ** **                                          | ** ** | ** **      | ** ** | ** **           | ** ** | ** **             | ** ** | **Balance at** | ** ** |
|-----------------------------------------------------|------------|-----------------|------------|----------------------|------------|------------------------|------------|----------------|------------|
| ** **                                          | ** ** | **Total**       | ** ** | **Amounts Incurred** | ** ** | **September 30,** | ** ** |
| **(In thousands)**                                  | ** ** | **Charges**     | ** ** | **Noncash**          | ** ** | **Cash**               | ** ** | **2004**       | ** ** |
| ** **                                          | ** ** | **(Unaudited)** | ** ** |
| Lease  termination and other related charges        |       | $               | 3,044      |                 | $          | (102                   | )          | $              | (113       | ) | $ | 2,829 |   |
| Excess  inventory write-downs                       |       | 2,906           |       | (2,906               | )          | —                 |       | —         |       |
| Severance  and other compensation costs             |       | 538             |       | —               |       | (81                    | )          | 457            |       |
| Other  restructuring charges                        |       | 818             |       | (65                  | )          | (502                   | )          | 251            |       |
| Total                                               |       | 7,306           |       | $                    | (3,073     | )                      | $          | (696           | )          | $ | 3,537 |   |
|                                                |       |            |       |                 |       |                   |       |           |       |
| Other  restructuring-related charges to be incurred |       | 1,578           |       |                 |       |                   |       |           |       |
| Total  expected restructuring charges               |       | $               | 8,884      |                 |       |                   |       |           |       |   |

 

Future cash payments, which will extend to 2013because of lease termination costs, will be funded from existing cash balancesand internally generated cash from operations.

** **

**8**

----

** **

**SeatingProduct Line and Furniture Manufacturing Facilities Restructuring**

 

During the second quarter of fiscal 2003, the Companyconsolidated its seating product line offerings and adopted a restructuringplan to down-size a furniture manufacturing facility in response to continuingweakness in the business, VIP and head-of-state aircraft market.  These actions were designed to reduceengineering, production and inventory carrying costs by supporting fewerproduct offerings and achieve profitability at the furniture manufacturingfacility based on its lower production levels. In connection with these actions, the Company recorded pre-tax chargesto operations totaling $7,132,000, comprised of the following:

 

•      *Lease Termination and RelatedCharges. *Lease termination chargesreflect lease cancellation costs for the facilities vacated and possessionreturned to the lessor in connection with down-sizing a furniture manufacturingfacility.  Other related charges includethe write-off of leasehold improvements related to the vacated facilities.

 

•      *Excess Inventory Write-Downs. *Inventory was written downby $3,073,000 to reflect its net realizable value for quantities on handexceeding current and forecast order backlog requirements related to the curtailed seating product offerings.

 

•      *Severance and Other CompensationCosts. *The Company reduced itstotal workforce at the down-sized facility by 49 employees, or 37%, from December 31,2002 levels.

 

The components of the restructuring, asset impairmentand other related charges are as follows:

 
| ** **                                   | ** ** | ** **  | ** ** | ** **           | ** ** | ** **            | ** ** | **Balance at** | ** ** |
|----------------------------------------------|------------|-------------|------------|----------------------|------------|-----------------------|------------|----------------|------------|
| ** **                                   | ** ** | **Total**   | ** ** | **Amounts Incurred** | ** ** | **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     | ) | $ | — |   |

 

The restructuring activities were completed during2003.

 

**Goodwill Impairment Charges**

 

As a result of the weakness in the business, VIP andhead-of-state aircraft market in 2003 and the decision to down-size a furnituremanufacturing facility, the goodwill associated with the furnituremanufacturing reporting unit was tested for recoverability in June 2003and found to be impaired.  As a result,$34,000,000 of goodwill associated with the reporting unit was written off andcharged to operations during the three months ended June 30, 2003.

 

As described in Note 3, on March 14, 2003, theCompany entered into a definitive agreement to sell its equity interests in thesubsidiaries comprising its Specialty Avionics Group for $140,000,000 incash.  Based upon the fair value of thegroup implied in the definitive agreement, the Company determined that thecarrying value of the group’s net assets was not fully recoverable.  As a result, the Company recorded a goodwillimpairment charge of $7,500,000 during the three months ended March 31, 2003to reduce the carrying value to estimated net realizable value.

 

9

----

** **

**Note3.**                                  Disposition of Specialty Avionics Group

 

On May 23, 2003, the Company consummated the sale ofthe subsidiaries comprising its Specialty Avionics Group for $140,000,000 incash.  Based upon the fair value of thegroup implied in the definitive agreement which was signed during the firstquarter of fiscal 2003, the Company determined that the carrying value of thegroup’s net assets was not fully recoverable. As required by SFAS No. 142, the Company recorded a goodwill impairmentcharge of $7,500,000 during the first quarter of fiscal 2003 to reduce thecarrying value to the estimated net realizable value established by thedefinitive agreement.  The Companyrecorded a modest gain on the sale, based on the actual financial position ofthe group on the date of sale.  As aresult of the sale, the Specialty Avionics Group is presented as a discontinuedoperation in the accompanying consolidated financial statements.

 

In accordance with the Financial Accounting StandardsBoard’s Emerging Issues Task Force Issue No. 87-24, “Allocation of Interest toDiscontinued Operations,” as amended, interest expense includes interest ondebt that was assumed by the buyer as well as interest on the $130,723,000 ofdebt that was required to be repaid as a result of the sale.  Interest expense was based on the historicalinterest rates charged during each of the periods.  In addition, and also in accordance with EITF87-24, costs and expenses exclude the allocation of general corporate overhead.

 

The following tables summarize the results ofoperations and cash flows of the Specialty Avionics Group for the five monthsended May 23, 2003, the date of sale.

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

 

**Note 4.**                                  Inventories

 

Inventories are comprised of the following as of September 30,2004 and December 31, 2003:

 
| **(In thousands)**                                                           | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                   | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| Raw materials                                                                |       | $                            | 28,683     |                        | $          | 30,414 |   |
| Work-in-process                                                              |       | 21,045                       |       | 6,817                       |       |
| Finished  goods                                                              |       | 2,130                        |       | 1,693                       |       |
| Costs and  estimated earnings in excess of billings on uncompleted contracts |       | 3,841                        |       | 4,057                       |       |
| Total  inventories                                                           |       | $                            | 55,699     |                        | $          | 42,981 |   |

 

Total costs and estimated earnings on all uncompletedcontracts as of September 30, 2004 and December 31, 2003 arecomprised of the following:

 
| **(In thousands)**                                                            | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                    | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| Costs  incurred on uncompleted contracts                                      |       | $                            | 17,229     |                        | $          | 71,824 |   |
| Estimated  earnings recognized                                                |       | 855                          |       | 77,782                      |       |
| Total costs  and estimated earnings                                           |       | 18,084                       |       | 149,606                     |       |
| Less  billings to date                                                        |       | (14,355                      | )          | (145,661                    | )          |
| Net                                                                           |       | $                            | 3,729      |                        | $          | 3,945 |   |
|                                                                          |       |                         |       |                        |       |
| Balance  sheet classification:                                                |       |                         |       |                        |       |
| Asset –  Costs and estimated earnings in excess of billings              |       | $                            | 3,841      |                        | $          | 4,057 |   |
| Liability –  Billings in excess of costs and estimated earnings (Note 6) |       | (112                         | )          | (112                        | )          |
| Net                                                                           |       | $                            | 3,729      |                        | $          | 3,945 |   |

 

11

----

 

**Note5.**                                  Other Assets, Principally Intangibles

 

Other assets are comprised of the following as of September 30,2004 and December 31, 2003:

 
| **(In thousands)**                                       | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                               | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| Identifiable  intangible assets with finite useful lives |       | $                            | 22,717     |                        | $          | 25,455 |   |
| Deferred  financing costs                                |       | 9,910                        |       | 11,812                      |       |
| Other  non-amortizable assets                            |       | 545                          |       | 825                         |       |
| Total other  assets                                      |       | $                            | 33,172     |                        | $          | 38,092 |   |

 

In connection with the debt restructuring described inNote 7, the Company recorded a noncash charge of $1,705,000 during the threemonths ended September 30, 2004 to write-off deferred financing costsassociated with the portion of the existing notes exchanged for new notes.

 

**Identifiable Intangible Assets with Finite UsefulLives**

 

Identifiable intangible assets with finite usefullives are comprised of the following as of September 30, 2004 and December 31,2003:

 
| ** **                      | ** ** | **September 30, 2004  (Unaudited)** | ** ** | **December 31, 2003**    | ** ** |
|---------------------------------|------------|------------------------------------------|------------|-------------------------------|------------|
| **(In thousands)**              | ** ** | **Cost**                                 | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** | **Cost** | ** ** | **Accumulated  Amortization** | ** ** | **Net** | ** ** |
|                            |       |                                     |       |                          |       |   |   |   |   |   |   |   |   |
| FAA  certifications             |       | $                                        | 22,272     |                          | $          | (7,336 | ) | $ | 14,936 |   | $ | 22,272 |   | $ | (6,222 | ) | $ | 16,050 |   |
| Engineering  drawings           |       | 7,645                                    |       | (2,668                        | )          | 4,977 |   | 7,645 |   | (2,286 | ) | 5,359 |   |
| Other  identifiable intangibles |       | 11,345                                   |       | (8,541                        | )          | 2,804 |   | 11,345 |   | (7,299 | ) | 4,046 |   |
| Total  identifiable intangibles |       | $                                        | 41,262     |                          | $          | (18,545 | ) | $ | 22,717 |   | $ | 41,262 |   | $ | (15,807 | ) | $ | 25,455 |   |

 

Estimated annual amortization expense for allidentifiable intangible assets with finite useful lives for the five-yearperiod ending December 31, 2008 is as follows: 2004 – $3,644,000; 2005 –$3,477,000; 2006 – $2,275,000; 2007 – $2,175,000; and 2008 – $2,171,000.

 

**Note6.**                                  Accrued Liabilities

 

Accrued liabilities are comprised of the following asof September 30, 2004 and December 31, 2003:

 
| **(In thousands)**                                                           | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                   | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| Salaries,  wages, compensated absences and payroll related taxes             |       | $                            | 5,185      |                        | $          | 4,017 |   |
| Accrued  interest                                                            |       | 3,724                        |       | 4,969                       |       |
| Current  portion of accrued product warranty obligations                     |       | 2,492                        |       | 2,064                       |       |
| Customer  advances and deposits                                              |       | 2,337                        |       | 3,147                       |       |
| Billings in  excess of costs and estimated earnings on uncompleted contracts |       | 112                          |       | 112                         |       |
| Other  accrued liabilities                                                   |       | 4,282                        |       | 3,581                       |       |
| Total  accrued liabilities                                                   |       | $                            | 18,132     |                        | $          | 17,890 |   |

 

12

----

 

**Note7.**                                  Short-Term Borrowings and Long-Term Debt

 

Short-term borrowings and long-term debt is comprisedof the following amounts as of September 30, 2004 and December 31,2003:
| **(In thousands)**                                                           | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                   | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| Short-term  borrowings:                                                      |       |                         |       |                        |       |
| 13.5% senior  unsecured promissory notes payable to related parties          |       | $                            | 5,000      |                        | $          | — |   |
| Long-term  debt:                                                             |       |                         |       |                        |       |
| First-lien  credit facility:                                                 |       |                         |       |                        |       |
| Term debt                                                                    |       | 80,521                       |       | 80,521                      |       |
| Revolving  line of credit                                                    |       | 17,800                       |       | —                      |       |
| Second-lien  term debt                                                       |       | 81,902                       |       | 80,067                      |       |
| 17% senior  discount notes                                                   |       | 67,045                       |       | —                      |       |
| Capital  lease obligations and other debt, secured by property and equipment |       | 7,961                        |       | 8,818                       |       |
| 12% senior  subordinated notes                                               |       | 35,000                       |       | 100,000                     |       |
| Total  short-term borrowings and long-term debt                              |       | 295,229                      |       | 269,406                     |       |
| Less  short-term borrowings and current portion of long-term debt            |       | (6,339                       | )          | (1,198                      | )          |
| Long-term  debt, less current portion                                        |       | $                            | 288,890    |                        | $          | 268,208 |   |

 

During the third quarter of fiscal 2004, holders of$65,000,000 of DeCrane Aircraft’s 12% senior subordinated notes due September 30,2008 (the “existing notes”) exchanged their notes for new 17% senior discountnotes 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 $128,772,000 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, payment and ranking described above, the newnotes have terms substantially identical to those contained in the existingnotes, although covenants limiting the incurrence of indebtedness, the grantingof liens and the making of restricted payments are more restrictive.

 

In addition to the interest accretion on the 17%senior discount notes, a portion of the interest charged on the second-lienterm debt is also pay-in-kind or “accreted” interest, payable at maturity.  An additional $2,667,000 and $3,880,000 ofinterest accreted to the principal balances of the notes and term debt duringthe three months and nine months ended September 30, 2004, respectively.

 

In September 2004, the Company received theproceeds from the issuance of 13.5% senior unsecured promissory notes in theaggregate principle amount of $5,000,000 to DLJ Merchant Banking Partners II,L.P. and affiliated funds, who are also stockholders and, as a result, relatedparties (see Note 16 to the audited financial statements included in theCompany’s 2003 Form 10-K for additional information on the related partyrelationship).  Unless extended, thenotes, plus accrued interest, are due on November 29, 2004.  The notes contain covenants identical tothose in the new 17% notes.

 

As of September 30, 2004, the Company hadirrevocable standby letters of credit in the amount of $318,000 issued andoutstanding under the first-lien credit facility, which reduces borrowingsavailable under the $24,000,000 revolving line of credit.

 

13

----

 

**Note 8.   MandatorilyRedeemable Preferred Stock**

 

As more fully described in “Note 1—Changes inAccounting Principles,” the Company adopted the provisions of SFAS No. 150, “Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity,” as of January 1, 2004.

 

The table below summarizes the increase in mandatorilyredeemable preferred stock during the nine months ended September 30,2004.

 
| ** **                                                             | ** ** | **DeCrane Aircraft  16% Senior 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                                             |       | 40,113                                           |       | 4,011                                     |       | — |   | 4,011 |   | — |   | 5,770 |   | 9,781 |   |
| Redemption  value accretion                                            |       | —                                           |       | —                                    |       | 264 |   | 264 |   | — |   | — |   | 264 |   |
| Write-off of  unamortized discount                                     |       | —                                           |       | —                                    |       | 2,193 |   | 2,193 |   | — |   | — |   | 2,193 |   |
| Balance, September 30,  2004 (Unaudited)                          |       | 473,032                                          |       | $                                         | 47,303     |   | $ | — |   | $ | 47,303 |   | 342,417 |   | $ | 77,172 |   | $ | 124,475 |   |
|                                                                   |       |                                             |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Per share  liquidation value as of September 30, 2004 (Unaudited) |       |                                             |       | $                                         | 100.00     |   |   |   |   |   |   |   | $ | 225.37 |   |   |   |

 

During the third quarter of fiscal 2004, the DeCraneAircraft amended the terms of its 16% senior preferred stock and DeCraneHoldings amended the terms of its 14% preferred stock as well.  The amended terms provide that furtherdividends on either class of preferred stock, if any, accrue at rates dependenton a specified financial ratio or if certain triggering events occur.  All dividends accrued through the amendmentdate and future dividends, if any, are not payable until redemption.  The amendment for the 16% preferred stockaccelerates the mandatory redemption date from March 31, 2009 to December 31,2008 while the September 30, 2009 mandatory redemption date for the 14%preferred stock remained unchanged.  Theamendment to the 16% preferred stock also adds several restrictive covenants.

 

The holders of the 16% preferred stock were issued348,945 shares of DeCrane Holdings common stock in connection with theamendment.  The common stock had anominal fair market value on the issuance date and was therefore recorded atits $0.01 per share par value.  Inconnection with the 16% preferred stock restructuring, the Company recorded anoncash charge of $2,193,000 during the three months ended September 30,2004 to write-off the unamortized issuance discount associated with the initialissuance of the preferred stock.

 

**PreferredStock Dividends**

 

Future preferred stock dividends, if any, aredependent, in part, upon a defined leverage ratio the Company achieves as ofeach quarterly testing date.  Dependingon the ratio achieved, and provided certain triggering events have notoccurred, dividends for the succeeding quarter accrue at a 0%, 4% or 16% annualrate on the 16% preferred stock and 0%, 3.5% or 14% on the 14% preferredstock.  If certain triggering events occur,such as failure to discharge any mandatory redemption obligations or complywith certain restrictive covenants and the like, dividends accrue at the 16%and 14% annual rates.  Based upon theleverage ratio achieved as of September 30, 2004, no dividends will accrueon either the 16% or 14% preferred stock from the amendment dates through December 31,2004.

 

14

----

 

**Note9.**                                  Income Taxes

 

The components of income (loss) before income taxesand cumulative effect of change in accounting principle and the provisions forincome tax benefit are as follows:

 
| ** **                                   | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **(In thousands)**                           | ** ** | **2004**                                   | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                   | ** ** | **(Unaudited)**                            | ** ** |
| Pre-tax  income (loss) reported by:          |       |                                       |       |                                      |       |   |   |   |   |
| Continuing  operations                       |       | $                                          | (12,164    | )                                         | $          | (6,529 | ) | $ | (40,211 | ) | $ | (62,031 | ) |
| Discontinued  operations                     |       | —                                     |       | —                                    |       | — |   | (5,286 | ) |
| Consolidated  pre-tax loss                   |       | $                                          | (12,164    | )                                         | $          | (6,529 | ) | $ | (40,211 | ) | $ | (67,317 | ) |
|                                         |       |                                       |       |                                      |       |   |   |   |   |
| Total  provision for income taxes (benefit): |       |                                       |       |                                      |       |   |   |   |   |
| Income tax  benefit based on pre-tax loss    |       | $                                          | (5,521     | )                                         | $          | (1,188 | ) | $ | (12,664 | ) | $ | (23,821 | ) |
| Net deferred  tax assets valuation allowance |       | 5,551                                      |       | 1,331                                     |       | 12,754 |   | 14,387 |   |
| Net  provision for income taxes (benefit)    |       | $                                          | 30         |                                      | $          | 143 |   | $ | 90 |   | $ | (9,434 | ) |
|                                         |       |                                       |       |                                      |       |   |   |   |   |
| Allocation  of total provision:              |       |                                       |       |                                      |       |   |   |   |   |
| Continuing  operations                       |       | $                                          | 30         |                                      | $          | 143 |   | $ | 90 |   | $ | (10,487 | ) |
| Discontinued  operations                     |       | —                                     |       | —                                    |       | — |   | 1,053 |   |
| Net  provision for income taxes (benefit)    |       | $                                          | 30         |                                      | $          | 143 |   | $ | 90 |   | $ | (9,434 | ) |

 

For the three months and nine months ended September 30,2004, the provision for income taxes, based on the reported consolidatedpre-tax loss, differs from the amount determined by applying the applicableU.S. statutory federal rate to the pre-tax loss primarily due to the effects ofstate and foreign income taxes and non-deductible expenses, principallymandatorily redeemable preferred stock dividends due to the adoption of SFASNo. 150 effective January 1, 2004 (Note 1).

 

For the three months and nine months ended September 30,2003, the provision for income taxes, based on the reported consolidatedpre-tax loss, differs from the amount determined by applying the applicableU.S. statutory federal rate to the pre-tax loss primarily due to the effects ofstate and foreign income taxes and non-deductible expenses, principally thenon-deductible portion of goodwill impairment charges and DeCrane Aircraft’s16% preferred stock dividends.

 

As more fully described in Note 11 to the auditedfinancial statements included in the Company’s 2003 Form 10-K, the Company hada net deferred tax asset of $19,528,000 fully offset by a valuation allowanceof the same amount as of December 31, 2003.

 

As required by SFAS No. 109, the Company evaluated itsdeferred tax assets for expected recoverability based on the nature of theitem, the associated taxing jurisdictions, the applicable expiration dates andfuture taxable income forecasts that would impact utilization.  Since there is no loss carry back potentialand the Company does not have any tax planning strategies to assurerecoverability, the only possibility for recovery of the net deferred assets isfuture taxable income.  Since there havebeen prior year losses, the Company believes it was not prudent to rely onfuture taxable income as the means to support the carrying value of the netdeferred tax assets.  Based upon theresults of operations for the nine months ended September 30, 2004, theCompany determined that an additional $12,754,000 valuation allowance wasrequired as of that date, $5,551,000 of which is applicable to the three-monthperiod.

 

15

----

 

**Note10.**                           Commitments and Contingencies

 

**Litigation**

 

Raytheon Aircraft Company (“Raytheon”) has filed acomplaint against the Company and one of its subsidiaries in the state court ofKansas with respect to alleged product liability related to certain aircraftseats sold to Raytheon by the Company’s subsidiary.  The complaint does not specify the amount ofdamages claimed by Raytheon, but the amount could be material.

 

This action has just been served on the Company and nodiscovery has commenced; accordingly, management has not had an opportunity todetermine the likely outcome of this claim. However, based on the allegations in the complaint and the factscurrently available, management does not know of a basis which would result inthis action having a material adverse effect on the Company’s business,consolidated financial position, results of operations or cash flows.  Further, the Company’s subsidiary may be indemnifiedby the entity from which it acquired the seat product line.

 

The Company and its subsidiaries are also involved inother routine legal and administrative proceedings incident to the normalconduct of business.  Management believesthe ultimate disposition of all such matters will not have a material adverseeffect on the Company’s business, consolidated financial position, results ofoperations or cash flows.

 

**Note11.**                           Business Segment Information

 

The Company supplies products and services to the business,VIP and head-of-state aircraft market within the aerospace industry.  The Company’s subsidiaries are organized intotwo groups, each of which is a strategic business that develops, manufacturesand sells distinct products and services. The groups and a description of their businesses are as follows:

 

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

 

•      *Systems Integration –* manufactures auxiliary fuel systems andauxiliary power units, provides system integration services, provides aircraftcompletion and refurbishment services and is a Boeing Business Jet authorizedservice center.

 

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

 

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

 

16

----

 

Management defines Adjusted EBITDA as earnings,determined using program accounting for product development costs, beforeinterest, income taxes, depreciation and amortization, restructuring, assetimpairment and other related charges, acquisition related charges notcapitalized and other noncash and nonoperating charges.  Management believes the presentation of thismeasure is relevant and useful to investors because it allows investors andanalysts to view group performance in a manner similar to the method used bymanagement, helps improve their ability to understand the Company’s coresegment performance, adjusted for items management believes are unusual, andmakes it easier to compare the Company’s results with other companies that havedifferent financing, capital structures and tax rates.  In addition, management believes thesemeasures are consistent with the manner in which its lenders and investorsmeasure the Company’s overall performance and liquidity, including its abilityto service debt and fund discretionary capital expenditure and productdevelopment programs.

 

The financial measure Adjusted EBITDA, as defined,excludes certain charges reflected in the Company’s financial statements whichare prepared in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”). However, the Company’s presentation of Adjusted EBITDA is in accordancewith the GAAP requirements of SFAS No. 131, “Disclosures about Segments of anEnterprise and Related Information,” which requires the Company to report theprimary measure of segment performance used by management to evaluate andmanage its businesses.  The Company’smethod of calculating Adjusted EBITDA may not be consistent with that of othercompanies and should be viewed in conjunction with measurements that arecomputed in accordance GAAP, such as net income (loss), the nearest comparableGAAP financial measure.  A reconciliationof Adjusted EBITDA to net income (loss) is included herein to clarify thedifferences between these financial measures.

 

The accounting policies of the groups aresubstantially the same as those described in the summary of significantaccounting policies in Note 1 to the audited financial statements included inthe Company’s 2003 Form 10-K.  Some transactionsare recorded at the Company’s corporate headquarters and are not allocated tothe groups, such as most of the Company’s cash and cash equivalents, debt andrelated net interest expense, corporate headquarters costs and income taxes.

 

The tables below summarize selected financial data bybusiness segment.

 
| ** **                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **(In thousands)**             | ** ** | **2004**                                   | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                     | ** ** | **(Unaudited)**                            | ** ** |
| Revenues:                      |       |                                       |       |                                      |       |   |   |   |   |
| Cabin  Management              |       | $                                          | 39,429     |                                      | $          | 29,655 |   | $ | 114,757 |   | $ | 89,910 |   |
| Systems  Integration           |       | 12,221                                     |       | 13,807                                    |       | 42,132 |   | 40,657 |   |
| Inter-group  elimination (1)   |       | (1,005                                     | )          | 811                                       |       | (2,830 | ) | (281 | ) |
| Consolidated  totals           |       | $                                          | 50,645     |                                      | $          | 44,273 |   | $ | 154,059 |   | $ | 130,286 |   |
|                           |       |                                       |       |                                      |       |   |   |   |   |
| Adjusted  EBITDA (as defined): |       |                                       |       |                                      |       |   |   |   |   |
| Cabin  Management              |       | $                                          | 7,675      |                                      | $          | 3,909 |   | $ | 17,297 |   | $ | 12,769 |   |
| Systems  Integration           |       | 1,784                                      |       | 3,698                                     |       | 7,212 |   | 10,035 |   |
| Corporate  (2)                 |       | (1,738                                     | )          | (1,133                                    | )          | (3,944 | ) | (4,640 | ) |
| Inter-group  elimination (3)   |       | 1                                          |       | (1                                        | )          | 2 |   | 111 |   |
| Consolidated  totals           |       | 7,722                                      |       | 6,473                                     |       | 20,567 |   | 18,275 |   |
| Reconciling  items (4)         |       | (19,916                                    | )          | (13,145                                   | )          | (60,868 | ) | (89,233 | ) |
| Net loss                       |       | $                                          | (12,194    | )                                         | $          | (6,672 | ) | $ | (40,301 | ) | $ | (70,958 | ) |

 

17

----

 
| **(In thousands)**                | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                        |       | **(Unaudited)**              |       |                        |       |
|                              |       |                         |       |                        |       |
| Total assets  (as of period end): |       |                         |       |                        |       |
| Cabin  Management                 |       | $                            | 239,575    |                        | $          | 224,116 |   |
| Systems  Integration              |       | 52,763                       |       | 58,395                      |       |
| Corporate  (5)                    |       | 14,283                       |       | 21,456                      |       |
| Inter-group  elimination (6)      |       | (30                          | )          | (91                         | )          |
| Consolidated  totals              |       | $                            | 306,591    |                        | $          | 303,876 |   |

 

----

(1)   Inter-group sales are accounted for at pricescomparable to sales to unaffiliated customers, and are eliminated inconsolidation.

 

(2)   Reflects the Company’s corporate headquarters costsand expenses not allocated to the groups.

 

(3)   Reflects elimination of the effect of inter-groupprofits in inventory.

 

(4)   Adjusted EBITDA (as defined) excludes the followingincome and (expenses) reflected in the Company’s financial statements which areprepared in accordance with generally accepted accounting principles:

 
| ** **                                                                                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **(In thousands)**                                                                                                     | ** ** | **2004**                                   | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                   |       | **(Unaudited)**                            |       |
| Depreciation  and amortization of long- lived assets (a)                                                               |       | $                                          | (2,247     | )                                         | $          | (2,383 | ) | $ | (6,850 | ) | $ | (7,350 | ) |
| Adjustment  to reflect program costs as research and development expenses and  nonrecurring program start-up costs (b) |       | (2,445                                     | )          | (2,211                                    | )          | (5,542 | ) | (7,062 | ) |
| Restructuring,  asset impairment and other related charges                                                             |       | (405                                       | )          | —                                    |       | (7,306 | ) | (41,132 | ) |
| Acquisition  related charges not capitalized                                                                           |       | (30                                        | )          | (10                                       | )          | (48 | ) | (27 | ) |
| Interest  expense                                                                                                      |       | (9,555                                     | )          | (6,546                                    | )          | (27,007 | ) | (18,883 | ) |
| Mandatorily  redeemable preferred stock dividends                                                                      |       | (1,163                                     | )          | (1,718                                    | )          | (9,781 | ) | (4,972 | ) |
| Loss on debt  and preferred stock restructuring                                                                        |       | (3,898                                     | )          | —                                    |       | (3,898 | ) | — |   |
| Other  expenses, net                                                                                                   |       | (143                                       | )          | (134                                      | )          | (346 | ) | (880 | ) |
| Provision  for income (taxes) benefit                                                                                  |       | (30                                        | )          | (143                                      | )          | (90 | ) | 10,487 |   |
| Income  (loss) from discontinued operations                                                                            |       | —                                     |       | —                                    |       | — |   | (5,650 | ) |
| Cumulative  effect of change in accounting principle                                                                   |       | —                                     |       | —                                    |       | — |   | (13,764 | ) |
| Total  reconciling items                                                                                               |       | $                                          | (19,916    | )                                         | $          | (13,145 | ) | $ | (60,868 | ) | $ | (89,233 | ) |

 

----

(a)   Reflects depreciation and amortization of long-livedassets but excludes amortization of deferred financing costs, which areclassified as a component of interest expense, as follows:

 

**18**

----

 
| ** **                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **(In thousands)**                                   | ** ** | **2004**                                   | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                           | ** ** | **(Unaudited)**                            | ** ** |
|                                                 |       |                                       |       |                                      |       |   |   |   |   |
| Depreciation  and amortization of long- lived assets |       | $                                          | 2,247      |                                      | $          | 2,383 |   | $ | 6,850 |   | $ | 7,350 |   |
| Amortization  of deferred financing costs            |       | 757                                        |       | 676                                       |       | 2,338 |   | 2,051 |   |
| Consolidated  depreciation and amortization          |       | $                                          | 3,004      |                                      | $          | 3,059 |   | $ | 9,188 |   | $ | 9,401 |   |

 

----

(b)         Under program accounting, which theCompany is required to use for determining covenant compliance under its creditagreements, certain product development and nonrecurring program start-up 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 expense as incurred.  This adjustment reflects the net differencebetween these two methods of accounting.

 

(5)   Reflects the Company’s corporate headquarters assets,excluding investments in and notes receivable from subsidiaries.

 

(6)   Reflects elimination of inter-group receivables andprofits in inventory as of period end.

 

**Note 12.**         Supplemental Condensed ConsolidatingFinancial Information

 

In conjunction with the 12% and 17% notes described inNote 7, the following condensed consolidating financial information ispresented segregating DeCrane Aircraft, as the issuer, and the guarantor andnon-guarantor subsidiaries.  Theaccompanying financial information in the guarantor subsidiaries columnreflects the financial position, results of operations and cash flows for thosesubsidiaries guaranteeing the notes. DeCrane Holdings is not a guarantor of the notes and is thereforereflected in the non-guarantor subsidiary column with DeCrane Aircraft’snon-guarantor subsidiaries.  DeCraneAircraft’s non-guarantor subsidiaries are companies within the SpecialtyAvionics Group which was sold in May 2003 and is therefore classified as acomponent of discontinued operations.

 

The guarantor subsidiaries are wholly-ownedsubsidiaries of DeCrane Aircraft and their guarantees are full andunconditional on a joint and several basis. There are no restrictions on the ability of the guarantor subsidiariesto transfer funds to the issuer in the form of cash dividends, loans oradvances.  Separate financial statementsof the guarantor subsidiaries are not presented because management believesthat such financial statements would not be material to investors.  Investments in subsidiaries in the followingcondensed consolidating financial information are accounted for under theequity method of accounting.  Consolidatingadjustments include the following:

 

(1)   Eliminationof investments in subsidiaries.

 

(2)   Eliminationof intercompany accounts.

 

(3)   Eliminationof equity in earnings of subsidiaries.

 

19

----

** **

**Balance Sheets**

 
| ** **                                                 | ** ** | **September 30, 2004  (Unaudited)** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------|------------|
| **(In thousands)**                                         | ** ** | **Issuer**                               | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| **Assets**                                                 |       |                                     |       |   |   |   |   |   |   |   |   |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Current  assets:                                           |       |                                     |       |   |   |   |   |   |   |   |   |
| Cash and  cash equivalents                                 |       | $                                        | 1,915      |   | $ | 859 |   | $ | — |   | $ | — |   | $ | 2,774 |   |
| Accounts receivable,  net                                  |       | —                                   |       | 21,842 |   | — |   | — |   | 21,842 |   |
| Inventories                                                |       | —                                   |       | 55,699 |   | — |   | — |   | 55,699 |   |
| Other  current assets                                      |       | 75                                       |       | 1,179 |   | — |   | — |   | 1,254 |   |
| Total  current assets                                      |       | 1,990                                    |       | 79,579 |   | — |   | — |   | 81,569 |   |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Property and  equipment, net                               |       | 793                                      |       | 28,627 |   | — |   | — |   | 29,420 |   |
| Other  assets, principally goodwill                        |       | 11,500                                   |       | 184,102 |   | — |   | — |   | 195,602 |   |
| Investments  in subsidiaries                               |       | 78,555                                   |       | — |   | (78,172 | ) | (383 | )(1) | — |   |
| Intercompany  receivables                                  |       | 228,878                                  |       | 55,209 |   | — |   | (284,087 | )(2) | — |   |
| Total assets                                               |       | $                                        | 321,716    |   | $ | 347,517 |   | $ | (78,172 | ) | $ | (284,470 | ) | $ | 306,591 |   |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Liabilities  and Stockholders’ Equity (Deficit)**   |       |                                     |       |   |   |   |   |   |   |   |   |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Current  liabilities:                                      |       |                                     |       |   |   |   |   |   |   |   |   |
| Current  portion of long-term debt                         |       | $                                        | 5,046      |   | $ | 1,293 |   | $ | — |   | $ | — |   | $ | 6,339 |   |
| Other  current liabilities                                 |       | 7,967                                    |       | 27,375 |   | — |   | — |   | 35,342 |   |
| Total  current liabilities                                 |       | 13,013                                   |       | 28,668 |   | — |   | — |   | 41,681 |   |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Long-term  debt, less current portion                      |       | 282,327                                  |       | 6,563 |   | — |   | — |   | 288,890 |   |
| Mandatorily  redeemable preferred stock                    |       | 47,303                                   |       | — |   | 77,172 |   | — |   | 124,475 |   |
| Intercompany  payables                                     |       | 55,209                                   |       | 228,878 |   | — |   | (284,087 | )(2) | — |   |
| Other  long-term liabilities                               |       | 3,357                                    |       | 4,989 |   | — |   | — |   | 8,346 |   |
|                                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Stockholders’  equity (deficit):                      |       |                                     |       |   |   |   |   |   |   |   |   |
| Paid-in  capital                                           |       | 111,670                                  |       | 151,492 |   | 61,519 |   | (264,483 | )(1) | 60,198 |   |
| Retained  earnings (deficit)                               |       | (191,163                                 | )          | (72,937 | ) | (216,863 | ) | 264,100 | (1) | (216,863 |   |
| Accumulated  other comprehensive loss                      |       | —                                   |       | (136 | ) | — |   | — |   | (136 | ) |
| Total  stockholders’ equity (deficit)                 |       | (79,493                                  | )          | 78,419 |   | (155,344 | ) | (383 | ) | (156,801 | ) |
| Total  liabilities and stockholders’ equity (deficit) |       | $                                        | 321,716    |   | $ | 347,517 |   | $ | (78,172 | ) | $ | (284,470 | ) | $ | 306,591 |   |

 

20

----

 
| ** **                                                                                          | ** ** | **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**

----

 

**Statements of Operations**

 
| ** **                                      | ** ** | **Three Months Ended September 30,  2004 (Unaudited)** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------------------------|------------|
| **(In thousands)**                              | ** ** | **Issuer**                                                  | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
|                                            |       |                                                        |       |   |   |   |   |   |   |   |   |
| Revenues                                        |       | $                                                           | —     |   | $ | 50,645 |   | $ | — |   | $ | — |   | $ | 50,645 |   |
| Cost of  sales                                  |       | —                                                      |       | 37,645 |   | — |   | — |   | 37,645 |   |
|                                            |       |                                                        |       |   |   |   |   |   |   |   |   |
| Gross profit                                    |       | —                                                      |       | 13,000 |   | — |   | — |   | 13,000 |   |
|                                            |       |                                                        |       |   |   |   |   |   |   |   |   |
| Operating  and other expenses (income):         |       |                                                        |       |   |   |   |   |   |   |   |   |
| Selling,  general and administrative expenses   |       | 2,121                                                       |       | 5,690 |   | — |   | — |   | 7,811 |   |
| Research and  development expenses              |       | —                                                      |       | 1,681 |   | — |   | — |   | 1,681 |   |
| Amortization  of intangible assets              |       | —                                                      |       | 913 |   | — |   | — |   | 913 |   |
| Interest  expense                               |       | 9,348                                                       |       | 207 |   | — |   | — |   | 9,555 |   |
| Mandatorily  redeemable preferred               |       |                                                        |       |   |   |   |   |   |   |   |   |
| stock  dividends                                |       | 478                                                         |       | — |   | 685 |   | — |   | 1,163 |   |
| Loss on debt  and preferred stock restructuring |       | 3,898                                                       |       | — |   | — |   | — |   | 3,898 |   |
| Intercompany  charges                           |       | (5,630                                                      | )          | 5,630 |   | — |   | — |   | — |   |
| Equity in  loss of subsidiaries                 |       | 690                                                         |       | — |   | 11,509 |   | (12,199 | )(3) | — |   |
| Other  expenses, net                            |       | 126                                                         |       | 17 |   | — |   | — |   | 143 |   |
| Provision  for income taxes (benefit)           |       | 478                                                         |       | (448 | ) | — |   | — |   | 30 |   |
| Total  operating and other expenses, net        |       | 11,509                                                      |       | 13,690 |   | 12,194 |   | (12,199 | ) | 25,194 |   |
| Net loss                                        |       | $                                                           | (11,509    | ) | $ | (690 | ) | $ | (12,194 | ) | $ | 12,199 |   | $ | (12,194 | ) |

 
| ** **                                        | ** ** | **Three Months Ended September 30,  2003 (Unaudited)** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------------------|------------|
| **(In thousands)**                                | ** ** | **Issuer**                                                  | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
|                                              |       |                                                        |       |   |   |   |   |   |   |   |   |
| Revenues                                          |       | $                                                           | —     |   | $ | 44,273 |   | $ | — |   | $ | — |   | $ | 44,273 |   |
| Cost of  sales                                    |       | —                                                      |       | 34,494 |   | — |   | — |   | 34,494 |   |
|                                              |       |                                                        |       |   |   |   |   |   |   |   |   |
| Gross profit                                      |       | —                                                      |       | 9,779 |   | — |   | — |   | 9,779 |   |
|                                              |       |                                                        |       |   |   |   |   |   |   |   |   |
| Operating  and other expenses (income):           |       |                                                        |       |   |   |   |   |   |   |   |   |
| Selling,  general and administrative expenses     |       | 313                                                         |       | 4,474 |   | — |   | — |   | 4,787 |   |
| Research and  development expenses                |       | —                                                      |       | 2,211 |   | — |   | — |   | 2,211 |   |
| Amortization  of intangible assets                |       | —                                                      |       | 912 |   | — |   | — |   | 912 |   |
| Interest  expense                                 |       | 6,419                                                       |       | 127 |   | — |   | — |   | 6,546 |   |
| Mandatorily  redeemable preferred stock dividends |       | —                                                      |       | — |   | 1,718 |   | — |   | 1,718 |   |
| Intercompany  charges                             |       | (6,690                                                      | )          | 6,690 |   | — |   | — |   | — |   |
| Equity in  loss of subsidiaries                   |       | 4,045                                                       |       | — |   | 4,954 |   | (8,999 | )(3) | — |   |
| Other  expenses (income), net                     |       | (553                                                        | )          | 687 |   | — |   | — |   | 134 |   |
| Provision for  income taxes (benefit)             |       | 1,420                                                       |       | (1,277 | ) | — |   | — |   | 143 |   |
| Total  operating and other expenses, net          |       | 4,954                                                       |       | 13,824 |   | 6,672 |   | (8,999 | ) | 16,451 |   |
| Net loss                                          |       | $                                                           | (4,954     | ) | $ | (4,045 | ) | $ | (6,672 | ) | $ | 8,999 |   | $ | (6,672 | ) |

 

22

----

 

**Statements of Operations**

 
| ** **                                        | ** ** | **Nine Months Ended September 30,  2004 (Unaudited)** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------------------|------------|
| **(In thousands)**                                | ** ** | **Issuer**                                                 | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
|                                              |       |                                                       |       |   |   |   |   |   |   |   |   |
| Revenues                                          |       | $                                                          | —     |   | $ | 154,059 |   | $ | — |   | $ | — |   | $ | 154,059 |   |
| Cost of  sales                                    |       | —                                                     |       | 121,801 |   | — |   | — |   | 121,801 |   |
|                                              |       |                                                       |       |   |   |   |   |   |   |   |   |
| Gross profit                                      |       | —                                                     |       | 32,258 |   | — |   | — |   | 32,258 |   |
|                                              |       |                                                       |       |   |   |   |   |   |   |   |   |
| Operating  and other expenses (income):           |       |                                                       |       |   |   |   |   |   |   |   |   |
| Selling,  general and administrative expenses     |       | 4,543                                                      |       | 18,293 |   | — |   | — |   | 22,836 |   |
| Research and  development expenses                |       | —                                                     |       | 5,863 |   | — |   | — |   | 5,863 |   |
| Amortization  of intangible assets                |       | —                                                     |       | 2,738 |   | — |   | — |   | 2,738 |   |
| Interest  expense                                 |       | 26,439                                                     |       | 568 |   | — |   | — |   | 27,007 |   |
| Mandatorily  redeemable preferred stock dividends |       | 4,011                                                      |       | — |   | 5,770 |   | — |   | 9,781 |   |
| Loss on debt  and preferred stock restructuring   |       | 3,898                                                      |       | — |   | — |   | — |   | 3,898 |   |
| Intercompany  charges                             |       | (16,509                                                    | )          | 16,509 |   | — |   | — |   | — |   |
| Equity in  loss of subsidiaries                   |       | 7,113                                                      |       | — |   | 34,531 |   | (41,644 | )(3) | — |   |
| Other expenses,  net                              |       | 340                                                        |       | 6 |   | — |   | — |   | 346 |   |
| Provision  for income taxes (benefit)             |       | 4,696                                                      |       | (4,606 | ) | — |   | — |   | 90 |   |
| Total  operating and other expense                |       | 34,531                                                     |       | 39,371 |   | 40,301 |   | (41,644 | ) | 72,559 |   |
| Net loss                                          |       | $                                                          | (34,531    | ) | $ | (7,113 | ) | $ | (40,301 | ) | $ | 41,644 |   | $ | (40,301 | ) |

 
| ** **                                          | ** ** | **Nine Months Ended September 30,  2003 (Unaudited)** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------------|------------|
| **(In thousands)**                                  | ** ** | **Issuer**                                                 | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
|                                                |       |                                                       |       |   |   |   |   |   |   |   |   |
| Revenues                                            |       | $                                                          | —     |   | $ | 130,286 |   | $ | — |   | $ | — |   | $ | 130,286 |   |
| Cost of  sales                                      |       | —                                                     |       | 102,086 |   | — |   | — |   | 102,086 |   |
|                                                |       |                                                       |       |   |   |   |   |   |   |   |   |
| Gross profit                                        |       | —                                                     |       | 28,200 |   | — |   | — |   | 28,200 |   |
|                                                |       |                                                       |       |   |   |   |   |   |   |   |   |
| Operating  and other expenses (income):             |       |                                                       |       |   |   |   |   |   |   |   |   |
| Selling,  general and administrative expenses       |       | 5,217                                                      |       | 16,479 |   | — |   | — |   | 21,696 |   |
| Research and  development expenses                  |       | —                                                     |       | 7,062 |   | — |   | — |   | 7,062 |   |
| Impairment  of goodwill                             |       | —                                                     |       | 34,000 |   | — |   | — |   | 34,000 |   |
| Amortization  of intangible assets                  |       | —                                                     |       | 2,738 |   | — |   | — |   | 2,738 |   |
| Interest  expense                                   |       | 18,535                                                     |       | 348 |   | — |   | — |   | 18,883 |   |
| Minority  interest in preferred stock of subsidiary |       | —                                                     |       | — |   | 4,972 |   | — |   | 4,972 |   |
| Intercompany  charges                               |       | (18,265                                                    | )          | 18,265 |   | — |   | — |   | — |   |
| Equity in  loss of subsidiaries                     |       | 51,013                                                     |       | 218 |   | 65,986 |   | (117,217 | )(3) | — |   |
| Other  expenses, net                                |       | 33                                                         |       | 847 |   | — |   | — |   | 880 |   |
| Provision  for income taxes (benefit)               |       | 9,453                                                      |       | (19,940 | ) | — |   | — |   | (10,487 | ) |
| Loss from  discontinued operations                  |       | —                                                     |       | 5,432 |   | 218 |   | — |   | 5,650 |   |
| Change in  accounting principle                     |       | —                                                     |       | 13,764 |   | — |   | — |   | 13,764 |   |
| Total  operating and other expenses, net            |       | 65,986                                                     |       | 79,213 |   | 71,176 |   | (117,217 | ) | 99,158 |   |
| Net loss                                            |       | $                                                          | (65,986    | ) | $ | (51,013 | ) | $ | (71,176 | ) | $ | 117,217 |   | $ | (70,958 | ) |

 

23

----

 

**Statements of Cash Flows**

 
| ** **                                            | ** ** | **Nine Months Ended September 30,  2004 (Unaudited)** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------------|------------|
| **(In thousands)**                                    | ** ** | **Issuer**                                                 | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
|                                                  |       |                                                       |       |   |   |   |   |   |   |   |   |
| **Cash  flows from operating activities:**            |       |                                                       |       |   |   |   |   |   |   |   |   |
| Net loss                                              |       | $                                                          | (34,531    | ) | $ | (7,113 | ) | $ | (40,301 | ) | $ | 41,644 |   | $ | (40,301 | ) |
| Noncash  adjustments:                                 |       |                                                       |       |   |   |   |   |   |   |   |   |
| Equity in  loss of subsidiaries                       |       | 7,113                                                      |       | — |   | 34,531 |   | (41,644 | )(3) | — |   |
| Other  noncash adjustments                            |       | 14,625                                                     |       | 9,677 |   | 5,770 |   | — |   | 30,072 |   |
| Changes in  working capital                           |       | (12,487                                                    | )          | 1,523 |   | — |   | — |   | (10,964 | ) |
| Net cash  provided by (used for) operating activities |       | (25,280                                                    | )          | 4,087 |   | — |   | — |   | (21,193 | ) |
|                                                  |       |                                                       |       |   |   |   |   |   |   |   |   |
| **Cash  flows from investing activities:**            |       |                                                       |       |   |   |   |   |   |   |   |   |
| Capital  expenditures                                 |       | (1                                                         | )          | (2,739 | ) | — |   | — |   | (2,740 | ) |
| Net cash  used for investing activities               |       | (1                                                         | )          | (2,739 | ) | — |   | — |   | (2,740 | ) |
|                                                  |       |                                                       |       |   |   |   |   |   |   |   |   |
| **Cash  flows from financing activities:**            |       |                                                       |       |   |   |   |   |   |   |   |   |
| Debt  borrowings:                                     |       |                                                       |       |   |   |   |   |   |   |   |   |
| Revolving  line of credit, net                        |       | 17,800                                                     |       | — |   | — |   | — |   | 17,800 |   |
| Short-term  promissory notes                          |       | 5,000                                                      |       | — |   | — |   | — |   | 5,000 |   |
| Debt  repayments:                                     |       |                                                       |       |   |   |   |   |   |   |   |   |
| Other  secured long-term debt                         |       | (7                                                         | )          | (885 | ) | — |   | — |   | (892 | ) |
| Deferred  financing costs                             |       | (2,137                                                     | )          | — |   | — |   | — |   | (2,137 | ) |
| Net cash  provided by (used for) financing activities |       | 20,656                                                     |       | (885 | ) | — |   | — |   | 19,771 |   |
|                                                  |       |                                                       |       |   |   |   |   |   |   |   |   |
| Net increase  (decrease) in cash and equivalents      |       | (4,625                                                     | )          | 463 |   | — |   | — |   | (4,162 | ) |
| Cash and  equivalents at beginning of period          |       | 6,540                                                      |       | 396 |   | — |   | — |   | 6,936 |   |
| Cash and  equivalents at end of period                |       | $                                                          | 1,915      |   | $ | 859 |   | $ | — |   | $ | — |   | $ | 2,774 |   |

 

24

----

 
| ** **                                            | ** ** | **Nine Months Ended September 30,  2003 (Unaudited)** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------------|------------|
| **(In thousands)**                                    | ** ** | **Issuer**                                                 | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
|                                                  |       |                                                       |       |   |   |   |   |   |   |   |   |
| **Cash  flows from operating activities:**            |       |                                                       |       |   |   |   |   |   |   |   |   |
| Net loss                                              |       | $                                                          | (65,986    | ) | $ | (51,013 | ) | $ | (71,176 | ) | $ | 117,217 | (3) | $ | (70,958 | ) |
| Loss from  discontinued operations                    |       | —                                                     |       | 5,432 |   | 218 |   | — |   | 5,650 |   |
| Noncash  adjustments:                                 |       |                                                       |       |   |   |   |   |   |   |   |   |
| Change in  accounting principle                       |       | —                                                     |       | 13,764 |   | — |   | — |   | 13,764 |   |
| Equity in  loss of subsidiaries                       |       | 51,013                                                     |       | 218 |   | 65,986 |   | (117,217 | )(3) | — |   |
| Other  noncash adjustments                            |       | (9,168                                                     | )          | 44,807 |   | 4,972 |   | — |   | 40,611 |   |
| Changes in  working capital                           |       | (5,350                                                     | )          | (11,242 | ) | — |   | — |   | (16,592 | ) |
| Net cash  provided by (used for) operating activities |       | (29,491                                                    | )          | 1,966 |   | — |   | — |   | (27,525 | ) |
|                                                  |       |                                                       |       |   |   |   |   |   |   |   |   |
| **Cash  flows from investing activities:**            |       |                                                       |       |   |   |   |   |   |   |   |   |
| Net proceeds  from sale of Specialty Avionics Group   |       | 132,800                                                    |       | — |   | — |   | — |   | 132,800 |   |
| Capital  expenditures                                 |       | (26                                                        | )          | (3,064 | ) | — |   | — |   | (3,090 | ) |
| Cash paid  for acquisitions                           |       | (600                                                       | )          | — |   | — |   | — |   | (600 | ) |
| Net cash  provided by (used for) investing activities |       | 132,174                                                    |       | (3,064 | ) | — |   | — |   | 129,110 |   |
|                                                  |       |                                                       |       |   |   |   |   |   |   |   |   |
| **Cash  flows from financing activities:**            |       |                                                       |       |   |   |   |   |   |   |   |   |
| Debt  borrowings:                                     |       |                                                       |       |   |   |   |   |   |   |   |   |
| Revolving  line of credit, net                        |       | 17,400                                                     |       | — |   | — |   | — |   | 17,400 |   |
| Debt  repayments:                                     |       |                                                       |       |   |   |   |   |   |   |   |   |
| First-lien  term debt                                 |       | (129,275                                                   | )          | — |   | — |   | — |   | (129,275 | ) |
| Other  secured long-term debt                         |       | (618                                                       | )          | (982 | ) | — |   | — |   | (1,600 | ) |
| Net cash  used for financing activities               |       | (112,493                                                   | )          | (982 | ) | — |   | — |   | (113,475 | ) |
| Net cash  provided by discontinued operations         |       | —                                                     |       | 2,194 |   | — |   | — |   | 2,194 |   |
| Net increase  (decrease) in cash and equivalents      |       | (9,810                                                     | )          | 114 |   | — |   | — |   | (9,696 | ) |
| Cash and  equivalents at beginning of period          |       | 12,343                                                     |       | 78 |   | — |   | — |   | 12,421 |   |
| Cash and  equivalents at end of period                |       | $                                                          | 2,533      |   | $ | 192 |   | $ | — |   | $ | — |   | $ | 2,725 |   |

 

25

----

 

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

 

The following discussions should be read in conjunctionwith our financial statements and accompanying notes included in this report.

 

**Results of Operations**

 

### **PerformanceMeasures**

### ** **

The following discussion of our results of operationsincludes discussions of financial measures and operating statistics that we useto evaluate the performance of, and trends in, our businesses.  We believe the presentation of these measuresand statistics are relevant and useful to investors because it allows them toview performance and trends in a manner similar to the methods we use.  These measures and statistics, and why theyare important to us and could be of interest to you, are described below.

 

**Adjusted EBITDA.**  Our discussionof the results of operations includes discussions of financial measuresdetermined in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”) as well as the financial measure AdjustedEBITDA, which excludes certain charges reflected in our GAAP basis financialstatements.  Our presentation of AdjustedEBITDA is in accordance with the GAAP requirements of SFAS No. 131, “Disclosuresabout Segments of an Enterprise and Related Information,” which requires us toreport the primary measure of segment performance we use to evaluate and manageour businesses.

 

We utilize more than one measurement to evaluatesegment performance and allocate resources among our operating segments;however, we consider Adjusted EBITDA, as defined below, to be the primarymeasurement of overall operating segment core economic performance and returnon invested capital.  We also useAdjusted EBITDA in the annual budgeting and planning for future periods, as oneof the decision-making criteria for funding discretionary capital expenditureand product development programs and as the measure for determining the valueof acquisitions and dispositions.  Ourboard of directors uses Adjusted EBITDA as one of the performance metrics fordetermining the amount of bonuses awarded pursuant to the cash incentive bonusplan and as an indicator of enterprise value used in determining the exerciseprice of stock options granted and the acceleration of stock option vestingpursuant the incentive stock option plan.

 

We define Adjusted EBITDA as earnings, determinedusing program accounting for product development costs, before interest, incometaxes, depreciation and amortization, restructuring, asset impairment and otherrelated charges, acquisition related charges not capitalized and other noncashand nonoperating charges.  We believe 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 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 beconsistent with that of other companies and should be viewed in conjunctionwith measurements that are computed in accordance GAAP, such as net income(loss), the nearest comparable GAAP financial measure.  Adjusted EBITDA should not be viewed assubstitutes for or superior to net income (loss), cash flow from operations orother data prepared in accordance with GAAP as a measure of our profitabilityor liquidity.  The notes to our financialstatements include information about our operating segments, including AdjustedEBITDA, and should be read in conjunction with the discussions presentedherein.  The notes to our financialstatements

 

26

----

 

also include a reconciliation of Adjusted EBITDA tonet income (loss) to clarify the differences between these financial measures.

 

**Bookings and Backlog.** Bookings and backlog are 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 purchaseorders received during the period and backlog represents the total invoicevalue of unfilled purchase orders as of the end of a period.  Orders may be subject to change orcancellation by the customer prior to shipment. The level of unfilled orders at any given date during the year will bematerially affected by the timing of our receipt of orders and the speed withwhich those orders are filled.

 

### **Changes inAccounting Principles**

### ** **

**Adoption of 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 preferredstock was reclassified as a liability and all quarterly dividends are reflectedas a charge against pre-tax income.  Inperiods prior to January 1, 2004, DeCrane Holdings’ 14% preferred stockdividends were deducted in arriving at the net income or loss applicable to 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 ofoperations for the three months and nine months ended September 30, 2003as if SFAS No. 150 had been in effect as of the beginning of 2003.

 
| ** **                       | ** ** | **Three Months Ended  September 30, 2003** | ** ** | **Nine Months Ended  September 30, 2003** | ** ** |
|----------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| **(In millions)**                | ** ** | **As Reported**                                 | ** ** | **Pro Forma**                                  | ** ** | **As Reported** | ** ** | **Pro Forma** | ** ** |
|                             |       |                                            |       |                                           |       |   |   |   |   |
| Loss from  continuing operations |       | $                                               | (6.7       | )                                              | $          | (9.0 | ) | $ | (51.5 | ) | $ | (58.3 | ) |
| Net loss                         |       | (6.7                                            | )          | (9.0                                           | )          | (70.9 | ) | (77.7 | ) |
|                                  |            |                                                 |            |                                                |            |  |  |  |  |  |  |  |  |

 

The pro forma data reflects DeCrane Holdings 14%preferred stock dividends of $2.3 million for the three months ended September 30,2003 and $6.8 million for the nine months ended September 30, 2003 ascharges against income during the periods.

 

**Change in Accounting for Product DevelopmentCosts.**  In addition, and as more fully described in “Note1—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 commencing January 1, 2003.

 

This change in accounting policy was made afterconcluding the 2003 fiscal year but was applied retroactively to the beginningof the year, January 1, 2003, as required by generally accepted accountingprinciples.  As a result of the change,program-related product development costs are now classified as a component ofresearch and development expenses in the consolidated financial statementsrather than classified as a component of inventory cost.  We have restated the results of operations bycharging

 

27

----

 

previously inventoried costs totaling $2.2 million and$7.1 million for the three months and nine months ended September 30,2003, respectively, to research and development expense and recording a $13.8million charge as of January 1, 2003 to reflect the cumulative effect ofthe change in accounting principle.

 

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

### ** **

Our results of operations for 2003 and 2004 have beenaffected by restructuring, impairment and other related charges pertaining to aseries of restructuring activities. These charges, which affect the comparability of our reported results ofoperations between periods, are more fully described in “—Restructuring, AssetImpairment and Other Related Charges” below.

 

### **Three Months En**ded September 30, 2004 Compared toThree Months Ended September 30, 2003

### ** **

**Revenues.* ***Revenues increased $6.3 million, or14.4%, to $50.6 million for the three months ended September 30, 2004 from$44.3 million for the three months ended September 30, 2003.  By segment, revenues changed as follows:

 
| ** **                           | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|
| **(In millions)**                    | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
|                                 |       |                               |       |   |   |
| Cabin Management                     |       | $                                  | 9.7        |   | 33.0 | % |
| Systems  Integration                 |       | (1.6                               | )          | (11.5 | ) |
| Increase in  inter-group elimination |       | (1.8                               | )          |   |   |
| Total                                |       | $                                  | 6.3        |   |   |   |

 

*Cabin Management. *Revenues increased by $9.7 million, or 33% compared tothe prior year, due to a higher volume of business, VIP and head-of-state jetproduction by aircraft manufacturers. The increase consisted of the following:

 

•                  an $8.5 million increase in aircraft furniture and related productsrevenues;

 

•                  a $1.1 million increase in cabin management and entertainment systemsrevenues; and

 

•                  a $1.2 million increase in seating products revenues; offset by

 

•                  a $1.1 million decrease in other product and services revenues.

 

*Systems Integration.* Revenues decreased by $1.6 million, or 11.5% compared to the prior year,due to:

 

•                  a $4.9 million decrease resulting from lower production of auxiliaryfuel systems pursuant to our supply contract with Boeing Business Jet (“BBJ”);and

 

•                  a $1.5 million decrease in service center revenues; offset by

 

•                  a $4.5 million increase in completion revenues; and

 

•                  a $0.3 million increase in revenues from integration kits and relatedservices for commercial aircraft.

 

BBJ has exercised itsoption to convert the supply contract to a “requirements” contract, from aguaranteed “take-or-pay” contract, commencing January 1, 2005.  Production under the “take-or-pay” portion ofthe contract for 2004 was completed during the second quarter of fiscal 2004and no new orders have been placed pursuant to the new “requirements”contract.  Based upon the number ofauxiliary fuel systems BBJ has in its inventory, we believe we may not receiveany orders for additional systems until fiscal 2005.  During the three months ended September 30,2004, auxiliary fuel systems revenues were $0.8 million compared to $5.7 millionfor the same period last year.

 

28

----

 

**Gross profit.** Gross profit increased $3.2 million, or 32.9%, to $13.0 million for thethree months ended September 30, 2004 from $9.8 million for the sameperiod in the prior year.  By segment,gross profit changed as follows:

 
| ** **           | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|----------------------|------------|------------------------------------|------------|
| **(In millions)**    | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
| Cabin  Management    |       | $                                  | 4.5        |   | 88.9 | % |
| Systems  Integration |       | (1.3                               | )          | (26.4 | ) |
| Total                |       | $                                  | 3.2        |   |   |   |

 

*Cabin Management.* Gross profit increased by $4.5 million, or 88.9% compared to the prioryear, primarily due to:

 

•                  a $4.8 million increase related to higher volume for our aircraftfurniture and related products;

 

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

 

•                  a $0.4 million increase in gross profit related to our other products;offset by

 

•                  $1.4 million of program start-up costs related to the interior of acustomer’s recently introduced new model aircraft, a portion of which arenonrecurring; and

 

•                  a $0.1 million increase in restructuring charges incurred in 2004compared to those incurred during the same period in 2003 related to ourfurniture and seating operations.

 

*Systems Integration.* Gross profit decreased by $1.3 million, or 26.4% compared to the prioryear, primarily due to:

 

•                  a $1.6 million decrease resulting from lower revenues from auxiliaryfuel systems and a change in product delivery mix to lower margin products; and

 

•                  $0.1 million of restructuring charges incurred in 2004 related to thereorganization of our manufacturing operations; offset by

 

•                  a $0.4 million increase resulting from the increase in revenuecommercial aircraft integration kits and a change in delivery mix to highermargin products.

 

**Selling, general and administrativeexpenses.**  Selling, general and administrative expensesincreased $3.0 million, or 63.2%, to $7.8 million for the three months ended September 30,2004, from $4.8 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    |       | $                                  | 1.6        |   | 71.6 | % |
| Systems  Integration |       | 0.6                                |       | 49.3 |   |
| Corporate            |       | 0.8                                |       |   |   |
| Total                |       | $                                  | 3.0        |   |   |   |

 

*Cabin Management. *SG&A expenses increased by $1.6 million, or 71.6%compared to the prior year, primarily due to:

 

•                  a $1.4 million increase attributable to a change in corporateallocations for insurance and incentive compensation; and

 

•                  $0.2 million of program start-up costs related to the interior of acustomer’s recently introduced new model aircraft, a portion of which arenonrecurring.

 

29

----

 

*Systems Integration. *SG&A expenses increased by $0.6 million, or 49.3%compared to the prior year, primarily as a result of higher sales and marketingactivities associated with the aircraft completion portion of our business andto changes in corporate allocations for insurance and incentive compensation.

 

*Corporate. *SG&A expenses increased by $0.8 million comparedto the prior year due principally to higher costs pursuant to the incentivecompensation plan and $0.2 million of restructuring charges incurred in 2004related to the reorganization of our manufacturing operations.

 

**Research and developmentexpenses. **Research anddevelopment expenses decreased $0.5 million, or 24.0%, to $1.7 million for thethree months ended September 30, 2004 compared to $2.2 million in theprior year.  By segment, research and development expenses changedas follows:

 
| ** **           | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|----------------------|------------|------------------------------------|------------|
| **(In millions)**    | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
| Cabin  Management    |       | $                                  | (0.8       | ) | (51.6 | )% |
| Systems  Integration |       | 0.3                                |       | 42.9 |   |
| Total                |       | $                                  | (0.5       | ) |   |   |

 

*Cabin Management. *R&Dexpenses decreased $0.8 million, or 51.6% compared to the prior year.  The decrease is primarily related to the nearcompleted development of our new single-design seat technology and design ofnew interior furnishing components for a major customer’s recently introducednew model aircraft.

 

*Systems Integration. *R&D expenses increased $0.3 million, or 42.9%compared to the prior year.  The increaseis principally due to the ongoing development of our cockpit door videosurveillance system for different models of commercial aircraft and a designmodification to an existing product.

 

**Depreciation and amortization ofintangibles.**  Depreciation and amortization expensedecreased $0.2 million to $2.2 million for the three months ended September 30,2004 from $2.4 million for the same period in the prior year.  The decline is attributable to reducedcapital expenditures and a lower depreciable base resulting from restructuringcharges.  Depreciation and amortizationchanged as follows:

 
| ** **                                   | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|----------------------------------------------|------------|------------------------------------|------------|
| **(In millions)**                            | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
| Depreciation  charged to:                    |       |                               |       |   |   |
| Cost of  sales                               |       | $                                  | (0.1       | ) | (3.1 | )% |
| Selling,  general and administrative expense |       | (0.1                               | )          | (20.0 | ) |
| Amortization  of intangible assets           |       | 0.0                                |       |   |   |
| Total                                        |       | $                                  | (0.2       | ) |   |   |

 

**Adjusted EBITDA. **We define Adjusted EBITDA as earnings, determinedusing program accounting for product development costs, before interest, incometaxes, depreciation and amortization, restructuring, asset impairment and otherrelated charges, acquisition related charges not capitalized and other noncashand nonoperating charges.  As described above in “—PerformanceMeasures—Adjusted EBITDA,” we use this financial measure to evaluate the coreeconomic performance of our operating segments. The notes to our financial statements include additional informationabout Adjusted EBITDA, and should be read in conjunction with the discussionspresented herein.  The notes to ourfinancial statements also include a reconciliation of Adjusted EBITDA to netincome (loss), a GAAP financial measure, to clarify the differences betweenthese two measures.

 

30

----

 

*Cabin Management. *Adjusted EBITDA increased by $3.8 million, or 96.3%,to $7.7 million for the three months ended September 30, 2004 compared to$3.9 million for the same period in the prior year.  Adjusted EBITDA as a percent of revenuesimproved to 19.5 % for the three months ended September 30, 2004 comparedto 13.2% for the same period last year. The $3.8 million increase is comprised of:

 

•                  a $2.5 million increase from improved margins which result, in part,from fixed costs being absorbed over a higher revenue base; and

 

•                  a $1.3 million increase resulting from a 33.0% revenue increase.

 

Our furniture and seating operations contributed $3.5million of the increase and our cabin management and entertainment systemscontributed $0.3 million of the increase.

 

*Systems Integration. *Adjusted EBITDA decreased by $1.9 million, or 51.8%,to $1.8 million for the three months ended September 30, 2004 compared to$3.7 million for the same period in the prior year.  AdjustedEBITDA as a percent of revenues declined to 14.6 % for the three months ended September 30,2004 compare to 26.8% for the same period last year.  The $1.9 million decrease is comprised of:

 

•                  a $1.5 million decrease resulting from the change in margin betweenperiods; and

 

•                  a $0.4 million decrease resulting from an 11.5% revenue decrease.

 

The decline in margin is attributable to a change inproduct delivery mix, principally resulting from auxiliary fuel systemsrevenues being replaced with revenues from lower margin products andservices.  A $2.0 million decline inauxiliary fuel tank, service center and aircraft completion margins waspartially offset by a $0.1 million increase in the margins for integration kitsand related services for commercial aircraft.

 

**Operatingincome.** Operating income increased $0.7 million, or 39.0%, to $2.6 million forthe three months ended September 30, 2004, from $1.9 million for the sameperiod in the prior year.  By segment,the operating loss changed as follows:

 
| ** **           | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|----------------------|------------|------------------------------------|------------|
| **(In millions)**    | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
| Cabin  Management    |       | $                                  | 3.7        |   | 474.1 | % |
| Systems  Integration |       | (2.2                               | )          | (88.8 | ) |
| Corporate            |       | (0.8                               | )          |   |   |
| Total                |       | $                                  | 0.7        |   |   |   |

 

*Cabin Management. *Operating income increased by $3.7million, or 474.1% compared to the prior year, due to:

 

•                  a $4.8 million increase in gross profit, primarily due to lowerrevenues related to our furniture and seating operations;

 

•                  a $0.8 million increase in gross profit related to higher volume forour cabin management and entertainment systems;

 

•                  a $0.8 million decrease in research and development expenses; and

 

•                  a $0.4 million increase in gross profit related to other products;offset by

 

•                  $1.6 million of program start-up costs incurred in 2004, a portion ofwhich are nonrecurring;

 

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

 

•                  a $0.1 million increase in restructuring charges incurred in 2004.

 

31

----

 

*Systems Integration. *Operating income decreased by $2.2 million, or 88.8%compared to the prior year, due to:

 

•                    a $1.3 million decrease resulting fromreduced gross profit on lower revenues;

 

•                    a $0.6 million increase in SG&Aspending; and

 

•                    a $0.3 million increase in research anddevelopment expenses.

 

**Interest expense.** Interest expense increased $3.1 million, or 46.0%, to $9.6 million forthe three months ended September 30, 2004 compared to $6.5 million for thesame period in the prior year.  Theincrease is attributable to:

 

•                    a $3.1 million increase attributable to$80.0 million of second-lien term debt issued in December 2003;

 

•                    a $0.6 million net increase in interestexpense resulting from the exchange of $65.0 million of 12% senior subordinatednotes for 17% senior discount notes; and

 

•                    a $0.2 million increase in other interestexpense; offset by

 

•                    a $0.8 million decrease in our first-lieninterest expense due to lower principal balances outstanding resulting from therepayment with the proceeds from our second-lien debt financing in December 2003,offset, in part, by a 1.5% increase in interest rate margins charged by ourlenders based on our consolidated debt leverage ratio.

 

**Mandatorily redeemable preferred stockdividends. **Mandatorily redeemable preferred stockdividends increased $0.5 million to $1.2 million for the three months ended September 30,2004 from $1.7 million for the same period in the prior year as follows:

 
| ** **                            | ** ** | **Three Months Ended  September 30,** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|
| **(In millions)**                     | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| DeCrane  Holdings 14% preferred stock |       | $                                          | 0.7        |   | $ | — |   |
| DeCrane  Aircraft 16% preferred stock |       | 0.5                                        |       | 1.7 |   |
| Total  dividends                      |       | $                                          | 1.2        |   | $ | 1.7 |   |

 

As more fully described in “—Changes in AccountingPrinciples” above, effective January 1, 2004 we adopted SFAS No. 150, “Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity.”  As a result of adopting SFASNo. 150, the 14% quarterly preferred stock dividends are reflected as a chargeagainst pre-tax income.  In periods priorto January 1, 2004, the 14% preferred stock dividends were deducted in arrivingat the net income or loss applicable to DeCrane Holdings’ common stockholdersand amounted to $2.3 million for the three months ended September 30,2003; DeCrane Aircraft’s 16% preferred stock dividends totaled $1.6 million andwere charged against pre-tax income as minority interest in preferred stock ofsubsidiary.  The decrease in dividendsbetween the periods is a result of amendments to the terms of both classes ofpreferred stock.

 

During the third quarter of fiscal 2004, the terms ofthe 16% and 14% preferred stock were amended to provide that further preferredstock dividends, if any, accrue at rates dependent on a specified financialratio or if certain triggering events occur. Future preferred stock dividends, if any, are dependent, in part, upon adefined leverage ratio achieved as of each quarterly testing date.  Depending on the ratio achieved, and providedcertain triggering events have not occurred, dividends for the succeedingquarter accrue at a 0%, 4% or 16% annual rate on the 16% preferred stock and0%, 3.5% or 14% on the 14% preferred stock. If certain triggering events occur, dividends accrue at the 16% and 14%annual rates.  Based upon the leverageratio achieved as of September 30, 2004, no dividends will accrue oneither the 16% or 14% preferred stock from the amendment date through December 31,2004.  See “—Liquidity and Capital Resources—Debt and Preferred Stock Restructuring” for additional information.

 

32

----

 

**Loss on debt and preferred stockrestructuring. **The loss ondebt and preferred stock restructuring of $3.9 million for the three monthsended September 30, 2004 reflects the write-off of deferred financingcosts attributable to the $65.0 million of 12% senior subordinated notesexchanged for 17% senior discount notes and the write-off of the remainingunamortized original issuance discount related to our 16% preferred stock.  See “—Liquidity and Capital Resources—Debt and Preferred Stock Restructuring” foradditional information.

 

**Provision for income taxes.** The provision for income taxes is comprised of the following:

 
| ** **                                           | ** ** | **Three Months Ended  September 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------|------------|
| **(In millions)**                                    | ** ** | **2004**                                   | ** ** | **2003** | ** ** |
| Income tax  (benefit) based on reported pre-tax loss |       | $                                          | (5.5       | ) | $ | (1.2 | ) |
| Net deferred  tax asset valuation allowance          |       | 5.5                                        |       | 1.3 |   |
| Net  prevision for income taxes                      |       | $                                          | —     |   | $ | 0.1 |   |

 

For the three months ended September 30, 2003,the provision for income taxes, based on the reported consolidated pre-taxloss, differs from the amount determined by applying the applicable U.S.statutory federal rate to the pre-tax loss primarily due to the effects ofstate and foreign income taxes and non-deductible expenses, principally thenon-deductible portion of goodwill impairment charges and DeCrane Aircraft’s16% preferred stock dividends.

 

For the three months ended September 30, 2004,the provision for income taxes, based on the reported consolidated pre-taxloss, differs from the amount determined by applying the applicable U.S.statutory federal rate to the pre-tax loss primarily due to the effects ofstate and foreign income taxes and non-deductible expenses, principallymandatorily redeemable preferred stock dividends due to the adoption of SFASNo. 150 effective January 1, 2004, as described above.

 

As more fully described in Note 11 to the auditedfinancial statements included in our 2003 Form 10-K, there were net deferredtax asset of $19.5 million fully offset by a valuation allowance of the sameamount as of December 31, 2003. Based upon the results of operations for the nine months ended September 30,2004, we determined that an additional $14.4 million valuation allowance wasrequired as of that date, $5.5 million of which is applicable to thethree-month period.

 

**Loss from continuing operations and net loss.** The loss from continuing operations and net loss increased $5.5 millionto a loss of $12.2 million for the three months ended September 30, 2004compared to a loss of $6.7 million for the same period in the prior year,primarily due to:

 

•                  a $3.9 million loss on our debt and preferred stock restructuring; and

 

•                    a $3.0 million increase in interest andother expenses (net); offset by

 

•                    a $0.7 million increase in operatingincome;

 

•                    a $0.6 million decrease in preferredstock dividends, principally resulting from the restructuring of our preferredstock; and

 

•                    a $0.1 million decrease in income taxexpense.

 

33

----

 

**Net loss applicable to commonstockholders.**  Net loss applicable to our commonstockholders increased $3.2 million to a net loss of $12.2 million for thethree months ended September 30, 2004 compared to a net loss of $9.0million for the same period in the prior year. The increase in the net loss applicable to our common stockholder isattributable to:

 

•                  a $5.5 million increase in our net loss; offset by

 

•                    a $2.3 million decrease in preferredstock dividends resulting from the January 1, 2004 adoption of SFAS No.150 which requires preferred stock dividends be deducted from the net income orloss for the period.

 

**Bookings and Backlog. **Bookings increased $27.1 million, or 77.6%, to $61.9million for the three months ended September 30, 2004 compared to $34.8million for the same period in the prior year. Backlog increased $25.6 million to $83.6 million as of September 30,2004 compared to $58.0 million as of December 31, 2003.  By segment, bookings and backlog changed asfollows:

 
| ** **           | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|----------------------|------------|------------------------------------|------------|
| **(In millions)**    | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
| Bookings:            |       |                               |       |   |   |
| Cabin  Management    |       | $                                  | 12.4       |   | 42.1 | % |
| Systems  Integration |       | 14.7                               |       | 267.6 |   |
| Total                |       | $                                  | 27.1       |   |   |   |
|                 |       |                               |       |   |   |
| Backlog:             |       |                               |       |   |   |
| Cabin  Management    |       | $                                  | 16.0       |   | 47.4 | % |
| Systems  Integration |       | 9.6                                |       | 39.6 |   |
| Total                |       | $                                  | 25.6       |   |   |   |

 

Cabin Management’s bookings and backlog increase is aresult of the increase in our customers’ aircraft production schedules duringthe period.  Systems Integration’sbookings and backlog increase is a result of booking an order for an aircraftcompletion during the quarter as well as an increase in orders for our cockpitdoor video surveillance system.

 

### **Nine month**s ended September 30, 2004 Comparedto Nine months ended September 30, 2003

### ** **

**Revenues.* ***Revenues increased $23.8 million, or18.2%, to $154.1 million for the nine months ended September 30, 2004 from$130.3 million for the nine months ended September 30, 2003.  By segment, revenues changed as follows:

 
| ** **                           | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|--------------------------------------|------------|------------------------------------|------------|
| **(In millions)**                    | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
| Cabin  Management                    |       | $                                  | 24.8       |   | 27.6 | % |
| Systems  Integration                 |       | 1.5                                |       | 3.6 |   |
| Increase in  inter-group elimination |       | (2.5                               | )          |   |   |
| Total                                |       | $                                  | 23.8       |   |   |   |

 

34

----

 

 

*Cabin Management. *Revenues increased by $24.8 million, or27.6% compared to the prior year due to a higher volume of business, VIP andhead-of-state jet production by aircraft manufacturers.  The increase consisted of the following:

 

•      a $20.3 million increase inaircraft furniture and related products revenues;

 

•      a $3.4 million increase incabin management and entertainment systems revenues; and

 

•      a $3.0 million increase inseating products revenues; offset by

 

•      a $1.9 million decrease inother product and services revenues.

* *

*Systems Integration.*  Revenuesincreased by $1.5 million, or 3.6% compared to the prior year, due to:

 

•      a $6.2 million increase incompletion and service center revenues; and

 

•      a $2.3 million increase inrevenues from integration kits and related services for commercial aircraft;offset by

 

•                  a $7.0 million decrease resulting fromlower production of auxiliary fuel systems pursuant to our supply contract withBBJ.

 

BBJ has exercised its option to convert the supplycontract to a “requirements” contract, from a guaranteed “take-or-pay”contract, commencing January 1, 2005. Production under the “take-or-pay” portion of the contract for 2004 iscomplete and no new orders have been placed pursuant to the new “requirements”contract.  Based upon the number ofauxiliary fuel systems BBJ has in its inventory, we believe we may not receiveany orders for additional systems until fiscal 2005.  During the nine months ended September 30,2004, auxiliary fuel systems revenues were $12.7 million compared to $19.7million for the same period last year. During the year ended December 31, 2003, BBJ auxiliary fuel systemsprovided approximately $26.4 million, or 15.5%, of our consolidated revenues.

** **

**Gross profit.**  Gross profitincreased $4.1 million, or 14.4%, to $32.3 million for the nine months endedSeptember 30, 2004 from $28.2 million for the same period in the prioryear.  By segment, gross profit changedas follows:

 
| ** **          | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|---------------------|------------|------------------------------------|------------|
| **(In  millions)**  | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
|                |       |                               |       |   |   |
| Cabin Management    |       | $                                  | 12.3       |   | 96.6 | % |
| Systems Integration |       | (8.2                               | )          | (53.4 | ) |
| Total               |       | $                                  | 4.1        |   |   |   |

* *

*Cabin Management.*  Gross profitincreased by $12.3 million, or 96.6% compared to the prior year, primarily dueto:

 

•                  a $5.7 million increase related to highervolume in aircraft furniture and related products revenues;

 

•                  a $5.7 million decrease in restructuringcharges incurred in 2004 compared to those incurred during the same period in2003 related to our furniture and seating operations;

 

•                  a $2.2 million increase in gross profitrelated to higher volume for our cabin management and entertainment systems;and

 

•                  a $0.1 million increase in gross profitrelated to other products; offset by

 

•                  $1.4 million of program start-up costsrelated to the interior of a customer’s recently introduced new model aircraft,a portion of which are nonrecurring.

 

35

----

 

*Systems Integration.*  Gross profitdecreased by $8.2 million, or 53.4% compared to the prior year, primarily dueto:

 

•                  $5.3 million of restructuring chargesincurred in 2004 related to the reorganization of our manufacturing operations;

 

•                  a $3.6 million decrease resulting fromreduced auxiliary fuel system revenues; and

 

•                  a $0.3 million decrease resulting fromthe change in product delivery mix; offset by

 

•                  a $1.0 million increase resulting fromthe increase in revenues from integration kits and related services forcommercial aircraft.

** **

**Selling, general and administrative expenses.** Selling, general and administrative expenses increased $1.1 million, or5.3%, to $22.8 million for the nine months ended September 30, 2004, from $21.7million for the same period in the prior year. By segment, SG&A expenses changed as follows:

 
| ** **          | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|---------------------|------------|------------------------------------|------------|
| **(In  millions)**  | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
| *** ***        | ** ** | ** **                         | ** ** | ** ** | ** ** |
| Cabin Management    |       | $                                  | 1.9        |   | 18.4 | % |
| Systems Integration |       | (0.1                               | )          | (2.4 | ) |
| Corporate           |       | (0.7                               | )          |   |   |
| Total               |       | $                                  | 1.1        |   |   |   |

 

*Cabin Management. *SG&A expenses increased by $1.9million, or 18.4% compared to the prior year due to:

 

•                  a $1.1 million increase in SG&Aspending in support of higher production levels and new programs;

 

•                  a $0.3 million increase in restructuringcharges incurred in 2004 versus the same period last year;

 

•                  a $0.3 million increase attributable to achange in corporate allocations for insurance and incentive compensation; and

 

•                  $0.2 million in program start-up costsrelated to the interior of a customer’s recently introduced new model aircraft,a portion of which are nonrecurring.

* *

*Systems Integration. *SG&A expenses decreased by $0.1million, or 2.4% compared to the prior year, due to lower labor and employeebenefit costs resulting from workforce reductions as well as other costreduction efforts offset by an increase in sales and marketing activitiesassociated with the aircraft completion portion of our business and a $0.1million increase in the corporate allocations for insurance.

 

*Corporate. *SG&A expenses decreased by $0.7million compared to the prior year due to:

 

•                  a $0.5 million decrease resulting from costreduction measures;

 

•                  a $0.4 million decrease in insuranceexpense resulting from higher allocations to the operating groups; offset by

 

•                  $0.2 million of 2004 restructuringcharges.

 

36

----

 

**Research and development expenses. **Research and developmentexpenses decreased $1.2 million, or 17.0%, to $5.9 million for the nine monthsended September 30, 2004 compared to $7.1 million in the prior year.  By segment, research and development expenses changedas follows:

 
| ** **          | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|---------------------|------------|------------------------------------|------------|
| **(In  millions)**  | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
|                |       |                               |       |   |   |
| Cabin Management    |       | $                                  | (2.4       | ) | 39.9 | % |
| Systems Integration |       | 1.2                                |       | 122.9 |   |
| Total               |       | $                                  | (1.2       | ) |   |   |

* *

*Cabin**Management. *R&D expenses decreased $2.4 million,or 39.9% compared to the prior year.  Thedecrease is primarily related to the near completed development of our newsingle-design seat technology and the design and engineering of new interiorfurnishing components for a major customer’s recently introduced new modelaircraft.

* *

*SystemsIntegration. *R&D expenses increased $1.2 million,or 122.9% compared to the prior year. The increase is principally due to the ongoing development of ourcockpit door video surveillance system for different models of commercialaircraft and a design modification to an existing product.

** **

**Depreciation and amortization of intangibles.** Depreciation and amortization expense decreased $0.6 million to $6.8million for the nine months ended September 30, 2004 from $7.4 million for thesame period in the prior year.  Thedecline is attributable to reduced capital expenditures and a lower depreciablebase resulting from restructuring charges. Depreciation and amortization changed as follows:

 
| ** **                                  | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|---------------------------------------------|------------|------------------------------------|------------|
| **(In  millions)**                          | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
|                                        |       |                               |       |   |   |
| Depreciation charged to:                    |       |                               |       |   |   |
| Cost of sales                               |       | $                                  | (0.3       | ) | (5.6 | )% |
| Selling, general and administrative expense |       | (0.3                               | )          | (20.5 | ) |
| Amortization of intangible assets           |       | 0.0                                |       |   |   |
| Total                                       |       | $                                  | (0.6       | ) |   |   |

 

**Adjusted EBITDA. **We define Adjusted EBITDA as earnings,determined using program accounting for product development costs, beforeinterest, income taxes, depreciation and amortization, restructuring, assetimpairment and other related charges, acquisition related charges notcapitalized and other noncash and nonoperating charges.  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 GAAP financialmeasure, to clarify the differences between these two measures.

* *

*CabinManagement. *Adjusted EBITDA increased by $4.5 million, or 35.5%, to $17.3 million for thenine months ended September 30, 2004 compared to $12.8 million for the sameperiod in the prior year.  AdjustedEBITDA as a percent of revenues improved to 15.1 % for the nine months endedSeptember 30, 2004 compared to 14.2% for the same period last year.  The $4.5 million increase is comprised of:

 

**•**                  a$3.5 million increase resulting from a 27.6% revenue increase; and

 

•                  a $1.0 million increase from improvedmargins which result, in part, from fixed costs being absorbed over a higherrevenue base.

 

37

----

 

Ourfurniture and seating operations contributed $3.3 million of the increase andour cabin management and entertainment systems contributed $1.2 million of theincrease.

* *

*Systems**Integration. *Adjusted EBITDA decreased by $2.8 million, or 28.1%,to $7.2 million for the nine months ended September 30, 2004 compared to $10.0million for the same period in the prior year. Adjusted EBITDA as a percent ofrevenues declined to 17.1 % for the nine months ended September 30, 2004compare to 24.7% for the same period last year. The $2.8 million decrease is comprised of:

 

•                  a $3.2 million decrease resulting fromthe change in margin between periods; offset by

 

•                  a $0.4 million increase resulting from a3.6% revenue increase.

 

The declinein margin is attributable to a change in product delivery mix, principallyresulting from auxiliary fuel systems revenues being replaced with revenuesfrom lower margin products and services. A $3.7 million decline in auxiliary fuel tank, service center andaircraft completion margins was partially offset by a $0.9 million increase inthe margins for integration kits and related services for commercial aircraft.

** **

**Impairment ofgoodwill. **During the nine months ended September 30,2003, a $34.0 million charge was recorded to reflect the impairment of goodwillin connection with the impairment testing provision of SFAS No. 142, “Goodwilland Other Intangible Assets.”  See “—Restructuring,Asset Impairment and Other Related Charges.”

** **

**Operating income(loss).** Operating income increased $38.1 million, or 102.2%, to income of $0.8million for the nine months ended September 30, 2004, compared to a loss of$37.3 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    |       | $                                  | 46.8       |   | 119.3 | % |
| Systems Integration |       | (9.3                               | )          | (131.6 | ) |
| Corporate           |       | 0.6                                |       |   |   |
| Total               |       | $                                  | 38.1       |   |   |   |

* *

*Cabin Management. *The operating income increased by $46.8million, or 119.3% compared to the prior year, primarily due to:

 

•                  a $34.0 million decrease in impairmentcharges;

 

•                  a $5.7 million increase in gross profit,primarily due to lower revenues related to our furniture and seatingoperations;

 

•                  a $5.4 million decrease in restructuringcharges incurred in 2004 as compared to 2003;

 

•                  a $2.4 million decrease in research anddevelopment expenses; and

 

•                  a $2.2 million increase in gross profitrelated to higher volume for our cabin management and entertainment systems;offset by

 

•                  $1.6 million in program start-up costsrelated to the interior of a customer’s recently introduced new model aircraft,a portion of which are nonrecurring; and

 

•                  a $1.6 million increase in SG&Aspending.

 

38

----

 

*Systems Integration. *The operating income decreased by $9.3million, or 131.6% compared to the prior year, due to:

 

•                  $5.4 million of restructuring chargesincurred in 2004;

 

•                  a $4.3 million decrease resulting fromreduced gross profit; and

 

•                  a $1.2 million increase in research anddevelopment expenses; offset by

 

•                  a net $1.5 million increase resultingfrom the conversion of a major customer supply contract to a requirements-onlycontract;

 

•                  a $0.1 million decrease in SG&Aspending.

** **

**Interest expense.**  Interestexpense increased $8.1 million, or 43.0%, to $27.0 million for the nine monthsended September 30, 2004 compared to $18.9 million for the same period in theprior year.  The increase is attributableto:

 

•                  a $9.0 million increase attributable to$80.0 million of second-lien term debt issued in December 2003;

 

•                  a $0.6 million net increase in interestexpense resulting from the exchange of $65.0 million of 12% senior subordinatednotes for 17% senior discount notes; and

 

•                  a $0.5 million increase in other interestexpense; offset by

 

•                  a $2.0 million decrease in our first-lieninterest expense due to lower principal balances outstanding resulting from therepayment with the proceeds from our second-lien debt financing in December2003, offset, in part, by a 1.5% increase in interest rate margins charged byour lenders based on our consolidated debt leverage ratio.

** **

**Mandatorily****redeemable preferred stock dividends. **Mandatorilyredeemable preferred stock dividends increased $4.8 million to $9.8 million forthe nine months ended September 30, 2004 from $5.0 million for the same periodin the prior year as follows:

 
| ** **                           | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------|------------|--------------------------------------|------------|
| **(In millions)**                    | ** ** | **2004**                             | ** ** | **2003** | ** ** |
|                                 |       |                                 |       |   |   |
| DeCrane Holdings 14% preferred stock |       | $                                    | 5.8        |   | $ | — |   |
| DeCrane Aircraft 16% preferred stock |       | 4.0                                  |       | 5.0 |   |
| Net income tax benefit               |       | $                                    | 9.8        |   | $ | 5.0 |   |

 

Asmore fully described in “—Changes in Accounting Principles” above, effectiveJanuary 1, 2004 we adopted SFAS No. 150, “Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity.”  As a result of adopting SFAS No. 150, the 14%quarterly preferred 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 $6.8 million for the nine months ended September 30, 2003; DeCrane Aircraft’s16% preferred stock dividends totaled $5.0 million and were charged againstpre-tax income as minority interest in preferred stock of subsidiary.  The decrease in dividends between the periodsis a result of amendments to the terms of both classes of preferred stock.

 

Duringthe third quarter of fiscal 2004, the terms of the 16% and 14% preferred stockwere amended to provide that further preferred stock dividends, if any, accrueat rates dependent on a specified financial ratio or if certain triggeringevents occur.  Future preferred stockdividends, if any, are dependent, in part, upon a defined leverage ratioachieved as of each quarterly testing date. Depending on the ratio achieved, and provided certain triggering eventshave not occurred, dividends for the succeeding quarter accrue at a 0%, 4% or16% annual rate on the 16% preferred stock and 0%, 3.5% or 14% on the

 

39

----

 

14% preferred stock.  If certain triggering events occur, dividendsaccrue at the 16% and 14% annual rates. Based upon the leverage ratio achieved as of September 30, 2004, no dividendswill accrue on either the 16% or 14% preferred stock from the amendment datethrough December 31, 2004.  See “—Liquidity and Capital Resources–Debt and Preferred Stock Restructuring” foradditional information.

** **

**Loss on debt and preferred stock restructuring. **The loss on debt andpreferred stock restructuring of $3.9 million for the nine months endedSeptember 30, 2004 reflects the write-off of deferred financing costsattributable to the $65.0 million of 12% senior subordinated notes exchangedfor 17% senior discount notes and the write-off of the remaining unamortizedoriginal issuance discount related to our 16% preferred stock.  See “—Liquidity and Capital Resources–Debt and Preferred Stock Restructuring” foradditional information.

** **

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

** **
| ** **                                           | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------|------------|
| **(In millions)**                                    | ** ** | **2004**                             | ** ** | **2003** | ** ** |
|                                                 |       |                                 |       |   |   |
| Income tax (benefit) based on reported  pre-tax loss |       | $                                    | (12.7      | ) | $ | (24.8 | ) |
| Net deferred tax asset valuation allowance           |       | 12.8                                 |       | 14.4 |   |
| Net provision for income tax (benefit)               |       | $                                    | 0.1        |   | $ | (10.4 | ) |

 

For the nine months ended September 30, 2003, theprovision for income taxes, based on the reported consolidated pre-tax loss,differs from the amount determined by applying the applicable U.S. statutoryfederal rate to the pre-tax loss primarily due to the effects of state andforeign income taxes and non-deductible expenses, principally thenon-deductible portion of goodwill impairment charges and DeCrane Aircraft’s16% preferred stock dividends.

 

Forthe nine months ended September 30, 2004, the provision for income taxes, basedon the reported consolidated pre-tax loss, differs from the amount determinedby applying 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, 2004, asdescribed above.

 

Asmore fully described in Note 11 to the audited financial statements included inthe Company’s 2003 Form 10-K, there were net deferred tax asset of $19.5million fully offset by a valuation allowance of the same amount as of December31, 2003.  Based upon the results ofoperations for the nine months ended September 30, 2004, we determined that anadditional $14.4 million valuation allowance was required as of that date.

** **

**Loss fromcontinuing operations.**  The loss from continuingoperations decreased $11.2 million to a loss of $40.3 million for the ninemonths ended September 30, 2004 compared to a loss of $51.5 million for thesame period in the prior year, primarily due to:

 

•                  a $38.1 million operating incomeincrease; offset by

 

•                  a $10.6 million decrease in income taxbenefit;

 

•                  a $7.6 million increase in interest andother expenses (net);

 

•                  a $4.8 million increase in preferredstock dividends, principally resulting from the adoption of SFAS No. 150, “Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity” as described above; and

 

•                  a $3.9 million loss on our debt andpreferred stock restructuring.

 

40

----

 

**Loss fromdiscontinued operations. **The loss from discontinued operations was$5.6 million for the nine months ended September 30, 2003 and reflects theresults of operations of our Specialty Avionics Group for the period fromJanuary 1, 2003 through May 22, 2003, the date on which it was sold.

** **

**Cumulativeeffect of change in accounting principle.**  As more fullydescribed in “—Changes in Accounting Principles” above, the $13.8 millioncharge in 2003 was to reflect the cumulative effect of the change in accountingfor product development costs as of January 1, 2003.

** **

**Net****loss.** Net loss decreased $30.6 million to a net loss of $40.3 million for thenine months ended September 30, 2004 compared to a net loss of $70.9 millionfor the same period in the prior year. The decrease is attributable to:

 

•                  a decrease in loss from continuingoperations of $11.2 million;

 

•                  a net decrease in cumulative effect ofchange in accounting principles of $13.8 million; and

 

•                  a decrease in the loss from discontinuedoperations of $5.6 million.

** **

**Net****loss applicable tocommon stockholders.**  Net loss applicable to our commonstockholders decreased $37.4 million to a net loss of $40.3 million for thenine months ended September 30, 2004 compared to a net loss of $77.7 millionfor the same period in the prior year. The decrease in the net loss applicable to our common stockholder isattributable to:

 

•                  a $30.6 million decrease in our net loss;and

 

•                  a $6.8 million decrease in preferredstock dividends resulting from the January 1, 2004 adoption of SFAS No. 150which requires preferred stock dividends be deducted from the net income orloss for the period.

** **

**Bookings****. **Bookings increased $51.5 million, or 40.2%, to $179.7million for the nine months ended September 30, 2004 compared to $128.2 millionfor the same period in the prior year. By segment, bookings changed as follows:

 
| ** **          | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|---------------------|------------|------------------------------------|------------|
| **(In millions)**   | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
|                |       |                               |       |   |   |
| Cabin Management    |       | $                                  | 37.2       |   | 41.0 | % |
| Systems Integration |       | 14.3                               |       | 38.2 |   |
| Total               |       | $                                  | 51.5       |   |   |   |

 

CabinManagement’s bookings increased as a result of the increase in our customers’aircraft production schedules during the period.  Systems Integration’s bookings increase is aresult of booking an order for an aircraft completion during the quarter aswell as an increase in orders for our cockpit door video surveillance system.

 

41

----

** **

**Re**structuring,Asset Impairment and Other Related Charges

** **

Thefollowing discussion should be read in conjunction with Note 2 accompanying ourfinancial statements included in this report.

Duringthe three months and nine months ended September 30, 2003 and 2004, we recordedrestructuring, asset impairment and other related pre-tax charges related to aseries of restructuring activities. These charges, and the effect these charges had on our reported resultsof operations, are summarized below.

 
| ** **                                                                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| **(In millions)**                                                          | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                       |       |                                  |       |                                 |       |   |   |   |   |
| Nature of charges:                                                         |       |                                  |       |                                 |       |   |   |   |   |
| Operational Realignment and Facilities  Restructuring                      |       | $                                     | 0.4        |                                 | $          | — |   | $ | 7.3 |   | $ | — |   |
| Seating Product Line and Furniture  Manufacturing Facilities Restructuring |       | —                                |       | —                               |       | — |   | 7.1 |   |
| Goodwill impairment charges                                                |       | —                                |       | —                               |       | — |   | 41.5 |   |
| Total pre-tax charges                                                      |       | $                                     | 0.4        |                                 | $          | — |   | $ | 7.3 |   | $ | 48.6 |   |
|                                                                       |       |                                  |       |                                 |       |   |   |   |   |
| Business segment recording the charges:                                    |       |                                  |       |                                 |       |   |   |   |   |
| Cabin Management                                                           |       | $                                     | 0.1        |                                 | $          | — |   | $ | 1.7 |   | $ | 41.1 |   |
| Systems Integration                                                        |       | 0.1                                   |       | —                               |       | 5.4 |   | — |   |
| Corporate                                                                  |       | 0.2                                   |       | —                               |       | 0.2 |   | — |   |
| Total charged to continuing operations                                     |       | 0.4                                   |       | —                               |       | 7.3 |   | 41.1 |   |
| Specialty Avionics (discontinued  operations)                              |       | —                                |       | —                               |       | — |   | 7.5 |   |
| Total pre-tax charges                                                      |       | $                                     | 0.4        |                                 | $          | — |   | $ | 7.3 |   | $ | 48.6 |   |
|                                                                       |       |                                  |       |                                 |       |   |   |   |   |
| Charged to operations:                                                     |       |                                  |       |                                 |       |   |   |   |   |
| Cost of sales                                                              |       | $                                     | 0.1        |                                 | $          | — |   | $ | 6.2 |   | $ | 6.5 |   |
| Selling, general and administrative  expenses                              |       | 0.3                                   |       | —                               |       | 1.1 |   | 0.6 |   |
| Impairment of goodwill                                                     |       | —                                |       | —                               |       | — |   | 34.0 |   |
| Total charged to continuing operations                                     |       | 0.4                                   |       | —                               |       | 7.3 |   | 41.1 |   |
| Charged to discontinued operations                                         |       | —                                |       | —                               |       | — |   | 7.5 |   |
| Total pre-tax charges                                                      |       | $                                     | 0.4        |                                 | $          | — |   | $ | 7.3 |   | $ | 48.6 |   |
|                                                                       |       |                                  |       |                                 |       |   |   |   |   |
| Components of charges:                                                     |       |                                  |       |                                 |       |   |   |   |   |
| Noncash charges                                                            |       | $                                     | 0.1        |                                 | $          | — |   | $ | 3.1 |   | $ | 37.6 |   |
| Cash charges                                                               |       | 0.3                                   |       | —                               |       | 4.2 |   | 3.5 |   |
| Total charged to continuing operations                                     |       | 0.4                                   |       | —                               |       | 7.3 |   | 41.1 |   |
| Charged to discontinued operations  (noncash)                              |       | —                                |       | —                               |       | — |   | 7.5 |   |
| Total pre-tax charges                                                      |       | $                                     | 0.4        |                                 | $          | — |   | $ | 7.3 |   | $ | 48.6 |   |

 

**OperationalRealignment and Facilities Restructuring**

 

Duringthe second quarter of fiscal 2004, we adopted plans to restructure theoperations of 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 Systems Integrationinvolves combining the manufacturing activities of two facilities into a singlefacility and eliminating some product offerings and service capabilitiesresulting 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 $7.3 million during the second and third quarters of fiscal2004, of which $3.1 million were noncash charges.

 

42

----

 

Thecharges are comprised of the write-down of surplus inventory, lease terminationand related charges, and severance and other compensation costs.  We also expect to incur additionalrestructuring-related expenses of approximately $1.6 million during the fourthquarter 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 $5.1 million through 2013 because of lease termination costs,will be funded from existing cash balances and internally generated cash fromoperations.

** **

**SeatingProduct Line and Furniture Manufacturing Facilities Restructuring**

 

Duringthe second 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.  Theseactions were designed to reduce engineering, production and inventory carryingcosts by supporting fewer product offerings and achieve profitability at thefurniture manufacturing facility based on its lower production levels.  In connection with these actions, we recordedpre-tax charges to operations totaling $7.1 million during the second quarterof fiscal 2003, of which $3.6 million were noncash charges.  The charges are comprised of the write-off ofexcess and obsolete inventory costs related to the discontinued product offerings,lease termination and related charges, and severance and other compensationcosts.  These restructuring activitieswere completed by the end of fiscal 2003.

** **

**Goodwill ImpairmentCharges**

 

As aresult of the weakness in the business, VIP and head-of-state aircraft marketin 2003 and the decision to down-size a furniture manufacturing facility, thegoodwill associated with the furniture manufacturing reporting unit was testedfor recoverability in June 2003 and found to be impaired.  As a result, $34.0 million of goodwillassociated with the reporting unit was written off and charged to operationsduring the three months ended June 30, 2003.

 

InMarch 2003, we entered into a definitive agreement to sell our equity interestsin the subsidiaries comprising the Specialty Avionics Group for $140.0 millionin cash.  Based upon the fair value ofthe group 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 endedMarch 31, 2003 to reduce the carrying value to estimated netrealizable value.

** **

**Liquidity and Capital Resources**

 

We area holding company and have no direct material operations.  Our only asset is our ownership of all of thecommon 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 liquidity needsare for income taxes and the payment of our preferred stock redemption andaccrued dividend payment obligations on September 30, 2009.

 

Ouronly source of cash is dividends from DeCrane Aircraft.  The first-lien credit facility, second-lienterm debt, senior discount notes and subordinated notes described below areobligations of DeCrane Aircraft and impose limitations on its ability to paydividends to us.  We believe that DeCraneAircraft’s debt instruments will permit it to supply us with sufficient cash tomeet the cash needs referred to above for the next twelve months.  However, if that is not the case, we wouldnot be able to satisfy those needs, because we have no other source of cashother than dividends from DeCrane Aircraft. We would then be required to secure alternate financing, which may notbe available on acceptable 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 principal sourcesof

 

43

----

 

liquidityare expected to be cash flow from operations, potential capital markettransactions and third party borrowings, principally under its first-liencredit facility.

** **

**Cash Flows Duringthe Nine months ended September 30, 2004**

 

Netcash used for operating activities was $21.2 million for the nine months endedSeptember 30, 2004 and consisted of $10.2 million of cash used by operationsafter adding back depreciation, amortization, preferred stock dividends,noncash restructuring charges, interest accretion and other noncash items,$13.8 million used for working capital and a $2.8 million increase in otherliabilities.  The following factorscontributed to the $13.8 million working capital increase:

 

•                  a $15.6 million increase in inventorycommensurate with higher revenues and order backlog; and

 

•                  a $0.4 million increase in accountsreceivables due to higher revenues; offset by

 

•                  a $2.2 million increase in accountspayable, accrued expenses and income taxes payable.

 

The$2.8 million increase in other liabilities is principally a result of accruinglease termination costs in connection with our 2004 operation realignment andfacilities restructuring.

 

Netcash used for investing activities consisted of capital expenditures of $2.7million for the nine months ended September 30, 2004.  We anticipate spending approximately $3.0 to$5.0 million for capital expenditures in 2004.

 

Netcash provided by financing activities was $19.8 million for the nine monthsended September 30, 2004 and consisted of:

 

•                  $17.8 million of net borrowings under ourrevolving line of credit;

 

•                  $5.0 million of proceeds from theissuance of 13.5% senior unsecured promissory notes; offset by

 

•                  $0.9 million of other secured long-termdebt repayments; and

 

•                  $2.1 million of financing costs relatedto our debt and preferred stock restructuring.

** **

**Debt andPreferred Stock Restructuring**

 

Duringthe third quarter of 2004, holders of $65.0 million 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 $128.8 millionaggregate accreted principal value at maturity. The new notes are senior unsecured obligations of DeCrane Aircraft andare guaranteed by its subsidiaries. Except for the changes in the interest rate and payment and rankingdescribed above, the new notes have terms substantially identical to thosecontained in the existing notes, although covenants limiting the incurrence ofindebtedness, the granting of liens and the making of restricted payments aremore restrictive.  The exchange will helpconserve working capital by reducing DeCrane Aircraft’s cash interest expenseby $7.7 million annually 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.  The amended terms provide that furtherdividends do not accrue on the preferred stock, except if a leverage ratio (asdefined) falls below certain specified levels or if certain triggering eventsoccur, such as failure to discharge any mandatory redemption obligations orcomply with certain restrictive covenants and the like.  Depending upon the future leverage ratioachieved, and provided that certain triggering events have not occurred,dividends accrue at a 0%, 4% or 16% annual rate on the 16% preferred stock and0%, 3.5% or 14% on the

 

44

----

 

14% preferredstock.  If certain triggering eventsoccur, dividends accrue at the 16% and 14% annual rates.  Based upon the leverage ratio achieved as ofSeptember 30, 2004, no dividends will accrue on either the 16% or 14% preferredstock from the amendment dates through December 31, 2004.

 

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 stock alsoadds several restrictive covenants.  Theholders of the 16% preferred stock were issued 348,945 shares of DeCraneHoldings common stock in connection with the amendment.

** **

**Short-TermBorrowings**

 

InSeptember 2004, we received the proceeds from the issuance of 13.5% seniorunsecured promissory notes in the aggregate principle amount of $5.0 million toDLJ Merchant Banking Partners II, L.P. and affiliated funds, who are alsostockholders and, as a result, related parties (see Note 16 to the auditedfinancial statements included in our 2003 Form 10-K for additionalinformation on the related party relationship). Unless extended, the notes, plus accrued interest, are due on November29, 2004.  The notes may be extended forup to three thirty-day periods, at the option of the noteholders.  While we believe the noteholders would extendthe notes beyond the current due date if requested, they are under noobligation to do so.  The notes containcovenants identical to those in the new 17% notes.

** **

**FutureLiquidity Improvements**

 

Wecontinue to explore transactions that would improve our liquidity and reduce ourcash needs.  We have not entered into anycommitments to do so and cannot assure you that we will be able to do so in thefuture.

 

Forexample, as disclosed in a Current Report on Form 8-K furnished on July 20,2004, we engaged in discussions with some of the holders of the remaining 12%senior subordinated notes that did not participate in exchange for the 17%notes.  We proposed that such holdersexchange their existing 12% senior subordinated notes for new senior notes thatwould bear interest at an annual rate of 2% in cash and 10% in kind.  We have terminated all such discussions withthe noteholders and no letters of intent or definitive agreements with respectto such proposal were executed.

** **

**DebtObligations and Capital Resources as of September 30, 2004**

 

As ofSeptember 30, 2004, first-lien credit facility borrowings and second-lien termdebt totaling $108.3 million are at variable interest rates based on definedmargins over the current prime rate or LIBOR. We also had $71.9 million of 15% second-lien term debt, $67.0 million of17% senior discount notes, $35.0 million of 12% subordinated notes, $8.0million of other secured indebtedness, and $5.0 million of 13.5% seniorunsecured promissory notes outstanding as of September 30, 2004.  In addition, our 16% mandatorily redeemablepreferred stock, which has characteristics of both a liability and equity, hada $47.3 million mandatorily redemption value as of September 30, 2004.

 

As ofSeptember 30, 2004, we had $39.9 million of working capital and $5.9 million ofborrowings available under our $24.0 million revolving line of credit, whichexpires in March 2006.

** **

**FinancialCondition and Liquidity**

 

Webelieve our expected operating cash flows, together with borrowings under ourfirst-lien credit facility ($5.9 million of which was available as of September30, 2004, the commitment for which expires in March 2006), will be sufficientto meet our operating expenses, working capital requirements, capital

 

45

----

 

expendituresand debt service obligations for the next twelve months.  However, our working capital needs generallyincrease as our order backlog and revenues increase, particularly with respectto orders where we must incur development costs and build inventory but we maynot receive full payment until delivery. Any significant delay in payments could increase our working capitalneeds beyond our expectations.  Further,our ability to comply with our debt financial covenants, pay principal orinterest and satisfy such cash obligations will depend on our future operatingperformance as well as competitive, legislative, regulatory, business and otherfactors beyond our control.  Although wecannot be certain, we expect to be in compliance with the revised financialcovenants through the end of the year based on our current operating plan.  See “Special Note Regarding Forward-LookingStatements and Risk Factors.”

** **

**Disclosure of ContractualObligations and Commitments**

 

Thefollowing table summarizes our known contractual obligations to make futurecash payments as of September 30, 2004, as well an estimate of the periodsduring which these payments are expected to be made.

 
| ** **                                      | ** ** | ** ** | ** ** | **Years Ending December 31,** | ** ** |
|-------------------------------------------------|------------|------------|------------|-------------------------------|------------|
| **(In millions)**                               | ** ** | **Total**  | ** ** | **2004**                      | ** ** | **2005  and  2006** | ** ** | **2007  and  2008** | ** ** | **2009  and  Beyond** | ** ** |
|                                            |       |       |       |                          |       |   |   |   |   |   |   |
| Short-term borrowings:                          |       |       |       |                          |       |   |   |   |   |   |   |
| 13.5% senior unsecured promissory notes (a)     |       | $          | 5.0        |                          | $          | 5.0 |   | $ | — |   | $ | — |   | $ | — |   |
| Long-term debt (b):                             |       |       |       |                          |       |   |   |   |   |   |   |
| First-lien credit facility (c):                 |       |       |       |                          |       |   |   |   |   |   |   |
| Term debt                                       |       | 80.5       |       | —                        |       | 15.0 |   | 65.5 |   | — |   |
| Revolving line of credit                        |       | 17.8       |       | —                        |       | 17.8 |   | — |   | — |   |
| Second-lien term debt (d)                       |       | 81.9       |       | —                        |       | — |   | 81.9 |   | — |   |
| 17% senior discount notes (e)                   |       | 67.0       |       | —                        |       | — |   | 67.0 |   | — |   |
| 12% subordinated notes (f)                      |       | 35.0       |       | —                        |       | — |   | 35.0 |   | — |   |
| Capital lease obligations (g)                   |       | 3.1        |       | 0.2                           |       | 0.9 |   | 0.6 |   | 1.4 |   |
| Other indebtedness (g)                          |       | 4.9        |       | 0.2                           |       | 1.7 |   | 0.6 |   | 2.4 |   |
| Total short-term borrowings and long-term  debt |       | 295.2      |       | 5.4                           |       | 35.4 |   | 250.6 |   | 3.8 |   |
|                                            |       |       |       |                          |       |   |   |   |   |   |   |
| Mandatorily redeemable preferred stock:         |       |       |       |                          |       |   |   |   |   |   |   |
| DeCrane Aircraft preferred stock (h)            |       | 47.3       |       | —                        |       | — |   | 47.3 |   | — |   |
| DeCrane Holdings preferred stock (i)            |       | 77.2       |       | —                        |       | — |   | — |   | 77.2 |   |
| Other long-term liabilities                     |       | 8.3        |       | —                        |       | 5.5 |   | 2.4 |   | 0.4 |   |
| Operating lease obligations                     |       | 9.8        |       | 0.7                           |       | 3.4 |   | 2.1 |   | 3.6 |   |
| Total obligations as of September 30, 2004      |       | $          | 437.8      |                          | $          | 6.1 |   | $ | 44.3 |   | $ | 302.4 |   | $ | 85.0 |   |

 

----

(a)                                  Excludes interest of$0.1 million payable at maturity.

 

(b)                                 Generally excludesinterest payments, which are described in the following notes.

 

(c)                                  The first-lien creditfacility bears interest at variable rates and therefore the amount of futureinterest payments are uncertain.  Thedebt bears interest based on a margin over, at our option, the prime rate orLIBOR.  As of September 30, 2004, thecurrent prime rate was 4.75% and the current LIBOR was 2.12%.  The margins applicable to portions of amountsborrowed vary depending on our consolidated debt leverage ratio.  Currently, the applicable margins are 4.00%to 4.75% for prime rate borrowings and 5.25% to 6.00% for LIBORborrowings.  The weighted-averageinterest rate on all first-lien debt was 7.37% as of September 30, 2004.

 

46

----

 

(d)                                 The second-lien termdebt is comprised of $70.0 million of fixed rate debt and $10.0 million ofvariable rate debt.  The fixed rate debtbears interest at 15%; 12% payable quarterly in cash and 3% pay-in-kind or “accreted”interest, payable at maturity.  Thevariable rate debt bears cash interest, at our option, at the prime rate plus7.5% or LIBOR plus 8.5%, plus 3% pay-in-kind interest payable at maturity.  The weighted-average interest rate on allsecond-lien debt was 14.77% as of September 30, 2004.  All of the second-lien debt matures on June30, 2008, at which time the cash payment obligation will be $91.7 million,including the 3% pay-in-kind interest obligation.

 

(e)                                  The 17% seniordiscount notes do not bear cash interest expense but instead accrete in valueat a 17% annual rate until maturity on September 30, 2008.  The notes will have a $128.8 millionaggregate accreted principal value at maturity.

 

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

 

(g)                                 Interest is generallypayable monthly.

 

(h)                                 Dividends do notaccrue on the preferred stock unless a defined leverage ratio falls belowcertain specified levels as of each quarterly testing date or if certaintriggering events occur.  Depending onthe future leverage ratio achieved, and provided certain triggering events havenot occurred, dividends accrue at a 0%, 4% or 16% annual rate for thesucceeding quarter.  If certaintriggering events occur, such as failure to discharge any mandatory redemptionobligations or comply with certain restrictive covenants and the like,dividends accrue at a 16% annual rate. Based on the leverage ratio achieved as of September 30, 2004, nodividends will accrue on the preferred stock through December 31, 2004.  Future dividends, if any, are not payableuntil redemption.  The mandatoryredemption date is December 31, 2008.  Our debt instruments restrict our ability tomake payments on our preferred stock.

 

(i)                                     Dividends do notaccrue on the preferred stock unless a defined leverage ratio falls belowcertain specified levels as of each quarterly testing date or if certain triggeringevents occur.  Depending on the futureleverage ratio achieved, and provided certain triggering events have notoccurred, dividends accrue at a 0%, 3.5% or 14% annual rate.  If certain triggering events occur, such asfailure to discharge any mandatory redemption obligations or comply withcertain restrictive covenants and the like, dividends accrue at a 14% annualrate.  Based on the leverage ratioachieved as of September 30, 2004, no dividends will accrue on the preferredstock through December 31, 2004.  Futuredividends, if any, are not payable until redemption.  The mandatory redemption date is September30, 2009.  Our debt instruments restrictour ability to make payments on our preferred stock.

** **

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

 

Duringour normal 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.

 

Inconnection with the sale of the Specialty Avionics Group, we made indemnitiesto the buyer with 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.

 

47

----

 

As ofSeptember 30, 2004, we also had irrevocable standby letters of credit in theamount of $0.3 million issued and outstanding under our first-lien creditfacility.

** **

**Recent Accounting Pronouncements**

** **

**AccountingPronouncements Adopted January 1, 2004**

 

Asmore fully described in Note 1 accompanying our financial statements includedin this report and “—Changes in Accounting Principles” above, effective January1, 2004 we adopted the provisions of SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity.”

** **

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

 

Allstatements other than statements of historical facts included in this report,including statements about our future performance and liquidity and futureindustry performance, are considered forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995.  These statements are subject to known and unknownrisks, uncertainties and other factors, which are difficult to predict.  We are vulnerable to a variety of factorsthat affect many businesses, such as:

 

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

 

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

 

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

 

•                  our reliance on large projects, whereunanticipated needs to incur development costs and acquire inventory or delaysin payment could increase our working capital needs;

 

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

 

•                  competition from larger companies;

 

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

 

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

 

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

 

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

 

•                  the ability to attract and retainqualified personnel;

 

•                  labor disturbances; and

 

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

 

Some ofthe more significant factors listed above are further described in our 2003Annual Report on Form 10-K and should be read in conjunction with thisreport.  Changes in such factors couldcause our actual 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 

 

48

----

 

thedate hereof or to reflect the occurrence of unanticipated events.  You should not rely on our forward-lookingstatements as if they were certainties.

** **

**ITEM3.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

 

We areexposed to various market risks, including interest rates and changes inforeign currency exchange rates.  Marketrisk is the potential loss arising from adverse changes in prevailing marketrates and prices.  From time to time, weuse derivative financial instruments to manage and reduce risks associated withthese factors.  We do not enter intoderivatives or other financial instruments for trading or speculative purposes.

** **

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

 

Marketrisk related to our variable-rate debt is estimated as the potential decreasein pre-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 ofSeptember 30, 2004, the current prime rate was 4.75% and the current LIBOR was2.12%.  Based on $108.3 million ofvariable-rate debt outstanding as of September 30, 2004, a hypothetical onepercent rise in interest rates, to 5.75% for prime rate borrowings and 3.12%for LIBOR borrowings, would reduce our pre-tax earnings by $1.1 millionannually.

 

Tolimit a portion of our exposure related to rising interest rates, we haveentered into an interest rate swap contract to effectively convert ourvariable-rate industrial revenue bonds to 4.2% fixed-rate debt until maturityin 2008.  The contract is considered tobe a hedge against changes in the amount of future cash flows associated withinterest payments on this portion of our variable-rate debt.  Market risk related to this interest rateswap contract is estimated as the potential higher interest expense we willincur if the variable 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 September 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.

 

Theestimated fair value of our recently issued $67.0 million of 17% fixed-ratelong-term senior discount notes was $48.9 million as of September 30,2004.  Market risk related to ourfixed-rate debt is deemed to be the potential increase in fair value resultingfrom a decrease in interest rates.  Forexample, a hypothetical ten percent decrease in the interest rates, from 17.0%to 15.3%, would increase the fair value of our fixed-rate debt by approximately$3.1 million.

 

Theestimated fair value of our $35.0 million of 12% fixed-rate long-term debtincreased $7.0 million, or 44.3%, to approximately $22.8.0 million as ofSeptember 30, 2004 from $15.8 million as of December 31, 2003.  Although we cannot be certain, we believe theincrease may be a result of the recovery of the business, VIP and head-of-stateaircraft market in 2004 and the exchange of $65.0 million of 12% notes for 17%senior discount notes with interest payable at maturity.  Market risk related to our fixed-rate debt isdeemed to be the potential increase in fair value resulting from a decrease ininterest rates.  For example, ahypothetical ten percent decrease in the interest rates, from 12.0% to 10.8%,would increase the fair value of our fixed-rate debt by approximately $1.3million.

** **

**ForeignCurrency Exchange Rate Risk.**  Our foreigncustomers are located in various parts of the world, primarily Canada, the Farand Middle East and Western Europe, and we have a subsidiary with manufacturingfacilities in Mexico.  To limit ourforeign currency exchange rate risk related to sales to our customers, ordersare almost always valued and sold in U.S. dollars.  We have entered into forward foreign exchangecontracts in the past, primarily to limit exposure related to foreign inventoryprocurement and operating costs.  Whilewe have not entered into any such contracts since 1998, we may

 

49

----

 

do soin the future depending on the volume of non-U.S. dollar denominatedtransactions and our assessment of future foreign exchange rate trends.

** **

**ITEM4.    CONTROLS AND PROCEDURES**

 

Themanagement of DeCrane Holdings Co. (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) or 15d-15(e))as of the end of the period covered by this report.  Based on that evaluation, the Chief ExecutiveOfficer and Chief Financial Officer concluded that the Company’s disclosurecontrols and procedures were effective as of the end of the period covered bythis report.

 

Therewas no change in the Company’s internal control over financial reportingidentified in connection with the evaluation required by paragraph (d) ofExchange Act Rules 13a-15 or 15d-15 that occurred during the Company’s lastfiscal quarter that has materially affected, or is reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

**PART II – OTHER INFORMATION**

**ITEM 1.    LEGALPROCEEDINGS**

 

SeeNote 10 to the consolidated financial statements included in this report.

 

**ITEM2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OFPROCEEDS**

 

OnJuly 23, 2004, the Company issued 348,945 shares of common stock, $0.01 parvalue, to the holders of its 16% senior preferred stock listed below inexchange for the their consent to amend the terms of the preferred stock.  The Company received no cash considerationupon issuance.  The common stock had anominal fair market value on the issuance date and was therefore recorded atits $0.01 per share par value.  Suchissuances were made in reliance upon an exemption from the registrationprovisions of the Act set forth in Section 4(2) thereof relative to issuancesby an issuer not involving any public offering or the rules and regulationsthereunder.

 
| **Holders of the 16% Senior  Preferred Stock**          |   | **Shares of  $0.01 Par Value  Common  Stock  Issued** |   |
|---------------------------------------------------------|--------|-------------------------------------------------------|--------|
|                                                    |   |                                                  |   |
| DLJ Investment Partners II, L.P                         |   | 158,632                                               |   |
| DLJ Investment Partners, L.P                            |   | 70,504                                                |   |
| DLJIP II Holdings, L.P                                  |   | 50,020                                                |   |
| Neon Capital Limited                                    |   | 29,311                                                |   |
| Putnam High Yield Trust                                 |   | 29,311                                                |   |
| Putnam Variable Trust – Putnam VT High  Yield Fund |   | 11,167                                                |   |
| Total                                                   |   | 348,945                                               |   |

 

50

----

 

**ITEM 6.    EXHIBITS**

 
| 3.2.1.2 |   | Certificate  of Amendment of Certificate of Incorporation of DeCrane Aircraft Holdings, Inc.  dated July 23, 2004 *                                                                                                                                                                                                                                    |
|---------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                                                                                                                                                        |
| 4.5.1   |   | DeCrane  Aircraft Holdings, Inc. 17% Senior Discount Notes Due 2008 (Note No. 1 dated  July 23, 2004)*                                                                                                                                                                                                                                                      |
|    |   |                                                                                                                                                                                                                                                                                                                                                        |
| 4.5.1.1 |   | DeCrane  Aircraft Holdings, Inc. 17% Senior Discount Notes Due 2008 (Note No. 2 dated  September 9, 2004)*                                                                                                                                                                                                                                                  |
|    |   |                                                                                                                                                                                                                                                                                                                                                        |
| 4.5.2   |   | Certificate  of Amendment to Certificate of Designations, Preferences and Rights of 14%  Senior Redeemable Exchangeable Preferred Stock Due 2009 (Now Designated as  Senior Redeemable Exchangeable Preferred Stock Due 2009) of DeCrane Holdings  Co. dated July 23, 2004 *                                                                                |
|    |   |                                                                                                                                                                                                                                                                                                                                                        |
| 4.6.2   |   | Certificate  of Amendment to Certificate of Designations, Preferences and Rights of 16%  Senior Redeemable Exchangeable Preferred Stock Due 2009 (now designated as  Senior Redeemable Exchangeable Preferred Stock Due 2008) of DeCrane Aircraft  Holdings, Inc. dated July 23, 2004 *                                                                     |
|    |   |                                                                                                                                                                                                                                                                                                                                                        |
| 4.7.2   |   | Amendment  No. 2 to the Senior Preferred Stock Registration Rights Agreement dated as of  June 30, 2000 among DeCrane Aircraft Holdings, Inc. and the holders of Senior  Preferred Stock dated July 23, 2004 *                                                                                                                                              |
|    |   |                                                                                                                                                                                                                                                                                                                                                        |
| 4.8     |   | Indenture  dated July 23, 2004 between DeCrane Aircraft Holdings, Inc. and U.S. Bank  National Association for 17% Senior Discount Notes Due 2008 *                                                                                                                                                                                                         |
|    |   |                                                                                                                                                                                                                                                                                                                                                        |
| 4.8.1   |   | First  Supplemental Indenture dated September 9, 2004 between DeCrane Aircraft  Holdings, Inc. and U.S. Bank National Association for 17% Senior Discount  Notes Due 2008 *                                                                                                                                                                                 |
|    |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.2.1  |   | Amendment  No. 1 to the Amended and Restated Investors’ Agreement dated as of  October 6, 2000 by and among DeCrane Holdings Co., DeCrane Aircraft  Holdings, Inc. and the stockholders named therein dated December 31, 2001 *                                                                                                                   |
|    |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.2.2  |   | Amendment  No. 2 to the Amended and Restated Investors’ Agreement dated as  October 6, 2000 by and among DeCrane Holdings Co., DeCrane Aircraft  Holdings, Inc. and the stockholders named therein dated July 23, 2004 *                                                                                                                          |
|    |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.10.8 |   | Fifth  Amendment to the Third Amended and Restated Credit Agreement dated as of  June 9, 2004 among DeCrane Aircraft Holdings, Inc., the lenders listed  therein and Credit Suisse First Boston, acting through its Cayman Islands  Branch (successor to DLJ Capital Funding, Inc.), as syndication agent and  administrative agent for the lenders *  |
|    |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.10.9 |   | Sixth  Amendment to the Third Amended and Restated Credit Agreement dated as of  July 16, 2004 among DeCrane Aircraft Holdings, Inc., the lenders listed  therein and Credit Suisse First Boston, acting through its Cayman Islands  Branch (successor to DLJ Capital Funding, Inc.), as syndication agent and  administrative agent for the lenders * |
|    |   |                                                                                                                                                                                                                                                                                                                                                        |
| 10.12.1 |   | First  Amendment to the Credit Agreement dated as of December 22, 2003 among DeCrane  Aircraft Holdings, Inc., the lenders listed therein and Credit Suisse First  Boston, acting through its Cayman Islands Branch (successor to DLJ Capital  Funding, Inc.), as syndication agent and administrative agent for the lenders  dated June 9, 2004 *          |

 

51

----

 
| 10.12.2 |   | Second  Amendment to the Credit Agreement dated as of December 22, 2003 among DeCrane  Aircraft Holdings, Inc., the lenders listed therein and Credit Suisse First  Boston, acting through its Cayman Islands Branch (successor to DLJ Capital  Funding, Inc.), as syndication agent and administrative agent for the lenders  dated July 16, 2004 * |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.13   |   | Exchange  Agreement dated as of July 23, 2004, among DeCrane Aircraft Holdings, Inc.,  the affiliates of DeCrane Aircraft set forth on the signature pages hereto as  Guarantors, and certain holders of DeCrane Aircraft’s 12% Senior Subordinated  Notes due 2008 (the “Old Notes”) set forth on the signature pages hereto *       |
|    |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.13.1 |   | Exchange  Agreement dated as of September 9, 2004, among DeCrane Aircraft Holdings,  Inc., the affiliates of DeCrane Aircraft set forth on the signature pages  hereto as Guarantors, and certain holders of DeCrane Aircraft’s 12% Senior  Subordinated Notes due 2008 (the “Old Notes”) set forth on the signature  pages hereto *  |
|    |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.14   |   | 16%  Senior Preferred Stock Amendment Agreement dated as of July 23, 2004, among  DeCrane Aircraft Holdings, Inc., DeCrane Holdings Co., and the other persons  set forth on the signature pages hereto *                                                                                                                                            |
|    |   |                                                                                                                                                                                                                                                                                                                                                 |
| 21.1    |   | List  of Subsidiaries of Registrant *                                                                                                                                                                                                                                                                                                                |
|    |   |                                                                                                                                                                                                                                                                                                                                                 |
| 31.1    |   | Chief  Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 *                                                                                                                                                                                                                                                  |
|    |   |                                                                                                                                                                                                                                                                                                                                                 |
| 31.2    |   | Chief  Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002 *                                                                                                                                                                                                                                                  |
|    |   |                                                                                                                                                                                                                                                                                                                                                 |
| 32      |   | Chief  Executive Officer and Chief Financial Officer Certifications Pursuant to  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *                                                                                                                                                                                                         |

 

----

| * |   | Filed  herewith |
|---|--------|-----------------|

 

**SIGNATURES**

 

Pursuantto the 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)** |
|--------------------|---------------------------------------|
|               |                                  |   |
|               |                                  |   |
|               |                                  |   |
|               |                                  |   |
| November  12, 2004 | By:                                   | /s/ RICHARD  J. KAPLAN |
|               | Name:                                 | Richard  J. Kaplan |
|               | Title:                                | Chief  Financial Officer and |
|               |                                  | Assistant  Secretary |

 

52

----