**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

**QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)**

**OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended March 31, 2005**

** **

**Commission File Number 000-22371**

 

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**DECRANEAIRCRAFT HOLDINGS, INC.**

(Exact name of registrant as specified in its charter)

 

| **Delaware**                     | ** ** | **34-1645569**       |
|----------------------------------|------------|----------------------|
| (State  or other jurisdiction of |       | (I.R.S.  Employer    |
| incorporation  or organization)  |       | Identification  No.) |

 

**8425Pulsar Place, Suite 340, Columbus, Ohio 43240**

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

 

**(614) 848-7700**

(Registrant’s telephone number, including area code)

 

**(Not Applicable)**

(Former name, former address and former fiscal year, if changed sincelast report)

 

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

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

 

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The number of shares of Registrant’s Common Stock, $.01 par value,outstanding as of May 16, 2005 was 100 shares.

 

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**Tableof Contents**

 
| ** **     |                                                                                             |       |
|----------------|--------------------------------------------------------------------------------------------------|------------|
|           | **Part I — Financial Information**                                                          |       |
|           |                                                                                             |       |
| **Item 1.**    | **Financial Statements  (Unaudited)**                                                            |       |
|           | Consolidated Balance Sheets  as of March 31, 2005 and December 31, 2004                          |       |
|           | Consolidated  Statements of Operations for the three months ended March 31, 2005 and 2004        |       |
|           | Consolidated  Statements of Stockholder’s Deficit for the three months ended March 31, 2005 |       |
|           | Consolidated  Statements of Cash Flows for the three months ended March 31, 2005 and 2004        |       |
|           | 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                                                                             |       |
|           | Three  months ended March 31, 2005 compared to 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                                  |       |
|           | 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** |                                                                                             |

 

 

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**PART I — FINANCIAL INFORMATION**

**ITEM 1.****                         ****FINANCIAL STATEMENTS**

**DECRANE AIRCRAFT HOLDINGS, INC. AND SUBSIDIARIES**

**Consolidated Balance Sheets**
| ** **                                                                                   | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ***(In thousands, except share data)***                                                      | ** ** | **2005**           | ** ** | **2004**              | ** ** |
| *** ***                                                                                 | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| **Assets**                                                                                   |       |               |       |                  |       |
|                                                                                         |       |               |       |                  |       |
| Current assets:                                                                              |       |               |       |                  |       |
| Cash                                                                                         |       | $                  | 2,264      |                  | $          | 979 |   |
| Accounts receivable, net                                                                     |       | 34,385             |       | 25,367                |       |
| Inventories                                                                                  |       | 54,534             |       | 51,253                |       |
| Prepaid expenses and other current assets                                                    |       | 1,351              |       | 944                   |       |
| Total current assets                                                                         |       | 92,534             |       | 78,543                |       |
|                                                                                         |       |               |       |                  |       |
| Property and equipment, net                                                                  |       | 26,934             |       | 27,565                |       |
| Goodwill                                                                                     |       | 162,430            |       | 162,430               |       |
| Other assets, principally intangibles, net                                                   |       | 29,362             |       | 31,455                |       |
| Total assets                                                                                 |       | $                  | 311,260    |                  | $          | 299,993 |   |
|                                                                                         |       |               |       |                  |       |
| **Liabilities and Stockholder’s Deficit**                                               |       |               |       |                  |       |
|                                                                                         |       |               |       |                  |       |
| Current liabilities:                                                                         |       |               |       |                  |       |
| Current portion of long-term debt                                                            |       | $                  | 29,086     |                  | $          | 1,314 |   |
| Accounts payable                                                                             |       | 20,775             |       | 16,666                |       |
| Accrued liabilities                                                                          |       | 25,962             |       | 23,657                |       |
| Total current liabilities                                                                    |       | 75,823             |       | 41,637                |       |
|                                                                                         |       |               |       |                  |       |
| Long-term debt                                                                               |       | 270,557            |       | 291,840               |       |
| Mandatorily redeemable preferred stock                                                       |       | 52,303             |       | 47,303                |       |
| Deferred income taxes                                                                        |       | 3,371              |       | 1,710                 |       |
| Other long-term liabilities                                                                  |       | 5,789              |       | 5,010                 |       |
|                                                                                         |       |               |       |                  |       |
| Commitments and contingencies (Note 9)                                                       |       |               |       |                  |       |
|                                                                                         |       |               |       |                  |       |
| Stockholder’s deficit:                                                                  |       |               |       |                  |       |
| Common stock, $.01 par value, 1,000 shares authorized and 100 shares issued  and outstanding |       | —             |       | —                |       |
| Additional paid-in capital                                                                   |       | 112,269            |       | 112,269               |       |
| Notes receivable for shares sold                                                             |       | (621               | )          | (621                  | )          |
| Accumulated deficit                                                                          |       | (208,231           | )          | (199,155              | )          |
| Total stockholder’s deficit                                                             |       | (96,583            | )          | (87,507               | )          |
| Total liabilities and stockholder’s deficit                                             |       | $                  | 311,260    |                  | $          | 299,993 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

1

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**DECRANE AIRCRAFT HOLDINGS, INC. AND SUBSIDIARIES**

**Consolidated Statements of Operations**

 
| ** **                                       | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------|------------|------------------------|------------|
| ** **                                       | ** ** | **March 31,**     | ** ** |
| ***(In thousands)***                             | ** ** | **2005**               | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **(Unaudited)**        | ** ** |
| Revenues                                         |       | $                      | 56,621     |   | $ | 48,597 |   |
| Cost of sales                                    |       | 43,638                 |       | 36,839 |   |
|                                             |       |                   |       |   |   |
| Gross profit                                     |       | 12,983                 |       | 11,758 |   |
|                                             |       |                   |       |   |   |
| Operating expenses:                              |       |                   |       |   |   |
| Selling, general and administrative expenses     |       | 7,466                  |       | 7,237 |   |
| Research and development expenses                |       | 1,566                  |       | 2,181 |   |
| Amortization of intangible assets                |       | 912                    |       | 912 |   |
| Total operating expenses                         |       | 9,944                  |       | 10,330 |   |
|                                             |       |                   |       |   |   |
| Income from operations                           |       | 3,039                  |       | 1,428 |   |
|                                             |       |                   |       |   |   |
| Other expenses:                                  |       |                   |       |   |   |
| Interest expense                                 |       | 10,225                 |       | 8,702 |   |
| Mandatorily redeemable preferred stock dividends |       | —                 |       | 1,732 |   |
| Other expenses, net                              |       | 179                    |       | 112 |   |
|                                             |       |                   |       |   |   |
| Loss before provision for income taxes           |       | (7,365                 | )          | (9,118 | ) |
| Provision for income taxes                       |       | 1,711                  |       | 30 |   |
|                                             |       |                   |       |   |   |
| Net loss                                         |       | $                      | (9,076     | ) | $ | (9,148 | ) |
|                                                  |            |                        |            |  |  |  |  |  |  |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

2

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**DECRANE AIRCRAFT HOLDINGS, INC. AND SUBSIDIARIES**

**Consolidated Statement of Stockholder’s Deficit**

 
| ** **                              | ** ** | ** **       | ** ** | ** **  | ** ** | ** **     | ** ** | **Notes**       | ** ** | ** **  | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|------------------|------------|-------------|------------|----------------|------------|-----------------|------------|-------------|------------|------------|------------|
| ** **                              | ** ** | ** **       | ** ** | ** **  | ** ** | **Additional** | ** ** | **Receivable**  | ** ** | ** **  | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **For Shares** | ** ** | **Accumulated** | ** ** | ** **  | ** ** |
| ***(In thousands, except share data)*** | ** ** | **Shares**       | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Sold**        | ** ** | **Deficit** | ** ** | **Total**  | ** ** |
|                                    |       |             |       |        |       |           |       |            |       |        |       |       |       |
| Balance, December 31, 2004         |       | 100              |       | $           | —     |           | $          | 112,269         |       | $           | (621       | )          | $          | (199,155 | ) | $ | (87,507 | ) |
|                                    |       |             |       |        |       |           |       |            |       |        |       |       |       |
| Net loss (Unaudited)                    |       | —           |       | —      |       | —         |       | —          |       | (9,076      | )          | (9,076     | )          |
|                                    |       |             |       |        |       |           |       |            |       |        |       |       |       |
| Balance, March 31, 2005 (Unaudited)     |       | 100              |       | $           | —     |           | $          | 112,269         |       | $           | (621       | )          | $          | (208,231 | ) | $ | (96,583 | ) |
|                                         |            |                  |            |             |            |                |            |                 |            |             |            |            |            |  |  |  |  |  |  |  |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

3

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**DECRANE AIRCRAFT HOLDINGS, INC. AND SUBSIDIARIES**

**Consolidated Statements of Cash Flows**

 
| ** **                                                                    | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                    | ** ** | **March 31,**          | ** ** |
| ***(In thousands)***                                                          | ** ** | **2005**               | ** ** | **2004** | ** ** |
| ** **                                                                    | ** ** | **(Unaudited)**        | ** ** |
| **Cash flows from operating  activities:**                                    |       |                   |       |   |   |
| Net loss                                                                      |       | $                      | (9,076     | ) | $ | (9,148 | ) |
| Adjustments to reconcile net loss to net cash used for operating  activities: |       |                   |       |   |   |
| Depreciation and amortization                                                 |       | 3,024                  |       | 3,116 |   |
| Long-term debt interest accretion                                             |       | 3,466                  |       | 606 |   |
| Deferred income taxes                                                         |       | 1,661                  |       | — |   |
| Mandatorily redeemable preferred stock dividends                              |       | —                 |       | 1,732 |   |
| Preferred stock redemption value accretion                                    |       | —                 |       | 117 |   |
| Other, net                                                                    |       | 11                     |       | 10 |   |
| Changes in assets and liabilities:                                            |       |                   |       |   |   |
| Accounts receivable                                                           |       | (9,018                 | )          | (5,514 | ) |
| Inventories                                                                   |       | (3,281                 | )          | (4,640 | ) |
| Prepaid expenses and other assets                                             |       | 48                     |       | (192 | ) |
| Accounts payable                                                              |       | 4,109                  |       | (519 | ) |
| Accrued liabilities                                                           |       | 2,255                  |       | 2,063 |   |
| Income taxes payable                                                          |       | 50                     |       | 139 |   |
| Other long-term liabilities                                                   |       | 779                    |       | (98 | ) |
| Net cash used for operating activities                                        |       | (5,972                 | )          | (12,328 | ) |
|                                                                          |       |                   |       |   |   |
| **Cash flows from investing  activities:**                                    |       |                   |       |   |   |
| Capital expenditures                                                          |       | (675                   | )          | (504 | ) |
| Net cash used for investing activities                                        |       | (675                   | )          | (504 | ) |
|                                                                          |       |                   |       |   |   |
| **Cash flows from financing  activities:**                                    |       |                   |       |   |   |
| Proceeds from issuance of mandatorily redeemable preferred stock              |       | 5,000                  |       | — |   |
| Debt borrowings:                                                              |       |                   |       |   |   |
| Promissory notes                                                              |       | 2,500                  |       | — |   |
| Revolving line of credit, net                                                 |       | 850                    |       | 8,850 |   |
| Other secured long-term                                                       |       | —                 |       | 46 |   |
| Debt repayments:                                                              |       |                   |       |   |   |
| Other secured long-term debt                                                  |       | (327                   | )          | (311 | ) |
| Deferred financing costs                                                      |       | (91                    | )          | — |   |
| Net cash provided by financing activities                                     |       | 7,932                  |       | 8,585 |   |
|                                                                          |       |                   |       |   |   |
| Net increase (decrease) in  cash                                              |       | 1,285                  |       | (4,247 | ) |
| Cash at beginning of  period                                                  |       | 979                    |       | 6,936 |   |
| Cash at end of period                                                         |       | $                      | 2,264      |   | $ | 2,689 |   |

 

Theaccompanying notes are an integral part of the consolidated financialstatements.

 

4

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**DECRANEAIRCRAFT HOLDINGS, INC. AND SUBSIDIARIES**

**Condensed Notes to Consolidated Financial Statements**

**(Unaudited)**

**Note 1.**           Summaryof Significant Accounting Policies

**Basis of Presentation**

This consolidated interim financial information isunaudited.  The Company believes theinterim financial information is presented on a basis consistent with theaudited financial statements and includes all adjustments necessary for a fairstatement of the financial condition, results of operations and cash flows forsuch interim periods.  All of theseadjustments include 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, 2004 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 2004 Form 10-K. Reclassifications have been made to the financial statements for priorperiods to conform to the current year presentation.

 

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

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 certain operations.  These actions are designed to reduceengineering, production and inventory carrying costs by supporting fewermanufacturing locations and product offerings. In addition, the Company decided to relocate its corporate office toColumbus, Ohio to be in closer proximity to its operating companies andcustomers.  The restructuring, assetimpairment and other related charges are 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 market rates decrease or should it take longer than expectedto sublease these facilities, the actual loss could exceed theseestimates.  Other related charges include the write-off of leasehold improvementsrelated to the vacated facilities.

 

5

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

•                  *Severance and OtherCompensation Costs. *The Company’stotal workforce was reduced by 25 employees, or 2%, from December 31, 2003levels.

•                  *Relocation Costs. *Relocation costs arecomprised of moving and related costs incurred in connection with therelocation of the corporate and group headquarters as well as the manufacturingfacility consolidation.

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

In connection with these actions, the Company recordedpre-tax cash charges to operations totaling $918,000 during the three monthsended March 31, 2005 as follows:

 
| ***(In thousands)***                         | ** ** | **(Unaudited)** | ** ** |
|----------------------------------------------|------------|-----------------|------------|
| Business segment recording the charges:      |       |            |       |
| Cabin Management                             |       | $               | 59         |   |
| Systems Integration                          |       | 347             |       |
| Corporate                                    |       | 512             |       |
| Total pre-tax charges                        |       | $               | 918        |   |
|                                         |       |            |       |
| Charged to operations:                       |       |            |       |
| Cost of sales                                |       | $               | 406        |   |
| Selling, general and administrative expenses |       | 512             |       |
| Total pre-tax charges                        |       | $               | 918        |   |

** **

**The components of the restructuring, assetimpairment and other related charges are as follows:**

** **
| ** **                                  | ** ** | **Balance at**   | ** ** | ** **      | ** ** | ** **           | ** ** | ** **      | ** ** | **Balance at**  | ** ** |
|---------------------------------------------|------------|------------------|------------|-----------------|------------|----------------------|------------|-----------------|------------|-----------------|------------|
| ** **                                  | ** ** | **December 31,** | ** ** | **Total**       | ** ** | **Amounts Incurred** | ** ** | **March 31,**   | ** ** |
| ***(In thousands)***                        | ** ** | **2004**         | ** ** | **Charges**     | ** ** | **Noncash**          | ** ** | **Cash**        | ** ** | **2005**        | ** ** |
| ** **                                  | ** ** | ** **       | ** ** | **(Unaudited)** | ** ** | **(Unaudited)**      | ** ** | **(Unaudited)** | ** ** | **(Unaudited)** | ** ** |
| Lease termination and other related charges |       | $                | 2,401      |            | $          | —               |       | $               | —     |            | $          | (146 | ) | $ | 2,255 |   |
| Severance and other compensation costs      |       | 175              |       | 465             |       | —               |       | (71             | )          | 569             |       |
| Relocation costs expensed as incurred       |       | —           |       | 453             |       | —               |       | (453            | )          | —          |       |
| Other restructuring charges                 |       | 203              |       | —          |       | —               |       | (4              | )          | 199             |       |
| Total                                       |       | $                | 2,779      |            | $          | 918                  |       | $               | —     |            | $          | (674 | ) | $ | 3,023 |   |
|                                             |            |                  |            |                 |            |                      |            |                 |            |                 |            |  |  |  |  |  |  |

Restructuring-related expenses incurred by the Companythrough March 31, 2005 totaled $9,133,000. The Company expects to incur additional restructuring-related expensesof approximately $1,800,000 during the remainder of fiscal year 2005.  These expenses, which are primarilyrelocation, travel and lease termination costs, will be expensed as incurred.

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

 

6

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**Note 3.**           Inventories

Inventories are comprised of the following as ofMarch 31, 2005 and December 31, 2004:

 
| ** **                                                                   | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ***(In thousands)***                                                         | ** ** | **2005**           | ** ** | **2004**              | ** ** |
| *** ***                                                                 | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| Raw materials                                                                |       | $                  | 31,105     |                  | $          | 29,421 |   |
| Work-in-process                                                              |       | 20,961             |       | 18,345                |       |
| Finished goods                                                               |       | 1,642              |       | 1,461                 |       |
| Costs and estimated earnings in excess of billings on uncompleted  contracts |       | 826                |       | 2,026                 |       |
| Total inventories                                                            |       | $                  | 54,534     |                  | $          | 51,253 |   |
|                                                                              |            |                    |            |                       |            |  |  |  |

Total costs and estimated earnings on all uncompletedcontracts as of March 31, 2005 and December 31, 2004 are comprised ofthe following:

 
| ** **                                                                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ***(In thousands)***                                                          | ** ** | **2005**           | ** ** | **2004**              | ** ** |
| *** ***                                                                  | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| Costs incurred on uncompleted contracts                                       |       | $                  | 7,168      |                  | $          | 20,083 |   |
| Estimated earnings recognized                                                 |       | 3,143              |       | 12,015                |       |
| Total costs and estimated earnings                                            |       | 10,311             |       | 32,098                |       |
| Less billings to date                                                         |       | (18,081            | )          | (34,263               | )          |
| Net                                                                           |       | $                  | (7,770     | )                     | $          | (2,165 | ) |
|                                                                          |       |               |       |                  |       |
| Balance sheet classification:                                                 |       |               |       |                  |       |
| Asset — Costs and estimated earnings in excess of billings               |       | $                  | 826        |                  | $          | 2,026 |   |
| Liability — Billings in excess of costs and estimated earnings (Note  5) |       | (8,596             | )          | (4,191                | )          |
| Net                                                                           |       | $                  | (7,770     | )                     | $          | (2,165 | ) |
|                                                                               |            |                    |            |                       |            |  |  |  |  |

 

**Note 4.**           OtherAssets, Principally Intangibles

Other assets are comprised of the following as ofMarch 31, 2005 and December 31, 2004:

 
| ** **                                              | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ***(In thousands)***                                    | ** ** | **2005**           | ** ** | **2004**              | ** ** |
| *** ***                                            | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| Identifiable intangible assets with finite useful lives |       | $                  | 20,903     |                  | $          | 21,805 |   |
| Deferred financing costs                                |       | 8,368              |       | 9,094                 |       |
| Other non-amortizable assets                            |       | 91                 |       | 556                   |       |
| Total other assets                                      |       | $                  | 29,362     |                  | $          | 31,455 |   |

** **

**7**

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** **

**IdentifiableIntangible Assets with Finite Useful Lives**

** **

Identifiable intangible assets with finite usefullives are comprised of the following as of March 31, 2005 andDecember 31, 2004:
| ** **                     | ** ** | **March 31, 2005 (Unaudited)** | ** ** | **December 31, 2004** | ** ** |
|--------------------------------|------------|--------------------------------|------------|----------------------------|------------|
| ** **                     | ** ** | ** **                     | ** ** | **Accumulated**            | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ***(In thousands)***           | ** ** | **Cost**                       | ** ** | **Amortization**           | ** ** | **Net** | ** ** | **Cost** | ** ** | **Amortization** | ** ** | **Net** | ** ** |
| FAA certifications             |       | $                              | 22,272     |                       | $          | (8,079 | ) | $ | 14,193 |   | $ | 22,272 |   | $ | (7,707 | ) | $ | 14,565 |   |
| Engineering drawings           |       | 7,645                          |       | (2,923                     | )          | 4,722 |   | 7,645 |   | (2,795 | ) | 4,850 |   |
| Other identifiable intangibles |       | 11,345                         |       | (9,357                     | )          | 1,988 |   | 11,345 |   | (8,955 | ) | 2,390 |   |
| Total identifiable intangibles |       | $                              | 41,262     |                       | $          | (20,359 | ) | $ | 20,903 |   | $ | 41,262 |   | $ | (19,457 | ) | $ | 21,805 |   |
|                                |            |                                |            |                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

Estimated annual amortization expense for allidentifiable intangible assets with finite useful lives for the five-year periodending December 31, 2009 is as follows: 2005 — $3,466,000; 2006 —$2,275,000; 2007 — $2,175,000; 2008 — $2,171,000; and 2009 — $2,164,000.

 

**Note 5.**           AccruedLiabilities

Accrued liabilities are comprised of the following asof March 31, 2005 and December 31, 2004:

 
| ** **                                                                   | ** ** | **March 31,**   | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------|------------|-----------------------|------------|
| ***(In thousands)***                                                         | ** ** | **2005**        | ** ** | **2004**              | ** ** |
| *** ***                                                                 | ** ** | **(Unaudited)** | ** ** | ** **            | ** ** |
| Billings in excess of costs and estimated earnings on uncompleted  contracts |       | $               | 8,596      |                  | $          | 4,191 |   |
| Salaries, wages, compensated absences and payroll related taxes              |       | 5,642           |       | 5,043                 |       |
| Accrued interest                                                             |       | 4,051           |       | 4,922                 |       |
| Current portion of accrued product warranty obligations                      |       | 2,509           |       | 2,445                 |       |
| Customer advances and deposits                                               |       | 1,265           |       | 1,992                 |       |
| Other accrued liabilities                                                    |       | 3,899           |       | 5,064                 |       |
| Total accrued liabilities                                                    |       | $               | 25,962     |                  | $          | 23,657 |   |

 

8

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**Note 6.**           Short-TermBorrowings and Long-Term Debt

** **

Short-term borrowings and long-term debt is comprisedof the following amounts as of March 31, 2005 and December 31, 2004:

 

| ** **                                                                   | ** ** | **March 31,**   | ** **   | **December 31,** | ** ** |
|------------------------------------------------------------------------------|------------|-----------------|--------------|-----------------------|------------|
| ***(In thousands)***                                                         | ** ** | **2005**        | ** **   | **2004**              | ** ** |
| *** ***                                                                 | ** ** | **(Unaudited)** | ** **   | ** **            | ** ** |
| First-lien credit facility:                                                  |       |            |         |                  |       |
| Term debt                                                                    |       | $               |  80,521 |                  | $          |  80,521 |   |
| Revolving line of credit                                                     |       | 13,400          |         | 12,550                |       |
| Second-lien term debt                                                        |       | 83,143          |         | 82,526                |       |
| 17% senior discount notes                                                    |       | 72,744          |         | 69,895                |       |
| 13.5% senior unsecured promissory notes payable to related parties           |       | 7,500           |         | 5,000                 |       |
| Capital lease obligations and other debt, secured by property and  equipment |       | 7,335           |         | 7,662                 |       |
| 12% senior subordinated notes                                                |       | 35,000          |         | 35,000                |       |
| Total short-term borrowings and long-term debt                               |       | 299,643         |         | 293,154               |       |
| Less short-term borrowings and current portion of long-term debt             |       | (29,086         | )            | (1,314                | )          |
| Long-term debt, less current portion                                         |       | $               | 270,557      |                  | $          |  291,840 |   |

 

In March 2005, the Company amended an existing loanagreement and entered into a new loan agreement with DLJ Merchant BankingPartners II, L.P. and affiliated funds, who are stockholders of DeCrane Holdingand, as a result, related parties.  Thedetails of these transactions are as follows:

•                  The maturity date of the existing$5,000,000 of 13.5% senior unsecured promissory notes was extended.  The notes are now due on March 31, 2006with interest payable on December 31, 2005 and at maturity.

•                  The Company entered into anew loan agreement which provides for up to $5,000,000 of additional borrowingsat rates and with terms identical to the existing 13.5% senior unsecuredpromissory notes, as amended.  As ofMarch 31, 2005, the Company had borrowed $2,500,000 pursuant to this agreementand borrowing of the remainder, if needed, is subject to customary conditionsincluding absence of a material adverse change in the Company’s business.

A portion of the interest charged on the second-lienterm debt and all of the interest charged on the 17% senior discount notes ispay-in-kind or “accreted” interest, payable at maturity.  An additional $3,466,000 of interest accretedto the principal balances of the term debt and notes during the three monthsended March 31, 2005.

As of March 31, 2005, the Company had irrevocablestandby letters of credit in the amount of $263,000 issued and outstandingunder the credit facility, which reduces borrowings available under the$24,000,000 revolving line of credit.

 

9

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**Note 7.**           MandatorilyRedeemable Preferred Stock

 

The table below summarizes the increase in mandatorilyredeemable preferred stock during the three months ended March 31, 2005.

 
| ** **                                                   | ** ** | **Number** | ** ** | **Mandatory**  | ** ** | **Net**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|----------------|------------|-----------|------------|
| ** **                                                   | ** ** | **of**     | ** ** | **Redemption** | ** ** | **Book**  | ** ** |
| ***(In thousands, except share and per share data)***        | ** ** | **Shares** | ** ** | **Value**      | ** ** | **Value** | ** ** |
| Balance, December 31, 2004                              |       | 250,000    |       | $              | 47,303     |      | $          | 47,303 |   |
| Issuance of additional shares (Unaudited)                    |       | 26,425     |       | 5,000          |       | 5,000     |       |
| Balance, March 31, 2005 (Unaudited)                          |       | 276,425    |       | $              | 52,303     |      | $          | 52,303 |   |
|                                                         |       |       |       |           |       |      |       |
| Per share liquidation value as of March 31, 2005 (Unaudited) |       | $          | 189.21     |           |       |      |       |   |
|                                                              |            |            |            |                |            |           |            |  |  |  |

 

In March 2005, the Company received $5,000,000 ofproceeds from the issuance of 26,425 additional shares of its Senior RedeemableExchangeable Preferred Stock due 2008 (“Preferred Stock”) to DLJ Merchant BankingPartners II, L.P. and affiliated funds, who are stockholders of DeCrane Holdingand, as a result, related parties.

During the third quarter of fiscal year 2004, theCompany amended the terms of its Preferred Stock.  The amended terms provide that further PreferredStock dividends, if any, accrue at rates dependent on a specified financialratio or if certain triggering events occur. All dividends accrued through the amendment date and future dividends,if any, are not payable until redemption. The amendment accelerates the mandatory redemption date from March 31,2009 to December 31, 2008 and adds several restrictive covenants.

The holders of the Preferred Stock were issued 348,945shares of DeCrane Holdings common stock in connection with the amendment.  The common stock had a nominal fair marketvalue on the issuance date and was therefore recorded at its $0.01 per sharepar value.

**Preferred Stock 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.  If certain triggering eventsoccur, such as failure to discharge any mandatory redemption obligations orcomply with certain restrictive covenants, dividends accrue at a 16% annualrate.  Based upon the leverage ratioachieved as of the March 31, 2005 testing date, no dividends have or willaccrue on the Preferred Stock through June 30, 2005, the next quarterly testingdate.

 

10

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**Note 8.**           IncomeTaxes

The components of the provisions for income taxes areas follows:

 
| ** **                                  | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------|------------|------------------------|------------|
| ** **                                  | ** ** | **March 31,**          | ** ** |
| ***(In thousands)***                        | ** ** | **2005**               | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | **(Unaudited)**        | ** ** |
| Total provision for income taxes:           |       |                   |       |   |   |
| Income tax benefit based on pre-tax loss    |       | $                      | (3,005     | ) | $ | (2,524 | ) |
| Net deferred tax assets valuation allowance |       | 4,716                  |       | 2,554 |   |
| Net provision for income taxes              |       | $                      | 1,711      |   | $ | 30 |   |

 

For the three months ended March 31, 2005, the incometax benefit, based on the reported consolidated pre-tax loss, differs from theamount determined by applying the applicable U.S. statutory federal rate to thepre-tax loss primarily due to the effects of state and foreign income taxes andnon-deductible expenses.

For the three months ended March 31, 2004, the incometax benefit, based on the reported consolidated pre-tax loss, differs from theamount determined by applying the applicable U.S. statutory federal rate to thepre-tax loss primarily due to the effects of state and foreign income taxes andnon-deductible expenses, principally Preferred Stock dividends.

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 three months ended March 31, 2005, the Companydetermined that an additional $4,716,000 valuation allowance was required as ofthat date.  The Company had a netdeferred tax asset of $35,574,000 and $32,519,000, offset by a valuationallowance of $38,945,000 and $34,229,000, respectively, as of March 31,2005 and December 31, 2004, respectively.

 

**Note 9.**           Commitmentsand Contingencies

**Litigation**

The Company and its subsidiaries are involved inroutine legal and administrative proceedings incident to the normal conduct ofbusiness.  Management believes theultimate disposition of all such matters will not have a material adverseeffect on the Company’s business, consolidated financial position, results ofoperations or cash flows.

 

11

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**Fundingof DeCrane Holdings Preferred Stock Obligations**

The Company is a wholly owned subsidiary of DeCraneHoldings whose capital structure also includes mandatorily redeemable preferredstock.  Since the Company is DeCraneHoldings’ only operating subsidiary and source of cash, the Company may berequired to fund DeCrane Holdings’ preferred stock dividend and redemptionobligations in the future.

Dividends on the DeCrane Holdings preferred stock, ifany, are dependent upon the leverage ratio (as defined) achieved as of eachquarterly testing date.  Depending on theratio achieved, dividends for the succeeding quarter accrue at a 0%, 3.5% or14% annual rate.  Based upon the leverageratio as of March 31, 2005, no dividends will accrue on the DeCraneHoldings preferred stock during the three months ending June 30, 2005, thenext quarterly testing date.  All futuredividends, if any, are not payable until September 30, 2009, the DeCraneHoldings mandatory preferred stock redemption date.  The DeCrane Holdings preferred stock has atotal redemption value of $77,172,000 as of March 31, 2005, includingaccumulated dividends.

 

**Note 10.**         BusinessSegment Information

The Company supplies products and services to thebusiness, VIP and head-of-state aircraft market within the aerospaceindustry.  The Company’s subsidiaries areorganized into two groups, each of which is a strategic business that develops,manufactures and sells distinct products and services.  The groups and a description of theirbusinesses 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 authorizedcompletion and service center.

Management utilizes more than one measurement toevaluate group performance and allocate resources; however, managementconsiders Adjusted EBITDA, as defined hereinafter, to be the primarymeasurement of a group’s overall core economic performance and return oninvested capital.  Management also usesAdjusted EBITDA in the Company’s annual budget and planning process for futureperiods, as one of the decision-making criteria for funding discretionarycapital expenditures and product development programs and as the measure indetermining the value of acquisitions and dispositions.  The board of directors uses Adjusted EBITDAas one of the performance metrics for determining the amount of bonuses awardedpursuant to the Company’s cash incentive bonus plan and as an indicator ofenterprise value used in determining the exercise price of stock optionsgranted and the acceleration of stock option vesting pursuant to the Company’sincentive stock option plan.

Management 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 one 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

 

12

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Company’s resultswith those of other companies that have different financing, capital structuresand 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 with GAAP, such as net loss, the nearest comparable GAAPfinancial measure.  A reconciliation ofAdjusted EBITDA to net loss is included herein to clarify the differencesbetween these financial measures.

The accounting policies of the groups aresubstantially the same as those of the Company. Some transactions are recorded at the Company’s corporate headquartersand are not allocated to the groups, such as most of the Company’s cash, debtand related net interest expense, corporate headquarters costs and incometaxes.

 

13

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The tables below summarize selected financial data bybusiness segment.

 
| ** **                    | ** ** | **Three Months Ended** | ** ** |
|-------------------------------|------------|------------------------|------------|
| ** **                    | ** ** | **March 31,**     | ** ** |
| ***(In thousands)***          | ** ** | **2005**               | ** ** | **2004** | ** ** |
| ** **                    | ** ** | **(Unaudited)**        | ** ** |
| Revenues:                     |       |                   |       |   |   |
| Cabin Management              |       | $                      | 45,356     |   | $ | 34,338 |   |
| Systems Integration           |       | 11,398                 |       | 14,531 |   |
| Inter-group elimination (1)   |       | (133                   | )          | (272 | ) |
| Consolidated totals           |       | $                      | 56,621     |   | $ | 48,597 |   |
|                          |       |                   |       |   |   |
| Adjusted EBITDA (as defined): |       |                   |       |   |   |
| Cabin Management              |       | $                      | 6,283      |   | $ | 3,440 |   |
| Systems Integration           |       | 1,872                  |       | 3,029 |   |
| Corporate (2)                 |       | (983                   | )          | (1,093 | ) |
| Inter-group elimination (3)   |       | —                 |       | 3 |   |
| Consolidated totals           |       | 7,172                  |       | 5,379 |   |
| Reconciling items (4)         |       | (16,248                | )          | (14,527 | ) |
| Net loss                      |       | $                      | (9,076     | ) | $ | (9,148 | ) |
|                               |            |                        |            |  |  |  |  |  |  |  |

** **
| ** **                       | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|--------------------|------------|-----------------------|------------|
| ***(In thousands)***             | ** ** | **2005**           | ** ** | **2004**              | ** ** |
| ** **                       | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| Total assets (as of period end): |       |               |       |                  |       |
| Cabin Management                 |       | $                  | 237,117    |                  | $          | 231,822 |   |
| Systems Integration              |       | 62,160             |       | 56,115                |       |
| Corporate (5)                    |       | 12,010             |       | 12,095                |       |
| Inter-group elimination (6)      |       | (27                | )          | (39                   | )          |
| Consolidated totals              |       | $                  | 311,260    |                  | $          | 299,993 |   |
|                                  |            |                    |            |                       |            |  |  |  |  |

----

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

(2)                      Reflects the Company’s corporateheadquarters costs and expenses not allocated to the groups.

(3)                      Reflects elimination of the effect ofinter-group profits in inventory.

 

14

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

 
| ** **                                                                    | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                    | ** ** | **March 31,**     | ** ** |
| ***(In thousands)***                                                          | ** ** | **2005**               | ** ** | **2004** | ** ** |
| *** ***                                                                  | ** ** | **(Unaudited)**        | ** ** |
| Depreciation and amortization of long-lived assets (a)                        |       | $                      | (2,207     | ) | $ | (2,326 | ) |
| Adjustment to reflect program costs as research and development  expenses (b) |       | (999                   | )          | (1,616 | ) |
| Restructuring, asset impairment and other related charges                     |       | (918                   | )          | — |   |
| Other cash and noncash charges                                                |       | (9                     | )          | (9 | ) |
| Interest expense                                                              |       | (10,225                | )          | (8,702 | ) |
| Mandatorily redeemable preferred stock dividends                              |       | —                 |       | (1,732 | ) |
| Other expenses, net                                                           |       | (179                   | )          | (112 | ) |
| Provision for income taxes                                                    |       | (1,711                 | )          | (30 | ) |
| Total reconciling items                                                       |       | $                      | (16,248    | ) | $ | (14,527 | ) |

----

(a)                      Reflects depreciation and amortization oflong-lived assets and amortization of deferred financing costs, which areclassified as a component of interest expense, as follows:

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|
| ** **                                         | ** ** | **March 31,**     | ** ** |
| ***(In thousands)***                               | ** ** | **2005**               | ** ** | **2004** | ** ** |
| ** **                                         | ** ** | **(Unaudited)**        | ** ** |
| Depreciation and amortization of long-lived assets |       | $                      | 2,207      |   | $ | 2,326 |   |
| Amortization of deferred financing costs           |       | 817                    |       | 790 |   |
| Consolidated depreciation and amortization         |       | $                      | 3,024      |   | $ | 3,116 |   |
|                                                    |            |                        |            |  |  |  |  |  |

(b)                     Under program accounting, which the Company isrequired to use for determining covenant compliance under its creditagreements, certain product development costs incurred in connection withspecific contracted programs are deferred and charged to cost of sales asrevenues related to the program are recognized. For financial reporting purposes, these costs are charged to researchand development expense as incurred. This adjustment reflects the net difference between these two methods ofaccounting.

(5)                      Reflects the Company’s corporateheadquarters assets, excluding investments in and notes receivable fromsubsidiaries.

(6)                      Reflects elimination of inter-groupreceivables and profits in inventory as of period end.

 

15

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**Note 11.**         SupplementalCondensed Consolidating Financial Information

In conjunction with the 12% and 17% notes described inNote 6, the following condensed consolidating financial information ispresented segregating the Company, as the issuer, and the guarantorsubsidiaries.  The accompanying financialinformation in the guarantor subsidiaries column reflects the financialposition, results of operations and cash flows for those subsidiariesguaranteeing the notes.

The guarantor subsidiaries are wholly-ownedsubsidiaries of the Company and their guarantees are full and unconditional ona joint and several basis.  There are norestrictions on the ability of the guarantor subsidiaries to transfer funds tothe issuer in the form of cash dividends, loans or advances.  Separate financial statements of theguarantor subsidiaries are not presented because management believes that suchfinancial statements would not be material to investors.  Investments in subsidiaries in the followingcondensed consolidating financial information are accounted for under theequity method of accounting. Consolidating adjustments include the following:

(1)                      Elimination ofinvestments in subsidiaries.

(2)                      Elimination ofintercompany accounts.

(3)                      Elimination ofequity in earnings of subsidiaries.

 

16

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**BalanceSheets**

 
| ** **                                       | ** ** | **March 31, 2005 (Unaudited)** | ** ** |
|--------------------------------------------------|------------|--------------------------------|------------|
| ** **                                       | ** ** | ** **                     | ** ** | **Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ***(In thousands)***                             | ** ** | **Issuer**                     | ** ** | **Subsidiaries** | ** ** | **Adjustments** | ** ** | **Total** | ** ** |
|                                             |       |                           |       |   |   |   |   |   |   |
| **Assets**                                       |       |                           |       |   |   |   |   |   |   |
|                                             |       |                           |       |   |   |   |   |   |   |
| Current assets:                                  |       |                           |       |   |   |   |   |   |   |
| Cash                                             |       | $                              | 1,371      |   | $ | 893 |   | $ | — |   | $ | 2,264 |   |
| Accounts receivable, net                         |       | —                         |       | 34,385 |   | — |   | 34,385 |   |
| Inventories                                      |       | —                         |       | 54,534 |   | — |   | 54,534 |   |
| Prepaid expenses and other current assets        |       | 24                             |       | 1,327 |   | — |   | 1,351 |   |
| Total current assets                             |       | 1,395                          |       | 91,139 |   | — |   | 92,534 |   |
|                                             |       |                           |       |   |   |   |   |   |   |
| Property and equipment, net                      |       | 647                            |       | 26,287 |   | — |   | 26,934 |   |
| Other assets, principally goodwill               |       | 9,968                          |       | 181,824 |   | — |   | 191,792 |   |
| Investments in subsidiaries                      |       | 77,050                         |       | — |   | (77,050 | )(1) | — |   |
| Intercompany receivables                         |       | 225,564                        |       | 52,740 |   | (278,304 | )(2) | — |   |
| Total assets                                     |       | $                              | 314,624    |   | $ | 351,990 |   | $ | (355,354 | ) | $ | 311,260 |   |
|                                             |       |                           |       |   |   |   |   |   |   |
| **Liabilities and Stockholder’s Deficit**   |       |                           |       |   |   |   |   |   |   |
|                                             |       |                           |       |   |   |   |   |   |   |
| Current liabilities:                             |       |                           |       |   |   |   |   |   |   |
| Current portion of long-term debt                |       | $                              | 27,852     |   | $ | 1,234 |   | $ | — |   | $ | 29,086 |   |
| Other current liabilities                        |       | 8,922                          |       | 37,815 |   | — |   | 46,737 |   |
| Total current liabilities                        |       | 36,774                         |       | 39,049 |   | — |   | 75,823 |   |
|                                             |       |                           |       |   |   |   |   |   |   |
| Long-term debt                                   |       | 264,542                        |       | 6,015 |   | — |   | 270,557 |   |
| Mandatorily redeemable preferred stock           |       | 52,303                         |       | — |   | — |   | 52,303 |   |
| Deferred income taxes                            |       | 3,371                          |       | — |   | — |   | 3,371 |   |
| Intercompany payables                            |       | 52,740                         |       | 225,564 |   | (278,304 | )(2) | — |   |
| Other long-term liabilities                      |       | 1,477                          |       | 4,312 |   | — |   | 5,789 |   |
|                                             |       |                           |       |   |   |   |   |   |   |
| Stockholder’s deficit:                      |       |                           |       |   |   |   |   |   |   |
| Additional paid-in capital                       |       | 111,648                        |       | 151,492 |   | (151,492 | )(1) | 111,648 |   |
| Accumulated deficit                              |       | (208,231                       | )          | (74,442 | ) | 74,442 |  (1) | (208,231 | ) |
| Total stockholder’s deficit                 |       | (96,583                        | )          | 77,050 |   | (77,050 | ) | (96,583 | ) |
| Total liabilities and stockholder’s deficit |       | $                              | 314,624    |   | $ | 351,990 |   | $ | (355,354 | ) | $ | 311,260 |   |
|                                                  |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

17

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| ** **                                       | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | ** **            | ** ** | **Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ***(In thousands)***                             | ** ** | **Issuer**            | ** ** | **Subsidiaries** | ** ** | **Adjustments** | ** ** | **Total** | ** ** |
|                                             |       |                  |       |   |   |   |   |   |   |
| **Assets**                                       |       |                  |       |   |   |   |   |   |   |
|                                             |       |                  |       |   |   |   |   |   |   |
| Current assets:                                  |       |                  |       |   |   |   |   |   |   |
| Cash                                             |       | $                     | 622        |   | $ | 357 |   | $ | — |   | $ | 979 |   |
| Accounts receivable, net                         |       | —                |       | 25,367 |   | — |   | 25,367 |   |
| Inventories                                      |       | —                |       | 51,253 |   | — |   | 51,253 |   |
| Prepaid expenses and other current assets        |       | 33                    |       | 911 |   | — |   | 944 |   |
| Total current assets                             |       | 655                   |       | 77,888 |   | — |   | 78,543 |   |
|                                             |       |                  |       |   |   |   |   |   |   |
| Property and equipment, net                      |       | 746                   |       | 26,819 |   | — |   | 27,565 |   |
| Other assets, principally goodwill               |       | 10,694                |       | 183,191 |   | — |   | 193,885 |   |
| Investments in subsidiaries                      |       | 77,758                |       | — |   | (77,758 | )(1) | — |   |
| Intercompany receivables                         |       | 223,068               |       | 55,307 |   | (278,375 | )(2) | — |   |
| Total assets                                     |       | $                     | 312,921    |   | $ | 343,205 |   | $ | (356,133 | ) | $ | 299,993 |   |
|                                             |       |                  |       |   |   |   |   |   |   |
| **Liabilities and Stockholder’s Deficit**   |       |                  |       |   |   |   |   |   |   |
|                                             |       |                  |       |   |   |   |   |   |   |
| Current liabilities:                             |       |                  |       |   |   |   |   |   |   |
| Current portion of long-term debt                |       | $                     | 48         |   | $ | 1,266 |   | $ | — |   | $ | 1,314 |   |
| Other current liabilities                        |       | 8,932                 |       | 31,391 |   | — |   | 40,323 |   |
| Total current liabilities                        |       | 8,980                 |       | 32,657 |   | — |   | 41,637 |   |
|                                             |       |                  |       |   |   |   |   |   |   |
| Long-term debt                                   |       | 285,538               |       | 6,302 |   | — |   | 291,840 |   |
| Mandatorily redeemable preferred stock           |       | 47,303                |       | — |   | — |   | 47,303 |   |
| Deferred income taxes                            |       | 1,710                 |       | — |   | — |   | 1,710 |   |
| Intercompany payables                            |       | 55,307                |       | 223,068 |   | (278,375 | )(2) | — |   |
| Other long-term liabilities                      |       | 1,590                 |       | 3,420 |   | — |   | 5,010 |   |
|                                             |       |                  |       |   |   |   |   |   |   |
| Stockholder’s deficit:                      |       |                  |       |   |   |   |   |   |   |
| Additional paid-in capital                       |       | 111,648               |       | 151,492 |   | (151,492 | )(1) | 111,648 |   |
| Accumulated deficit                              |       | (199,155              | )          | (73,734 | ) | 73,734 |  (1) | (199,155 | ) |
| Total stockholder’s deficit                 |       | (87,507               | )          | 77,758 |   | (77,758 | ) | (87,507 | ) |
| Total liabilities and stockholder’s deficit |       | $                     | 312,921    |   | $ | 343,205 |   | $ | (356,133 | ) | $ | 299,993 |   |
|                                                  |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

18

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**Statementsof Operations**

 
| ** **                                   | ** ** | **Three Months Ended March 31, 2005 (Unaudited)** | ** ** |
|----------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                   | ** ** | ** **                                        | ** ** | **Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ***(In thousands)***                         | ** ** | **Issuer**                                        | ** ** | **Subsidiaries** | ** ** | **Adjustments** | ** ** | **Total** | ** ** |
|                                         |       |                                              |       |   |   |   |   |   |   |
| Revenues                                     |       | $                                                 | —     |   | $ | 56,621 |   | $ | — |   | $ | 56,621 |   |
| Cost of sales                                |       | —                                            |       | 43,638 |   | — |   | 43,638 |   |
|                                         |       |                                              |       |   |   |   |   |   |   |
| Gross profit                                 |       | —                                            |       | 12,983 |   | — |   | 12,983 |   |
|                                         |       |                                              |       |   |   |   |   |   |   |
| Operating and other expenses (income):       |       |                                              |       |   |   |   |   |   |   |
| Selling, general and administrative expenses |       | 1,620                                             |       | 5,846 |   | — |   | 7,466 |   |
| Research and development expenses            |       | —                                            |       | 1,566 |   | — |   | 1,566 |   |
| Amortization of intangible assets            |       | —                                            |       | 912 |   | — |   | 912 |   |
| Interest expense                             |       | 10,035                                            |       | 190 |   | — |   | 10,225 |   |
| Intercompany charges                         |       | (5,668                                            | )          | 5,668 |   | — |   | — |   |
| Equity in loss of subsidiaries               |       | 708                                               |       | — |   | (708 | )(3) | — |   |
| Other expenses (income), net                 |       | 212                                               |       | (33 | ) | — |   | 179 |   |
| Provision for income taxes (benefit)         |       | 2,169                                             |       | (458 | ) | — |   | 1,711 |   |
| Total operating and other expense, net       |       | 9,076                                             |       | 13,691 |   | (708 | ) | 22,059 |   |
|                                         |       |                                              |       |   |   |   |   |   |   |
| Net loss                                     |       | $                                                 | (9,076     | ) | $ | (708 | ) | $ | 708 |   | $ | (9,076 | ) |

 

 
| ** **                                       | ** ** | **Three Months Ended March 31, 2004 (Unaudited)** | ** ** |
|--------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                       | ** ** | ** **                                        | ** ** | **Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ***(In thousands)***                             | ** ** | **Issuer**                                        | ** ** | **Subsidiaries** | ** ** | **Adjustments** | ** ** | **Total** | ** ** |
|                                             |       |                                              |       |   |   |   |   |   |   |
| Revenues                                         |       | $                                                 | —     |   | $ | 48,597 |   | $ | — |   | $ | 48,597 |   |
| Cost of sales                                    |       | —                                            |       | 36,839 |   | — |   | 36,839 |   |
|                                             |       |                                              |       |   |   |   |   |   |   |
| Gross profit                                     |       | —                                            |       | 11,758 |   | — |   | 11,758 |   |
|                                             |       |                                              |       |   |   |   |   |   |   |
| Operating and other expenses (income):           |       |                                              |       |   |   |   |   |   |   |
| Selling, general and administrative expenses     |       | 1,198                                             |       | 6,039 |   | — |   | 7,237 |   |
| Research and development expenses                |       | —                                            |       | 2,181 |   | — |   | 2,181 |   |
| Amortization of intangible assets                |       | —                                            |       | 912 |   | — |   | 912 |   |
| Interest expense                                 |       | 8,516                                             |       | 186 |   | — |   | 8,702 |   |
| Mandatorily redeemable preferred stock dividends |       | 1,732                                             |       | — |   | — |   | 1,732 |   |
| Intercompany charges                             |       | (5,257                                            | )          | 5,257 |   | — |   | — |   |
| Equity in loss of subsidiaries                   |       | 1,706                                             |       | — |   | (1,706 | )(3) | — |   |
| Other expenses (income), net                     |       | 118                                               |       | (6 | ) | — |   | 112 |   |
| Provision for income taxes (benefit)             |       | 1,135                                             |       | (1,105 | ) | — |   | 30 |   |
| Total operating and other expense, net           |       | 9,148                                             |       | 13,464 |   | (1,706 | ) | 20,906 |   |
|                                             |       |                                              |       |   |   |   |   |   |   |
| Net loss                                         |       | $                                                 | (9,148     | ) | $ | (1,706 | ) | $ | 1,706 |   | $ | (9,148 | ) |
|                                                  |            |                                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

19

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**Statementsof Cash Flows**

 
| ** **                                                       | ** ** | **Three Months Ended March 31, 2005 (Unaudited)** | ** ** |
|------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                       | ** ** | ** **                                        | ** ** | **Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ***(In thousands)***                                             | ** ** | **Issuer**                                        | ** ** | **Subsidiaries** | ** ** | **Adjustments** | ** ** | **Total** | ** ** |
|                                                             |       |                                              |       |   |   |   |   |   |   |
| **Cash flows from operating activities:**                        |       |                                              |       |   |   |   |   |   |   |
| Net loss                                                         |       | $                                                 | (9,076     | ) | $ | (708 | ) | $ | 708 |   | $ | (9,076 | ) |
| Noncash adjustments:                                             |       |                                              |       |   |   |   |   |   |   |
| Equity in loss of subsidiaries                                   |       | 708                                               |       | — |   | (708 | )(3) | — |   |
| Other noncash adjustments                                        |       | 6,057                                             |       | 2,105 |   | — |   | 8,162 |   |
| Changes in working capital                                       |       | (5,163                                            | )          | 105 |   | — |   | (5,058 | ) |
| Net cash provided by (used for) operating activities             |       | (7,474                                            | )          | 1,502 |   | — |   | (5,972 | ) |
| **Cash flows from investing activities:**                        |       |                                              |       |   |   |   |   |   |   |
| Capital expenditures                                             |       | (18                                               | )          | (657 | ) | — |   | (675 | ) |
| Net cash used for investing activities                           |       | (18                                               | )          | (657 | ) | — |   | (675 | ) |
|                                                             |       |                                              |       |   |   |   |   |   |   |
| **Cash flows from financing activities:**                        |       |                                              |       |   |   |   |   |   |   |
| Proceeds from issuance of mandatorily redeemable preferred stock |       | 5,000                                             |       | — |   | — |   | 5,000 |   |
| Debt borrowings:                                                 |       |                                              |       |   |   |   |   |   |   |
| Revolving line of credit, net                                    |       | 850                                               |       | — |   | — |   | 850 |   |
| Short-term promissory notes                                      |       | 2,500                                             |       | — |   | — |   | 2,500 |   |
| Other secured long-term debt repayments                          |       | (18                                               | )          | (309 | ) | — |   | (327 | ) |
| Deferred financing costs                                         |       | (91                                               | )          | — |   | — |   | (91 | ) |
| Net cash provided by (used for) financing activities             |       | 8,241                                             |       | (309 | ) | — |   | 7,932 |   |
|                                                             |       |                                              |       |   |   |   |   |   |   |
| Net increase in cash                                             |       | 749                                               |       | 536 |   | — |   | 1,285 |   |
| Cash at beginning of period                                      |       | 622                                               |       | 357 |   | — |   | 979 |   |
|                                                             |       |                                              |       |   |   |   |   |   |   |
| Cash at end of period                                            |       | $                                                 | 1,371      |   | $ | 893 |   | $ | — |   | $ | 2,264 |   |
|                                                                  |            |                                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

20

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| ** **                                           | ** ** | **Three Months Ended March 31, 2004 (Unaudited)** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                           | ** ** | ** **                                        | ** ** | **Guarantor** | ** ** | **Consolidating** | ** ** | **Consolidated** | ** ** |
| ***(In thousands)***                                 | ** ** | **Issuer**                                        | ** ** | **Subsidiaries** | ** ** | **Adjustments** | ** ** | **Total** | ** ** |
|                                                 |       |                                              |       |   |   |   |   |   |   |
| **Cash flows from operating activities:**            |       |                                              |       |   |   |   |   |   |   |
| Net loss                                             |       | $                                                 | (9,148     | ) | $ | (1,706 | ) | $ | 1,706 |   | $ | (9,148 | ) |
| Noncash adjustments:                                 |       |                                              |       |   |   |   |   |   |   |
| Equity in loss of subsidiaries                       |       | 1,706                                             |       | — |   | (1,706 | )(3) | — |   |
| Other noncash adjustments                            |       | 3,322                                             |       | 2,259 |   | — |   | 5,581 |   |
| Changes in working capital                           |       | (9,058                                            | )          | 297 |   | — |   | (8,761 | ) |
| Net cash provided by (used for) operating activities |       | (13,178                                           | )          | 850 |   | — |   | (12,328 | ) |
| **Cash flows from investing activities:**            |       |                                              |       |   |   |   |   |   |   |
| Capital expenditures                                 |       | —                                            |       | (504 | ) | — |   | (504 | ) |
| Net cash used for investing activities               |       | —                                            |       | (504 | ) | — |   | (504 | ) |
| **Cash flows from financing activities:**            |       |                                              |       |   |   |   |   |   |   |
| Debt borrowings:                                     |       |                                              |       |   |   |   |   |   |   |
| Revolving line of credit, net                        |       | 8,850                                             |       | — |   | — |   | 8,850 |   |
| Other secured long-term debt                         |       | —                                            |       | 46 |   | — |   | 46 |   |
| Other secured long-term debt repayments              |       | (3                                                | )          | (308 | ) | — |   | (311 | ) |
| Net cash provided by (used for) financing activities |       | 8,847                                             |       | (262 | ) | — |   | 8,585 |   |
|                                                 |       |                                              |       |   |   |   |   |   |   |
| Net increase (decrease) in cash                      |       | (4,331                                            | )          | 84 |   | — |   | (4,247 | ) |
| Cash at beginning of period                          |       | 6,540                                             |       | 396 |   | — |   | 6,936 |   |
|                                                 |       |                                              |       |   |   |   |   |   |   |
| Cash at end of period                                |       | $                                                 | 2,209      |   | $ | 480 |   | $ | — |   | $ | 2,689 |   |
|                                                      |            |                                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

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**ITEM 2.****                         ****MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

The following discussions should be read inconjunction with our financial statements and accompanying notes included inthis 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 is 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, theirimportance to us and potential significance to investors, are described below.

**Adjusted EBITDA.**  Our discussionof the results of operations includes the use of financial measures determinedin accordance with accounting principles generally accepted in the UnitedStates of America (“GAAP”) as well as the financial measure Adjusted EBITDA,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,“Disclosures about Segments of an Enterprise and Related Information,” whichrequires us to report the primary measure of segment performance we use toevaluate and manage our businesses.

We utilize more than one measurement to evaluatesegment performance and allocate resources among our operating segments; however,we consider Adjusted EBITDA, as defined below, to be the primary measurement ofoverall operating segment core economic performance and return on investedcapital.  We also use Adjusted EBITDA inour annual budgeting and planning for future periods, as one of thedecision-making criteria for funding discretionary capital expenditure andproduct development programs and as the measure for determining the value ofacquisitions and dispositions.  Our boardof 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 those of other companies that have different financing,capital structures and tax rates.  Inaddition, we believe these measures are consistent with the manner in which ourlenders and investors measure our overall performance and liquidity, includingour ability to service debt and fund discretionary capital expenditure andproduct development programs.

Our method of calculating Adjusted EBITDA may not beconsistent with that of other companies and should be viewed in conjunctionwith measurements that are computed in accordance with GAAP, such as net loss,the nearest comparable GAAP financial measure. Adjusted EBITDA should not be viewed as a substitute for or superior tonet loss, cash flow from operations or other data prepared in accordance withGAAP as a measure of our profitability or liquidity.  The notes to our financial

 

22

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statements includeinformation about our operating segments, including Adjusted EBITDA, and shouldbe read in conjunction with the discussions presented herein.  The notes to our financial statements alsoinclude a reconciliation of Adjusted EBITDA to net loss to clarify thedifferences 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.

### **Restructuring, AssetImpairment and Other Related Charges**

Our results of operations for 2005 have been affectedby restructuring and other related charges pertaining to a series ofrestructuring activities.  These charges,which affect the comparability of our reported results of operations betweenperiods, are more fully described in “—Restructuring, Asset Impairment andOther Related Charges” below.

### **Three Months Ended March31, 2005 Compared to Three Months Ended March 31, 2004**

**Revenues.* ***Revenues increased $8.0 million, or16.5%, to $56.6 million for the three months ended March 31, 2005 from$48.6 million for the three months ended March 31, 2004.  By segment, revenues changed as follows:

 
| ** **              | ** ** | **Increase (Decrease)** | ** ** |
|-------------------------|------------|-------------------------|------------|
| ** **              | ** ** | **from 2004**           | ** ** |
| ***(In millions)***     | ** ** | **Amount**              | ** ** | **Percent** | ** ** |
|                    |       |                    |       |   |   |
| Cabin Management        |       | $                       | 11.0       |   | 32.1 | % |
| Systems Integration     |       | (3.1                    | )          | (21.6 | ) |
| Inter-group elimination |       | 0.1                     |       |   |   |
| Total                   |       | $                       | 8.0        |   |   |   |

*Cabin Management. *Revenues increased by $11.0 million, or 32.1%,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 $9.1 million increase in aircraft furniture and related productsrevenues;

•                  a $0.9 million increase in cabin management and entertainment systemsrevenues; and

•                  a $1.1 million increase in seating products revenues; offset by

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

*Systems Integration.* Revenues decreased by $3.1 million, or 21.6%, compared to the prioryear, due to:

•                  a $5.6 million decrease in revenues from auxiliary fuel systemspursuant to our supply contract with Boeing Business Jet (“BBJ”), which ceasedto be a take-or-pay contract in 2004; offset by

•                  a $2.2 million increase in aircraft completion and service centerrevenues; and

 

23

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

**Gross profit.** Gross profit increased $1.2 million, or 10.4%, to $13.0 million for thethree months ended March 31, 2005 from $11.8 million for the same periodin the prior year.  By segment, grossprofit changed as follows:

 
| ** **          | ** ** | **Increase (Decrease)** | ** ** |
|---------------------|------------|-------------------------|------------|
| ** **          | ** ** | **from 2004**           | ** ** |
| ***(In millions)*** | ** ** | **Amount**              | ** ** | **Percent** | ** ** |
|                |       |                    |       |   |   |
| Cabin Management    |       | $                       | 2.6        |   | 37.2 | % |
| Systems Integration |       | (1.4                    | )          | (28.8 | ) |
| Total               |       | $                       | 1.2        |   |   |   |

*Cabin Management.* Gross profit increased by $2.6 million, or 37.2%, compared to the prioryear, primarily due to:

•                  a $1.8 million increase related to higher volume for our aircraftfurniture and related products;

•                  a $0.7 million increase in gross profit related to higher volume forour cabin management and entertainment systems; and

•                  a $0.1 million increase in gross profit related to our other products.

*Systems Integration.* Gross profit decreased by $1.4 million, or 28.8%, compared to the prioryear, primarily due to:

•                  a $1.2 million decrease resulting from lower revenues from auxiliaryfuel systems and a change in product delivery mix to lower margin products; and

•                  $0.3 million of restructuring charges incurred in 2005 related to thereorganization of our manufacturing operations; offset by

•                  a $0.1 million increase resulting from the increase in revenue fromcommercial aircraft integration kits and a change in delivery mix to highermargin products.

**Selling, general and administrativeexpenses.**  Selling, general and administrative(“SG&A”) expenses increased $0.2 million, or 3.2%, to $7.5 million for thethree months ended March 31, 2005, from $7.2 million for the same periodin the prior year.  By segment, SG&Aexpenses changed as follows:

 
| ** **          | ** ** | **Increase (Decrease)** | ** ** |
|---------------------|------------|-------------------------|------------|
| ** **          | ** ** | **from 2004**           | ** ** |
| ***(In millions)*** | ** ** | **Amount**              | ** ** | **Percent** | ** ** |
|                |       |                    |       |   |   |
| Cabin Management    |       | $                       | (0.3       | ) | (7.1 | )% |
| Systems Integration |       | 0.1                     |       | 5.1 |   |
| Corporate           |       | 0.4                     |       |   |   |
| Total               |       | $                       | 0.2        |   |   |   |

*CabinManagement. *SG&A expenses decreased by $0.3million, or 7.1%, compared to the prior year, primarily as a result of theconsolidation of the group’s headquarters as part of the operationalrealignment and facilities consolidation that commenced in the second quarterof 2004.

*SystemsIntegration. *SG&A expenses increased by $0.1million, or 5.1%, compared to the prior year, primarily as a result of highersales and marketing activities associated with the aircraft completion portionof our business.

 

24

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*Corporate. *SG&A expenses increased by $0.4 million compared tothe prior year due principally to restructuring charges incurred in 2005related to the relocation of the Company’s corporate office.

**Research and developmentexpenses. **Research anddevelopment expenses decreased $0.6 million, or 28.2%, to $1.6 million for thethree months ended March 31, 2005 compared to $2.2 million in the prioryear.  By segment, research and development expenses changedas follows:

 
| ** **          | ** ** | **Increase (Decrease)** | ** ** |
|---------------------|------------|-------------------------|------------|
| ** **          | ** ** | **from 2004**           | ** ** |
| ***(In millions)*** | ** ** | **Amount**              | ** ** | **Percent** | ** ** |
|                |       |                    |       |   |   |
| Cabin Management    |       | $                       | (1.1       | ) | (65.7 | )% |
| Systems Integration |       | 0.5                     |       | 104.8 |   |
| Total               |       | $                       | (0.6       | ) |   |   |

*Cabin Management. *R&D expenses decreased by $1.1 million, or 65.7%,compared to the prior year.  The decreaseis primarily related to the near completed development of our new single-designseat technology and the design and engineering of new interior furnishingcomponents for a customer’s recently introduced new model aircraft.

*Systems Integration. *R&D expenses increased by $0.5 million, or 104.8%,compared to the prior year.  The increaseis principally due to the development of several new products.

**Depreciation and amortization ofintangibles.**  Depreciation and amortization expensedecreased $0.1 million to $3.0 million for the three months endedMarch 31, 2005 from $3.1 million for the same period in the prioryear.  The decline is attributable toreduced capital expenditures and a lower depreciable base that resulted fromrestructuring charges.  Depreciation andamortization changed as follows:

 
| ** **                                  | ** ** | **Increase (Decrease)** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| ** **                                  | ** ** | **from 2004**           | ** ** |
| ***(In millions)***                         | ** ** | **Amount**              | ** ** | **Percent** | ** ** |
|                                        |       |                    |       |   |   |
| Depreciation charged to:                    |       |                    |       |   |   |
| Cost of sales                               |       | $                       | (0.1       | ) | (9.1 | )% |
| Selling, general and administrative expense |       | (0.0                    | )          | (6.9 | ) |
| Amortization of intangible assets           |       | 0.0                     |       |   |   |
| Total                                       |       | $                       | (0.1       | ) |   |   |
|                                             |            |                         |            |  |  |  |  |

**Adjusted EBITDA (as previouslydefined).**

*Cabin Management. *Adjusted EBITDAincreased $2.8 million, or 82.6%, to $6.3 million for the three months endedMarch 31, 2005 compared to $3.4 million for the same period in the prioryear.  Adjusted EBITDA as a percent ofrevenues improved to 13.9% for the three months ended March 31, 2005compared to 10.0% for the same period last year.  The $2.8 million increase is comprised of:

•                  a $1.7 million increase from improved margins which resulted, in part,from fixed costs being absorbed over a higher revenue base; and

•                  a $1.1 million increase resulting from a 32.1% revenue increase.

Our furniture and seatingoperations contributed $2.0 million of the increase and our cabin managementand entertainment systems contributed $0.8 million of the increase.

 

25

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*SystemsIntegration. *Adjusted EBITDA decreased $1.1 million,or 38.2%, to $1.9 million for the three months ended March 31, 2005compared to $3.0 million for the same period in the prior year.  AdjustedEBITDA as a percent of revenues declined to 16.4% for the three months endedMarch 31, 2005 compared to 20.8% for the same period last year.  The $1.1 million decrease is comprised of:

•                  a $0.4 million decrease resulting from the change in margin betweenperiods; and

•                  a $0.7 million decrease resulting from a 21.6% revenue decrease.

The decline in margin isattributable to a change in product delivery mix, principally resulting fromauxiliary fuel systems revenues being replaced with revenues from lower marginproducts and services.  A $1.2 milliondecline in auxiliary fuel tank, service center and aircraft completion marginswas partially offset by a $0.1 million increase in the margins for integration kitsand related services for commercial aircraft.

**Operating income.**  Operating income increased $1.6 million, or113.0%, to $3.0 million for the three months ended March 31, 2005, from$1.4 million for the same period in the prior year.  By segment, the operating income changed asfollows:

 
| ** **          | ** ** | **Increase (Decrease)** | ** ** |
|---------------------|------------|-------------------------|------------|
| ** **          | ** ** | **from 2004**           | ** ** |
| ***(In millions)*** | ** ** | **Amount**              | ** ** | **Percent** | ** ** |
|                |       |                    |       |   |   |
| Cabin Management    |       | $                       | 4.0        |   | 534.0 | % |
| Systems Integration |       | (2.0                    | )          | (105.4 | ) |
| Corporate           |       | (0.4                    | )          |   |   |
| Total               |       | $                       | 1.6        |   |   |   |

*Cabin Management. *Operating income increased by $4.0million, or 534.0%, compared to the prior year, due to:

•                  a $1.8 million increase in gross profit, primarily due to higherrevenues related to our furniture and seating operations;

•                  a $0.7 million increase in gross profit related to higher volume forour cabin management and entertainment systems;

•                  a $1.1 million decrease in research and development expenses;

•                  a $0.3 million decrease in SG&A spending; and

•                  a $0.1 million increase in gross profit related to other products.

*SystemsIntegration. *Operating income decreased by $2.0million, or 105.4%, compared to the prior year, due to:

•                  a $1.1 million decrease resulting from reduced gross profit on lowerrevenues;

•                  a $0.1 million increase in SG&A spending;

•                  a $0.5 million increase in research and development expenses; and

•                  $0.3 million of restructuring charges incurred in 2005.

 

26

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**Interest expense.** Interest expense increased $1.5 million, or 17.5%, to $10.2 million forthe three months ended March 31, 2005 compared to $8.7 million for thesame period in the prior year.  Theincrease is attributable to:

•                  a $0.9 million net increase in interest expense resulting from theexchange of $65.0 million of 12% senior subordinated notes for 17% seniordiscount notes; and

•                  a $0.6 million increase in other interest expense.

**Mandatorily redeemable preferred stockdividends. **There were no dividends on our PreferredStock for the three months ended March 31, 2005, but dividends totaled$1.7 million during the three months ended March 31, 2004.  The $1.7 million decrease in dividendsbetween the periods is a result of an amendment to the terms of the PreferredStock.  See “—Liquidity and Capital Resources—Debt and Mandatorily Redeemable Preferred Stock Restructuring” for additional information.

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

 
| ** **                                        | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|
| ** **                                        | ** ** | **March 31**           | ** ** |
| ***(In millions)***                               | ** ** | **2005**               | ** ** | **2004** | ** ** |
|                                              |       |                   |       |   |   |
| Income tax benefit based on reported pre-tax loss |       | $                      | (3.0       | ) | $ | (2.5 | ) |
| Net deferred tax asset valuation allowance        |       | 4.7                    |       | 2.5 |   |
| Net provision for income taxes                    |       | $                      | 1.7        |   | $ | — |   |
|                                                   |            |                        |            |  |  |  |  |  |

For the three months ended March 31, 2005, 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.

For the three months ended March 31, 2004, 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 Preferred Stockdividends.

We had a net deferred tax asset of $35.6 million and$32.5 million, offset by a valuation allowance of $38.9 million and $34.2million, respectively, as of March 31, 2005 and December 31, 2004,respectively.

**Net loss.** Net loss decreased $0.1 million for the three months endedMarch 31, 2005 compared to the same period in the prior year.  The decrease in the net loss is attributableto:

•                  a $1.8 million decrease in our pre-tax net loss; offset by

•                  a $1.7 million increase in our provision for income taxes.

 

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**Bookings and Backlog. **Bookings increased $14.0 million, or 20.7%, to $82.2million for the three months ended March 31, 2005 compared to $68.2million for the same period in the prior year. Backlog increased $25.6 million to $116.5 million as of March 31,2005 compared to $90.9 million as of December 31, 2004.  By segment, bookings and backlog changed asfollows:

 
| ** **          | ** ** | **Increase (Decrease)** | ** ** |
|---------------------|------------|-------------------------|------------|
| ** **          | ** ** | **from 2004**           | ** ** |
| ***(In millions)*** | ** ** | **Amount**              | ** ** | **Percent** | ** ** |
|                |       |                    |       |   |   |
| Bookings:           |       |                    |       |   |   |
| Cabin Management    |       | $                       | 5.0        |   | 11.0 | % |
| Systems Integration |       | 9.0                     |       | 40.8 |   |
| Total               |       | $                       | 14.0       |   |   |   |
|                |       |                    |       |   |   |
| Backlog:            |       |                    |       |   |   |
| Cabin Management    |       | $                       | 5.7        |   | 12.0 | % |
| Systems Integration |       | 19.9                    |       | 46.4 |   |
| 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 billings increase is a result of booking orders for auxiliary fueltank installations and booking an additional aircraft completion as well as anincrease in orders for our cockpit door video surveillance system during thequarter.

**Restructuring, AssetImpairment and Other Related Charges**

The following discussion should be read in conjunctionwith Note 2 accompanying our financial statements included in this report.

During the three months ended March 31, 2005, inconjunction with the operational realignment and facilities restructuringdiscussed below, we recorded $0.9 million of pre-tax cash restructuring andother related charges.  These charges,and the effect these charges had on our reported results of operations, aresummarized below.

 
| ***(In millions)***                          | ** ** | ** ** | ** ** |
|----------------------------------------------|------------|------------|------------|
| Business segment recording the charges:      |       |       |       |
| Cabin Management                             |       | $          | 0.1        |   |
| Systems Integration                          |       | 0.3        |       |
| Corporate                                    |       | 0.5        |       |
| Total pre-tax charges                        |       | $          | 0.9        |   |
|                                         |       |       |       |
| Charged to operations:                       |       |       |       |
| Cost of sales                                |       | $          | 0.4        |   |
| Selling, general and administrative expenses |       | 0.5        |       |
| Total pre-tax charges                        |       | $          | 0.9        |   |
|                                              |            |            |            |  |  |  |

During the second quarter of fiscal year 2004, weadopted plans to restructure the operations of our 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

 

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manufacturing locationsand product offerings.  In addition, wedecided to relocate our corporate office to Columbus, Ohio to be in closerproximity to our operating companies and customers.

The total restructuring, asset impairment and otherrelated charges are comprised of the write-down of surplus inventory, leasetermination and related charges, and severance and other compensationcosts.  We also expect to incuradditional restructuring-related expenses of approximately $1.8 million duringthe remainder of fiscal year 2005 to complete the restructuring plans.  These expenses, which are primarilyrelocation and travel costs, will be expensed as incurred.  Future cash payments, which will extend to2013 because of lease termination costs, will be funded from existing cash balancesand expected internally generated cash from operations.

**Liquidity and CapitalResources**

Our principal cash needs are for debt service, workingcapital, capital expenditures and strategic acquisitions, as well as to provideDeCrane Holdings with cash to finance its needs, which consists primarily ofthe redemption of its preferred stock in 2009. Our principal sources of liquidity are expected to be cash flow fromoperations, potential capital market transactions and third party borrowings,principally under our first-lien credit facility.

**Cash Flows During the Three Months Ended March 31,2005**

Net cash used for operating activities was $6.0million for the three months ended March 31, 2005 and consisted of $1.0million of cash used for operations after adding back depreciation,amortization, interest accretion and other noncash items and $5.8 million usedfor working capital, offset by a $0.8 million increase in otherliabilities.  The following factorscontributed to the $5.8 million working capital increase:

•                  a $9.0 million increase in accounts receivables due to higher revenues;and

•                  a $3.3 million increase in inventory commensurate with higher revenuesand order backlog; offset by

•                  a $6.4 million increase in accounts payable and accrued expensescommensurate with higher inventories and production levels; and

•                  a $0.1 million net decrease in other working capital items.

The $0.8 million increasein other liabilities is principally a result of accruing relocation costs inconnection with our 2004 operation realignment and facilities restructuring.

Net cash used forinvesting activities consisted of capital expenditures of $0.7 million for thethree months ended March 31, 2005. We anticipate spending approximately $4.0 to $6.0 million for capitalexpenditures in 2005.

Net cash provided by financingactivities was $7.9 million for the three months ended March 31, 2005 andconsisted of:

•                  $5.0 million of proceeds from the issuance of Preferred Stock;

•                  $2.5 million of proceeds from the issuance of 13.5% senior unsecuredpromissory notes; and

•                  $0.8 million of net borrowings under our revolving line of credit;offset by

•                  $0.4 million of other secured long-term debt repayments.

 

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**Issuance of MandatorilyRedeemable Preferred Stock**

In March 2005, wereceived $5.0 million of proceeds from the issuance of 26,425 additional sharesof our Senior Redeemable Exchangeable Preferred Stock due 2008 to DLJ MerchantBanking Partners II, L.P. and affiliated funds, who are stockholders of DeCraneHolding and, as a result, related parties. The cash proceeds from the issuance were used to fund working capitalneeds.

**Debt and Mandatorily RedeemablePreferred Stock Restructuring**

During the third quarter of 2004, holders of $65.0million of our 12% senior subordinated notes due September 30, 2008 (the“existing notes”) exchanged their notes for new 17% senior discount notes dueSeptember 30, 2008 (the “new notes”). The new notes do not bear cash interest and have an initial accretedvalue equal to the principal amount of the notes exchanged.  The new notes accrete in value at a 17%annual rate and will have a $128.8 million aggregate accreted principal valueat maturity.  The new notes are seniorunsecured obligations and are guaranteed by our subsidiaries.  Except for the changes in the interest rateand payment and ranking described above, the new notes have terms substantiallysimilar to those contained in the existing notes, although covenants limitingthe incurrence of indebtedness, the granting of liens and the making ofrestricted payments are more restrictive. The exchange will help conserve working capital by reducing our cashinterest expense by $7.7 million annually through September 2008.

Concurrent with the note exchange, we amended theterms of our Preferred Stock.  DeCraneHoldings, our parent, amended the terms of its 14% preferred stock aswell.  The amended terms provide thatfurther dividends do not accrue on the Preferred Stock, except if a leverageratio (as defined) falls below certain specified levels or if certaintriggering events occur, such as failure to discharge any mandatory redemptionobligations or comply with certain restrictive covenants.  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 Preferred Stock and 0%,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 March 31, 2005, no dividends will accrue on either thePreferred Stock or 14% preferred stock through June 30, 2005.

All dividends accrued through the amendment date andfuture dividends, if any, are not payable until redemption.  The amendment for the 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 Preferred Stock also adds several restrictive covenants.  The holders of the Preferred Stock wereissued 348,945 shares of DeCrane Holdings common stock in connection with theamendment.

 

 

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**Short-Term Borrowings**

In March 2005, we amended an existing loan agreementand entered into a new loan agreement with DLJ Merchant Banking Partners II,L.P. and affiliated funds, who are stockholders of DeCrane Holding and, as aresult, related parties.  The details ofthese transactions are as follows:

•                  The maturity date of theexisting $5.0 million of 13.5% senior unsecured promissory notes wasextended.  The notes are now due onMarch 31, 2006 with interest payable on December 31, 2005 and atmaturity.

•                  We entered into a new loanagreement which provides for up to $5.0 million of additional borrowings atrates and with terms identical to the existing 13.5% senior unsecuredpromissory notes, as amended.  As ofMarch 31, 2005, we had borrowed $2.5 million pursuant to this agreement andborrowing of the remainder, if needed, is subject to customary conditionsincluding absence of a material adverse change in our business.

**DebtObligations and Capital Resources as of March 31, 2005**

As of March 31, 2005, first-lien credit facilityborrowings and second-lien term debt totaling $104.3 million were at variableinterest rates based on defined margins over the current prime rate orLIBOR.  We also had $72.8 million of 15%second-lien term debt, $72.7 million of 17% senior discount notes, $35.0million of 12% subordinated notes, $7.3 million of other secured indebtedness,and $7.5 million of 13.5% senior unsecured promissory notes outstanding as ofMarch 31, 2005.  In addition, our PreferredStock, which has characteristics of both a liability and equity, had amandatory redemption value of $52.3 million as of March 31, 2005.

As of March 31, 2005, we had $16.7 million of workingcapital, $10.3 million of borrowings available under our $24.0 millionrevolving line of credit and $2.5 million of borrowings available under our13.5% senior unsecured promissory notes. Both the line of credit and the 13.5% senior unsecured promissory notesexpire in March 2006.

**Financial Condition and Liquidity**

On March 31, 2006, our first-lien credit facility willexpire and any borrowings outstanding on that date will become due and payable($13.4 million was borrowed as of March 31, 2005).  In addition, on that date we are required tomake principal payments in the amount of $4.3 million on our first-lien termdebt and repay $7.5 million of promissory notes to our principal investors,unless these maturities are further extended by the investors.  While we believe the note holders wouldfurther extend the notes beyond the current due date if requested, they areunder no obligation to do so.  We areexploring various alternatives for the restructuring or replacementof the first-lien credit facility as well as additional debt and/or equitytransactions that would further improve liquidity.  We have not entered into any commitments to doso and cannot assure you that we will be successful in our efforts.

We believe expected operating cash flows, togetherwith borrowings under the first-lien credit facility ($10.3 million of whichwas available as of March 31, 2005) and the $2.5 million of availableborrowings under our 13.5% senior unsecured promissory notes to our principalinvestors will be sufficient to meet operating expenses, working capitalrequirements, capital expenditures and debt service obligations up to March 31,2006.  However, our ability to complywith debt financial covenants, pay principal or interest and satisfy orrefinance our March 31, 2006 debt obligations will depend on our future operatingperformance as well as competitive, legislative, regulatory, business and otherfactors beyond our control.  Based oncurrent information, we expect to be in compliance with the financial 

 

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covenants through the end of the year based on ourcurrent operating plan.  See “SpecialNote Regarding Forward-Looking Statements and Risk Factors.”

**Disclosure of ContractualObligations and Commitments**

The following table summarizes our known contractualobligations to make future cash payments as of March 31, 2005, as well asan estimate of the periods during which these payments are expected to be made.

 
| ** **                                  | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|------------|------------|
| ** **                                  | ** ** | ** ** | ** ** | **Years Ending December 31,** | ** ** |
| ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | **2006** | ** ** | **2008** | ** ** | **2010** | ** ** |
| ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | **and** | ** ** | **and** | ** ** | **and** | ** ** |
| ***(In millions)***                         | ** ** | **Total**  | ** ** | **2005** | ** ** | **2007** | ** ** | **2009** | ** ** | **Beyond** | ** ** |
|                                        |       |       |       |   |   |   |   |   |   |   |   |
| Long-term debt (a):                         |       |       |       |   |   |   |   |   |   |   |   |
| First-lien credit facility (b):             |       |       |       |   |   |   |   |   |   |   |   |
| Term debt                                   |       | $          | 80.5       |   | $ | — |   | $ | 80.5 |   | $ | — |   | $ | — |   |
| Revolving line of credit                    |       | 13.4       |       | — |   | 13.4 |   | — |   | — |   |
| Second-lien term debt (c)                   |       | 83.1       |       | — |   | — |   | 83.1 |   | — |   |
| 17% senior discount notes (d)               |       | 72.7       |       | — |   | — |   | 72.7 |   | — |   |
| 13.5% senior unsecured promissory notes (e) |       | 7.5        |       | — |   | 7.5 |   | — |   | — |   |
| 12% subordinated notes (f)                  |       | 35.0       |       | — |   | — |   | 35.0 |   | — |   |
| Capital lease obligations (g)               |       | 2.8        |       | 0.3 |   | 0.8 |   | 0.4 |   | 1.3 |   |
| Other indebtedness (g)                      |       | 4.6        |       | 0.8 |   | 1.2 |   | 0.5 |   | 2.1 |   |
| Total long-term debt                        |       | 299.6      |       | 1.1 |   | 103.4 |   | 191.7 |   | 3.4 |   |
|                                        |       |       |       |   |   |   |   |   |   |   |   |
| Other long-term liabilities                 |       | 5.8        |       | 1.5 |   | 1.6 |   | 2.4 |   | 0.3 |   |
| Operating lease obligations                 |       | 12.7       |       | 2.8 |   | 4.2 |   | 2.0 |   | 3.7 |   |
| Mandatorily redeemable preferred stock      |       | 52.3       |       | — |   | — |   | 52.3 |   | — |   |
| Total obligations as of March 31, 2005      |       | $          | 370.4      |   | $ | 5.4 |   | $ | 109.2 |   | $ | 248.4 |   | $ | 7.4 |   |

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(a)                      Generallyexcludes interest payments, which are described in the following notes.

(b)                     The first-lien creditfacility bears interest at variable rates and therefore the amount of futureinterest payments are uncertain.  Thedebt bears interest based on a margin over, at our option, the prime rate orLIBOR.  As of March 31, 2005, the currentprime rate was 5.75% and the current LIBOR was 2.56%.  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 8.23% as of March 31, 2005.

(c)                      The second-lienterm debt 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 14.82% as of March 31, 2005.  All of the second-lien debt matures on June30, 2008, at which time the cash payment obligation will be $91.4 million,including the 3% pay-in-kind interest obligation.

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

 

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(e)                      Excludesinterest of $1.2 million payable at maturity.

(f)                        Interest ispayable semiannually.

(g)                     Interest is generallypayable monthly.

**Disclosure**About Off-Balance Sheet Commitments and Indemnities

We are a wholly-owned subsidiary of DeCrane Holdings,whose capital structure also includes mandatorily redeemable preferredstock.  Since we are DeCrane Holdings’only operating subsidiary and source of cash, we may be required to fundDeCrane Holdings’ dividend and redemption obligations in the future, subject tosignificant limitations contained in our first-lien credit agreement,second-lien term notes and our senior discount notes and subordinated notesindentures.

Dividends do not accrue on the DeCrane Holdingspreferred stock unless a defined leverage ratio falls below certain specifiedlevels as of each quarterly testing date or if certain triggering eventsoccur.  Depending on the future leverageratio achieved, and provided certain triggering events have not occurred,dividends accrue at a 0%, 3.5% or 14% annual rate for the succeedingquarter.  If certain triggering eventsoccur, such as failure to discharge any mandatory redemption obligations orcomply with certain restrictive covenants and the like, dividends accrue at a14% annual rate.  Based on the leverageratio achieved as of March 31, 2005, no dividends will accrue on theDeCrane Holdings preferred stock during the three months ending June 30,2005, the next quarterly testing date. Future dividends, if any, are not payable until redemption.  The DeCrane Holdings preferred stock has atotal redemption value of $77.2 million as of March 31, 2005 and ismandatorily redeemable on September 30, 2009.

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

In connection with the 2003 sale of the SpecialtyAvionics Group, we made indemnities to the buyer with respect to a number ofcustomary, and certain other specific, representations and warranties.  Our indemnities with respect to some of thesematters are limited in terms of duration with the maximum of potential futurepayments capped at $14.0 million and our indemnities with respect to specifiedenvironmental matters will expire not later than October 2010 and provides fora maximum liability of $5.0 million, while others will have no limitations.

As of March 31, 2005, we had irrevocable standbyletters of credit in the amount of $0.3 million issued and outstanding underour first-lien credit facility.

 

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

All statements other than statements of historicalfacts included in this report, including statements about our futureperformance and liquidity and future industry performance, are consideredforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995.  Thesestatements are subject to known and unknown risks, uncertainties and otherfactors, which are difficult to predict. We are vulnerable to a variety of factors that affect many businesses,such as:

•                  fuel prices and general economic conditions that affect demand foraircraft and air travel, which in turn affect demand for our products andservices;

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

•                  our reliance on large projects, where unanticipated needsto incur development costs and acquire inventory or delays in payment couldincrease our working capital needs;

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

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

•                  liability and other claims asserted against us that exceeds ourinsurance coverage;

•                  the ability to attract and retain qualified personnel;

•                  labor disturbances; and

•                  changes in operating strategy, or our acquisition and capitalexpenditure plans.

Some of the more significant factors listed above andadditional risk factors are further described in our 2004 Annual Report on Form10-K and should be read in conjunction with this report.  Changes in such factors could cause ouractual results to differ materially from those contemplated in suchforward-looking statements.  Although webelieve that the expectations reflected in such forward-looking statements arereasonable, we can give no assurance that such expectations will prove to becorrect.  We undertake no obligation torelease publicly any revisions to these forward-looking statements to reflectevents or circumstances after the date hereof or to reflect the occurrence ofunanticipated events.  You should notrely on our forward-looking statements as if they were certainties.

**ITEM 3.**                             QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKETRISK

We are exposed to various market risks, includinginterest rates and changes in foreign currency exchange rates.  Market risk is the potential loss arisingfrom adverse changes in prevailing market rates and prices.  From time to time, we use derivativefinancial instruments to manage and reduce risks associated with thesefactors.  We do not enter intoderivatives or other financial instruments for trading or speculative purposes.

**Interest Rate Risk.**  Asignificant portion of our capital structure is comprised of long-term variableand fixed-rate debt.

Market risk related to our variable-rate debt isestimated as the potential decrease in pre-tax earnings resulting from anincrease in interest rates.  The interestrates applicable to variable-rate debt are, at our option, based on definedmargins over the current prime rate or LIBOR. As of March 31, 2005, the current prime rate was 5.75% and thecurrent LIBOR was 2.56%.  Based on $104.3million of variable-rate debt outstanding as of March 31, 2005, ahypothetical one percent rise in interest rates, to 6.75%for

 

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prime rate borrowings and 3.56% for LIBORborrowings, would reduce our pre-tax earnings by $1.0 million annually.

The estimated fair value of our 17% senior discountnotes, which are long-term, fixed-rate obligations, approximates their $72.7million carrying value as of March 31, 2005. Market risk related to our fixed-rate debt is deemed to be the potentialincrease in fair value resulting from a decrease in interest rates.  For example, a hypothetical ten percentdecrease in the interest rates, from 17.0% to 15.3%, would increase the fairvalue of our fixed-rate debt by approximately $3.1 million.

Market risk related to our $35.0 million of 12%subordinated notes, which are long-term, fixed-rate obligations, is deemed tobe the potential increase in fair value resulting from a decrease in interestrates.  For example, a hypothetical tenpercent decrease in the interest rates, from 12.0% to 10.8%, would increase thefair value of our fixed-rate debt by approximately $1.3 million.

**Foreign Currency Exchange Rate Risk.** Our foreign customers are located in various parts of the world,primarily Canada, the Far and Middle East and Western Europe, and we have asubsidiary with manufacturing facilities in Mexico.  To limit our foreign currency exchange raterisk related to sales to our customers, orders are almost always valued andsold in U.S. dollars.  We have enteredinto forward foreign exchange contracts in the past, primarily to limitexposure related to foreign inventory procurement and operating costs for agroup of subsidiaries that has since been sold. While we have not recently entered into any such contracts, we may do soin the future depending on the volume of non-U.S. dollar denominated transactionsand our assessment of future foreign exchange rate trends.

**ITEM 4.**                             CONTROLSAND PROCEDURES

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

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

 

**PART II — OTHER INFORMATION**

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

See Note 9 to the consolidated financial statementsincluded in this report.

 

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**ITEM 2.****                            ****UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

On March 29, 2005 weissued 26,425 additional shares of our Senior Redeemable Exchangeable PreferredStock due 2008 to a group of investors for its liquidation value of $189.21 pershare.  The $5.0 million of cash proceedsfrom the issuance was used to fund working capital needs.  Such issuances were made in reliance upon anexemption from the registration provision of the Act set forth in Section 4(2)thereof relative to issuances by an issuer not involving any public offering orthe rules and regulations thereunder. The investors, who are listed in the table below, are the principalstockholders of DeCrane Holdings Co., our parent company.

 
| ** **                               | ** ** | **No. of**    | ** ** |
|------------------------------------------|------------|---------------|------------|
| ** **                               | ** ** | **Shares of** | ** ** |
| ** **                               | ** ** | **Preferred** | ** ** |
| ** **                               | ** ** | **Stock**     | ** ** |
| ** **                               | ** ** | **Purchased** | ** ** |
|                                     |       |          |       |
| DLJ Merchant Banking Partners II, L.P.   |       | 16,646        |       |
| MBP II Plan Investors                    |       | 6,567         |       |
| DLJ Diversified Partners, L.P.           |       | 973           |       |
| DLJ Offshore Partners II, C.V.           |       | 819           |       |
| DLJ Merchant Banking Partners II-A, L.P. |       | 663           |       |
| DLJ Diversified Partners-A, L.P.         |       | 361           |       |
| DLJ Millennium Partners, L.P.            |       | 269           |       |
| DLJ EAB Partners, L.P.                   |       | 75            |       |
| DLJ Millennium Partners-A, L.P.          |       | 52            |       |
| Total                                    |       | 26,425        |       |

 

**ITEM 6.****                            ****EXHIBITS**

 
| 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 Section 906 of the Sarbanes-Oxley Act of 2002 * |

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*                                                     Filed herewith

 

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**SIGNATURES**

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

 
| ** **   | **DECRANE  AIRCRAFT HOLDINGS, INC. (Registrant)** |
|--------------|---------------------------------------------------|
|         |                                              |   |
| May 16, 2005 | By:                                               | /s/ RICHARD J. KAPLAN |
|         | Name:                                             | Richard J. Kaplan |
|         | Title:                                            | Senior Vice President,  Chief Financial Officer, |
|         |                                              | Secretary, Treasurer  and Director |

 

 

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