**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q**

 

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

 

**For the quarterly period ended March 31, 2004**

 

**Commission File Number 000-22371**

 

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**DECRANEAIRCRAFT HOLDINGS, INC.**

(Exact name of registrant as specified in itscharter)

 

| **Delaware**                                                                                        |   | **34-1645569**                        |
|-----------------------------------------------------------------------------------------------------|--------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization)                                     |   | (I.R.S. Employer  Identification No.) |
|                                                                                                |   |                                  |
| **2361 Rosecrans Avenue, Suite 180, El Segundo, CA 90245**                                          |
| (Address, including zip code, of principal  executive offices)                                      |
|                                                                                                |   |                                  |
| **(310) 725-9123**                                                                                  |
| (Registrant’s telephone number, including  area code)                                          |
|                                                                                                |   |                                  |
| **(Not Applicable)**                                                                                |
| (Former address and telephone number of  principal executive offices, if changed since last report) |

 

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

 

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

 

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The number of shares of Registrant’s CommonStock, $.01 par value, outstanding as of May 3, 2004 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, 2004 and December 31,  2003                                   |   |
|                                    |                                                                                                      |   |
|                                    | Consolidated Statements of Operations for  the three months ended March 31, 2004 and 2003                 |   |
|                                    |                                                                                                      |   |
|                                    | Consolidated Statements of Stockholder’s  Equity (Deficit) for the three months ended March 31, 2004 |   |
|                                    |                                                                                                      |   |
|                                    | Consolidated Statements of Cash Flows for  the three months ended March 31, 2004 and 2003                 |   |
|                                    |                                                                                                      |   |
|                                    | Condensed Notes to Consolidated Financial  Statements                                                     |   |
|                                    |                                                                                                      |   |
| **Item 2.**                             | **Management’s Discussion and Analysis of  Financial Condition and Results of Operations**           |   |
|                                    |                                                                                                      |   |
|                                    | Results of Operations                                                                                     |   |
|                                    |                                                                                                      |   |
|                                    | Performance Measures                                                                                      |   |
|                                    |                                                                                                      |   |
|                                    | Changes in Accounting Principles                                                                          |   |
|                                    |                                                                                                      |   |
|                                    | Three months ended March 31 2004                                                                          |   |
|                                    |                                                                                                      |   |
|                                    | Liquidity and Capital Resources                                                                           |   |
|                                    |                                                                                                      |   |
|                                    | Disclosure of Contractual Obligations and  Commitments                                                    |   |
|                                    |                                                                                                      |   |
|                                    | Disclosure About Off-Balance Sheet  Commitments and Indemnities                                           |   |
|                                    |                                                                                                      |   |
|                                    | Recent Accounting Pronouncements                                                                          |   |
|                                    |                                                                                                      |   |
|                                    | Special Note Regarding Forward Looking  Statements and Risk Factors                                       |   |
|                                    |                                                                                                      |   |
| **Item 3.**                             | **Quantitative and Qualitative Disclosure  About Market Risk**                                            |   |
|                                    |                                                                                                      |   |
| **Item 4.**                             | **Controls and Procedures**                                                                               |   |
|                                    |                                                                                                      |   |
| **Part II – Other Information**    |                                                                                                      |
|                                    |                                                                                                      |   |
| **Item 1.**                             | **Legal Proceedings**                                                                                     |   |
|                                    |                                                                                                      |   |
| **Item 6.**                             | **Exhibits and Reports on Form 8-K**                                                                      |   |
|                                    |                                                                                                      |   |
|                                    | Exhibits                                                                                                  |   |
|                                    |                                                                                                      |   |
|                                    | Reports on Form 8-K                                                                                       |   |
|                                    |                                                                                                      |   |
| **Signatures**                          |                                                                                                      |   |

 

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**PART I – FINANCIALINFORMATION**

 

**ITEM1.****                             FINANCIALSTATEMENTS**

 

**DECRANEAIRCRAFT HOLDINGS, INC. AND SUBSIDIARIES**

 

**Consolidated BalanceSheets**

 
| **(In  thousands, except share data)**                                                                                                   |   | **March 31,  2004** |    | **December 31,  2003** |   |
|------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|---------|-----------------------------|--------|
|                                                                                                                                     |   | **(Unaudited)**          |    |                        |   |
|                                                                                                                                     |   |                     |    |                        |   |
| **Assets**                                                                                                                               |   |                     |    |                        |   |
|                                                                                                                                     |   |                     |    |                        |   |
| Current assets:                                                                                                                          |   |                     |    |                        |   |
| Cash and cash equivalents                                                                                                                |   | $                        | 2,689   |                        | $      | 6,936 |   |
| Accounts receivable, net                                                                                                                 |   | 26,969                   |    | 21,455                      |   |
| Inventories                                                                                                                              |   | 47,621                   |    | 42,981                      |   |
| Prepaid expenses and other  current assets                                                                                               |   | 1,159                    |    | 1,082                       |   |
| Total current assets                                                                                                                     |   | 78,438                   |    | 72,454                      |   |
|                                                                                                                                     |   |                     |    |                        |   |
| Property and equipment, net                                                                                                              |   | 29,962                   |    | 30,900                      |   |
| Goodwill                                                                                                                                 |   | 162,430                  |    | 162,430                     |   |
| Other assets, principally  intangibles, net                                                                                              |   | 36,407                   |    | 38,092                      |   |
| Total assets                                                                                                                             |   | $                        | 307,237 |                        | $      | 303,876 |   |
|                                                                                                                                     |   |                     |    |                        |   |
| **Liabilities, Mandatorily Redeemable  Preferred Stock and Stockholder’s Equity (Deficit)**                                         |   |                     |    |                        |   |
|                                                                                                                                     |   |                     |    |                        |   |
| Current liabilities:                                                                                                                     |   |                     |    |                        |   |
| Current portion of long-term  debt                                                                                                       |   | $                        | 1,271   |                        | $      | 1,198 |   |
| Accounts payable                                                                                                                         |   | 14,943                   |    | 15,462                      |   |
| Accrued liabilities                                                                                                                      |   | 19,953                   |    | 17,890                      |   |
| Income taxes payable                                                                                                                     |   | 41                       |    | —                      |   |
| Total current liabilities                                                                                                                |   | 36,208                   |    | 34,550                      |   |
|                                                                                                                                     |   |                     |    |                        |   |
| Long-term debt                                                                                                                           |   | 277,326                  |    | 268,208                     |   |
| Mandatorily redeemable  preferred stock                                                                                                  |   | 42,684                   |    | —                      |   |
| Other long-term liabilities                                                                                                              |   | 5,366                    |    | 5,464                       |   |
|                                                                                                                                     |   |                     |    |                        |   |
| Commitments and contingencies  (Note 9)                                                                                                  |   |                     |    |                        |   |
|                                                                                                                                     |   |                     |    |                        |   |
| Mandatorily redeemable  preferred stock                                                                                                  |   | —                   |    | 40,835                      |   |
|                                                                                                                                     |   |                     |    |                        |   |
| Stockholder’s equity  (deficit):                                                                                                    |   |                     |    |                        |   |
| Common stock, $.01 par value,  1,000 shares authorized and 100 shares issued and outstanding as of March 31,  2004 and December 31, 2003 |   | —                   |    | —                      |   |
| Additional paid-in capital                                                                                                               |   | 112,987                  |    | 112,987                     |   |
| Notes receivable for shares  sold                                                                                                        |   | (1,286                   | )       | (1,268                      | )      |
| Accumulated deficit                                                                                                                      |   | (165,780                 | )       | (156,632                    | )      |
| Accumulated other  comprehensive loss                                                                                                    |   | (268                     | )       | (268                        | )      |
| Total stockholder’s equity  (deficit)                                                                                               |   | (54,347                  | )       | (45,181                     | )      |
| Total liabilities,  mandatorily redeemable preferred stock and stockholder’s equity (deficit)                                       |   | $                        | 307,237 |                        | $      | 303,876 |   |

 

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

 

1

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**DECRANEAIRCRAFT HOLDINGS, INC. AND SUBSIDIARIES**

 

**ConsolidatedStatements of Operations**

 
|                                                               |   | **Three  Months Ended  March 31,** |   |
|--------------------------------------------------------------------|--------|-----------------------------------------|--------|
| **(In  thousands)**                                                |   | **2004**                                |   | **2003** |   |
|                                                               |   | **(Unaudited)**                         |   |
| Revenues                                                           |   | $                                       | 48,597 |   | $ | 41,900 |   |
| Cost of sales                                                      |   | 36,839                                  |   | 28,878 |   |
|                                                               |   |                                    |   |   |   |
| Gross profit                                                       |   | 11,758                                  |   | 13,022 |   |
|                                                               |   |                                    |   |   |   |
| Operating expenses:                                                |   |                                    |   |   |   |
| Selling, general and  administrative expenses                      |   | 7,237                                   |   | 9,930 |   |
| Research and development  expenses                                 |   | 2,181                                   |   | 1,573 |   |
| Amortization of intangible  assets                                 |   | 912                                     |   | 912 |   |
| Total operating expenses                                           |   | 10,330                                  |   | 12,415 |   |
|                                                               |   |                                    |   |   |   |
| Income from operations                                             |   | 1,428                                   |   | 607 |   |
|                                                               |   |                                    |   |   |   |
| Other expenses:                                                    |   |                                    |   |   |   |
| Interest expense                                                   |   | 8,702                                   |   | 5,869 |   |
| Mandatorily redeemable  preferred stock dividends                  |   | 1,732                                   |   | — |   |
| Other expenses, net                                                |   | 112                                     |   | 339 |   |
|                                                               |   |                                    |   |   |   |
| Loss from continuing  operations before provision for income taxes |   | (9,118                                  | )      | (5,601 | ) |
| Provision for income (taxes)  benefit                              |   | (30                                     | )      | 1,265 |   |
|                                                               |   |                                    |   |   |   |
| Loss from continuing  operations                                   |   | (9,148                                  | )      | (4,336 | ) |
|                                                               |   |                                    |   |   |   |
| Loss from discontinued  operations, net of tax                     |   | —                                  |   | (6,397 | ) |
| Cumulative effect of change  in accounting principles              |   | —                                  |   | (13,764 | ) |
|                                                               |   |                                    |   |   |   |
| Net loss                                                           |   | (9,148                                  | )      | (24,497 | ) |
|                                                               |   |                                    |   |   |   |
| Accrued preferred stock  dividends                                 |   | —                                  |   | (1,480 | ) |
| Preferred stock redemption  value accretion                        |   | —                                  |   | (117 | ) |
|                                                               |   |                                    |   |   |   |
| Net loss applicable to common  stockholder                         |   | $                                       | (9,148 | ) | $ | (26,094 | ) |

 

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

 

2

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**DECRANEAIRCRAFT HOLDINGS, INC. AND SUBSIDIARIES**

 

**ConsolidatedStatement of Stockholder’s Equity (Deficit)**

 
| **(In  thousands, except share data)** |   | **Common Stock** |   | **Additional  Paid-in  Capital** |   | **Notes  Receivable  For Shares  Sold** |   | **Accumulated  Deficit** |   | **Accumulated  Other  Comprehensive  Loss** |   | **Total** |   |
|----------------------------------------|--------|------------------|--------|----------------------------------|--------|-----------------------------------------|--------|--------------------------|--------|---------------------------------------------|--------|-----------|--------|
| **Shares**                             |   | **Amount**       |
|                                   |   |             |   |                             |   |                                    |   |                     |   |                                        |   |      |   |   |   |
| Balance, December 31, 2003        |   | 100              |   | $                                | — |                                    | $      | 112,987                  |   | $                                           | (1,268 | )         | $      | (156,632 | ) | $ | (268 | ) | $ | (45,181 | ) |
|                                   |   |             |   |                             |   |                                    |   |                     |   |                                        |   |      |   |   |   |
| Comprehensive loss:                    |   |             |   |                             |   |                                    |   |                     |   |                                        |   |      |   |   |   |
| Net loss                               |   | —           |   | —                           |   | —                                  |   | —                   |   | (9,148                                      | )      | —    |   | (9,148 | ) |
|                                   |   |             |   |                             |   |                                    |   |                     |   |                                        |   |      |   |   |   |
| Notes receivable interest accrued      |   | —           |   | —                           |   | —                                  |   | (18                      | )      | —                                      |   | —    |   | (18 | ) |
|                                   |   |             |   |                             |   |                                    |   |                     |   |                                        |   |      |   |   |   |
| Balance, March 31, 2004 (Unaudited)    |   | 100              |   | $                                | — |                                    | $      | 112,987                  |   | $                                           | (1,286 | )         | $      | (165,780 | ) | $ | (268 | ) | $ | (54,347 | ) |

 

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

 

3

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**DECRANEAIRCRAFT HOLDINGS, INC. AND SUBSIDIARIES**

 

**ConsolidatedStatements of Cash Flows**

 
|                                                                               |   | **Three  Months Ended  March 31,** |   |
|------------------------------------------------------------------------------------|--------|------------------------------------|--------|
| **(In  thousands)**                                                                |   | **2004**                           |   | **2003** |   |
|                                                                               |   | **(Unaudited)**                    |   |
| **Cash flows  from operating activities:**                                         |   |                               |   |   |   |
| Net loss                                                                           |   | $                                  | (9,148 | ) | $ | (24,497 | ) |
| Adjustments to reconcile net  income to net cash provided by operating activities: |   |                               |   |   |   |
| Cumulative effect of change  in accounting principles                              |   | —                             |   | 13,764 |   |
| Loss from discontinued  operations                                                 |   | —                             |   | 6,397 |   |
| Depreciation and amortization                                                      |   | 3,116                              |   | 3,211 |   |
| Mandatorily redeemable  preferred stock dividends                                  |   | 1,732                              |   | — |   |
| Interest accretion on  second-lien term debt                                       |   | 606                                |   | — |   |
| Preferred stock redemption  value accretion                                        |   | 117                                |   | — |   |
| Deferred income taxes                                                              |   | —                             |   | (1,869 | ) |
| Other, net                                                                         |   | 10                                 |   | 404 |   |
| Changes in assets and liabilities:                                                 |   |                               |   |   |   |
| Accounts receivable                                                                |   | (5,514                             | )      | (233 | ) |
| Inventories                                                                        |   | (4,640                             | )      | (9,861 | ) |
| Prepaid expenses and other  assets                                                 |   | (192                               | )      | (3,248 | ) |
| Accounts payable                                                                   |   | (519                               | )      | 2,521 |   |
| Accrued liabilities                                                                |   | 2,063                              |   | (7,877 | ) |
| Income taxes payable                                                               |   | 139                                |   | 46 |   |
| Other long-term liabilities                                                        |   | (98                                | )      | (1,125 | ) |
| Net cash used for operating  activities                                            |   | (12,328                            | )      | (22,367 | ) |
|                                                                               |   |                               |   |   |   |
| **Cash flows  from investing activities:**                                         |   |                               |   |   |   |
| Capital expenditures                                                               |   | (504                               | )      | (1,098 | ) |
| Cash paid for acquisition  contingent consideration                                |   | —                             |   | (600 | ) |
| Net cash used for investing  activities                                            |   | (504                               | )      | (1,698 | ) |
|                                                                               |   |                               |   |   |   |
| **Cash flows  from financing activities:**                                         |   |                               |   |   |   |
| Debt borrowings:                                                                   |   |                               |   |   |   |
| Revolving line of credit, net                                                      |   | 8,850                              |   | 27,150 |   |
| Other secured long-term                                                            |   | 46                                 |   | — |   |
| Debt repayments:                                                                   |   |                               |   |   |   |
| First-lien term debt                                                               |   | —                             |   | (3,275 | ) |
| Other secured long-term debt                                                       |   | (311                               | )      | (935 | ) |
| Net cash provided by  financing activities                                         |   | 8,585                              |   | 22,940 |   |
|                                                                               |   |                               |   |   |   |
| Net cash provided by  discontinued operations                                      |   | —                             |   | 3,341 |   |
|                                                                               |   |                               |   |   |   |
| Net increase (decrease) in  cash and cash equivalents                              |   | (4,247                             | )      | 2,216 |   |
| Cash and cash equivalents at  beginning of period                                  |   | 6,936                              |   | 12,421 |   |
| Cash and cash equivalents at  end of period                                        |   | $                                  | 2,689  |   | $ | 14,637 |   |

 

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

 

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**

 

These consolidated interim financialstatements are unaudited.  The Companybelieves the interim financial statements are presented on a basis consistentwith the audited financial statements and include all adjustments necessary fora fair presentation of the financial condition, results of operations and cashflows for such interim periods.  All ofthese adjustments are normal recurring adjustments.

 

Preparation of these consolidated financialstatements in conformity with accounting principles generally accepted in theUnited States of America requires the Company to make estimates and judgmentsthat affect the reported amounts of assets, liabilities and disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenues and expenses during thereporting periods.  Actual results coulddiffer from those estimates.

 

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

 

**Changes in Accounting Principles**

 

*SFAS No. 150 Adopted January 1, 2004*

 

Effective January 1, 2004, the Companyadopted SFAS No. 150, “Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity.”  SFAS No. 150 establishes standards for the classification andmeasurement of certain financial instruments with characteristics of bothliabilities and equity.  SFAS No. 150requires classification of financial instruments within its scope as aliability, including financial instruments issued in the form of shares thatare mandatorily redeemable, because those financial instruments are deemed tobe, in essence, obligations of the issuer. As a result of adopting of SFAS No. 150 on January 1, 2004, the 16%mandatorily redeemable preferred stock was reclassified as a liability and thequarterly dividend and redemption value accretion are reflected as chargesagainst pre-tax income.  In periodsprior to January 1, 2004, these charges were deducted in arriving at the netincome or loss applicable to the Company’s common stockholder.

 

The following table summarizes the results ofoperations for the three months ended March 31, 2003 as if SFAS No. 150 hadbeen in effect as of the beginning of 2003.

 

5

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|                             |   | **Three  Months Ended  March 31, 2003** |   |
|----------------------------------|--------|-----------------------------------------|--------|
| **(In  thousands)**              |   | **As  Reported**                        |   | **Pro Forma** |   |
|                             |   | **(Unaudited)**                         |   |
| Loss from continuing  operations |   | $                                       | (4,336 | ) | $ | (5,933 | ) |
| Net loss                         |   | (24,497                                 | )      | (26,094 | ) |
|                                  |        |                                         |        |  |  |  |  |

 

The pro forma data reflects the $1,480,000 ofpreferred stock dividends and $117,000 of redemption value accretion as chargesagainst income during the period.

 

*Discontinued Use of Program AccountingCommencing January 1, 2003*

 

As more fully described in “Note 1—Change inAccounting Principle” to the audited financial statements included in theCompany’s 2003 Form 10-K, the Company elected to discontinue the use of programaccounting for the costs of products manufactured for delivery underproduction-type contracts.  As a result,certain deferred program costs are no longer included in inventory commencingJanuary 1, 2003.

 

This change in accounting policy was madeafter concluding the 2003 fiscal year but was applied retroactively to thebeginning of the year, January 1, 2003, as required by generally acceptedaccounting principles.  As a result ofthe change, program-related product development costs are now classified as acomponent of research and development expenses in the consolidated financialstatements rather than classified as a component of inventory cost.  As a result of the change, the Company hasrestated its results of operations for the three months ended March 31, 2003 bycharging $1,573,000 of previously inventoried costs to research and developmentexpense and recording a $13,764,000 charge as of January 1, 2003 toreflect the cumulative effect of the change in accounting principle.

 

**Stock Option Plan**

 

The Company has one stock-based employeecompensation plan, which is more fully described in the notes to its auditedfinancial statements.  As permittedunder SFAS No. 123, “Accounting for Stock-Based Compensation,” the Companymeasures compensation expense related to the employee stock option planutilizing the intrinsic value method as prescribed by Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations.  No stock-basedemployee compensation cost is reflected in net income (loss), as all optionsgranted under the plan had an exercise price equal to the value of theunderlying common stock on the date of grant.

 

The following table illustrates the effect onnet income if the Company had applied the fair value recognition provisions ofSFAS No. 123 to stock-based employee compensation.

 
|                                                                                                                                           |   | **Three  Months Ended  March 31,** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------|--------|
| **(In  thousands)**                                                                                                                            |   | **2004**                           |   | **2003** |   |
|                                                                                                                                           |   | **(Unaudited)**                    |   |
| Net loss, as reported                                                                                                                          |   | $                                  | (9,148 | ) | $ | (24,497 | ) |
| Less total stock-based  employee compensation expense determined under the  fair value based method for all awards, net of related tax effects |   | (81                                | )      | (94 | ) |
| Pro forma net loss                                                                                                                             |   | $                                  | (9,229 | ) | $ | (24,591 | ) |

 

The effect of applying SFAS No. 123 maynot be representative of the pro forma effect in future years since additionaloptions may be granted during those future years.

 

6

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**Note 2.****                                  Dispositionof Specialty Avionics Group**

 

On March 14, 2003, the Company entered into adefinitive agreement to sell its equity interests in the subsidiariescomprising its Specialty Avionics Group for $140,000,000 in cash.  The sale was consummated on May 23,2003.  Based upon the fair value of thegroup implied in the definitive agreement, the Company determined that thecarrying value of the group’s net assets was not fully recoverable.  As required by SFAS No. 142, the Companyrecorded a goodwill impairment charge of $7,500,000 during the three monthsended March 31, 2003 to reduce the carrying value to the estimatednet realizable value established by the definitive agreement.  As a result of the sale, the SpecialtyAvionics Group is presented as a discontinued operation in the accompanyingconsolidated financial statements.

 

In accordance with the Financial AccountingStandards Board’s Emerging Issues Task Force Issue No. 87-24, “Allocation ofInterest to Discontinued Operations,” as amended, interest expense includesinterest on debt that is to be assumed by the buyer as well as interest on the$130,723,000 of debt that was required to be repaid as a result of thesale.  Interest expense was based on thehistorical interest rates charged during each of the periods.  In addition, and also in accordance withEITF 87-24, costs and expenses exclude the allocation of general corporateoverhead.

 

The following tables summarize the resultsoperations and cash flows of the Specialty Avionics Group for the three monthsended March 31, 2003.

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

 

7

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

 

**Note 3.****                                  Inventories**

 

Inventories are comprised of the following asof March 31, 2004 and December 31, 2003:

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

 

Total costs and estimated earnings on alluncompleted contracts as of March 31, 2004 and December 31, 2004 arecomprised of the following:

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

 

8

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**Note 4.****                                  OtherAssets, Principally Intangibles**

 

Other assets are comprised of the followingas of March 31, 2004 and December 31, 2003:

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

 

**Identifiable Intangible Assets with FiniteUseful Lives**

 

Identifiable intangible assets with finiteuseful lives are comprised of the following as of March 31, 2004 andDecember 31, 2003:

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

 

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

 

**Note 5.****                                  AccruedLiabilities**

 

Accrued liabilities are comprised of thefollowing as of March 31, 2004 and December 31, 2003:

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

 

9

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**Note 6.****                                  Long-TermDebt**

 

Long-term debt includes the following amountsas of March 31, 2004 and December 31, 2003:

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

 

A portion of the interest charged on thesecond-lien term debt is pay-in-kind or “accreted” interest, payable atmaturity.  An additional $606,000 ofpay-in-kind interest accreted to the initial principal balance of the term debtduring the three months ended March 31, 2004.

 

As of March 31, 2004, the Company hadirrevocable standby letters of credit in the amount of $318,000 issued andoutstanding under the first-lien credit facility, which reduces borrowingsavailable under the $24,000,000 revolving line of credit.

 

**Note 7.****                                  MandatorilyRedeemable Preferred Stock**

 

As more fully described in “Note 1—Changes inAccounting Principles,” the Company adopted the provisions of SFAS No. 150,“Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity,” as of January 1, 2004.

 

The table below summarizes the increase inmandatorily redeemable preferred stock during the three months ended March 31,2004.

 
| **(In  thousands, except share and per share data)**          |   | **Number  of  Shares** |   | **Mandatory  Redemption  Value** |   | **Unamortized  Issuance  Discount** |   | **Net  Book  Value** |   |
|---------------------------------------------------------------|--------|------------------------|--------|----------------------------------|--------|-------------------------------------|--------|----------------------|--------|
|                                                          |   |                   |   |                             |   |                                |   |                 |   |
| Balance, December 31,  2003                              |   | 432,919                |   | $                                | 43,292 |                                | $      | (2,457               | )      | $ | 40,835 |   |
| Preferred stock dividends                                     |   | 17,317                 |   | 1,732                            |   | —                              |   | 1,732                |   |
| Redemption value accretion                                    |   | —                 |   | —                           |   | 117                                 |   | 117                  |   |
| Balance, March 31, 2004  (Unaudited)                          |   | 450,236                |   | $                                | 45,024 |                                | $      | (2,340               | )      | $ | 42,684 |   |
|                                                          |   |                   |   |                             |   |                                |   |                 |   |
| Per share liquidation value  as of March 31, 2004 (Unaudited) |   |                   |   | $                                | 100.00 |                                |   |                 |   |   |

 

Holders of the preferred stock are entitledto receive, when, as and if declared, dividends at a rate equal to 16% perannum.  Prior to June 30, 2005, theCompany may, at its option, pay dividends either in cash or by the issuance ofadditional shares of preferred stock. Since the preferred stock issuance date on June 30, 2000, the Companyhas elected to issue additional shares in lieu of cash dividend payments.  The preferred stock is mandatorilyredeemable in cash on March 31, 2009.

 

10

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**Note 8.****                                  IncomeTaxes**

 

The components of income (loss) before incometaxes and cumulative effect of change in accounting principle and theprovisions for income tax benefit are as follows:

 
|                                                       |   | **Three  Months Ended  March 31,** |   |
|------------------------------------------------------------|--------|------------------------------------|--------|
| **(In  thousands)**                                        |   | **2004**                           |   | **2003** |   |
|                                                       |   | **(Unaudited)**                    |   |
|                                                       |   |                               |   |   |   |
| Pre-tax loss reported by:                                  |   |                               |   |   |   |
| Continuing operations                                      |   | $                                  | (9,118 | ) | $ | (5,601 | ) |
| Discontinued operations                                    |   | —                             |   | (5,688 | ) |
| Consolidated pre-tax loss                                  |   | $                                  | (9,118 | ) | $ | (11,289 | ) |
|                                                       |   |                               |   |   |   |
| Total provision for income  taxes (benefit):               |   |                               |   |   |   |
| Income tax benefit based on  pre-tax loss                  |   | $                                  | (2,524 | ) | $ | (556 | ) |
| Net deferred tax asset  valuation allowance                |   | 2,554                              |   | — |   |
| Net provision for income  taxes (benefit)                  |   | $                                  | 30     |   | $ | (556 | ) |
|                                                       |   |                               |   |   |   |
| Allocation of total provision  for income taxes (benefit): |   |                               |   |   |   |
| Continuing operations                                      |   | $                                  | 30     |   | $ | (1,265 | ) |
| Discontinued operations                                    |   | —                             |   | 709 |   |
| Net provision for income tax  benefit                      |   | $                                  | 30     |   | $ | (556 | ) |

 

For the three months ended March 31, 2003,the provision for income taxes, based on the reported consolidated pre-taxloss, differs from the amount determined by applying the applicable U.S.statutory federal rate to the pre-tax loss primarily due to the effects ofstate and foreign income taxes and non-deductible expenses, principally thenon-deductible portion of goodwill impairment.

 

For the three months ended March 31, 2004,the provision for income taxes, based on the reported consolidated pre-taxloss, differs from the amount determined by applying the applicable U.S.statutory federal rate to the pre-tax loss primarily due to the effects ofstate and foreign income taxes and non-deductible expenses, principallymandatorily redeemable preferred stock dividends due to the adoption of SFASNo. 150 effective January 1, 2004 (Note 1).

 

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

 

As required by SFAS No. 109, the Companyevaluated its deferred assets for expected recoverability based on the natureof the item, the associated taxing jurisdictions, the applicable expirationdates and future 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 assure recoverability,the only possibility for recovery of the net deferred assets is future taxableincome.  Since there have been prioryear losses, the Company believes it is not prudent to rely on future income asthe means to support the carrying value of the net asset.  As a result of the evaluation, the Companyrecorded a $19,528,000 valuation allowance, eliminating the net deferred asset,as of December 31, 2003.  Based upon theresults of operations for the three months ended March 31, 2004, the Company determinedthat an additional $2,554,000 valuation allowance was required as of that date.

 

11

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**Note 9.****                                  Commitmentsand Contingencies**

 

**Litigation**

 

Raytheon Aircraft Company (“Raytheon”) hasfiled a complaint against the Company and one of its subsidiaries in the statecourt of Kansas with respect to alleged product liability related to certainaircraft seats sold to Raytheon by the Company’s subsidiary.  The complaint does not specify the amount ofdamages claimed by Raytheon, but the amount could be material.

 

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

 

The Company and its subsidiaries are alsoinvolved in other routine legal and administrative proceedings incident to thenormal conduct of business.  Managementbelieves the ultimate disposition of all such matters will not have a materialadverse effect on the Company’s business, consolidated financial position,results of operations or cash flows.

 

**Funding of DeCrane Holdings Preferred StockObligations**

 

The Company is a wholly owned subsidiary ofDeCrane Holdings whose capital structure also includes mandatorily redeemablepreferred stock.  Since the Company isDeCrane Holdings’ only operating subsidiary and source of cash, the Company maybe required to fund DeCrane Holdings’ preferred stock dividend and redemptionobligations in the future.

 

DeCrane Holdings’ preferred stock dividendsare payable quarterly at a rate of 14% per annum.  Prior to September 30, 2005, dividends are not paid in cash butinstead accrete to the liquidation value of the preferred stock, which, inturn, increases the redemption obligation. On or after September 30, 2005, preferred stock dividends are requiredto be paid in cash, if declared, and the preferred stock is mandatorilyredeemable on September 30, 2009.  TheDeCrane Holdings preferred stock has a total redemption value of $73,901,000 asof March 31, 2004, including accumulated dividends.

 

12

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**Note 10.****                           BusinessSegment Information**

 

The Company supplies products and services tothe business, VIP and head-of-state aircraft market within the aerospaceindustry.  The Company’s subsidiariesare organized into two groups, each of which is a strategic business thatdevelops, manufactures and sells distinct products and services.  The groups and a description of theirbusinesses are as follows:

 

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

 

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

 

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

 

Management utilizes more than one measurementto evaluate group performance and allocate resources; however, managementconsiders Adjusted EBITDA, as defined, to be the primary measurement of agroup’s overall core economic performance and return on invested capital.  Management also uses Adjusted EBITDA in theCompany’s annual budget and planning process for future periods, as one of thedecision-making criteria for funding discretionary capital expenditures andproduct development programs and as the measure in determining the value ofacquisitions and dispositions.  Theboard of directors uses Adjusted EBITDA as one of the performance metrics for determiningthe amount of bonuses awarded to pursuant to the Company’s 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 to the Company’s incentive stock option plan.

 

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

 

The financial measure Adjusted EBITDA, asdefined, excludes certain charges reflected in the Company’s financialstatements which are prepared in accordance with accounting principlesgenerally accepted in the United States of America (“GAAP”).  However, the Company’s presentation ofAdjusted EBITDA is in accordance with the GAAP requirements of SFAS No. 131,“Disclosures about Segments of an Enterprise and Related Information,” whichrequires the Company to report the primary measure of segment performance usedby management to evaluate and manage its businesses.  The Company’s method of calculating Adjusted EBITDA may not beconsistent with that of other companies and should be viewed in conjunctionwith measurements that are computed in accordance GAAP, such as net income(loss), the nearest comparable GAAP financial measure.  A reconciliation of Adjusted EBITDA to netincome (loss) is included herein to clarify the differences between thesefinancial measures.

 

13

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The accounting policies of the groups aresubstantially the same as those described in the summary of significantaccounting policies Note 1 to the audited financial statements.  Some transactions are recorded at theCompany’s corporate headquarters and are not allocated to the groups, such asmost of the Company’s cash and cash equivalents, debt and related net interestexpense, corporate headquarters costs and income taxes.

 

The tables below summarize selected financialdata by business segment.

 
|                          |   | **Three  Months Ended  March 31,** |   |
|-------------------------------|--------|-----------------------------------------|--------|
| **(In  thousands)**           |   | **2004**                                |   | **2003** |   |
|                          |   | **(Unaudited)**                         |   |
|                          |   |                                    |   |   |   |
| Revenues:                     |   |                                    |   |   |   |
| Cabin Management              |   | $                                       | 34,338 |   | $ | 30,620 |   |
| Systems Integration           |   | 14,531                                  |   | 12,132 |   |
| Inter-group elimination (1)   |   | (272                                    | )      | (852 | ) |
| Consolidated totals           |   | $                                       | 48,597 |   | $ | 41,900 |   |
|                          |   |                                    |   |   |   |
| Adjusted EBITDA (as defined): |   |                                    |   |   |   |
| Cabin Management              |   | $                                       | 3,440  |   | $ | 4,550 |   |
| Systems Integration           |   | 3,029                                   |   | 2,157 |   |
| Corporate (2)                 |   | (1,093                                  | )      | (2,112 | ) |
| Inter-group elimination (3)   |   | 3                                       |   | 110 |   |
| Consolidated totals           |   | 5,379                                   |   | 4,705 |   |
| Reconciling items (4)         |   | (14,527                                 | )      | (29,202 | ) |
| Net loss                      |   | $                                       | (9,148 | ) | $ | (24,497 | ) |

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

 

----

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

 

(2)          Reflects the Company’s corporate headquarterscosts 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)**                                                           |   | **2004**                                |    | **2003** |   |
|                                                                          |   | **(Unaudited)**                         |    |
| Depreciation and amortization  of long-lived assets (a)                       |   | $                                       | (2,326  | ) | $ | (2,516 | ) |
| Adjustment to reflect program  costs as research and development expenses (b) |   | (1,616                                  | )       | (1,573 | ) |
| Acquisition related charges  not capitalized                                  |   | (9                                      | )       | (9 | ) |
| Interest expense                                                              |   | (8,702                                  | )       | (5,869 | ) |
| Mandatorily redeemable  preferred stock dividends                             |   | (1,732                                  | )       | — |   |
| Other expenses, net                                                           |   | (112                                    | )       | (339 | ) |
| Provision for income (taxes)  benefit                                         |   | (30                                     | )       | 1,265 |   |
| Income (loss) from  discontinued operations                                   |   | —                                  |    | (6,397 | ) |
| Cumulative effect of change  in accounting principle                          |   | —                                  |    | (13,764 | ) |
| Total reconciling items                                                       |   | $                                       | (14,527 | ) | $ | (29,202 | ) |

 

----

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

 

(b)         Under 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 toresearch and development expense as incurred. This adjustment reflects the net difference between these two methods ofaccounting.

 

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

 

(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% subordinatednotes described in Note 6, the following condensed consolidating financialinformation is presented segregating the Company, as the issuer, and theguarantor and non-guarantor subsidiaries. The accompanying financial information in the guarantor subsidiariescolumn reflects the financial position, results of operations and cash flowsfor those subsidiaries guaranteeing the notes. The non-guarantor subsidiaries are companies within the SpecialtyAvionics Group which was sold in May 2003 and are therefore classified as a componentof discontinued operations.

 

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 of investments in subsidiaries.

 

(2)          Elimination of intercompany accounts.

 

(3)          Elimination of equity in earnings ofsubsidiaries.

 

16

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**Balance Sheets**

 
|                                                                                               |   | **March 31,  2004 (Unaudited)** |    |
|----------------------------------------------------------------------------------------------------|--------|---------------------------------|---------|
| **(In thousands)**                                                                                 |   | **Issuer**                      |    | **Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                                                               |   |                            |    |   |   |   |   |   |   |
| **Assets**                                                                                         |   |                            |    |   |   |   |   |   |   |
|                                                                                               |   |                            |    |   |   |   |   |   |   |
| Current assets:                                                                                    |   |                            |    |   |   |   |   |   |   |
| Cash and cash equivalents                                                                          |   | $                               | 2,209   |   | $ | 480 |   | $ | — |   | $ | 2,689 |   |
| Accounts receivable, net                                                                           |   | —                          |    | 26,969 |   | — |   | 26,969 |   |
| Inventories                                                                                        |   | —                          |    | 47,621 |   | — |   | 47,621 |   |
| Other current assets                                                                               |   | 122                             |    | 1,037 |   | — |   | 1,159 |   |
| Total current assets                                                                               |   | 2,331                           |    | 76,107 |   | — |   | 78,438 |   |
|                                                                                               |   |                            |    |   |   |   |   |   |   |
| Property and equipment, net                                                                        |   | 951                             |    | 29,011 |   | — |   | 29,962 |   |
| Other assets, principally  goodwill                                                                |   | 12,845                          |    | 185,992 |   | — |   | 198,837 |   |
| Investments in subsidiaries                                                                        |   | 83,962                          |    | — |   | (83,962 | )(1) | — |   |
| Intercompany receivables                                                                           |   | 230,562                         |    | 62,826 |   | (293,388 | )(2) | — |   |
| Total assets                                                                                       |   | $                               | 330,651 |   | $ | 353,936 |   | $ | (377,350 | ) | $ | 307,237 |   |
|                                                                                               |   |                            |    |   |   |   |   |   |   |
| **Liabilities  and Stockholder’s Equity (Deficit)**                                           |   |                            |    |   |   |   |   |   |   |
|                                                                                               |   |                            |    |   |   |   |   |   |   |
| Current liabilities:                                                                               |   |                            |    |   |   |   |   |   |   |
| Current portion of long-term  debt                                                                 |   | $                               | 7       |   | $ | 1,264 |   | $ | — |   | $ | 1,271 |   |
| Other current liabilities                                                                          |   | 6,111                           |    | 28,826 |   | — |   | 34,937 |   |
| Total current liabilities                                                                          |   | 6,118                           |    | 30,090 |   | — |   | 36,208 |   |
|                                                                                               |   |                            |    |   |   |   |   |   |   |
| Long-term debt, less current  portion                                                              |   | 270,111                         |    | 7,215 |   | — |   | 277,326 |   |
| Mandatorily redeemable  preferred stock                                                            |   | 42,684                          |    | — |   | — |   | 42,684 |   |
| Intercompany payables                                                                              |   | 62,826                          |    | 230,562 |   | (293,388 | )(2) | — |   |
| Other long-term liabilities                                                                        |   | 2,991                           |    | 2,375 |   | — |   | 5,366 |   |
|                                                                                               |   |                            |    |   |   |   |   |   |   |
| Stockholder’s equity  (deficit):                                                              |   |                            |    |   |   |   |   |   |   |
| Paid-in capital                                                                                    |   | 111,701                         |    | 151,492 |   | (151,492 | )(1) | 111,701 |   |
| Retained earnings (deficit)                                                                        |   | (165,780                        | )       | (67,530 | ) | 67,530 | (1) | (165,780 | ) |
| Accumulated other  comprehensive loss                                                              |   | —                          |    | (268 | ) | — |   | (268 | ) |
| Total stockholder’s equity  (deficit)                                                         |   | (54,079                         | )       | 83,694 |   | (83,962 | ) | (54,347 | ) |
| Total liabilities,  mandatorily redeemable preferred stock and stockholder’s equity (deficit) |   | $                               | 330,651 |   | $ | 353,936 |   | $ | (377,350 | ) | $ | 307,237 |   |

 

17

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|                                                                                               |   | **December  31, 2003** |    |
|----------------------------------------------------------------------------------------------------|--------|------------------------|---------|
| **(In thousands)**                                                                                 |   | **Issuer**             |    | **Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                                                               |   |                   |    |   |   |   |   |   |   |
| **Assets**                                                                                         |   |                   |    |   |   |   |   |   |   |
|                                                                                               |   |                   |    |   |   |   |   |   |   |
| Current assets:                                                                                    |   |                   |    |   |   |   |   |   |   |
| Cash and cash equivalents                                                                          |   | $                      | 6,540   |   | $ | 396 |   | $ | — |   | $ | 6,936 |   |
| Accounts receivable, net                                                                           |   | —                 |    | 21,455 |   | — |   | 21,455 |   |
| Inventories                                                                                        |   | —                 |    | 42,981 |   | — |   | 42,981 |   |
| Other current assets                                                                               |   | 254                    |    | 828 |   | — |   | 1,082 |   |
| Total current assets                                                                               |   | 6,794                  |    | 65,660 |   | — |   | 72,454 |   |
|                                                                                               |   |                   |    |   |   |   |   |   |   |
| Property and equipment, net                                                                        |   | 1,047                  |    | 29,853 |   | — |   | 30,900 |   |
| Other assets, principally  goodwill                                                                |   | 13,615                 |    | 186,907 |   | — |   | 200,522 |   |
| Investments in subsidiaries                                                                        |   | 85,668                 |    | — |   | (85,668 | )(1) | — |   |
| Intercompany receivables                                                                           |   | 261,631                |    | 100,642 |   | (362,273 | )(2) | — |   |
| Total assets                                                                                       |   | $                      | 368,755 |   | $ | 383,062 |   | $ | (447,941 | ) | $ | 303,876 |   |
|                                                                                               |   |                   |    |   |   |   |   |   |   |
| **Liabilities,  Mandatorily Redeemable Preferred Stock and Stockholder’s Equity (Deficit)**   |   |                   |    |   |   |   |   |   |   |
|                                                                                               |   |                   |    |   |   |   |   |   |   |
| Current liabilities:                                                                               |   |                   |    |   |   |   |   |   |   |
| Current portion of long-term  debt                                                                 |   | $                      | 11      |   | $ | 1,187 |   | $ | — |   | $ | 1,198 |   |
| Other current liabilities                                                                          |   | 8,532                  |    | 24,820 |   | — |   | 33,352 |   |
| Total current liabilities                                                                          |   | 8,543                  |    | 26,007 |   | — |   | 34,550 |   |
|                                                                                               |   |                   |    |   |   |   |   |   |   |
| Long-term debt, less current  portion                                                              |   | 260,654                |    | 7,554 |   | — |   | 268,208 |   |
| Intercompany payables                                                                              |   | 100,642                |    | 261,631 |   | (362,273 | )(2) | — |   |
| Other long-term liabilities                                                                        |   | 2,994                  |    | 2,470 |   | — |   | 5,464 |   |
|                                                                                               |   |                   |    |   |   |   |   |   |   |
| Mandatorily redeemable  preferred stock                                                            |   | 40,835                 |    | — |   | — |   | 40,835 |   |
|                                                                                               |   |                   |    |   |   |   |   |   |   |
| Stockholder’s equity  (deficit):                                                              |   |                   |    |   |   |   |   |   |   |
| Paid-in capital                                                                                    |   | 111,719                |    | 151,492 |   | (151,492 | )(1) | 111,719 |   |
| Retained earnings (deficit)                                                                        |   | (156,632               | )       | (65,824 | ) | 65,824 | (1) | (156,632 | ) |
| Accumulated other  comprehensive loss                                                              |   | —                 |    | (268 | ) | — |   | (268 | ) |
| Total stockholder’s equity  (deficit)                                                         |   | (44,913                | )       | 85,400 |   | (85,668 | ) | (45,181 | ) |
| Total liabilities,  mandatorily redeemable preferred stock and stockholder’s equity (deficit) |   | $                      | 368,755 |   | $ | 383,062 |   | $ | (447,941 | ) | $ | 303,876 |   |

 

18

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**Statements of Operations**

 
|                                              |   | **Three  Months Ended March 31, 2004 (Unaudited)** |   |
|---------------------------------------------------|--------|----------------------------------------------------|--------|
| **(In thousands)**                                |   | **Issuer**                                         |   | **Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                              |   |                                               |   |   |   |   |   |   |   |
| Revenues                                          |   | $                                                  | — |   | $ | 48,597 |   | $ | — |   | $ | 48,597 |   |
| Cost of sales                                     |   | —                                             |   | 36,839 |   | — |   | 36,839 |   |
|                                              |   |                                               |   |   |   |   |   |   |   |
| Gross profit                                      |   | —                                             |   | 11,758 |   | — |   | 11,758 |   |
|                                              |   |                                               |   |   |   |   |   |   |   |
| Operating and other expenses  (income):           |   |                                               |   |   |   |   |   |   |   |
| Selling, general and  administrative expenses     |   | 1,198                                              |   | 6,039 |   | — |   | 7,237 |   |
| Research and development  expenses                |   | —                                             |   | 2,181 |   | — |   | 2,181 |   |
| Amortization of intangible  assets                |   | —                                             |   | 912 |   | — |   | 912 |   |
| Interest expense                                  |   | 8,516                                              |   | 186 |   | — |   | 8,702 |   |
| Mandatorily redeemable  preferred stock dividends |   | 1,732                                              |   | — |   | — |   | 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 |   |
|                                              |   |                                               |   |   |   |   |   |   |   |
| Net loss                                          |   | $                                                  | (9,148 | ) | $ | (1,706 | ) | $ | 1,706 |   | $ | (9,148 | ) |

 
|                                                 |   | **Three  Months Ended March 31, 2003 (Unaudited)** |    |
|------------------------------------------------------|--------|---------------------------------------------------------|---------|
| **(In thousands)**                                   |   | **Issuer**                                              |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                 |   |                                                    |    |   |   |   |   |   |   |   |   |
| Revenues                                             |   | $                                                       | —  |   | $ | 41,900 |   | $ | — |   | $ | — |   | $ | 41,900 |   |
| Cost of sales                                        |   | —                                                  |    | 28,878 |   | — |   | — |   | 28,878 |   |
|                                                 |   |                                                    |    |   |   |   |   |   |   |   |   |
| Gross profit                                         |   | —                                                  |    | 13,022 |   | — |   | — |   | 13,022 |   |
|                                                 |   |                                                    |    |   |   |   |   |   |   |   |   |
| Operating and other expenses  (income):              |   |                                                    |    |   |   |   |   |   |   |   |   |
| Selling, general and  administrative expenses        |   | 3,036                                                   |    | 6,894 |   | — |   | — |   | 9,930 |   |
| Research and development  expenses                   |   | —                                                  |    | 1,573 |   | — |   | — |   | 1,573 |   |
| Amortization of intangible  assets                   |   | —                                                  |    | 912 |   | — |   | — |   | 912 |   |
| Interest expense                                     |   | 5,820                                                   |    | 49 |   | — |   | — |   | 5,869 |   |
| Intercompany charges                                 |   | (6,523                                                  | )       | 6,523 |   | — |   | — |   | — |   |
| Equity in loss of  subsidiaries                      |   | 19,748                                                  |    | 69 |   | — |   | (19,817 | )(3) | — |   |
| Other expenses, net                                  |   | 174                                                     |    | 165 |   | — |   | — |   | 339 |   |
| Provision for income taxes  (benefit)                |   | 2,242                                                   |    | (3,507 | ) | — |   | — |   | (1,265 | ) |
| Loss from discontinued  operations                   |   | —                                                  |    | 6,328 |   | 69 |   | — |   | 6,397 |   |
| Cumulative effect of change  in accounting principle |   | —                                                  |    | 13,764 |   | — |   | — |   | 13,764 |   |
|                                                 |   |                                                    |    |   |   |   |   |   |   |   |   |
| Net loss                                             |   | $                                                       | (24,497 | ) | $ | (19,748 | ) | $ | (69 | ) | $ | 19,817 |   | $ | (24,497 | ) |

 

19

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**Statements of Cash Flows**

 
|                                                  |   | **Three  Months Ended March 31, 2004 (Unaudited)** |   |
|-------------------------------------------------------|--------|----------------------------------------------------|--------|
| **(In thousands)**                                    |   | **Issuer**                                         |   | **Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  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:**            |   |                                               |   |   |   |   |   |   |   |
|                                                  |   |                                               |   |   |   |   |   |   |   |
| Net revolving line of credit  borrowings              |   | 8,850                                              |   | — |   | — |   | 8,850 |   |
| Other secured long-term  borrowings                   |   | —                                             |   | 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 and equivalents      |   | (4,331                                             | )      | 84 |   | — |   | (4,247 | ) |
| Cash and equivalents at  beginning of period          |   | 6,540                                              |   | 396 |   | — |   | 6,936 |   |
|                                                  |   |                                               |   |   |   |   |   |   |   |
| Cash and equivalents at end  of period                |   | $                                                  | 2,209  |   | $ | 480 |   | $ | — |   | $ | 2,689 |   |

 

20

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|                                                  |   | **Three  Months Ended March 31, 2003 (Unaudited)** |    |
|-------------------------------------------------------|--------|---------------------------------------------------------|---------|
| **(In thousands)**                                    |   | **Issuer**                                              |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                  |   |                                                    |    |   |   |   |   |   |   |   |   |
| **Cash flows  from operating activities:**            |   |                                                    |    |   |   |   |   |   |   |   |   |
|                                                  |   |                                                    |    |   |   |   |   |   |   |   |   |
| Net loss                                              |   | $                                                       | (24,497 | ) | $ | (19,748 | ) | $ | (69 | ) | $ | 19,817 | (3) | $ | (24,497 | ) |
| Noncash adjustments:                                  |   |                                                    |    |   |   |   |   |   |   |   |   |
| Cumulative effect of change  in accounting principle  |   | —                                                  |    | 13,764 |   | — |   | — |   | 13,764 |   |
| Loss from discontinued  operations                    |   | —                                                  |    | 6,328 |   | 69 |   | — |   | 6,397 |   |
| Equity in loss of  subsidiaries                       |   | 19,748                                                  |    | 69 |   | — |   | (19,817 | )(3) | — |   |
| Other noncash adjustments                             |   | 237                                                     |    | 1,509 |   | — |   | — |   | 1,746 |   |
| Changes in working capital                            |   | (16,438                                                 | )       | (3,339 | ) | — |   | — |   | (19,777 | ) |
| Net cash used for operating  activities               |   | (20,950                                                 | )       | (1,417 | ) | — |   | — |   | (22,367 | ) |
|                                                  |   |                                                    |    |   |   |   |   |   |   |   |   |
| **Cash flows  from investing activities:**            |   |                                                    |    |   |   |   |   |   |   |   |   |
|                                                  |   |                                                    |    |   |   |   |   |   |   |   |   |
| Cash paid for acquisitions,  net of cash acquired     |   | (600                                                    | )       | — |   | — |   | — |   | (600 | ) |
| Capital expenditures                                  |   | (3                                                      | )       | (1,095 | ) | — |   | — |   | (1,098 | ) |
| Net cash used for investing activities                |   | (603                                                    | )       | (1,095 | ) | — |   | — |   | (1,698 | ) |
|                                                  |   |                                                    |    |   |   |   |   |   |   |   |   |
| **Cash flows  from financing activities:**            |   |                                                    |    |   |   |   |   |   |   |   |   |
|                                                  |   |                                                    |    |   |   |   |   |   |   |   |   |
| Net revolving line of credit  borrowings              |   | 27,150                                                  |    | — |   | — |   | — |   | 27,150 |   |
| First-lien term debt  repayments                      |   | (3,275                                                  | )       | — |   | — |   | — |   | (3,275 | ) |
| Other secured long-term debt  repayments              |   | (114                                                    | )       | (821 | ) | — |   | — |   | (935 | ) |
| Net cash provided by (used  for) financing activities |   | 23,761                                                  |    | (821 | ) | — |   | — |   | 22,940 |   |
|                                                  |   |                                                    |    |   |   |   |   |   |   |   |   |
| Net cash provided by  discontinued operations         |   | —                                                  |    | 3,341 |   | — |   | — |   | 3,341 |   |
|                                                  |   |                                                    |    |   |   |   |   |   |   |   |   |
| Net increase in cash and  equivalents                 |   | 2,208                                                   |    | 8 |   | — |   | — |   | 2,216 |   |
| Cash and equivalents at  beginning of period          |   | 12,343                                                  |    | 78 |   | — |   | — |   | 12,421 |   |
|                                                  |   |                                                    |    |   |   |   |   |   |   |   |   |
| Cash and equivalents at end  of period                |   | $                                                       | 14,551  |   | $ | 86 |   | $ | — |   | $ | — |   | $ | 14,637 |   |

 

21

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

 

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

 

**Results of Operations**

 

### **Performance Measures**

 

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

 

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

 

We utilize more than one measurement toevaluate segment performance and allocate resources among our operatingsegments; however, we consider Adjusted EBITDA, as defined below, to be theprimary measurement of overall operating segment core economic performance andreturn on invested capital.  We also useAdjusted EBITDA in the annual budgeting and planning for future periods, as oneof the decision-making criteria for funding discretionary capital expenditureand product development programs and as the measure for determining the valueof acquisitions and dispositions.  Ourboard of directors uses Adjusted EBITDA as one of the performance metrics fordetermining the amount of bonuses awarded to pursuant to the cash incentivebonus plan 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,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.  We believe the presentation of this measureis relevant and useful to investors because it allows investors and analysts toview group performance in a manner similar to the method we use, helps improvetheir ability to understand our core segment performance, adjusted for items webelieve are unusual, and makes it easier to compare our results with othercompanies that have different financing, capital structures and tax rates.  In addition, we believe these measures areconsistent with the manner in which our lenders and investors measure ouroverall performance and liquidity, including our ability to service debt andfund discretionary capital expenditure and product development programs.

 

Our method of calculating Adjusted EBITDA maynot be consistent with that of other companies and should be viewed inconjunction with measurements that are computed in accordance GAAP, such as netincome (loss), the nearest comparable GAAP financial measure.  Adjusted EBITDA should not be viewed assubstitutes for or superior to net income (loss), cash flow from operations orother data prepared in accordance with GAAP as a measure of our profitabilityor liquidity.  The notes to ourfinancial statements include information about our operating segments,including Adjusted EBITDA, and should be read in conjunction with thediscussions presented herein.  The notesto our financial statements

 

22

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

 

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

 

Bookings represent the total invoice value ofpurchase orders received during the period and backlog represents the totalinvoice value of unfilled purchase orders as of the end of a period.  Orders may be subject to change orcancellation by the customer prior to shipment.  The level of unfilled orders at any given date during the yearwill be materially affected by the timing of our receipt of orders and thespeed with which those orders are filled.

 

### **Changes in Accounting Principles**

 

**Adoptionof SFAS No. 150.** Effective January 1, 2004, we adopted SFAS No. 150, “Accounting forCertain Financial Instruments with Characteristics of both Liabilities andEquity.”  SFAS No. 150 establishesstandards for the classification and measurement of certain financialinstruments with characteristics of both liabilities and equity.  SFAS No. 150 requires classification offinancial instruments within its scope as a liability, including financialinstruments issued in the form of shares that are mandatorily redeemable,because those financial instruments are deemed to be, in essence, obligationsof the issuer.  As a result of adoptingof SFAS No. 150 on January 1, 2004, the 16% mandatorily redeemable preferredstock was reclassified as a liability and the quarterly dividend and redemptionvalue accretion are reflected as charges against pre-tax income.  In periods prior to January 1, 2004, thesecharges were deducted in arriving at the net income or loss applicable to theCompany’s common stockholder.

 

The following table summarizes the results ofoperations for the three months ended March 31, 2003 as if SFAS No. 150 hadbeen in effect as of the beginning of 2003.

 
|                             |   | **Three  Months Ended  March 31, 2003** |   |
|----------------------------------|--------|-----------------------------------------|--------|
| **(In  millions)**               |   | **As  Reported**                        |   | **Pro Forma** |   |
|                             |   | **(Unaudited)**                         |   |
|                             |   |                                    |   |   |   |
| Loss from continuing  operations |   | $                                       | (4.3   | ) | $ | (5.9 | ) |
| Net loss                         |   | (24.5                                   | )      | (26.1 | ) |
|                                  |        |                                         |        |  |  |  |  |

 

The pro forma data reflects $1.5 million ofpreferred stock dividends and $0.1 million of redemption value accretion ascharges against income during the period.

 

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

 

This change in accounting policy was madeafter concluding the 2003 fiscal year but was applied retroactively to thebeginning of the year, January 1, 2003, as required by generally acceptedaccounting principles.  As a result ofthe change, program-related product development costs are now classified as acomponent of research and development expenses in the consolidated financialstatements rather than classified as a component of inventory cost.  As a result of the change, we have restatedthe results of operations for the three months ended March 31, 2003 by charging$1,573,000 of previously inventoried

 

23

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

 

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

 

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

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

 

*Cabin Management. *Revenues increased by $3.7 million, or12.1% compared to the prior year due to a higher volume of corporate jetproduction by aircraft manufacturers. The increase consisted of the following:

 

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

 

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

 

•                  a $1.5 millionincrease in seating products revenues; offset by

 

•                  a $0.1 milliondecrease in other product and services revenues.

 

*Systems Integration.*  Revenues increased by $2.4 million, or 19.8%compared to the prior year, due to:

 

•                  the receipt of$4.2 million for the conversion of a major supply contract for auxiliary fuelsystems to a “requirements” only contract from a guaranteed “take-or-pay”contract; and

 

•                  a $0.8 millionincrease in the commercial aircraft systems integration engineering services;offset by

 

•                  a $2.6 milliondecrease resulting from lower production of auxiliary fuel tank systems.

 

**Gross profit.**  Gross profit decreased $1.3 million, or9.7%, to $11.7 million for the three months ended March 31, 2004 from $13.0million for the same period in the prior year. By segment, gross profit changed as follows:

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

 

*Cabin Management.*  Gross profit decreased by $0.8 million, or8.6% compared to the prior year, primarily due to:

 

•                  a $1.6 milliondecrease due to lower margins resulting from the costs associated with thestart-up of production for new aircraft programs as well as a change in salesmix; offset by

 

•                  a $0.8 millionincrease in gross profit related to higher volume for our cabin management andentertainment systems.

 

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*Systems Integration.*  Gross profit decreased by $0.5 million, or9.5% compared to the prior year, primarily due to:

 

•                  a $2.3 milliondecrease resulting from lower revenues and a change in product delivery mix;offset by

 

•                  a $1.5 millionincrease resulting from the conversion of a major supply contract for auxiliaryfuel systems to a “requirements” only contact from a guaranteed “take-or-pay”contract; and

 

•                  a $0.3 millionincrease resulting from the increase in commercial aircraft systems integrationengineering services revenues.

 

During the three months endedMarch 31, 2004, we received $4.2 million as compensation for converting thesupply contract to a requirements-only contract.  In conjunction with the conversion, we charged $2.7 million tocost of sales to write-off unamortized design and engineering costs and toreduce excess raw material inventory related to this contract to its netrealizable value.

 

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

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

 

*Cabin Management. *SG&A expenses decreased by $0.2million, or 4.4% compared to the prior year, due to ongoing cost reductionmeasures.

 

*Systems Integration. *SG&A expensesdecreased by $1.4 million, or 41.4% compared to the prior year, due to lowerlabor and employee benefit costs resulting from workforce reductions in 2003 aswell as other cost reduction efforts.

 

*Corporate. *SG&A expenses decreased by $1.1 millioncompared to the prior year due principally to lower costs pursuant to theincentive compensation plan.

 

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

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

 

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

 

*Systems Integration. *R&Dexpenses increased $0.4 million, or 411.7% compared to the prior year.  The increase is principally due to thedevelopment of several new products.

 

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**Depreciation and amortization of intangibles.**  Depreciation and amortization expensedecreased $0.2 million to $2.3 million for the three months ended March 31,2004 from $2.5 million for the same period in the prior year.  The decline is attributable to reduced capitalexpenditures and lower depreciable base. By segment, depreciation and amortization changed as follows.

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

 

**Adjusted EBITDA. **Asdescribed above in “—Performance Measures–Adjusted EBITDA,” we use thisfinancial measure to evaluate the core economic performance of our operating segments.  The notes to our financial statementsinclude additional information about Adjusted EBITDA, and should be read inconjunction with the discussions presented herein.  The notes to our financial statements also include areconciliation of Adjusted EBITDA to net income (loss), a GAAP financialmeasure, to clarify the differences between these two measures.

 

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

 

•                  a $1.6 milliondecrease in gross profit related to our business, VIP and head-of-stateaircraft furniture and seating operations; and

 

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

 

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

 

•                  a $0.8 millionincrease in gross profit related our cabin management and entertainmentsystems; and

 

•                  a $0.2 milliondecrease in SG&A spending.

 

*Systems Integration. *Adjusted EBITDAincreased by $0.8 million, or 40.4%, to $3.0 million for the three months endedMarch 31, 2004 compared to $2.2 million for the same period in the prior yeardue to:

 

•                  a $1.4 milliondecrease in SG&A spending; and

 

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

 

•                  a $0.5 milliondecline in gross profit; and

 

•                  a $0.4 millionincrease in research and development expenses.

 

**Operating income.**  Operating income increased $0.8 million, or135.3%, to $1.4 million for the three months ended March 31, 2004, from $0.6million for the same period in the prior year. By segment, operating income changed as follows:

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

 

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*Cabin Management. *Operating income decreased by $0.7million, or 47.9% compared to the prior year, due to:

 

•                  a $1.5 milliondecrease in gross profit, primarily due to lower revenues related to ourfurniture and seating operations; and

 

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

 

•                  a $0.8 millionincrease in gross profit related to higher volume for our cabin management andentertainment systems; and

 

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

 

*Systems Integration.*Operatingincome increased by $0.5 million, or 35.3% compared to the prior year, due to:

 

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

 

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

 

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

 

•                  a $0.4 millionincrease in research and development expenses.

 

**Interest expense.**  Interest expense increased $2.8 million, or48.3%, to $8.7 million for the three months ended March 31, 2004 compared to$5.9 million for the same period in the prior year.  The increase is attributable to:

 

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

 

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

 

•                  a $0.5 milliondecrease in our first-lien interest expense due to lower principal balancesoutstanding resulting from the partial refinancing with second-lien debt inDecember, partially offset by a 1.5% increase in interest rate margins chargedby our lenders based on the consolidated debt leverage ratio.

 

**Mandatorilyredeemable preferred stock dividends. **Dividendson our 16% mandatorily redeemable preferred stock totaled $1.7 million for thethree months ended March 31, 2004.  As morefully described in “—Changes in Accounting Principles” above, effective January1, 2004 we adopted SFAS No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity.”  As a result of adopting of SFAS No. 150, the 16% quarterlypreferred stock dividends are reflected as a charge against pre-taxincome.  In periods prior to January 1,2004, preferred stock dividends were deducted in arriving at the net income orloss applicable to our common stockholder and amounted to $1.5 million for thethree months ended March 31, 2003.  Theincrease between periods is attributable to the quarterly compounding of thedividends accrued but not declared and paid.

 

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

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

 

For the three months ended March 31, 2003,the provision for income taxes, based on the reported consolidated pre-taxloss, differs from the amount determined by applying the applicable U.S.statutory

 

27

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federal rate to the pre-tax loss primarily due to the effects of stateand foreign income taxes and non-deductible expenses, principally thenon-deductible portion of goodwill impairment charges.

 

For the three months ended March 31, 2004,the provision for income taxes, based on the reported consolidated pre-taxloss, differs from the amount determined by applying the applicable U.S.statutory federal rate to the pre-tax loss primarily due to the effects ofstate and foreign income taxes and non-deductible expenses, principallymandatorily redeemable preferred stock dividends due to the adoption of SFASNo. 150 effective January 1, 2004 described above..

 

As more fully described in Note 11 to theaudited financial statements included in our 2003 Form 10-K, we had a netdeferred tax asset of $19.5 million fully offset by a valuation allowance ofthe same amount as of December 31,2003.

 

As required by SFAS No. 109, we evaluated ourdeferred assets for expected recoverability based on the nature of the item,the associated taxing jurisdictions, the applicable expiration dates and futuretaxable income forecasts that would impact utilization.  Since there is no loss carry back potentialand there are no tax planning strategies to assure recoverability, the onlypossibility for recovery of the net deferred assets is future taxableincome.  Since there have been prioryear losses, we believe it is not prudent to rely on future income as the meansto support the carrying value of the net asset.  As a result of the evaluation, we recorded a $19.5 millionvaluation allowance, eliminating the net deferred asset, as of December 31,2003.  Based upon the results ofoperations for the three months ended March 31, 2004, we Company determinedthat an additional $2.5 million valuation allowance was required as of thatdate.

 

**Lossfrom continuing operations.**  The loss from continuing operations increased $4.8 million to aloss of $9.1 million for the three months ended March 31, 2004 compared to aloss of $4.3 million for the same period in the prior year, primarily due to:

 

•                  a $2.6 millionincrease in interest and other expenses (net);

 

•                  a $1.3 milliondecrease in income tax benefit; and

 

•                  $1.7 million ofpreferred stock dividends resulting from the adoption of SFAS No. 150,“Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity” as described above; offset by

 

•                  a $0.8 millionincrease in operating income.

 

**Lossfrom discontinued operations. **Lossfrom discontinued operations was $6.4 million for the three months ended March31, 2003 and reflects the results of operations of our Specialty Avionics Groupwhich was sold on May 22, 2003.

 

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

 

**Net loss.**  Net loss decreased $15.4 million to a netloss of $9.1 million for the three months ended March 31, 2004 compared to anet loss of $24.5 million for the same period in the prior year.  The decrease is attributable to:

 

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

 

•                  a decrease inthe loss from discontinued operations of $6.4 million; offset by

 

•                  an increase inloss from continuing operations of $4.8 million.

 

28

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**Net loss applicable to common stockholder.**  Net loss applicable to DeCrane Holdings, ourcommon stockholder, decreased $17.0 million to a net loss of $9.1 million forthe three months ended March 31, 2004 compared to a net loss of $26.1 millionfor the same period in the prior year. The decrease in the net loss applicable to our common stockholder isattributable to:

 

•                  a $15.4 milliondecrease in our net loss; and

 

•                  a $1.6 milliondecrease in preferred stock dividends and redemption value accretion resultingfrom the January 1, 2004 adoption of SFAS No. 150 which requires preferredstock dividends be deducted from the net income or loss for the period.

 

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

 

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

 

**Liquidity and Capital Resources**

 

Our principal cash needs are for debtservice, working capital, capital expenditures and possible strategicacquisitions, as well as to provide DeCrane Holdings with cash to finance itsneeds, which consists primarily of cash dividends on its preferred stockbeginning in 2005, if declared.  Ourprincipal sources of liquidity are expected to be cash flow from operations,potential capital market transactions and third party borrowings, principallyunder our first-lien credit facility.

 

**Cash Flows During the Three months endedMarch 31, 2004**

 

Net cash used by operating activities was$12.3 million for the three months ended March 31, 2004 and consisted of $3.5million of cash used by operations after adding back depreciation,amortization, preferred stock dividends, interest accretion and other noncashitems and $8.7 million used for working capital and a $0.1 million decrease inother liabilities.  The followingfactors contributed to the $8.7 million working capital increase:

 

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

 

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

 

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

 

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

 

•                  a $0.1 millionincrease in income taxes payable due to lower levels of taxable income.

 

Net cash used by investing activitiesconsisted of capital expenditures of $0.5 million for the three months endedMarch 31, 2004.  We anticipate spendingapproximately $3.0 to $5.0 million for capital expenditures in 2004.

 

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

 

•                  $8.9 million ofdebt borrowings, primarily on the revolving line of credit; offset by

 

•                  $0.3 million ofother secured long-term debt repayments.

 

29

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**Debt Obligations andCapital Resources as of March 31, 2004**

 

As of March 31, 2004, first-lien creditfacility borrowings and second-lien term debt totaling $99.5 million are atvariable interest rates based on defined margins over the current prime rate orLIBOR.  We also had $100.0 million of12% subordinated notes, $70.6 million of 15% second-lien term debt and othersecured indebtedness totaling $8.5 million outstanding as of March 31,2004.  In addition, our 16% mandatorilyredeemable preferred stock, which has characteristics of both a liability andequity, had a $45.0 million mandatorily redemption value as of March 31, 2004.

 

As of March 31, 2004, we had $42.2 million ofworking capital and $14.8 million of borrowings available under our revolvingline of credit, which expires in March 2006.

 

**Financial Conditionand Liquidity**

 

We believe our expected operating cash flows,together with borrowings under our first-lien credit facility ($14.8 million ofwhich was available as of March 31, 2004, the commitment for which expires inMarch 2006), will be sufficient to meet our operating expenses, working capitalrequirements, capital expenditures and debt service obligations for the nexttwelve months.  However, our ability tocomply with our debt financial covenants, pay principal or interest and satisfyour other debt obligations will depend on our future operating performance aswell as competitive, legislative, regulatory, business and other factors beyondour control.  Although we cannot becertain, we expect to be in compliance with the revised financial covenantsthrough the end of the year based on our current operating plan.

 

We continue to explore the possiblerestructuring of our other debt and equity instruments that would improve ourliquidity and reduce our cash needs.  Wehave not entered into any definitive documentation to do so and cannot assureyou that we will be able to do so in the future.

 

**Disclosure of Contractual Obligations andCommitments**

 

The following table summarizes our knowncontractual obligations to make future cash payments as of March 31, 2004, aswell an estimate of the periods during which these payments are expected to bemade.

 
|                                        |   |      |   | **Years  Ending December 31,** |   |
|---------------------------------------------|--------|-----------|--------|--------------------------------|--------|
| **(In  millions)**                          |   | **Total** |   | **2004**                       |   | **2005  and  2006** |   | **2007  and  2008** |   | **2009  and  Beyond** |   |
|                                        |   |      |   |                           |   |   |   |   |   |   |   |
| Long-term debt (a):                         |   |      |   |                           |   |   |   |   |   |   |   |
| First-lien credit facility  (b):            |   |      |   |                           |   |   |   |   |   |   |   |
| Term debt                                   |   | $         | 80.5   |                           | $      | — |   | $ | 15.0 |   | $ | 65.5 |   | $ | — |   |
| Revolving line of credit                    |   | 8.9       |   | —                         |   | 8.9 |   | — |   | — |   |
| Second-lien term debt (c)                   |   | 80.7      |   | —                         |   | — |   | 80.7 |   | — |   |
| 12% subordinated notes (d)                  |   | 100.0     |   | —                         |   | — |   | 100.0 |   | — |   |
| Capital lease obligations (e)               |   | 3.3       |   | 0.4                            |   | 0.9 |   | 0.6 |   | 1.4 |   |
| Other indebtedness (e)                      |   | 5.2       |   | 0.5                            |   | 1.7 |   | 0.6 |   | 2.4 |   |
| Total long-term debt                        |   | 278.6     |   | 0.9                            |   | 26.5 |   | 247.4 |   | 3.8 |   |
|                                        |   |      |   |                           |   |   |   |   |   |   |   |
| Mandatorily redeemable  preferred stock (f) |   | 45.0      |   | —                         |   | — |   | — |   | 45.0 |   |
| Other long-term liabilities                 |   | 5.4       |   | —                         |   | 3.7 |   | 1.7 |   | — |   |
| Operating lease obligations                 |   | 14.0      |   | 2.2                            |   | 5.0 |   | 2.4 |   | 4.4 |   |
| Total obligations as of March  31, 2004     |   | $         | 343.0  |                           | $      | 3.1 |   | $ | 35.2 |   | $ | 251.5 |   | $ | 53.2 |   |

 

30

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(a)                                  Excludes interestpayments.

 

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

 

(c)                                  The second-lien termdebt is comprised of $70.0 million of fixed rate debt and $10.0 million ofvariable rate debt.  The fixed rate debtbears interest at 15%; 12% payable quarterly in cash and 3% pay-in-kind or“accreted” interest, payable at maturity. The variable rate debt bears cash interest, at our option, at the primerate plus 7.5% or LIBOR plus 8.5%, plus 3% pay-in-kind interest payable atmaturity.  The weighted-average interestrate on all second-lien debt was 14.33% as of March 31, 2004.  All of the second-lien debt matures on June30, 2008, at which time the cash payment obligation will be $91.7 million,including the 3% pay-in-kind interest obligation.

 

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

 

(e)                                  Interest is generallypayable monthly.

 

(f)                                    Dividends accruequarterly at a 16% annual rate.  Priorto June 30, 2005, we may, at our option, pay dividends either in cash or by theissuance of additional shares of preferred stock.  Since the issuance of the preferred stock in June 2000, we haveelected to issue additional shares in lieu of cash dividend payments and maycontinue to do so until June 2005, after which time we are required to payquarterly dividends in cash, if declared. Our debt instruments restrict our ability to make payments on our preferredstock.  If we elect to continue issuingadditional shares until June 2005, our mandatory redemption obligation on March31, 2009, the mandatory redemption date, will be $54.8 million and our annualcash dividend payment obligation will be $8.8 million, payable quarterly,commencing September 2005, if declared.

 

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

 

We are a wholly-owned subsidiary of DeCraneHoldings, whose capital structure also includes mandatorily redeemablepreferred stock.  Since we are DeCraneHoldings’ only operating subsidiary and source of cash, we may be required tofund DeCrane Holdings’ redemption obligation in the future, subject tosignificant limitations contained in our first-lien credit agreement,second-lien term notes and the subordinated notes indenture.  The DeCrane Holdings preferred stock has atotal redemption value of $73.9 million as of March 31, 2004 and the preferredstock is mandatorily redeemable on September 30, 2009.

 

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

 

In connection with the sale of the 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 ofthese matters are limited in terms of duration with the maximum of potentialfuture payments capped at $14.0 million and our indemnities with respect tospecified

 

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environmental matters will expire not later than October 2010 andprovides for a maximum liability of $5.0 million, while others will have nolimitations.

 

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

 

**Recent Accounting Pronouncements**

 

**AccountingPronouncements Adopted January 1, 2004**

 

As more fully described in Note 1 accompanyingour financial statements included in this report and “—Changes in AccountingPrinciples” above, effective January 1, 2004 we adopted the provisions of SFASNo. 150, “Accounting for Certain Financial Instruments with Characteristics ofboth Liabilities and Equity.”

 

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

 

All statements other than statements ofhistorical facts 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 andgeneral economic conditions that affect demand for aircraft and air travel,which in turn affect demand for our products and services;

 

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

 

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

 

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

 

•                  competition fromlarger companies;

 

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

 

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

 

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

 

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

 

•                  the ability toattract and retain qualified personnel;

 

•                  labordisturbances; and

 

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

 

Some of the more significant factors listedabove are further described in our 2003 Annual Report on Form 10-K and shouldbe read in conjunction with this report. Changes in such factors could cause our actual results to differmaterially from those contemplated in such forward-looking statements.  Although we believe that the expectationsreflected in such forward-looking statements are reasonable, we can give noassurance that such expectations will prove to be correct.  We undertake no obligation to release publiclyany revisions to these forward-looking statements to reflect events orcircumstances after

 

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the date hereof or to reflect the occurrence of unanticipatedevents.  You should not rely on ourforward-looking statements as if they were certainties.

 

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

 

We are exposed to various market risks,including interest 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 these factors.  We do not enter into derivatives or otherfinancial instruments for trading or speculative purposes.

 

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

 

Market risk related to our variable-rate debtis estimated as the potential decrease in pre-tax earnings resulting from anincrease in interest rates.  Theinterest rates applicable to variable-rate debt are, at our option, based ondefined margins over the current prime rate or LIBOR.  As of March 31, 2004, the current prime rate was 4.00% and thecurrent LIBOR was 1.08%.  Based on $99.5million of variable-rate debt outstanding as of March 31, 2004, a hypotheticalone percent rise in interest rates, to 5.00% for prime rate borrowings and2.08% for LIBOR borrowings, would reduce our pre-tax earnings by $1.0 millionannually.

 

To limit a portion of our exposure related torising interest rates, we have entered into an interest rate swap contract toeffectively convert our variable-rate industrial revenue bonds to 4.2%fixed-rate debt until maturity in 2008. The contract is considered to be a hedge against changes in the amountof future cash flows associated with interest payments on this portion of ourvariable-rate debt.  Market risk relatedto this interest rate swap contract is estimated as the potential higherinterest expense we will incur if the variable interest rate decreases belowthe 4.2% fixed rate.  Based on the $3.1million of variable-rate debt converted to fixed-rate debt outstanding as ofMarch 31 2004, a hypothetical one percent decrease in the variable interestrate to 3.2%, would reduce our pre-tax earnings by less than $0.1 millionannually.

 

The estimated fair value of our $100.0million fixed-rate long-term debt increased $20.0 million, or 44.4%, toapproximately $65.0 million as of March 31, 2004 from $45.0 million as ofDecember 31, 2003.  Market risk relatedto our fixed-rate debt is deemed to be the potential increase in fair valueresulting from a decrease in interest rates. For example, a hypothetical ten percent decrease in the interest rates,from 12.0% to 10.8%, would increase the fair value of our fixed-rate debt byapproximately $5.0 million.

 

**ForeignCurrency 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 rate risk related to salesto our customers, orders are almost always valued and sold in U.S.dollars.  We have entered into forwardforeign exchange contracts in the past, primarily to limit exposure related toforeign inventory procurement and operating costs.  While we have not entered into any such contracts since 1998, wemay do so in the future depending on the volume of non-U.S. dollar denominatedtransactions and our assessment of future foreign exchange rate trends.

 

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

 

The management of DeCrane Aircraft Holdings,Inc. (the “Company”), under the supervision and with the participation of theCompany’s Chief Executive Officer and Chief Financial Officer, conducted anevaluation of the Company’s “disclosure controls and procedures” (as defined inExchange Act Rules 13a-15(e) or 15d-15(e)) as of the end of the period coveredby this report.  Based on thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures were effective as of theend of the period covered by this report.

 

There was no change in the Company’s internalcontrol over financial reporting identified in connection with the evaluationrequired by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurredduring the 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.****                             LEGALPROCEEDINGS**

 

See Note 9 to the consolidated financialstatements included in this report.

 

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

 

a.                                       Exhibits

 

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

 

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

 

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

 

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

 

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*                                         Filed herewith

 

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

 

b.                                      Reports on Form 8-K

 

None.

 

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**SIGNATURES**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
|         | **DECRANE AIRCRAFT HOLDINGS, INC.  (Registrant)** |
|--------------|---------------------------------------------------|
|         |                                              |
|         |                                              |
| May 14, 2004 | By:                                               | /s/  RICHARD J. KAPLAN |
|         | Name:                                             | Richard J. Kaplan |
|         | Title:                                            | Senior Vice President, Chief Financial Officer, |
|         |                                              | Secretary, Treasurer and Director |

 

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