**UNITEDSTATES****SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-Q /A**

**(AMENDMENTNO. 1)**

 

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

 

**For the quarterly period ended June 30,2003**

 

**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.) |

 

**2361Rosecrans Avenue, Suite 180, El Segundo, CA 90245**

(Address, including zip code, of principalexecutive offices)

 

**(310)725-9123**

(Registrant’s telephone number, includingarea code)

 

**(NotApplicable)**

(Former address and telephone number ofprincipal executive offices, if changed since last report)

 

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

 

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

 

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The number of shares of Registrant’s Common Stock, $.01 par value,outstanding as of August 1, 2003 was 100 shares.

 

 

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**Tableof Contents**

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

 

DeCraneAircraft Holdings, Inc. is filing this Amendment No. 1 on Form 10-Q/A for thequarterly period ended June 30, 2003 to amend and restate, in itsentirety, its Quarterly Report on Form 10-Q originally filed with theSecurities and Exchange Commission on August 14, 2003 (referred to hereinas the “Original Report” and the “Amended Report”).  Except for the reclassifications described below, no changes havebeen made in this Amended Report to the consolidated financial position,results of operations or cash flows we reported in our Original Report.  This Amended Report does not reflect eventsoccurring after the August 14, 2003 filing of our Original Report ormodify or update the disclosures set forth in that Original Report in any wayto reflect any changes in our business or our consolidated financial position,results of operations or cash flows subsequent to the filing date of theOriginal Report.  For the convenience ofthe reader, we deemed it desirable to amend and restate our Original Report inits entirety.

 

In thisAmended Report, we are reclassifying our consolidated statements of financialposition, results of operations and cash flows to reflect interest expense andgeneral corporate overhead allocations in accordance with EITF 87-24,“Allocation of Interest to Discontinued Operations,” for all periods presentedas described in Note 2 accompanying our financial statements included in thisreport.  In addition, we are also makingsimilar conforming changes to other parts of the Original Report as well.

 

This AmendedReport should be read in conjunction with our Amendment No. 1 on Form 10-K/Afor the fiscal year ended December 31, 2002 and our Amendment No. 1 onForm 10-Q/A for the quarterly period ended March 31, 2003 filedconcurrently with this Amended Report. As required by Rule 12b-15 of the Securities Exchange Act of 1934, ourChief Executive Officer and Chief Financial Officer are providing updatedcertifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002and updated written statements pursuant to Title 18 United States CodeSection 1350, as adopted pursuant to Section 906 of the Act.

 

i

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**PART I****– FINANCIALINFORMATION**

 

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

 

**DECRANEAIRCRAFT HOLDINGS, INC. AND SUBSIDIARIES**

 

**Consolidated BalanceSheets**

 
| **(In thousands, except share data)**                                                                                                          |   | **June 30,  2003** |       | **December 31,  2002** |       |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|------------|-----------------------------|------------|
|                                                                                                                                           |   | **(Unaudited)**         |       |                        |       |
| **Assets**                                                                                                                                     |   |                    |       |                        |       |
| Current assets:                                                                                                                                |   |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                      |   | $                       | 3,673      |                        | $          | 12,421 |   |
| Accounts receivable, net                                                                                                                       |   | 20,726                  |       | 26,354                      |       |
| Inventories                                                                                                                                    |   | 63,125                  |       | 59,300                      |       |
| Deferred income taxes                                                                                                                          |   | 172                     |       | 16,430                      |       |
| Prepaid expenses and other current assets                                                                                                      |   | 1,609                   |       | 1,724                       |       |
| Current assets of discontinued operations                                                                                                      |   | —                  |       | 160,741                     |       |
| Total current assets                                                                                                                           |   | 89,305                  |       | 276,970                     |       |
|                                                                                                                                           |   |                    |       |                        |       |
| Property and equipment, net                                                                                                                    |   | 34,801                  |       | 36,139                      |       |
| Goodwill                                                                                                                                       |   | 162,430                 |       | 196,430                     |       |
| Other assets, principally intangibles, net                                                                                                     |   | 36,110                  |       | 39,428                      |       |
| Total assets                                                                                                                                   |   | $                       | 322,646    |                        | $          | 548,967 |   |
|                                                                                                                                           |   |                    | ** ** |                        | ** ** |
| **Liabilities, Mandatorily Redeemable  Preferred Stock and Stockholder’s Equity (Deficit)**                                               |   |                    |       |                        |       |
| Current liabilities:                                                                                                                           |   |                    |       |                        |       |
| Current portion of long-term debt                                                                                                              |   | $                       | 8,485      |                        | $          | 16,317 |   |
| Accounts payable                                                                                                                               |   | 9,847                   |       | 13,055                      |       |
| Accrued liabilities                                                                                                                            |   | 20,645                  |       | 31,494                      |       |
| Income taxes payable                                                                                                                           |   | 149                     |       | —                      |       |
| Current liabilities of discontinued  operations                                                                                                |   | —                  |       | 19,928                      |       |
| Total current liabilities                                                                                                                      |   | 39,126                  |       | 80,794                      |       |
|                                                                                                                                           |   |                    |       |                        |       |
| Long-term debt, less current portion                                                                                                           |   | 251,372                 |       | 364,700                     |       |
| Deferred income taxes                                                                                                                          |   | 387                     |       | 27,077                      |       |
| Other long-term liabilities                                                                                                                    |   | 11,485                  |       | 7,364                       |       |
|                                                                                                                                           |   |                    |       |                        |       |
| Commitments and contingencies (Note 11)                                                                                                        |   |                    |       |                        |       |
|                                                                                                                                           |   |                    |       |                        |       |
| Mandatorily redeemable preferred stock                                                                                                         |   | 37,335                  |       | 34,081                      |       |
|                                                                                                                                           |   |                    |       |                        |       |
| Stockholder’s equity (deficit):                                                                                                           |   |                    |       |                        |       |
| Common stock, $.01 par value, 1,000 shares  authorized; 100 shares issued and outstanding as of June 30, 2003 and  December 31, 2002 |   | —                  |       | —                      |       |
| Additional paid-in capital                                                                                                                     |   | 117,958                 |       | 121,212                     |       |
| Notes receivable for shares sold                                                                                                               |   | (2,665                  | )          | (2,591                      | )          |
| Accumulated deficit                                                                                                                            |   | (131,988                | )          | (83,309                     | )          |
| Accumulated other comprehensive loss                                                                                                           |   | (364                    | )          | (361                        | )          |
| Total stockholder’s equity (deficit)                                                                                                      |   | (17,059                 | )          | 34,951                      |       |
| Total liabilities, mandatorily redeemable  preferred stock and stockholder’s equity (deficit)                                             |   | $                       | 322,646    |                        | $          | 548,967 |   |

 

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****June 30,** |    | **Six Months  Ended****June 30,** |   |
|--------------------------------------------------------------------|--------|------------------------------------------|---------|----------------------------------------|--------|
| **(In thousands)**                                                 |   | **2003**                                 |    | **2002**                               |   | **2003** |   | **2002** |   |
|                                                               |   | **(Unaudited)**                          |    |
| Revenues                                                           |   | $                                        | 44,113  |                                   | $      | 61,293 |   | $ | 86,013 |   | $ | 122,112 |   |
| Cost of sales                                                      |   | 45,383                                   |    | 47,831                                 |   | 76,286 |   | 92,212 |   |
|                                                               |   |                                     |    |                                   |   |   |   |   |   |
| Gross profit (loss)                                                |   | (1,270                                   | )       | 13,462                                 |   | 9,727 |   | 29,900 |   |
|                                                               |   |                                     |    |                                   |   |   |   |   |   |
| Operating expenses:                                                |   |                                     |    |                                   |   |   |   |   |   |
| Selling, general and administrative  expenses                      |   | 6,572                                    |    | 12,088                                 |   | 14,477 |   | 24,247 |   |
| Impairment of goodwill                                             |   | 34,000                                   |    | —                                 |   | 34,000 |   | — |   |
| Amortization of intangible assets                                  |   | 914                                      |    | 874                                    |   | 1,826 |   | 1,717 |   |
| Total operating expenses                                           |   | 41,486                                   |    | 12,962                                 |   | 50,303 |   | 25,964 |   |
|                                                               |   |                                     |    |                                   |   |   |   |   |   |
| Income (loss) from operations                                      |   | (42,756                                  | )       | 500                                    |   | (40,576 | ) | 3,936 |   |
|                                                               |   |                                     |    |                                   |   |   |   |   |   |
| Other expenses:                                                    |   |                                     |    |                                   |   |   |   |   |   |
| Interest expense                                                   |   | 6,468                                    |    | 6,134                                  |   | 12,337 |   | 12,082 |   |
| Other expenses, net                                                |   | 407                                      |    | 86                                     |   | 746 |   | 199 |   |
|                                                               |   |                                     |    |                                   |   |   |   |   |   |
| Loss from continuing operations before  provision for income taxes |   | (49,631                                  | )       | (5,720                                 | )      | (53,659 | ) | (8,345 | ) |
| Income tax benefit                                                 |   | 9,365                                    |    | 2,050                                  |   | 10,630 |   | 3,191 |   |
|                                                               |   |                                     |    |                                   |   |   |   |   |   |
| Loss from continuing operations                                    |   | (40,266                                  | )       | (3,670                                 | )      | (43,029 | ) | (5,154 | ) |
|                                                               |   |                                     |    |                                   |   |   |   |   |   |
| Discontinued operations and change in  accounting principle:       |   |                                     |    |                                   |   |   |   |   |   |
| Income (loss) from discontinued operations,  net of tax            |   | 747                                      |    | 1,738                                  |   | (5,650 | ) | (35,702 | ) |
| Cumulative effect of change in accounting  principle               |   | —                                   |    | —                                 |   | — |   | (17,828 | ) |
|                                                               |   |                                     |    |                                   |   |   |   |   |   |
| Net loss                                                           |   | (39,519                                  | )       | (1,932                                 | )      | (48,679 | ) | (58,684 | ) |
|                                                               |   |                                     |    |                                   |   |   |   |   |   |
| Accrued preferred stock dividends                                  |   | (1,540                                   | )       | (1,316                                 | )      | (3,020 | ) | (2,581 | ) |
| Preferred stock redemption value accretion                         |   | (117                                     | )       | (117                                   | )      | (234 | ) | (234 | ) |
|                                                               |   |                                     |    |                                   |   |   |   |   |   |
| Net loss applicable to common stockholder                          |   | $                                        | (41,176 | )                                      | $      | (3,365 | ) | $ | (51,933 | ) | $ | (61,499 | ) |

 

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)**

 
|                                            |   | **Common  Stock** |   | **Additional  Paid-in** |   | **Notes  Receivable  For Shares** |   | **Accumulated** |   | **Accumulated  Other  Comprehensive** |   |     |   |
|-------------------------------------------------|--------|-------------------|--------|-------------------------|--------|-----------------------------------|--------|-----------------|--------|---------------------------------------|--------|----------|--------|
| **(In thousands, except share data)**           |   | **Shares**        |   | **Amount**              |   | **Capital**                       |   | **Sold**        |   | **Deficit**                           |   | **Loss** |   | **Total** |   |
|                                            |   |              |   |                    |   |                              |   |            |   |                                  |   |     |   |   |   |
| Balance, December 31, 2002                 |   | 100               |   | $                       | — |                              | $      | 121,212         |   | $                                     | (2,591 | )        | $      | (83,309 | ) | $ | (361 | ) | $ | 34,951 |   |
|                                            |   |              |   |                    |   |                              |   |            |   |                                  |   |     |   |   |   |
| Comprehensive income (loss):                    |   |              |   |                    |   |                              |   |            |   |                                  |   |     |   |   |   |
| Net loss                                        |   | —            |   | —                  |   | —                            |   | —          |   | (48,679                               | )      | —   |   | (48,679 | ) |
| Unrealized loss on interest rate swap  contract |   | —            |   | —                  |   | —                            |   | —          |   | —                                |   | (3       | )      | (3 | ) |
|                                            |   |              |   |                    |   |                              |   |            |   |                                  |   |     |   | (48,682 | ) |
|                                            |   |              |   |                    |   |                              |   |            |   |                                  |   |     |   |   |   |
| Accrued preferred stock dividends               |   | —            |   | —                  |   | (3,020                            | )      | —          |   | —                                |   | —   |   | (3,020 | ) |
|                                            |   |              |   |                    |   |                              |   |            |   |                                  |   |     |   |   |   |
| Preferred stock redemption value accretion      |   | —            |   | —                  |   | (234                              | )      | —          |   | —                                |   | —   |   | (234 | ) |
|                                            |   |              |   |                    |   |                              |   |            |   |                                  |   |     |   |   |   |
| Notes receivable interest accrued               |   | —            |   | —                  |   | —                            |   | (74             | )      | —                                |   | —   |   | (74 | ) |
|                                            |   |              |   |                    |   |                              |   |            |   |                                  |   |     |   |   |   |
| Balance, June 30, 2003 (Unaudited)         |   | 100               |   | $                       | — |                              | $      | 117,958         |   | $                                     | (2,665 | )        | $      | (131,988 | ) | $ | (364 | ) | $ | (17,059 | ) |

 

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**

 
|                                                                               |   | **Six Months  Ended  June 30,** |    |
|------------------------------------------------------------------------------------|--------|--------------------------------------|---------|
| **(In thousands)**                                                                 |   | **2003**                             |    | **2002** |   |
|                                                                               |   | **(Unaudited)**                      |    |
| **Cash flows from operating activities:**                                          |   |                                 |    |   |   |
| Net loss                                                                           |   | $                                    | (48,679 | ) | $ | (58,684 | ) |
| Adjustments to reconcile net income to net  cash provided by operating activities: |   |                                 |    |   |   |
| Loss from discontinued operations                                                  |   | 5,650                                |    | 35,702 |   |
| Cumulative effect of change in accounting  principle                               |   | —                               |    | 17,828 |   |
| Depreciation and amortization                                                      |   | 6,342                                |    | 6,743 |   |
| Noncash portion of restructuring, asset  impairment and other related charges      |   | 43,926                               |    | 5,910 |   |
| Deferred income taxes                                                              |   | (11,659                              | )       | (1,008 | ) |
| Other, net                                                                         |   | 295                                  |    | 212 |   |
| Changes in assets and liabilities:                                                 |   |                                 |    |   |   |
| Accounts receivable                                                                |   | 4,207                                |    | 7,725 |   |
| Inventories                                                                        |   | (12,705                              | )       | (1,786 | ) |
| Prepaid expenses and other assets                                                  |   | 541                                  |    | (1,540 | ) |
| Accounts payable                                                                   |   | (2,251                               | )       | (1,090 | ) |
| Accrued liabilities                                                                |   | (10,755                              | )       | (14,340 | ) |
| Income taxes payable                                                               |   | 385                                  |    | 30 |   |
| Other long-term liabilities                                                        |   | 4,761                                |    | 448 |   |
| Net cash used for operating activities                                             |   | (19,942                              | )       | (3,850 | ) |
|                                                                               |   |                                 |    |   |   |
| **Cash flows from investing activities:**                                          |   |                                 |    |   |   |
| Net cash proceeds from sale of Specialty  Avionics Group                           |   | 132,800                              |    | — |   |
| Capital expenditures                                                               |   | (2,002                               | )       | (2,024 | ) |
| Cash paid for acquisition contingent  consideration                                |   | (600                                 | )       | (5,890 | ) |
| Net cash provided by (used for) investing  activities                              |   | 130,198                              |    | (7,914 | ) |
|                                                                               |   |                                 |    |   |   |
| **Cash flows from financing activities:**                                          |   |                                 |    |   |   |
| Principal payments on term debt,  capitalized leases and other debt                |   | (130,448                             | )       | (4,486 | ) |
| Net borrowings under senior revolving  credit facility                             |   | 9,250                                |    | 8,000 |   |
| Deferred financing costs                                                           |   | —                               |    | (1,663 | ) |
| Other, net                                                                         |   | —                               |    | 277 |   |
| Net cash provided by (used for) financing  activities                              |   | (121,198                             | )       | 2,128 |   |
|                                                                               |   |                                 |    |   |   |
| Net cash provided by discontinued  operations                                      |   | 2,194                                |    | 8,747 |   |
|                                                                               |   |                                 |    |   |   |
| Net decrease in cash and cash equivalents                                          |   | (8,748                               | )       | (889 | ) |
| Cash and cash equivalents at beginning of  period                                  |   | 12,421                               |    | 9,478 |   |
| Cash and cash equivalents at end of period                                         |   | $                                    | 3,673   |   | $ | 8,589 |   |

 

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

 

4

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**DECRANEAIRCRAFT HOLDINGS, INC. AND SUBSIDIARIES**

 

**Condensed Notes****toConsolidated Financial Statements**

**(Unaudited)**

 

**Note 1.****                                  Summaryof Significant Accounting Policies**

 

**Basis of Presentation**

 

These consolidatedinterim financial statements are unaudited. The Company believes the interim financial statements are presented on abasis consistent with the audited financial statements and include alladjustments necessary for a fair presentation of the financial condition,results of operations and cash flows for such interim periods.  All of these adjustments are normalrecurring adjustments.

 

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

 

The results ofoperations for interim periods do not necessarily predict the operating resultsfor any other interim period or for the full year.  The consolidated balance sheet as of December 31, 2002 hasbeen derived from audited financial statements but does not include alldisclosures required by accounting principles generally accepted in the UnitedStates of America as permitted by interim reporting requirements.  These consolidated interim financialstatements should be read in conjunction with Management’s Discussion andAnalysis of Financial Condition and Results of Operations and the auditedfinancial statements and related notes included in the Company’s 2002 Form 10-K/ Amendment No. 1, as described below.

 

As the Companyoriginally described in its Form 10-K for the year ended December 31, 2002and Form 10-Q for the three months ended March 31, 2003, its failure toconsummate the sale of the Specialty Avionics Group by June 30, 2003 wouldhave been an event of default under the amended senior credit facility.  As a result, the Company’s independentaccountants qualified their report on its audited financial statements for theyear ended December 31, 2002 with respect to its ability to continue as agoing concern.  Consummation of the saleand repayment of $130.0 million of borrowings alleviated the independentaccountants’ doubt about the Company’s ability to continue as a goingconcern.  As a result, the Company’sindependent accountants issued a revised, unqualified report on its financialstatements, which the Company included in Amendment No. 1 to its Form 10-K forthe year ended December 31, 2002.

 

Reclassificationshave also been made to the financial statements for all periods presented,principally to reflect the disposition of the Specialty Avionics Group as adiscontinued operation (Note 2).

 

5

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**Stock Option Plan**

 

The Companyhas one stock-based employee compensation plan, which is more fully describedin the notes to its audited financial statements.  As permitted under SFAS No. 123, “Accounting for Stock-BasedCompensation,” the Company measures compensation expense related to theemployee stock option plan utilizing the intrinsic value method as prescribedby Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued toEmployees,” and related interpretations. No stock-based employee compensation cost is reflected in net income(loss), as all options granted under the plan had an exercise price equal tothe value of the underlying common stock on the date of grant.

 

The followingtable illustrates the effect on net income if the Company had applied the fairvalue recognition provisions of SFAS No. 123 to stock-based employeecompensation.

 
|                                                                                                                                           |   | **Three  Months Ended  June 30,** |    | **Six Months  Ended  June 30,** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|---------|--------------------------------------|--------|
| **(In thousands)**                                                                                                                             |   | **2003**                               |    | **2002**                             |   | **2003** |   | **2002** |   |
|                                                                                                                                           |   | **(Unaudited)**                        |    |
| Net loss, as reported                                                                                                                          |   | $                                      | (39,519 | )                                    | $      | (1,932 | ) | $ | (48,679 | ) | $ | (58,684 | ) |
| Less total stock-based employee  compensation expense determined under the fair value based method for all  awards, net of related tax effects |   | (94                                    | )       | (94                                  | )      | (188 | ) | (188 | ) |
| Pro forma net loss                                                                                                                             |   | $                                      | (39,613 | )                                    | $      | (2,026 | ) | $ | (48,867 | ) | $ | (58,872 | ) |

 

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

 

**Accounting Pronouncements AdoptedJanuary 1, 2003**

 

EffectiveJanuary 1, 2003 the Company adopted the following accountingpronouncements.

 

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

 

Among otherthings, SFAS No. 145 rescinds various pronouncements regarding earlyextinguishment of debt and allows extraordinary accounting treatment for earlyextinguishment only when the provisions of Accounting Principles Board OpinionNo. 30, “Reporting the Results of Operations–Reporting the Effects of Disposalof a Segment of a Business, and Extraordinary, Unusual and InfrequentlyOccurring Events and Transactions” are met. Adoption of this new standard did not have an impact on the Company’sconsolidated financial position, or results of operations or cash flow.

 

6

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

 

SFAS No. 146supersedes previous accounting guidance, principally Emerging Issues Task ForceIssue No. 94-3, “Liability Recognition for Certain Employee TerminationBenefits and Other Costs to Exit an Activity (including Certain Costs Incurredin a Restructuring).”  SFAS No. 146requires that the liability for costs associated with an exit or disposalactivity be initially measured at fair value and recognized when the liabilityis incurred.  In periods subsequent toinitial measurement, changes to the liability are measured using thecredit-adjusted risk-free rate that was used in the initial measurement of theliability recorded.  The cumulativeeffect of a change resulting from revisions to either the timing or the amountof estimated cash flows is recognized as an adjustment to the liability in theperiod of the change and charged to the same line items in the statement ofoperations used when the related costs were initially recognized.  Under EITF No. 94-3, a liability for an exitcost was recognized at the date of a company’s commitment to an exit plan.

 

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

 

*FASB Interpretation No. 45 – Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers*

 

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

 

**RecentlyIssued Accounting Pronouncement**

 

*SFAS No. 150 – Accounting for Certain Financial Instruments withCharacteristics of both Liabilities and Equity*

 

Issued inMay 2003, 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. The Company will be required to reclassify its mandatorily redeemablepreferred stock as a liability commencing July 1, 2003 and reflectquarterly dividend and redemption value accretion on its 16% preferred stock asa charge against pre-tax income in future periods.

 

7

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

 

During thefourth quarter of fiscal 2002 the Company assessed its long-term business strategiesin light of current aerospace industry conditions.  The Company believes that as the aerospace industry recovers, thedemand for its Cabin Management and Systems Integration Groups’ products andservices for business, VIP and head-of-state aircraft will return to historicallevels and, accordingly, the Company decided to focus its resources in thesemarket segments.  To accomplish thisobjective, the Company embarked on a plan to sell its Specialty Avionics Group,which is highly dependent on the commercial airline industry.

 

OnMarch 14, 2003, the Company entered into a definitive agreement to sellits equity interests in the subsidiaries comprising its Specialty AvionicsGroup to Wings Holdings, Inc., an affiliate of Odyssey Investment Partners, LLC,for $140,000,000 in cash.  The sale wasconsummated on May 23, 2003.  Theselling price is subject to a post-closing adjustment related to the amount ofworking capital at closing.  Proceeds of$130,000,000 from the sale were used to repay senior credit facility borrowings(Note 8).  The sale of the SpecialtyAvionics Group is not expected to affect the operations of the remainingoperating groups.

 

Based upon thefair value of the group implied in the definitive agreement, the Companydetermined that the carrying value of the group’s net assets was not fullyrecoverable.  As required by SFAS No.142, the Company recorded a goodwill impairment charge of $7,500,000 during thethree months ended March 31, 2003 to reduce the carrying value to theestimated net realizable value established by the definitive agreement.  The Company recorded a modest $689,000 gain,net of tax, on the sale during the second quarter of fiscal 2003, based on theactual financial position of the group on the date of sale.  The ultimate gain or loss on the sale issubject to finalizing the post-closing adjustment, which is not expected to bematerial, if any.

 

As a result ofthe sale, the Specialty Avionics Group is presented as a discontinued operationin the accompanying consolidated financial statements.  The financial statements for prior periodshave been reclassified to segregate the group’s assets and liabilities, resultsof operations and cash flows for all periods.

 

In accordancewith the Financial Accounting Standards Board’s Emerging Issues Task ForceIssue No. 87-24, “Allocation of Interest to Discontinued Operations,” asamended, interest expense includes interest on debt that is to be assumed bythe buyer as well as interest on the $130,000,000 of debt that was required tobe repaid as a result of the sale. Interest expense was based on the historical interest rates chargedduring each of the periods.  Inaddition, and also in accordance with EITF 87-24, costs and expenses excludethe allocation of general corporate overhead.

 

The followingtables summarize the financial position, results operations and cash flows ofthe Specialty Avionics Group.

 

8

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

 
|                                                 |   | **Three Months Ended****June 30,** |   | **Six Months Ended****June 30,** |   |
|------------------------------------------------------|--------|-----------------------------------------|--------|---------------------------------------|--------|
| **(In thousands)**                                   |   | **2003 (1)**                            |   | **2002**                              |   | **2003 (1)** |   | **2002** |   |
|                                                 |   | **(Unaudited)**                         |   |
|                                                 |   |                                    |   |
| Results of Operations:                               |   |                                    |   |                                  |   |   |   |   |   |
| Revenues                                             |   | $                                       | 13,125 |                                  | $      | 25,039 |   | $ | 36,595 |   | $ | 50,383 |   |
|                                                 |   |                                    |   |                                  |   |   |   |   |   |
| Operating expenses:                                  |   |                                    |   |                                  |   |   |   |   |   |
| Costs and expenses                                   |   | 11,136                                  |   | 19,369                                |   | 30,128 |   | 38,774 |   |
| Impairment of goodwill                               |   | —                                  |   | —                                |   | 7,500 |   | — |   |
| Amortization of intangible assets                    |   | 321                                     |   | 557                                   |   | 878 |   | 1,114 |   |
| Total operating expenses                             |   | 11,457                                  |   | 19,926                                |   | 38,506 |   | 39,888 |   |
|                                                 |   |                                    |   |                                  |   |   |   |   |   |
| Income (loss) from operations                        |   | 1,668                                   |   | 5,113                                 |   | (1,911 | ) | 10,495 |   |
|                                                 |   |                                    |   |                                  |   |   |   |   |   |
| Other expenses:                                      |   |                                    |   |                                  |   |   |   |   |   |
| Interest expense:                                    |   |                                    |   |                                  |   |   |   |   |   |
| Debt required to be repaid with proceeds  from sale  |   | 1,146                                   |   | 1,863                                 |   | 2,952 |   | 3,674 |   |
| Debt obligations assumed by the buyer                |   | 68                                      |   | 198                                   |   | 270 |   | 402 |   |
| Other expenses, net                                  |   | 52                                      |   | 153                                   |   | 153 |   | 186 |   |
|                                                 |   |                                    |   |                                  |   |   |   |   |   |
| Pre-tax income (loss)                                |   | 402                                     |   | 2,899                                 |   | (5,286 | ) | 6,233 |   |
| Provision for income taxes                           |   | 344                                     |   | 1,161                                 |   | 1,053 |   | 2,613 |   |
|                                                 |   |                                    |   |                                  |   |   |   |   |   |
| Income (loss) before change in accounting  principle |   | 58                                      |   | 1,738                                 |   | (6,339 | ) | 3,620 |   |
| Cumulative effect of change in accounting  principle |   | —                                  |   | —                                |   | — |   | (39,322 | ) |
|                                                 |   |                                    |   |                                  |   |   |   |   |   |
| Income (loss) from operations                        |   | 58                                      |   | 1,738                                 |   | (6,339 | ) | (35,702 | ) |
| Gain on sale, net of tax                             |   | 689                                     |   | —                                |   | 689 |   | — |   |
|                                                 |   |                                    |   |                                  |   |   |   |   |   |
| Net income (loss) from discontinued  operations      |   | $                                       | 747    |                                  | $      | 1,738 |   | $ | (5,650 | ) | $ | (35,702 | ) |

 

----

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

 

9

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|                                                  |   | **Six Months Ended****June 30,** |   |
|-------------------------------------------------------|--------|---------------------------------------|--------|
| **(In thousands)**                                    |   | **2003 (1)**                          |   | **2002** |   |
|                                                  |   | **(Unaudited)**                       |   |
| Cash Flows Provided By (Used For):                    |   |                                  |   |   |   |
| Operating activities                                  |   | $                                     | 3,760  |   | $ | 9,441 |   |
| Investing activities                                  |   | (902                                  | )      | (468 | ) |
| Financing activities                                  |   | (649                                  | )      | (180 | ) |
| Net (increase) decrease in cash and cash  equivalents |   | (13                                   | )      | (90 | ) |
| Effect of foreign currency translation on  cash       |   | (2                                    | )      | 44 |   |
| Net cash provided by discontinued  operations         |   | $                                     | 2,194  |   | $ | 8,747 |   |

 

----

(1)                                  Reflectscash flows through May 23, 2003, the date of sale.

 

**Note 3.****                                  Restructuring,Asset Impairment and Other Related Charges**

 

During thethree months and six months ended June 30, 2003 and 2002, the Companyrecorded restructuring, asset impairment and other related charges as follows:

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

 

10

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**Seating Product Line and FurnitureManufacturing Facilities Restructuring**

 

During thesecond quarter of fiscal 2003, the Company consolidated its seating productline offerings and adopted a restructuring plan to down-size a furnituremanufacturing facility in response to continuing weakness in the business, VIPand head-of-state aircraft market. These actions were designed to reduce engineering, production andinventory carrying costs by supporting fewer product offerings and achieveprofitability at the furniture manufacturing facility based on its lowerproduction levels.  In connection withthese actions, the Company recorded pre-tax charges to operations totaling$13,394,000 during the second quarter of fiscal 2003.  The charges are comprised of the following:

 

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

 

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

 

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

 

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

 

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

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

 

As required bySFAS No. 146, the charges recorded were discounted by $560,000 to initiallymeasure and reflect the liabilities incurred as a result of the restructuringplan at their fair value as of June 30, 2003.  The cumulative effect of a changes resulting from revisions toeither the timing or the amount of estimated cash flows will be recognized asan adjustment to the liability in the period of the change.  Future cash payments will be funded fromexisting cash balances and internally generated cash from operations.

 

11

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**Seat Manufacturing Facilities Restructuring**

 

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

 

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

 

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

 

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

 

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

 

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

 

The componentsof the amounts incurred were as follows:

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

 

Thisrestructuring plan was completed during the second quarter of fiscal 2002.

 

12

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**Asset Realignment Restructuring**

 

During thesecond quarter of fiscal 2001, the Company’s Cabin Management Group adopted arestructuring plan to realign production programs between its manufacturingfacilities.  In response to the adverseimpact on the aerospace industry resulting from the September 11thterrorist attack and its aftermath, as well as the weakening of global economicconditions, the Company announced and implemented a further restructuring planin December 2001 designed to reduce costs and conserve workingcapital.  This plan included permanentlyclosing one manufacturing facility and idling a second facility for anindefinite period, curtailing several product development programs andinstituting workforce reductions.  Dueto the ongoing weakness of the business, VIP and head-of-state aircraft market,the Company decided during the second quarter of fiscal 2002 to permanentlyclose the temporarily idled manufacturing facility.  The restructuring, asset impairment and other related chargesrecorded during fiscal 2002 were comprised of the following:

 

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

 

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

 

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

 

The componentsof the amounts incurred were as follows:

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

 

Thisrestructuring plan was completed during the fourth quarter of fiscal 2002.

 

**Goodwill ImpairmentCharges**

 

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

 

As describedin Note 2, on March 14, 2003, the Company entered into a definitiveagreement to sell its equity interests in the subsidiaries comprising itsSpecialty Avionics Group for $140,000,000 in cash.  Based upon the fair value of the group implied in the definitiveagreement, the Company determined that the carrying value of the group’s netassets was not fully recoverable.  As aresult, the Company recorded a goodwill impairment charge of $7,500,000 duringthe three months ended March 31, 2003 to reduce the carrying value toestimated net realizable value.

 

13

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**Note 4.****                                  Inventories**

 

Inventoriesare comprised of the following as of June 30, 2003 and December 31,2002:

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

 

Periodicassessments are performed to ensure recoverability of the program costs andadjustments are made, if necessary, to reduce inventoried costs to estimatedrealizable value.  In connection withthe curtailment of several seating product offerings (Note 3), all inventoriedcosts related these programs, which aggregated $6,262,000, were charged to costof sales during the three months ended June 30, 2003.  In addition, $3,073,000 of excess andobsolete inventory associated with the curtailed seating product offerings anddown-sizing of a furniture manufacturing facility was also charged to cost ofsales during the three months ended June 30, 2003.

 

Total costsand estimated earnings on all uncompleted contracts as of June 30, 2003and December 31, 2002 are comprised of the following:

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

 

Revenues andearnings for products manufactured under long-term contracts are recognizedunder the percentage-of-completion method using total contract price, actualcosts incurred to date and an estimate of the completion costs for eachcontract.  Provisions for estimatedlosses on uncompleted contracts are made in the period in which such losses aredetermined.

 

14

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**Note 5.****                                  Goodwill**

 

EffectiveJanuary 1, 2002, the Company adopted SFAS No. 142, “Goodwill and Other IntangibleAssets” and the provisions of SFAS No. 141, “Business Combinations,” which wererequired to be adopted concurrent with the adoption of SFAS No. 142.  During 2002, the Company completed thetransitional impairment testing of goodwill recorded as of January 1, 2002as required under SFAS No. 142.  Fairvalue of each reporting unit was determined using a discounted cash flowapproach taking into consideration projections based on the individualcharacteristics of the reporting units, historical trends, market multiples forcomparable businesses and independent appraisals.  Unallocated goodwill was allocated to the reporting units forimpairment testing purposes.

 

The resultsindicated that the carrying value of goodwill was impaired.  The resulting impairment was primarilyattributable to a change in the evaluation criteria for goodwill utilized underprevious accounting guidance to the fair value approach stipulated in SFAS No.142.  In accordance with the transitionalprovision of SFAS No. 142, the Company recorded a $17,828,000 noncashwrite-down of goodwill (net of $878,000 income tax benefit) as ofJanuary 1, 2002 as a cumulative effect of a change in accountingprinciple.  An additional $39,322,000noncash write-down of goodwill pertained to the Specialty Avionics Group and isincluded in the loss from discontinued operations.

 

Changes in thecarrying amount of goodwill, by business segment (Note 12), for the six monthsended June 30, 2003 are as follows:

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

 

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

 

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

 

15

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As a result ofthe continuing weakness in the business, VIP and head-of-state aircraft marketand the Company’s decision to down-size a furniture manufacturing facility inthe second quarter of fiscal 2003, the Company determined that it shouldreevaluate the carrying value of its goodwill prior to the annualOctober 31st testing date. Accordingly, the Company performed a step-one test of goodwillassociated with its furniture manufacturing reporting unit for recoverabilityand found the goodwill to be impaired. As a result, the Company recorded a pre-tax charge to operations of$34,000,000 during the three months ended June 30, 2003 based on acomparison of the estimated book value of the net assets of the reporting unitto its fair value.  The charge wasprimarily a result of a decrease in fair value caused by using lower cash flowforecasts based on the most recently reduced industry estimates of aircraftdeliveries resulting from overall industry weakness.  The amount recorded is an estimate and may be revised during thethird quarter of fiscal 2003 upon completion of step two of the goodwillimpairment model, which measures the amount of impairment.

 

**Note 6.****                                  OtherAssets**

 

Other assetsare comprised of the following as of June 30, 2003 and December 31,2002:

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

 

**Identifiable Intangible Assets with FiniteUseful Lives**

 

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

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

 

Estimatedannual amortization expense for all identifiable intangible assets with finiteuseful lives for the five-year period ending December 31, 2007 is asfollows: 2003 – $3,644,000; 2004 – $3,644,000; 2005 – $3,477,000; 2006 –$2,275,000; and 2007 – $2,175,000.

 

16

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**Note 7.****                                  AccruedLiabilities**

 

Accruedliabilities are comprised of the following as of June 30, 2003 andDecember 31, 2002:

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

 

**Note 8.****                                  Long-TermDebt**

 

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

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

 

During 2003,the Company amended its senior credit facility to permit the sale of itsSpecialty Avionics Group.  Uponconsummation of the sale on May 23, 2003, the Company repaid $130,000,000of senior credit borrowings with the estimated net proceeds from the sale.  The Company may be required to repayadditional borrowings upon final determination of the net proceeds from thesale.

 

The amendmentalso revised various financial covenants (which the Company would otherwisehave not been able to meet), decreases by $10,000,000 the maximum permittedrevolving line of credit borrowings to $40,000,000, increases the prime rateand LIBOR interest margins by 1.5% and permits the issuance of specified typesof additional indebtedness and the repurchase of up to $20,000,000 of theCompany’s 12% senior subordinated notes with the proceeds from the sale ofjunior securities.

 

17

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**Note 9.****                                  IncomeTaxes**

 

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

 
|                                        |   | **Three  Months Ended  June 30,** |       | **Six Months  Ended  June 30,** |       |
|---------------------------------------------|--------|----------------------------------------|------------|--------------------------------------|------------|
| **(In thousands)**                          |   | **2003**                               |       | **2002**                             |       | **2003** |   | **2002** |   |
|                                        |   | **(Unaudited)**                        |       |
| Pre-tax income (loss) reported by:          |   |                                   |       |                                 |       |   |   |   |   |
| Continuing operations                       |   | $                                      | (49,631    | )                                    | $          | (5,720 | ) | $ | (53,659 | ) | $ | (8,345 | ) |
| Discontinued operations                     |   | 402                                    |       | 2,899                                |       | (5,286 | ) | 6,233 |   |
| Consolidated pre-tax loss                   |   | $                                      | (49,229    | )                                    | $          | (2,821 | ) | $ | (58,945 | ) | $ | (2,112 | ) |
|                                        |   |                                   | ** ** |                                 | ** ** |   | ** ** |   | ** ** |
| Total provision for income taxes (benefit): |   |                                   |       |                                 |       |   |   |   |   |
| Income tax benefit based on pre-tax loss    |   | $                                      | (22,077    | )                                    | $          | (889 | ) | $ | (22,633 | ) | $ | (578 | ) |
| Net deferred tax assets valuation allowance |   | 13,056                                 |       | —                               |       | 13,056 |   | — |   |
| Net income tax benefit                      |   | $                                      | (9,021     | )                                    | $          | (889 | ) | $ | (9,577 | ) | $ | (578 | ) |
|                                        |   |                                   |       |                                 |       |   |   |   |   |
| Allocation of total provision:              |   |                                   |       |                                 |       |   |   |   |   |
| Continuing operations                       |   | $                                      | (9,365     | )                                    | $          | (2,050 | ) | $ | (10,630 | ) | $ | (3,191 | ) |
| Discontinued operations                     |   | 344                                    |       | 1,161                                |       | 1,053 |   | 2,613 |   |
| Net provision for income tax benefit        |   | $                                      | (9,021     | )                                    | $          | (889 | ) | $ | (9,577 | ) | $ | (578 | ) |

 

For the threemonths and six months ended June 30, 2003 and 2002, the provision forincome taxes, based on the reported consolidated pre-tax loss, differs from theamount determined by applying the applicable U.S. statutory federal rate to thepre-tax loss primarily due to the effects of state and foreign income taxes andthe non-deductible portion of goodwill impairment charges.

 

As ofJune 30, 2003, the Company had net deferred tax assets of $12,841,000,prior to recording the valuation allowance in June 2003, as opposed to netdeferred tax liabilities in prior periods. The change to a net asset position was primarily caused by the$34,000,000 goodwill impairment charge recorded during the second quarter offiscal 2003.  SFAS No. 109, “Accountingfor Income Taxes,” requires the recognition of a deferred tax asset for thefuture income tax benefit of the goodwill deductions that will be taken forincome tax purposes (i.e. the goodwill that has been written off in thefinancial statements for book purposes will continue to be amortized anddeducted for tax purposes and accordingly represents a new deferred tax asset).

 

As required bySFAS No. 109, the Company evaluated its deferred assets for expectedrecoverability based on the nature of the item, the associated taxingjurisdictions, the applicable expiration dates and future taxable incomeforecasts that would impact utilization. Since there is no loss carry back potential and the Company does nothave any tax planning strategies to assure recoverability, the only possibilityfor recovery of the net deferred assets is future taxable income.  Since there have been prior year losses, theCompany believes it was not prudent to rely on future income as the means tosupport the carrying value of the net assets. As a result of the Company’s evaluation, it determined that recovery wasnot likely in certain taxing jurisdictions and applied its judgment inestimating the amount of valuation allowance necessary under the circumstancesto reduce the assets carrying value to realizable value.  Accordingly, the Company recorded the$13,056,000 valuation allowance, eliminating the net deferred asset, as ofJune 30, 2003.

 

18

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For periodsprior to June 30, 2003, the Company had net deferred tax liabilities($9,002,000 as of March 31, 2003 and $10,647,000 as of December 31,2002).  The full realization of thedeferred assets was achieved through the reversal of the deferred taxliabilities in future periods.  As aresult, a valuation allowance was not required for periods prior toJune 30, 2003.

 

Deferred taxassets and liabilities are comprised of the following as of June 30, 2003and December 31, 2002:

 
| **(In thousands)**                                            |   | **June 30,  2003** |   | **December 31,  2002** |   |
|---------------------------------------------------------------|--------|-------------------------|--------|-----------------------------|--------|
|                                                          |   | **(Unaudited)**         |   |                        |   |
| Gross deferred tax assets:                                    |   |                    |   |                        |   |
| Loss carryforwards                                            |   | $14,768                 |   | $12,173                     |   |
| Accrued liabilities                                           |   | 7,081                   |   | 6,797                       |   |
| Inventory                                                     |   | 3,389                   |   | 4,252                       |   |
| Other                                                         |   | 848                     |   | 832                         |   |
| Gross deferred tax assets                                     |   | 26,086                  |   | 24,054                      |   |
|                                                          |   |                    |   |                        |   |
| Gross deferred tax (liabilities):                             |   |                    |   |                        |   |
| Intangible assets                                             |   | (9,300                  | )      | (31,267                     | )      |
| Program costs                                                 |   | (3,707                  | )      | (6,168                      | )      |
| Property and equipment                                        |   | (238                    | )      | (3,119                      | )      |
| Other                                                         |   | —                  |   | (56                         | )      |
| Gross deferred tax (liabilities)                              |   | (13,245                 | )      | (40,610                     | )      |
|                                                          |   |                    |   |                        |   |
| Net deferred assets (liabilities) before  valuation allowance |   | 12,841                  |   | (16,556                     | )      |
| Net deferred tax asset valuation allowance                    |   | (13,056                 | )      | —                      |   |
| Net deferred tax liability                                    |   | $                       | (215   | )                           | $      | (16,556 | ) |
|                                                          |   |                    |   |                        |   |
| Balance sheet classification:                                 |   |                    |   |                        |   |
| Continuing operations:                                        |   |                    |   |                        |   |
| Current deferred tax asset                                    |   | $                       | 172    |                        | $      | 16,430 |   |
| Noncurrent deferred tax (liability)                           |   | (387                    | )      | (27,077                     | )      |
| Net continuing operations                                     |   | (215                    | )      | (10,647                     | )      |
|                                                          |   |                    |   |                        |   |
| Discontinued operations:                                      |   |                    |   |                        |   |
| Current deferred tax asset                                    |   | —                  |   | 6,201                       |   |
| Noncurrent deferred tax (liability)                           |   | —                  |   | (12,110                     | )      |
| Net discontinued operations                                   |   | —                  |   | (5,909                      | )      |
| Net deferred tax (liability)                                  |   | $                       | (215   | )                           | $      | (16,556 | ) |

 

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**Note 10.****                           CapitalStructure**

 

**Mandatorily Redeemable Preferred Stock**

 

The tablebelow summarizes the increase in mandatorily redeemable preferred stock duringthe six months ended June 30, 2003.

 
| **(In thousands, except share and per share data)**               |   | **Number  of  Shares** |   | **Mandatory  Redemption  Value** |   | **Unamortized  Issuance  Discount** |   | **Net  Book  Value** |   |
|-------------------------------------------------------------------|--------|------------------------|--------|----------------------------------|--------|-------------------------------------|--------|----------------------|--------|
|                                                              |   |                   |   |                             |   |                                |   |                 |   |
| Balance, December 31, 2002                                   |   | 370,061                |   | $                                | 37,006 |                                | $      | (2,925               | )      | $ | 34,081 |   |
| Accrued dividends and redemption value  accretion                 |   | 14,803                 |   | 3,020                            |   | 234                                 |   | 3,254                |   |
| Balance, June 30, 2003 (Unaudited)                           |   | 384,864                |   | $                                | 40,026 |                                | $      | (2,691               | )      | $ | 37,335 |   |
|                                                              |   |                   |   |                             |   |                                |   |                 |   |
| Per share liquidation value as of  June 30, 2003 (Unaudited) |   |                   |   | $                                | 100.00 |                                |   |                 |   |   |

 

Holders of thepreferred stock are entitled to receive, when, as and if declared, dividends ata rate equal to 16% per annum.  Prior toJune 30, 2005, the Company may, at its option, pay dividends either incash or by the issuance of additional shares of preferred stock.  Since the preferred stock issuance date onJune 30, 2000, the Company has elected to issue additional shares in lieuof cash dividends.

 

**Note 11.****                           Commitmentsand Contingencies**

 

**Litigation**

 

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

 

The Companywas a defendant in most, but not all, of the actions brought by the estates ofthe 229 victims of the crash.  Theactions, which sought damages and costs in unstated amounts, claimednegligence, strict liability, and breach of warranty.  Virtually all of the cases have been settled by Boeing andSwissair’s insurers and both assignment of the claims against, and releases infavor of, the Company have been obtained by the Boeing and Swissair insurers.

 

Boeing andSwissair have made a claim (but have not commenced litigation) against theCompany to contribute to the amounts paid to settle the cases.  As there is no litigation pending, nodiscovery has been taken by either side as to liability for the crash.  The Company believes that it is notresponsible for the crash and, in any event, it maintains insurance for suchmatters.  The Company further believesthat any loss it may sustain upon the ultimate resolution of this matter, ifany, will not exceed the amount of insurance coverage maintained.  Accordingly, no accrual for loss has beenrecorded.

 

20

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The Companyand its subsidiaries are also involved in other routine legal andadministrative proceedings incident to the normal conduct of business.  Management believes the ultimate dispositionof all such matters will not have a material adverse effect on the Company’sbusiness, consolidated financial position, results of operations or cash flows.

 

**Funding of DeCrane Holdings Preferred StockObligations**

 

The Company isa wholly owned subsidiary of DeCrane Holdings whose capital structure alsoincludes mandatorily redeemable preferred stock.  Since the Company is DeCrane Holdings’ only operating subsidiary andsource of cash, the Company may be required to fund DeCrane Holdings’ preferredstock dividend and redemption obligations in the future.

 

DeCraneHoldings’ preferred stock dividends are payable quarterly at a rate of 14% perannum.  Prior to September 30,2005, dividends are not paid in cash but instead accrete to the liquidationvalue of the preferred stock, which, in turn, increases the redemptionobligation.  On or afterSeptember 30, 2005, preferred stock dividends are required to be paid incash, if declared, and the preferred stock is mandatorily redeemable onSeptember 30, 2009.  The DeCraneHoldings preferred stock has a total redemption value of $66,654,000 as ofJune 30, 2003, including accumulated dividends.

 

**Note 12.****                           BusinessSegment Information**

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

The tablesbelow summarize selected financial data by business segment.

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

 

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| **(In thousands)**                            |   | **June 30,  2003** |    | **December 31,  2002** |   |
|-----------------------------------------------|--------|-------------------------|---------|-----------------------------|--------|
|                                          |   | **(Unaudited)**         |    |                        |   |
| Total assets (as of period end):              |   |                    |    |                        |   |
| Cabin Management                              |   | $                       | 236,941 |                        | $      | 281,655 |   |
| Systems Integration                           |   | 69,049                  |    | 62,437                      |   |
| Corporate (5)                                 |   | 17,091                  |    | 44,247                      |   |
| Inter-group elimination (6)                   |   | (435                    | )       | (113                        | )      |
| Continuing operations                         |   | 322,646                 |    | 388,226                     |   |
| Discontinued operations (Specialty  Avionics) |   | —                  |    | 160,741                     |   |
| Consolidated totals                           |   | $                       | 322,646 |                        | $      | 548,967 |   |

 

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(1)                                  Inter-groupsales are accounted for at prices comparable to sales to unaffiliatedcustomers, and are eliminated in consolidation.

 

(2)                                  Reflectsthe Company’s corporate headquarters costs and expenses not allocated to thegroups.

 

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

 

(4)                                  Thetable below reconciles the financial measure Adjusted EBITDA, as defined, tonet loss.

 
|                                                       |   | **Three  Months Ended  June 30,** |    | **Six Months  Ended  June 30,** |   |
|------------------------------------------------------------|--------|----------------------------------------|---------|--------------------------------------|--------|
| **(In thousands)**                                         |   | **2003**                               |    | **2002**                             |   | **2003** |   | **2002** |   |
|                                                       |   | **(Unaudited)**                        |    |
| Consolidated Adjusted EBITDA (as defined)                  |   | $                                      | 7,097   |                                 | $      | 11,398 |   | $ | 11,802 |   | $ | 21,708 |   |
| Restructuring, asset impairment and other  related charges |   | (47,394                                | )       | (7,666                               | )      | (47,394 | ) | (11,709 | ) |
| Depreciation and amortization of long-lived  assets (a)    |   | (2,451                                 | )       | (2,680                               | )      | (4,967 | ) | (5,447 | ) |
| Acquisition related charges not capitalized                |   | (8                                     | )       | (468                                 | )      | (17 | ) | (478 | ) |
| Other noncash charges                                      |   | —                                 |    | (84                                  | )      | — |   | (138 | ) |
| Interest expense                                           |   | (6,468                                 | )       | (6,134                               | )      | (12,337 | ) | (12,082 | ) |
| Other expenses, net                                        |   | (407                                   | )       | (86                                  | )      | (746 | ) | (199 | ) |
| Income tax benefit                                         |   | 9,365                                  |    | 2,050                                |   | 10,630 |   | 3,191 |   |
| Income (loss) from discontinued operations                 |   | 747                                    |    | 1,738                                |   | (5,650 | ) | (35,702 | ) |
| Cumulative effect of change in accounting  principle       |   | —                                 |    | —                               |   | — |   | (17,828 | ) |
| Net loss                                                   |   | $                                      | (39,519 | )                                    | $      | (1,932 | ) | $ | (48,679 | ) | $ | (58,684 | ) |

 

----

(a)          Reflectsdepreciation and amortization of long-lived assets and amortization of deferredfinancing costs, which are classified as a component of interest expense, asfollows:

 

23

----

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

 

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

 

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

 

**Note 13.****                           SupplementalCondensed Consolidating Financial Information**

 

In conjunction with the 12% senior subordinated notes described inNote 8, the following condensed consolidating financial information ispresented segregating the Company, as the issuer, and guarantor andnon-guarantor subsidiaries.  Theaccompanying financial information in the guarantor subsidiaries columnreflects the financial position, results of operations and cash flows for thosesubsidiaries guaranteeing the senior credit facility and the notes.

 

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

 

(1)          Elimination of investments in subsidiaries.

 

(2)          Elimination of intercompany accounts.

 

(3)          Elimination of equity in earnings ofsubsidiaries.

 

24

----

 

**Balance Sheets**

 
|                                                                                               |   | **June 30, 2003 (Unaudited)** |    |
|----------------------------------------------------------------------------------------------------|--------|------------------------------------|---------|
| **(In thousands)**                                                                                 |   | **Issuer**                         |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                                                               |   |                               |    |   |   |   |   |   |   |   |   |
| **Assets**                                                                                         |   |                               |    |   |   |   |   |   |   |   |   |
|                                                                                               |   |                               |    |   |   |   |   |   |   |   |   |
| Current assets:                                                                                    |   |                               |    |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                                                          |   | $                                  | 3,571   |   | $ | 102 |   | $ | — |   | $ | — |   | $ | 3,673 |   |
| Accounts receivable, net                                                                           |   | —                             |    | 20,726 |   | — |   | — |   | 20,726 |   |
| Inventories                                                                                        |   | —                             |    | 63,125 |   | — |   | — |   | 63,125 |   |
| Other current assets                                                                               |   | 1,190                              |    | 591 |   | — |   | — |   | 1,781 |   |
| Total current assets                                                                               |   | 4,761                              |    | 84,544 |   | — |   | — |   | 89,305 |   |
|                                                                                               |   |                               |    |   |   |   |   |   |   |   |   |
| Property and equipment, net                                                                        |   | 2,105                              |    | 32,696 |   | — |   | — |   | 34,801 |   |
| Goodwill                                                                                           |   | 10,224                             |    | 152,206 |   |   |   |   |   | 162,430 |   |
| Other assets, principally intangibles, net                                                         |   | —                             |    | 36,110 |   | — |   | — |   | 36,110 |   |
| Investments in subsidiaries                                                                        |   | 289,218                            |    | — |   | — |   | (289,218 | )(1) | — |   |
| Intercompany receivables                                                                           |   | 56,259                             |    | 74,846 |   | — |   | (131,105 | )(2) | — |   |
| Total assets                                                                                       |   | $                                  | 362,567 |   | $ | 380,402 |   | $ | — |   | $ | (420,323 | ) | $ | 322,646 |   |
|                                                                                               |   |                               |    |   |   |   |   |   |   |   |   |
| **Liabilities,  Mandatorily Redeemable Preferred Stock and Stockholder’s Equity (Deficit)**   |   |                               |    |   |   |   |   |   |   |   |   |
|                                                                                               |   |                               |    |   |   |   |   |   |   |   |   |
| Current liabilities:                                                                               |   |                               |    |   |   |   |   |   |   |   |   |
| Current portion of long-term debt                                                                  |   | $                                  | 7,336   |   | $ | 1,149 |   | $ | — |   | $ | — |   | $ | 8,485 |   |
| Other current liabilities                                                                          |   | 10,477                             |    | 20,164 |   | — |   | — |   | 30,641 |   |
| Total current liabilities                                                                          |   | 17,813                             |    | 21,313 |   | — |   | — |   | 39,126 |   |
|                                                                                               |   |                               |    |   |   |   |   |   |   |   |   |
| Long-term debt, less current portion                                                               |   | 242,936                            |    | 8,436 |   | — |   | — |   | 251,372 |   |
| Intercompany payables                                                                              |   | 74,846                             |    | 56,259 |   | — |   | (131,105 | )(2) | — |   |
| Other long-term liabilities                                                                        |   | 6,332                              |    | 5,540 |   | — |   | — |   | 11,872 |   |
|                                                                                               |   |                               |    |   |   |   |   |   |   |   |   |
| Mandatorily redeemable preferred stock                                                             |   | 37,335                             |    | — |   | — |   | — |   | 37,335 |   |
|                                                                                               |   |                               |    |   |   |   |   |   |   |   |   |
| Stockholder’s equity (deficit):                                                               |   |                               |    |   |   |   |   |   |   |   |   |
| Paid-in capital                                                                                    |   | 115,293                            |    | 337,592 |   | — |   | (337,592 | )(1) | 115,293 |   |
| Retained earnings deficit                                                                          |   | (131,988                           | )       | (48,374 | ) | — |   | 48,374 | (1) | (131,988 | ) |
| Accumulated other comprehensive loss                                                               |   | —                             |    | (364 | ) | — |   | — |   | (364 | ) |
| Total stockholder’s equity (deficit)                                                          |   | (16,695                            | )       | 288,854 |   | — |   | (289,218 | ) | (17,059 | ) |
| Total liabilities, mandatorily redeemable  preferred stock and stockholder’s equity (deficit) |   | $                                  | 362,567 |   | $ | 380,402 |   | $ | — |   | $ | (420,323 | ) | $ | 322,646 |   |

 

25

----

 
|                                                                                     |   | **December 31, 2002** |    |
|------------------------------------------------------------------------------------------|--------|----------------------------|---------|
| **(In thousands)**                                                                       |   | **Issuer**                 |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                                                     |   |                       |    |   |   |   |   |   |   |   |   |
| **Assets**                                                                               |   |                       |    |   |   |   |   |   |   |   |   |
|                                                                                     |   |                       |    |   |   |   |   |   |   |   |   |
| Current assets:                                                                          |   |                       |    |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                                                |   | $                          | 12,343  |   | $ | 78 |   | $ | — |   | $ | — |   | $ | 12,421 |   |
| Accounts receivable, net                                                                 |   | —                     |    | 26,354 |   | — |   | — |   | 26,354 |   |
| Inventories                                                                              |   | —                     |    | 59,300 |   | — |   | — |   | 59,300 |   |
| Other current assets                                                                     |   | 17,711                     |    | 443 |   | — |   | — |   | 18,154 |   |
| Assets of discontinued operations                                                        |   | —                     |    | 166,507 |   | 5,197 |   | (10,963 | )(1) | 160,741 |   |
| Total current assets                                                                     |   | 30,054                     |    | 252,682 |   | 5,197 |   | (10,963 | ) | 276,970 |   |
|                                                                                     |   |                       |    |   |   |   |   |   |   |   |   |
| Property and equipment, net                                                              |   | 2,485                      |    | 33,654 |   | — |   | — |   | 36,139 |   |
| Other assets, principally intangibles, net                                               |   | 11,708                     |    | 224,150 |   | — |   | — |   | 235,858 |   |
| Investments in subsidiaries                                                              |   | 348,559                    |    | — |   | — |   | (348,559 | )(1) | — |   |
| Intercompany receivables                                                                 |   | 276,121                    |    | 172,389 |   | 5,740 |   | (454,250 | )(2) | — |   |
| Total assets                                                                             |   | $                          | 668,927 |   | $ | 682,875 |   | $ | 10,937 |   | $ | (813,772 | ) | $ | 548,967 |   |
|                                                                                     |   |                       |    |   |   |   |   |   |   |   |   |
| **Liabilities,  Mandatorily Redeemable Preferred Stock and Stockholder’s Equity**   |   |                       |    |   |   |   |   |   |   |   |   |
|                                                                                     |   |                       |    |   |   |   |   |   |   |   |   |
| Current liabilities:                                                                     |   |                       |    |   |   |   |   |   |   |   |   |
| Current portion of long-term debt                                                        |   | $                          | 15,337  |   | $ | 980 |   | $ | — |   | $ | — |   | $ | 16,317 |   |
| Other current liabilities                                                                |   | 16,786                     |    | 27,763 |   | — |   | — |   | 44,549 |   |
| Liabilities of discontinued operations                                                   |   | —                     |    | 19,954 |   | (26 | ) | — |   | 19,928 |   |
| Total current liabilities                                                                |   | 32,123                     |    | 48,697 |   | (26 | ) | — |   | 80,794 |   |
|                                                                                     |   |                       |    |   |   |   |   |   |   |   |   |
| Long-term debt, less current portion                                                     |   | 355,568                    |    | 9,132 |   | — |   | — |   | 364,700 |   |
| Intercompany payables                                                                    |   | 178,242                    |    | 276,008 |   | — |   | (454,250 | )(2) | — |   |
| Other long-term liabilities                                                              |   | 33,601                     |    | 840 |   | — |   | — |   | 34,441 |   |
|                                                                                     |   |                       |    |   |   |   |   |   |   |   |   |
| Mandatorily redeemable preferred stock                                                   |   | 34,081                     |    | — |   | — |   | — |   | 34,081 |   |
|                                                                                     |   |                       |    |   |   |   |   |   |   |   |   |
| Stockholder’s equity:                                                               |   |                       |    |   |   |   |   |   |   |   |   |
| Paid-in capital                                                                          |   | 118,621                    |    | 337,592 |   | 15,440 |   | (353,032 | )(1) | 118,621 |   |
| Retained earnings (deficit)                                                              |   | (83,309                    | )       | 10,967 |   | (4,477 | ) | (6,490 | )(1) | (83,309 | ) |
| Accumulated other comprehensive loss                                                     |   | —                     |    | (361 | ) | — |   | — |   | (361 | ) |
| Total stockholder’s equity                                                          |   | 35,312                     |    | 348,198 |   | 10,963 |   | (359,522 | ) | 34,951 |   |
| Total liabilities, mandatorily redeemable  preferred stock and stockholder’s equity |   | $                          | 668,927 |   | $ | 682,875 |   | $ | 10,937 |   | $ | (813,772 | ) | $ | 548,967 |   |
|                                                                                          |        |                            |         |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

26

----

 

**Statements of Operations**

 
|                                          |   | **Six Months Ended June 30, 2003 (Unaudited)** |    |
|-----------------------------------------------|--------|-----------------------------------------------------|---------|
| **(In thousands)**                            |   | **Issuer**                                          |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                          |   |                                                |    |   |   |   |   |   |   |   |   |
| Revenues                                      |   | $                                                   | —  |   | $ | 86,013 |   | $ | — |   | $ | — |   | $ | 86,013 |   |
| Cost of sales                                 |   | —                                              |    | 76,286 |   | — |   | — |   | 76,286 |   |
|                                          |   |                                                |    |   |   |   |   |   |   |   |   |
| Gross profit                                  |   | —                                              |    | 9,727 |   | — |   | — |   | 9,727 |   |
|                                          |   |                                                |    |   |   |   |   |   |   |   |   |
| Selling, general and administrative  expenses |   | 4,904                                               |    | 9,573 |   | — |   | — |   | 14,477 |   |
| Impairment of goodwill                        |   | —                                              |    | 34,000 |   | — |   | — |   | 34,000 |   |
| Amortization of intangible assets             |   | —                                              |    | 1,826 |   | — |   | — |   | 1,826 |   |
| Interest expense                              |   | 12,116                                              |    | 221 |   | — |   | — |   | 12,337 |   |
| Intercompany charges                          |   | (11,575                                             | )       | 11,575 |   | — |   | — |   | — |   |
| Equity in loss of subsidiaries                |   | 34,615                                              |    | 218 |   | — |   | (34,833 | )(3) | — |   |
| Other expenses, net                           |   | 586                                                 |    | 160 |   | — |   | — |   | 746 |   |
| Provision for income taxes (benefit)          |   | 8,033                                               |    | (18,663 | ) | — |   | — |   | (10,630 | ) |
| Loss from discontinued operations             |   | —                                              |    | 5,432 |   | 218 |   | — |   | 5,650 |   |
|                                          |   |                                                |    |   |   |   |   |   |   |   |   |
| Net loss                                      |   | $                                                   | (48,679 | ) | $ | (34,615 | ) | $ | (218 | ) | $ | 34,833 |   | $ | (48,679 | ) |

 
|                                                 |   | **Six Months Ended June 30, 2002 (Unaudited)** |    |
|------------------------------------------------------|--------|-----------------------------------------------------|---------|
| **(In thousands)**                                   |   | **Issuer**                                          |    | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                 |   |                                                |    |   |   |   |   |   |   |   |   |
| Revenues                                             |   | $                                                   | —  |   | $ | 122,112 |   | $ | — |   | $ | — |   | $ | 122,112 |   |
| Cost of sales                                        |   | —                                              |    | 92,212 |   | — |   | — |   | 92,212 |   |
|                                                 |   |                                                |    |   |   |   |   |   |   |   |   |
| Gross profit                                         |   | —                                              |    | 29,900 |   | — |   | — |   | 29,900 |   |
|                                                 |   |                                                |    |   |   |   |   |   |   |   |   |
| Selling, general and administrative  expenses        |   | 5,788                                               |    | 18,459 |   | — |   | — |   | 24,247 |   |
| Amortization of intangible assets                    |   | —                                              |    | 1,717 |   | — |   | — |   | 1,717 |   |
| Interest expense                                     |   | 12,008                                              |    | 74 |   | — |   | — |   | 12,082 |   |
| Intercompany charges                                 |   | (14,310                                             | )       | 14,310 |   | — |   | — |   | — |   |
| Equity in loss of subsidiaries                       |   | 54,287                                              |    | 9,510 |   | — |   | (63,797 | )(3) | — |   |
| Other expenses, net                                  |   | 174                                                 |    | 25 |   | — |   | — |   | 199 |   |
| Provision for income tax benefit                     |   | (747                                                | )       | (2,444 | ) | — |   | — |   | (3,191 | ) |
| Loss from discontinued operations                    |   | —                                              |    | 26,192 |   | 9,510 |   | — |   | 35,702 |   |
| Cumulative effect of change in accounting  principle |   | 1,484                                               |    | 16,344 |   | — |   | — |   | 17,828 |   |
|                                                 |   |                                                |    |   |   |   |   |   |   |   |   |
| Net loss                                             |   | $                                                   | (58,684 | ) | $ | (54,287 | ) | $ | (9,510 | ) | $ | 63,797 |   | $ | (58,684 | ) |

 

27

----

 

**Statements of Cash Flows**

 
|                                                         |   | **Six Months Ended June 30, 2003 (Unaudited)** |       |
|--------------------------------------------------------------|--------|-----------------------------------------------------|------------|
| **(In thousands)**                                           |   | **Issuer**                                          |       | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                         |   |                                                | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Cash flows from  operating activities:**                   |   |                                                |       |   |   |   |   |   |   |   |   |
|                                                         |   |                                                |       |   |   |   |   |   |   |   |   |
| Net loss                                                     |   | $                                                   | (48,679    | ) | $ | (34,615 | ) | $ | (218 | ) | $ | 34,833 | (3) | $ | (48,679 | ) |
| Loss from discontinued operations                            |   | —                                              |       | 5,432 |   | 218 |   | — |   | 5,650 |   |
| Noncash adjustments:                                         |   |                                                |       |   |   |   |   |   |   |   |   |
| Equity in loss of subsidiaries                               |   | 34,615                                              |       | 218 |   | — |   | (34,833 | )(3) | — |   |
| Other noncash adjustments                                    |   | (21,973                                             | )          | 61,060 |   | — |   | — |   | 39,087 |   |
| Changes in working capital                                   |   | 15,765                                              |       | (31,765 | ) | — |   | — |   | (16,000 | ) |
| Net cash used for operating activities                       |   | (20,272                                             | )          | 330 |   | — |   | — |   | (19,942 | ) |
|                                                         |   |                                                | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Cash flows from  investing activities:**                   |   |                                                |       |   |   |   |   |   |   |   |   |
|                                                         |   |                                                |       |   |   |   |   |   |   |   |   |
| Net proceeds from sale of Specialty  Avionics Group          |   | 132,800                                             |       | — |   | — |   | — |   | 132,800 |   |
| Capital expenditures                                         |   | (26                                                 | )          | (1,976 | ) | — |   | — |   | (2,002 | ) |
| Cash paid for acquisitions                                   |   | (600                                                | )          | — |   | — |   | — |   | (600 | ) |
| Net cash provided by (used for) investing  activities        |   | 132,174                                             |       | (1,976 | ) | — |   | — |   | 130,198 |   |
|                                                         |   |                                                | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Cash flows from  financing activities:**                   |   |                                                |       |   |   |   |   |   |   |   |   |
|                                                         |   |                                                |       |   |   |   |   |   |   |   |   |
| Principal payments on long-term debt,  leases and other debt |   | (129,924                                            | )          | (524 | ) | — |   | — |   | (130,448 | ) |
| Net senior revolving credit facility  borrowings             |   | 9,250                                               |       | — |   | — |   | — |   | 9,250 |   |
| Net cash used for financing activities                       |   | (120,674                                            | )          | (524 | ) | — |   | — |   | (121,198 | ) |
|                                                         |   |                                                |       |   |   |   |   |   |   |   |   |
| Net cash provided by discontinued  operations                |   | —                                              |       | 2,194 |   | — |   | — |   | 2,194 |   |
|                                                         |   |                                                |       |   |   |   |   |   |   |   |   |
| Net increase (decrease) in cash and  equivalents             |   | (8,772                                              | )          | 24 |   | — |   | — |   | (8,748 | ) |
| Cash and equivalents at beginning of period                  |   | 12,343                                              |       | 78 |   | — |   | — |   | 12,421 |   |
|                                                         |   |                                                |       |   |   |   |   |   |   |   |   |
| Cash and equivalents at end of period                        |   | $                                                   | 3,571      |   | $ | 102 |   | $ | — |   | $ | — |   | $ | 3,673 |   |

 

28

----

 
|                                                  |   | **Six Months Ended June 30, 2002 (Unaudited)** |       |
|-------------------------------------------------------|--------|-----------------------------------------------------|------------|
| **(In thousands)**                                    |   | **Issuer**                                          |       | **Guarantor  Subsidiaries** |   | **Non-Guarantor  Subsidiaries** |   | **Consolidating  Adjustments** |   | **Consolidated  Total** |   |
|                                                  |   |                                                | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Cash flows from  operating activities:**            |   |                                                |       |   |   |   |   |   |   |   |   |
|                                                  |   |                                                |       |   |   |   |   |   |   |   |   |
| Net loss                                              |   | $                                                   | (58,684    | ) | $ | (54,287 | ) | $ | (9,510 | ) | $ | 63,797 | (3) | $ | (58,684 | ) |
| Loss from discontinued operations                     |   | —                                              |       | 26,192 |   | 9,510 |   | — |   | 35,702 |   |
| Noncash adjustments:                                  |   |                                                |       |   |   |   |   |   |   |   |   |
| Equity in loss of subsidiaries                        |   | 54,287                                              |       | 9,510 |   | — |   | (63,797 | )(3) | — |   |
| Other noncash adjustments                             |   | 2,318                                               |       | 27,367 |   | — |   | — |   | 29,685 |   |
| Changes in working capital                            |   | 3,664                                               |       | (14,217 | ) | — |   | — |   | (10,553 | ) |
| Net cash provided by (used for) operating  activities |   | 1,585                                               |       | (5,435 | ) | — |   | — |   | (3,850 | ) |
|                                                  |   |                                                | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Cash flows from  investing activities:**            |   |                                                |       |   |   |   |   |   |   |   |   |
|                                                  |   |                                                |       |   |   |   |   |   |   |   |   |
| Cash paid for acquisitions                            |   | (5,890                                              | )          | — |   | — |   | — |   | (5,890 | ) |
| Capital expenditures                                  |   | (46                                                 | )          | (1,978 | ) | — |   | — |   | (2,024 | ) |
| Net cash used for investing activities                |   | (5,936                                              | )          | (1,978 | ) | — |   | — |   | (7,914 | ) |
|                                                  |   |                                                | ** ** |   | ** ** |   | ** ** |   | ** ** |   | ** ** |
| **Cash flows from  financing activities:**            |   |                                                |       |   |   |   |   |   |   |   |   |
|                                                  |   |                                                |       |   |   |   |   |   |   |   |   |
| Net senior revolving credit facility  borrowings      |   | 8,000                                               |       | — |   | — |   | — |   | 8,000 |   |
| Principal payments on long-term debt and leases       |   | (2,863                                              | )          | (1,623 | ) | — |   | — |   | (4,486 | ) |
| Deferred financing costs                              |   | (1,663                                              | )          | — |   | — |   | — |   | (1,663 | ) |
| Other, net                                            |   | (268                                                | )          | 545 |   | — |   | — |   | 277 |   |
| Net cash provided by (used for) financing  activities |   | 3,206                                               |       | (1,078 | ) | — |   | — |   | 2,128 |   |
|                                                  |   |                                                |       |   |   |   |   |   |   |   |   |
| Net cash provided by discontinued  operations         |   | —                                              |       | 8,747 |   | — |   | — |   | 8,747 |   |
|                                                  |   |                                                |       |   |   |   |   |   |   |   |   |
| Net increase (decrease) in cash and  equivalents      |   | (1,145                                              | )          | 256 |   | — |   | — |   | (889 | ) |
| Cash and equivalents at beginning of period           |   | 9,641                                               |       | (163 | ) | — |   | — |   | 9,478 |   |
|                                                  |   |                                                |       |   |   |   |   |   |   |   |   |
| Cash and equivalents at end of period                 |   | $                                                   | 8,496      |   | $ | 93 |   | $ | — |   | $ | — |   | $ | 8,589 |   |

 

29

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| **ITEM 2****.** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|-----------------|-------------------------------------------------------------------------------------------------|

 

The followingdiscussions should be read in conjunction with our financial statements andaccompanying notes included in this report.

 

**Recent Developments**

 

OnMay 23, 2003, we consummated the sale of our equity interests in thesubsidiaries comprising the Specialty Avionics Group to Wings Holdings, Inc.,an affiliate of Odyssey Investment Partners, LLC, for $140.0 million incash.  Proceeds of $130.0 million fromthe sale were used to repay senior credit facility borrowings, in accordancewith the facility’s terms which were amended to permit the sale.

 

As weoriginally described in our Form 10-K for the year ended December 31, 2002and Form 10-Q for the three months ended March 31, 2003, our failureto consummate the sale of the Specialty Avionics Group by June 30, 2003would have been an event of default under the amended senior creditfacility.  As a result, our independentaccountants qualified their report on our audited financial statements for theyear ended December 31, 2002 with respect to our ability to continue as agoing concern.  Consummation of the saleand repayment of $130.0 million of borrowings alleviated our independentaccountants’ doubt about our ability to continue as a going concern.  As a result, our independent accountantsissued a revised, unqualified report on our financial statements, which weincluded in Amendment No. 1 to our Form 10-K for the year endedDecember 31, 2002.  See “—Liquidityand Capital Resources–Recent Developments Affecting Financial Condition and Liquidity”below for additional information.

 

The sale ofthe Specialty Avionics Group is not expected to affect the operations of theremaining operating groups.  As a resultof the sale, the Specialty Avionics Group is presented as a discontinuedoperation in our consolidated financial statements and our discussion below ofour results of operations reflects only continuing operations for all periods.

 

**Industry Overview and Trends**

 

We compete inthe aircraft products and services market of the aerospace industry.  The market for our products and services islargely driven by demand in the three civil aircraft markets: business, VIP andhead-of-state aircraft and, to a lesser extent, commercial and regionalaircraft.  Weak global economicconditions, which were exacerbated by the September 11, 2001 terroristattack on the United States, ongoing concerns about global terrorism, thecurrent Middle Eastern military conflicts and the Severe Acute RespiratorySyndrome, or SARS, epidemic are all adversely impacting the aerospace industryand have led to a decrease in demand for business, VIP and head-of-stateaircraft.  In response to certain ofthese adverse conditions, we have announced and implemented a series ofrestructuring activities designed to reduce expenses and conserve workingcapital.  See “—Restructuring, AssetImpairment and Other Related Charges” below for additional information.

 

The business,VIP and head-of-state aircraft portion of our business experienced weaknessduring 2002 and will continue to experience weakness throughout 2003 as evidencedby various manufacturers’ announced plans to temporarily suspend production atvarious times throughout the year in response to the weak demand for newaircraft.  However, we believe business,VIP and head-of-state aircraft deliveries may experience a modest recovery in2004 and continuing recovery thereafter. The commercial aircraft portion of our business, which subsequent to thesale of the Specialty Avionics Group accounts for less than 5% of consolidatedrevenues, also experienced significant weakness in 2002 and the first half of2003 and we believe this condition will continue through 2003 and into 2004,with potential recovery not expected to occur until at least 2005.  Our beliefs are based on the assumptionsthat 

 

30

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we will experience economicrecovery and there are no further negative geo-political developments affectingour industry.

 

**Results of Operations**

 

**Performance Measures**

 

The followingdiscussion of our results of operations includes discussions of financialmeasures and operating statistics we use to evaluate the performance of, andtrends in, our businesses.  We believethe presentation of these measures and statistics are relevant and useful toinvestors because it allows them to view performance and trends in a mannersimilar to the methods we use.  Thesemeasures and statistics, and why they are important to us and could be ofinterest to you, are described below.

 

**Adjusted EBITDA.**  Our discussion of the results of operationsincludes discussions of financial measures determined in accordance withaccounting principles generally accepted in the United States of America(“GAAP”) as well as the financial measure Adjusted EBITDA, which excludescertain charges reflected in our GAAP basis financial statements.  Our presentation of Adjusted EBITDA is inaccordance with the GAAP requirements of SFAS No. 131, “Disclosures aboutSegments of an Enterprise and Related Information,” which requires us to reportthe primary measure of segment performance we use to evaluate and manage ourbusinesses.

 

We utilizemore than one measurement to evaluate segment performance and allocateresources among our operating segments; however, we consider Adjusted EBITDA,as defined below, to be the primary measurement of overall operating segmentcore economic performance and return on invested capital.  We also use Adjusted EBITDA in the annualbudgeting and planning for future periods, as one of the decision-making criteriafor funding discretionary capital expenditure and product development programsand as the measure for determining the value of acquisitions anddispositions.  Our board of directorsuses Adjusted EBITDA as one of the performance metrics for determining theamount of bonuses awarded to pursuant to the cash incentive bonus plan and asan indicator of enterprise value used in determining the exercise price ofstock options granted and the acceleration of stock option vesting pursuant theincentive stock option plan.

 

We defineAdjusted EBITDA as earnings before interest, income taxes, depreciation andamortization, restructuring, asset impairment and other related charges,acquisition related charges not capitalized and other noncash and nonoperatingcharges.  We believe the presentation ofthis measure is relevant and useful to investors because it allows investorsand analysts to view segment performance in a manner similar to the method weuse, helps improve their ability to understand our core segment performance,adjusted for items we believe are unusual, and makes it easier to compare ourresults with other companies that have different financing, capital structuresand tax rates.  In addition, we believethese measures are consistent with the manner in which our lenders andinvestors measure our overall performance and liquidity, including our abilityto service debt and fund discretionary capital expenditure and productdevelopment programs.

 

Our method ofcalculating Adjusted EBITDA may not be consistent with that of other companiesand should be viewed in conjunction with measurements that are computed inaccordance GAAP, such as net income (loss), the nearest comparable GAAPfinancial measure.  Adjusted EBITDAshould not be viewed as substitutes for or superior to net income (loss), cash flowfrom operations or other data prepared in accordance with GAAP as a measure ofour profitability or liquidity.  Thenotes to our financial statements include information about our operatingsegments, including Adjusted EBITDA, and should be read in conjunction with thediscussions presented herein.  The notesto our financial statements also include a reconciliation of Adjusted EBITDA tonet income (loss) to clarify the differences between these financial measures.

 

31

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**Bookings and Backlog.**  Bookings and backlog are operatingstatistics we use as leading trend indicators of future demand for our productsand services.  Bookings and backlog arebased upon the value of purchase orders received from our customers, which willresult in revenues, if and when such orders are filled.

 

Bookingsrepresent the total invoice value of purchase orders received during the periodand backlog represents the total invoice value of unfilled purchase orders asof the end of a period.  Orders may besubject to change or cancellation by the customer prior to shipment.  The level of unfilled orders at any givendate during the year will be materially affected by the timing of our receiptof orders and the speed with which those orders are filled.

 

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

 

Our results ofoperations have been affected by restructuring, asset impairment and otherrelated charges relating to a series of restructuring activities and goodwillimpairment charges.  These charges,which affect the comparability of our reported results of operations betweenperiods, are more fully described in “—Restructuring, Asset Impairment andOther Related Charges” and “—Goodwill Impairment Charges” below.

 

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

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

 

*Cabin Management. *Revenues decreased by $18.6 million, or38.6% compared to the prior year.  Thedecrease, which is across substantially all of our product and servicescategories, is caused by the ongoing adverse impact of weak global economicconditions which reduces the affordability of business, VIP and head-of-stateaircraft and therefore demand for the products and services we provide.  The 2003 decrease consists of:

 

•                  a $18.0 milliondecrease in aircraft furniture and related products revenues;

 

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

 

•                  a $0.2 milliondecrease in seating products revenues; offset by,

 

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

 

The revenuedecrease was caused by lower order volume from our customers as opposed to aloss of customers or price reductions. The decrease in order volume is attributable to weak global economicconditions and the impact these conditions are having on manufacturers ofbusiness, VIP and head-of-state aircraft and therefore demand for the productsand services we provide to them.  Weakglobal economic conditions have reduced the amount of discretionary incomeavailable to purchase and operate these types of aircraft.  As a result, the manufacturers of theseaircraft have experienced a decrease in orders for new aircraft which, in turn,reduces the orders our customers place with us.

 

32

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Revenues fromTextron and Bombardier, our principal customers, decreased $14.1 millioncompared to the prior year as a result of the decrease in orders and resultinglower production of aircraft they are experiencing due to the economicdownturn.  Both companies temporarilysuspended production of various models of aircraft for several weeks duringfiscal 2003 in response to their low order backlog resulting from the weakdemand for new aircraft.  We also expecta further decline in revenues from Textron during the third quarter of fiscal2003 as a result of their additional planned shut downs.  We also experienced similar volume decreasesfrom our other customers during the period.

 

*Systems Integration.*  Revenues increased by $1.5 million, or 11.3%compared to the prior year, due to:

 

•                  a $2.1 millionincrease resulting from revenue recognized pursuant to the “take-or-pay”provisions of a major supply contract; offset by,

 

•                  a $0.6 milliondecrease in the commercial aircraft systems integration engineering servicesprovided in the aftermath of September 11th and resultingdown-turn in the commercial airline industry; the airline industry’s correspondingreduction in the size of its operating fleet and the delay or postponement ofretrofit and refurbishment programs for the remaining operational fleet reduceddemand for our integration and engineering services.

 

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

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

 

*Cabin Management.*  Gross profit decreased by $13.8 million, or182.5% compared to the prior year, primarily due to:

 

•                  a $5.9 milliondecrease in profit margins due to lower volume for our business, VIP andhead-of-state aircraft furniture and seating products; and

 

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

 

•                  a $8.1 million decreasecaused by restructuring charges incurred in 2003 as compared to those recordedin 2002 related to the consolidation of our seating and related manufacturingoperations; offset by

 

•                  a $0.8 millionincrease in revenues for other products and services.

 

*Systems Integration.*  Gross profit decreased by $1.0 million, or17.7% compared to the prior year, primarily as a result of unfavorable overheadabsorption caused by lower production volume and a change in product deliverymix.

 

33

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**Selling, general and administrative expenses.**  Selling, general and administrative expensesdecreased $5.5 million, or 45.4%, to $6.6 million for the three months endedJune 30, 2003, from $12.1 million for the same period last year.  By segment, SG&A expenses changed asfollows:

 
|                |   | **Increase (Decrease)  From 2002** |   |
|---------------------|--------|------------------------------------|--------|
| **(In  millions)**  |   | **Amount**                         |   | **Percent** |   |
|                |   |                               |   |   |   |
| Cabin Management    |   | $                                  | (4.0   | ) | (49.5 | )% |
| Systems Integration |   | (1.2                               | )      | (56.7 | ) |
| Corporate           |   | (0.3                               | )      |   |   |
| Total               |   | $                                  | (5.5   | ) |   |   |

 

*Cabin Management. *SG&A expenses decreased by $4.0million, or 49.5% compared to the prior year, due to:

 

•                  a $2.4 millionreduction resulting from restructuring charges recorded in 2003 as compared tothose recorded in 2002 related to the consolidation of our seating and relatedmanufacturing operations; and

 

•                  a $1.6 milliondecrease in expenses resulting from cost reduction measures implemented inresponse to lower sales volume resulting from the weak global economicconditions.

 

*Systems Integration. *SG&A expensesdecreased by $1.2 million, or 56.7% compared to the prior year, due to lowerlabor and employee benefit costs resulting from workforce reductions in 2003.

 

**Impairment ofgoodwill. **Duringthe three months ended June 30, 2003, a $34.0 million charge was recordedto reflect the additional impairment of goodwill in connection with theimpairment testing provision of SFAS No. 142, “Goodwill and Other IntangibleAssets.”  The additional impairmentresults from continued weak global economic conditions which reduces theaffordability of business, VIP and head-of-state aircraft and therefore demandfor the products and services we provide. The impairment charge pertains to our furniture manufacturing reportingunit within our Cabin Management Group. See “—Goodwill Impairment Charges” below for additional information.

 

**Depreciation and amortization of intangibles.**  Depreciation and amortization expensedecreased $0.2 million to $2.5 million for the three months ended June 30,2003 from $2.7 million for the same period last year, primarily resulting fromreduced capital expenditures and a lower depreciable base resulting fromimpairment charges recorded during 2002 as follows:

 
|                                        |   | **Increase (Decrease)  From 2002** |   |
|---------------------------------------------|--------|------------------------------------|--------|
| **(In  millions)**                          |   | **Amount**                         |   | **Percent** |   |
|                                        |   |                               |   |   |   |
| Depreciation charged to:                    |   |                               |   |   |   |
| Cost of sales                               |   | $                                  | (0.1   | ) | (8.1 | )% |
| Selling, general and administrative expense |   | (0.2                               | )      | (25.1 | ) |
| Amortization of intangible assets           |   | 0.1                                |   | 8.2 |   |
| Total                                       |   | $                                  | (0.2   | ) |   |   |

 

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

 

34

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

 

•                  a $5.3 milliondecrease in gross profit related to lower volume in our business/VIP aircraftfurniture and seating operations; and

 

•                  a $0.6 milliondecrease in gross profit related to lower volume in our cabin management andentertainment systems; offset by,

 

•                  a $1.2 millionincrease in gross profit related to our other products and services.

 

*Systems Integration. *Adjusted EBITDAincreased by $0.1 million, or 2.1% over the prior year, due to reduced SG&Aspending resulting from workforce reductions.

 

**Operating income.**  Operating income decreased $43.3 million toa loss of $42.8 million for the three months ended June 30, 2003, fromincome of $0.5 million for the same period last year.  By segment, operating income changed as follows:

 
|                |   | **Increase (Decrease)  From 2002** |   |
|---------------------|--------|------------------------------------|--------|
| **(In  millions)**  |   | **Amount**                         |   | **Percent** |   |
|                |   |                               |   |   |   |
| Cabin Management    |   | $                                  | (43.8  | ) | (4380.0 | )% |
| Systems Integration |   | 0.2                                |   | 4.7 |   |
| Corporate           |   | 0.3                                |   |   |   |
| Total               |   | $                                  | (43.3  | ) |   |   |

 

*Cabin Management. *Operating income decreased by $43.8million, or 4380.0% compared to the prior year, due to:

 

•                  a $4.1 milliondecrease in gross profit, principally related to lower revenues in ourbusiness, VIP and head-of-state aircraft furniture and seating operations;

 

•                  a $34.0 millionincrease in goodwill impairment charges; and

 

•                  a $5.7 millionincrease in restructuring charges recorded in 2003 as compared to thoserecorded in 2002 related to the consolidation of our seating and relatedmanufacturing operations.

 

*Systems Integration.*Operating income increased by $0.2 million,or 4.7% compared to the prior year, due to reduced SG&A spending resultingfrom workforce reductions in 2003.

 

**Interest expense.**  Interest expense increased $0.3 million, or5.4%, to $6.5 million for the three months ended June 30, 2003 compared to$6.2 million for the same period last year. The increase is attributable to a 1.5% increase in interest rate marginscharged by our lenders pursuant to the March 28, 2003 senior bank creditfacility amendment, partially offset by lower principal balances outstanding.

 

**Provision for income taxes.**  The provision for income taxes, based on thereported consolidated pre-tax loss, differs from the amount determined byapplying the applicable U.S. statutory federal rate to the pre-tax lossprimarily due to the effects of state and foreign income taxes, thenon-deductible portion of goodwill impairment charges and a $13.1 milliondeferred tax asset valuation allowance established as of June 30, 2003.

 

As of June 30, 2003, we had net deferred tax assets of $12.8million, prior to recording the valuation allowance in June 2003, asopposed to net deferred tax liabilities in prior periods.  The change to a net asset position wasprimarily caused by the $34.0 million goodwill impairment charge recordedduring the second quarter of fiscal 2003. SFAS No. 109, “Accounting for Income Taxes,” requires the recognition ofa deferred tax asset for the future income tax benefit of the goodwilldeductions that will be taken for income tax purposes (i.e. the goodwill thathas been written off in the financial statements for

 

35

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book purposes will continue tobe amortized and deducted for tax purposes and accordingly represents a newdeferred tax asset).

 

As required bySFAS No. 109, we evaluated our deferred assets for expected recoverabilitybased on the nature of the item, the associated taxing jurisdictions, the applicableexpiration dates and future taxable income forecasts that would impactutilization.  Since there is no losscarry back potential and we do not have any tax planning strategies to assurerecoverability, the only possibility for recovery of the net deferred assets isfuture taxable income.  Since there havebeen prior year losses, we believe it was not prudent to rely on future incomeas the means to support the carrying value of the net assets.  As a result of our evaluation, we determinedthat recovery was not likely in certain taxing jurisdictions and applied ourjudgment in estimating the amount of valuation allowance necessary under thecircumstances to reduce the assets carrying value to realizable value.  Accordingly, we recorded the $13.1 millionvaluation allowance, eliminating the net deferred asset, as of June 30,2003.

 

For periodsprior to June 30, 2003, we had net deferred tax liabilities ($9.0 millionas of March 31, 2003 and $10.6 million as of December 31, 2002).  The full realization of the deferred assetswas achieved through the reversal of the deferred tax liabilities in futureperiods.  As a result, a valuationallowance was not required for periods prior to June 30, 2003.

 

**Loss from continuingoperations.** The loss from continuing operations increased $36.6 million to a loss of$40.3 million for the three months ended June 30, 2003 compared to a lossof $3.7 million for the same period last year, primarily due to:

 

•                  a $43.3 milliondecrease in operating income, resulting, in part, from a $34.0 million goodwillimpairment charge; and

 

•                  a $0.6 millionincrease in interest and other expenses (net); offset by

 

•                  a $7.3 millionincrease in the provision for income tax benefit.

 

**Incomefrom discontinued operations.**  Income from discontinued operationsdecreased $1.0 million to $0.7 million for the three months ended June 30,2003 compared to $1.7 million for the same period last year primarily theresult of the disposition of the Specialty Avionics Group on May 22, 2003as compared to a full quarter of results included in the prior year.  Income from discontinued operations for thethree months ended June 30, 2003 includes a modest $0.7 million gain, netof tax, on the sale of the group.

 

**Net loss.**  Net loss increased $37.6 million to a netloss of $39.5 million for the three months ended June 30, 2003 compared toa net loss of $1.9 million for the same period last year.  The increase is attributable to an increasein the loss from continuing operations of $36.6 million and a decrease in theincome from discontinued operations of $1.0 million.

 

**Net loss applicable to common stockholder.**  Net loss applicable to DeCrane Holdings, ourcommon stockholder, increased $37.8 million to a net loss of $41.2 million forthe three months ended June 30, 2003 compared to a net loss of $3.4million for the same period last year. The increase in the net loss applicable to our common stockholder isattributable to:

 

•                  a $37.6 millionincrease in our net loss; and

 

•                  a $0.2 millionincrease in accrued 16% mandatorily redeemable preferred stock dividendsresulting from the quarterly compounding of accrued dividends.

 

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

 

36

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**Backlog at end of period.**  Backlog increased $7.3 million to $74.1million as of June 30, 2003 compared to $66.8 million as ofDecember 30, 2002.

 

As described in “—Industry Overview and Trends,” the acts and ongoingthreats of global terrorism, the current military conflicts, SARS epidemic andweak global economic conditions are having an adverse impact on our business,resulting in the decrease in bookings during 2003 and related backlog at theend of the period.  In addition, webelieve that some of our customers have substantially reduced their order leadtimes which may have adversely affected bookings during the period.

 

We are not able to predict the continuing impact these events will haveon bookings and backlog in future periods. However, given the magnitude of these events, the adverse impact couldbe material.

 

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

### ** **

Our results of operations have been affected by restructuring, assetimpairment and other related charges relating to a series of restructuringactivities and goodwill impairment charges. These charges, which affect the comparability of our reported results ofoperations between periods, are more fully described in “—Restructuring, AssetImpairment and Other Related Charges” and “—Goodwill Impairment Charges” below.

 

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

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

 

*Cabin Management. *Revenues decreased by $33.8 million, or36.0% compared to the prior year.  Thedecrease, which is across substantially all of our product and servicescategories, is caused by the ongoing adverse impact of weak global economicconditions which reduces the affordability of business, VIP and head-of-stateaircraft and therefore demand for the products and services we provide.  The 2003 decrease consists of:

 

•                  a $29.5 milliondecrease in aircraft furniture and related products revenues;

 

•                  a $2.8 milliondecrease in cabin management and entertainment systems revenues; and

 

•                  a $1.8 milliondecrease in seating products revenues; offset by,

 

•                  a $0.3 millionincrease in other product and services revenues.

 

The revenue decrease was caused by lower order volume from ourcustomers as opposed to a loss of customers or price reductions.  The decrease in order volume is attributableto weak global economic conditions and the impact these conditions are havingon manufacturers of business, VIP and head-of-state aircraft and thereforedemand for the products and services we provide to them.  Weak global economic conditions have reducedthe amount of discretionary income available to purchase and operate thesetypes of aircraft.  As a result, themanufacturers of these aircraft have experienced a decrease in orders for newaircraft which, in turn, reduces the orders our customers place with us.

 

Revenues from Textron and Bombardier, our principal customers,decreased $24.4 million compared to the prior year as a result of the decreasein orders and resulting lower production of aircraft

 

37

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they are experiencing due tothe economic downturn.  Both companiestemporarily suspended production of various models of aircraft for severalweeks during fiscal 2003 in response to their low order backlog resulting fromthe weak demand for new aircraft.  Wealso expect a further decline in revenues from Textron during the third quarterof fiscal 2003 as a result of their additional planned shut downs.  We also experienced similar volume decreasesfrom our other customers during the period.

 

*Systems Integration.*  Revenues decreased by $1.5 million, or 5.1%compared to the prior year, due to:

 

•                  a $1.3 milliondecrease in the commercial aircraft systems integration engineering servicesprovided in the aftermath of September 11th and resultingdown-turn in the commercial airline industry; the airline industry’scorresponding reduction in the size of its operating fleet and the delay orpostponement of retrofit and refurbishment programs for the remainingoperational fleet reduced demand for our integration and engineering services;and

 

•                  a $2.3 milliondecrease resulting from reduced production and delivery of business, VIP andhead-of-state aircraft products and services due to the adverse impact weakglobal economic conditions are having on the demand for those types ofaircraft; offset by

 

•                  a $2.1 millionincrease resulting from revenue pursuant to the “take-or-pay” provisions of amajor supply contract.

 

**Gross profit.**  Gross profit decreased $20.2 million, or67.5%, to $9.7 million for the six months ended June 30, 2003 from $29.9million for the same period last year. By segment, gross profit changed as follows:

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

 

*Cabin Management.*  Gross profit decreased by $16.3 million, or93.1% compared to the prior year, primarily due to:

 

•                  a $9.8 milliondecrease in profit margins due to lower volume for our business, VIP and head-of-stateaircraft furniture and seating products; and

 

•                  a $1.0 milliondecrease in gross profit related to lower volume for our cabin management andentertainment systems; and

 

•                  a $6.9 millionincrease caused by restructuring charges incurred in 2003 as compared to thoserecorded in 2002 related to the consolidation of our seating and relatedmanufacturing operations; offset by

 

•                  a $1.4 millionincrease in other products and services. $0.2 million of the increase is the result of an increase in revenuesand the remaining increase of $1.2 million is due to a $2.1 million decrease inmaterials costs, offset by a $0.9 million increase in direct labor and overheadcosts.

 

*Systems Integration.*  Gross profit decreased by $3.9 million, or32.3% compared to the prior year, primarily due to:

 

•                  a $3.0 milliondecrease resulting from lower revenues and unfavorable overhead absorption as aresult of lower production and a change in product delivery mix; and

 

•                  a $0.9 milliondecrease in the commercial aircraft systems integration engineering servicesprovided.

 

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**Selling, general and administrative expenses.**  Selling, general and administrative expensesdecreased $9.8 million, or 40.3%, to $14.5 million for the six months endedJune 30, 2003, from $24.3 million for the same period last year.  By segment, SG&A expenses changed asfollows:

 
|                |   | **Increase (Decrease)  From 2002** |   |
|---------------------|--------|------------------------------------|--------|
| **(In  millions)**  |   | **Amount**                         |   | **Percent** |   |
|                |   |                               |   |   |   |
| Cabin Management    |   | $                                  | (7.5   | ) | (47.5 | )% |
| Systems Integration |   | (2.0                               | )      | (47.2 | ) |
| Corporate           |   | (0.3                               | )      |   |   |
| Total               |   | $                                  | (9.8   | ) |   |   |

 

*Cabin Management. *SG&A expenses decreased by $7.5million, or 47.5% compared to the prior year, due to:

 

•                  a $5.3 millionreduction caused by restructuring charges incurred in 2003 as compared to thoserecorded in 2002 related to the consolidation of our seating and relatedmanufacturing operations; and

 

•                  a $2.2 milliondecrease in expenses resulting from cost reduction measures implemented inresponse to lower sales volume resulting from the weak global economicconditions.

 

*Systems Integration. *SG&A expensesdecreased by $2.0 million, or 47.2% compared to the prior year, due to lowerlabor and employee benefit costs resulting from workforce reductions in 2003.

 

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

 

**Depreciation and amortization of intangibles.**  Depreciation and amortization expensedecreased $0.5 million to $5.0 million for the six months ended June 30,2003 from $5.5 million for the same period last year, primarily resulting fromreduced capital expenditures and a lower depreciable base resulting fromimpairment charges recorded during 2002 as follows.

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

 

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

 

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*Cabin Management. *AdjustedEBITDA decreased by $7.6 million, or 46.3% compared to the prior year primarilydue to:

 

•                  a $7.7 milliondecrease in gross profit related to our business/VIP aircraft furniture andseating operations; and

 

•                  a $1.0 milliondecrease in gross profit related our cabin management and entertainmentsystems; offset by,

 

•                  a $1.4 millionincrease in gross profit related to our other products and services.

 

*Systems Integration. *Adjusted EBITDAdecreased by $2.1 million, or 24.5% over the prior year, due to lower salesvolume partially offset by reduced SG&A spending resulting from workforcereductions.

 

**Operating income.**  Operating income decreased $44.5 million toa loss of $40.6 million for the six months ended June 30, 2003, fromoperating income of $3.9 million for the same period last year.  By segment, operating income changed asfollows:

 
|                |   | **Increase (Decrease)  From 2002** |   |
|---------------------|--------|------------------------------------|--------|
| **(In  millions)**  |   | **Amount**                         |   | **Percent** |   |
|                |   |                               |   |   |   |
| Cabin Management    |   | $                                  | (43.2  | ) | 792.5 | % |
| Systems Integration |   | (1.9                               | )      | (27.8 | ) |
| Corporate           |   | 0.6                                |   |   |   |
| Total               |   | $                                  | (44.5  | ) |   |   |

 

*Cabin Management. *Operating income decreased by $43.2million, or 792.5% compared to the prior year, due to:

 

•                  a $1.6 millionincrease in restructuring charges incurred in 2003 as compared to thoserecorded in 2002 related to the consolidation of our seating and relatedmanufacturing operations; and

 

•                  a $34.0 millionincrease in goodwill impairment charges; and

 

•                  a $9.8 milliondecrease in gross profit, primarily due to lower revenues related to ourfurniture and seating operations; offset by

 

•                  a $2.2 milliondecrease in expenses resulting from cost reduction measures implemented inresponse to lower sales volume resulting from the weak global economicconditions;

 

*Systems Integration.*Operatingincome decreased by $1.9 million, or 27.8% compared to the prior year, dueprimarily to lower revenues, offset by reduced SG&A spending.

 

**Interest expense.**  Interest expense increased $0.3 million, or2.1%, to $12.3 million for the six months ended June 30, 2003 compared to$12.0 million for the same period last year. The increase is attributable to a 1.5% increase in interest rate marginscharged by our lenders pursuant to the March 28, 2003 senior bank creditfacility amendment, partially offset by lower principal balances outstanding.

 

**Provision for income taxes.**  The provision for income taxes, based on thereported consolidated pre-tax loss, differs from the amount determined byapplying the applicable U.S. statutory federal rate to the pre-tax lossprimarily due to the effects of state and foreign income taxes, thenon-deductible portion of goodwill impairment charges and a $13.1 milliondeferred tax asset valuation allowance established as of June 30, 2003.

 

As ofJune 30, 2003, we had net deferred tax assets of $12.8 million, prior torecording the valuation allowance in June 2003, as opposed to net deferredtax liabilities in prior periods.  Thechange

 

40

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to a net asset position wasprimarily caused by the $34.0 million goodwill impairment charge recordedduring the second quarter of fiscal 2003. SFAS No. 109, “Accounting for Income Taxes,” requires the recognition ofa deferred tax asset for the future income tax benefit of the goodwilldeductions that will be taken for income tax purposes (i.e. the goodwill thathas been written off in the financial statements for book purposes willcontinue to be amortized and deducted for tax purposes and accordinglyrepresents a new deferred tax asset).

 

As required bySFAS No. 109, we evaluated our deferred assets for expected recoverabilitybased on the nature of the item, the associated taxing jurisdictions, theapplicable expiration dates and future taxable income forecasts that wouldimpact utilization.  Since there is noloss carry back potential and we do not have any tax planning strategies toassure recoverability, the only possibility for recovery of the net deferredassets is future taxable income.  Sincethere have been prior year losses, we believe it was not prudent to rely onfuture income as the means to support the carrying value of the netassets.  As a result of our evaluation,we determined that recovery was not likely in certain taxing jurisdictions andapplied our judgment in estimating the amount of valuation allowance necessaryunder the circumstances to reduce the assets carrying value to realizablevalue.  Accordingly, we recorded the$13.1 million valuation allowance, eliminating the net deferred asset, as ofJune 30, 2003.

 

For periodsprior to June 30, 2003, we had net deferred tax liabilities ($9.0 millionas of March 31, 2003 and $10.6 million as of December 31, 2002).  The full realization of the deferred assetswas achieved through the reversal of the deferred tax liabilities in futureperiods.  As a result, a valuationallowance was not required for periods prior to June 30, 2003.

 

**Loss from continuingoperations.** The loss from continuing operations increased $37.9 million to a loss of$43.0 million for the six months ended June 30, 2003 compared to a loss of$5.1 million for the same period last year, primarily due to:

 

•                  a $44.5 milliondecrease in operating income resulting, in part, from a $34.0 million goodwillimpairment charge; and

 

•                  a $0.2 millionincrease in interest and other expenses (net); offset by

 

•                  a $7.4 millionincrease in the provision for income tax benefit.

 

**Loss fromdiscontinued operations.**  Loss from discontinued operations decreased $30.0 million, to a lossof $5.7 million for the six months ended June 30, 2003 compared to a lossof $35.7 million for the same period last year.  The decrease is primarily due to:

 

•                  a $39.4 millioncharge in 2002 to reflect the cumulative effect on discontinued operations ofthe change in accounting principle associated with initial adoption of SFAS No.142, “Goodwill and Other Intangible Assets” as described below; offset by

 

•                  a $7.5 millioncharge in 2003 to the impairment of goodwill to reduce the carrying value ofassets sold to their estimated net realizable value; and

 

•                  the result ofthe disposition of the Specialty Avionics Group on May 22, 2003 ascompared to a full six months of results included in the prior year.

 

The loss fromdiscontinued operations for the six months ended June 30, 2003 is net of amodest $0.7 million gain, net of tax, on the sale of the group.

 

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

 

41

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**Net loss.**  Net loss decreased $10.0 million to a netloss of $48.7 million for the six months ended June 30, 2003 compared to anet loss of $58.7 million for the same period last year.  The decrease is attributable to:

 

•                  an increase inloss from continuing operations of $37.8 million; offset by

 

•                  a decrease inloss from discontinued operations of $30.0 million; and

 

•                  a decrease incumulative effect of change in accounting principle of $17.8 million.

 

**Net loss applicable to common stockholder.**  Net loss applicable to DeCrane Holdings, ourcommon stockholder, decreased $9.6 million to a net loss of $51.9 million forthe six months ended June 30, 2003 compared to a net loss of $61.5 millionfor the same period last year.  Thedecrease in the net loss applicable to our common stockholder is attributableto:

 

•                  a $10.0 milliondecrease in our net loss; offset by

 

•                  a $0.4 millionincrease in accrued 16% mandatorily redeemable preferred stock dividendsresulting from the quarterly compounding of accrued dividends.

 

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

 

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**Restructuring, Asset Impairment and OtherRelated Charges**

 

The followingdiscussion should be read in conjunction with Note 3 accompanying our financialstatements included in this report.

 

During thethree months and six months ended June 30, 2003, we recordedrestructuring, asset impairment and other related pre-tax charges related to aseries of restructuring activities. These charges, and the effect these charges had on our reported resultsof operations, are summarized below.

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

 

**Seating Product Lineand Furniture Manufacturing Facilities Restructuring**

 

During thesecond quarter of fiscal 2003, we consolidated our seating product lineofferings and adopted a restructuring plan to down-size a furnituremanufacturing facility in response to continuing weakness in the business, VIPand head-of-state aircraft market. These actions were designed to reduce engineering, production andinventory carrying costs by supporting fewer product offerings and achieveprofitability at the furniture manufacturing facility based on its lower productionlevels.  In connection with theseactions, we recorded pre-tax charges to operations totaling $13.4 millionduring the second quarter of fiscal 2003, of which $9.9 million were noncashcharges.

 

The chargesare comprised of the write-off of inventoried costs related to discontinuedproduct offerings, lease termination and related charges, excess and obsoleteinventory write-downs and severance and other compensation costs.  As required by SFAS No. 146, thecharges recorded were discounted by

 

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$0.6 million to initiallymeasure and reflect the liabilities incurred as a result of the restructuringplan at their fair value as of June 30, 2003.  The cumulative effect of a changes resulting from revisions toeither the timing or the amount of estimated cash flows will be recognized asan adjustment to the liability in the period of the change.

 

Theserestructuring activities were substantially completed during the second quarterof fiscal 2003.  A $3.3 millionrestructuring reserve remains as of June 30, 2003 for lease terminationand related costs.  The manufacturingfacilities were closed during June 2003. The future cash payments will be funded from existing cash balances andinternally generated cash from operations.

 

**Asset Realignment Restructuring**

 

During thesecond quarter of fiscal 2001, we adopted a restructuring plan to realignaircraft furniture production programs among our manufacturing facilities.  In addition, and in response to the adverseimpact on the aerospace industry resulting from the September 11thterrorist attack and its aftermath, as well as the weakening of global economicconditions, we announced and implemented a further restructuring plan inDecember 2001 designed to reduce costs and conserve working capital.  This plan included permanently closing onemanufacturing facility and idling a second facility for an indefinite period,curtailing several product development programs and instituting workforcereductions.

 

Due to theongoing weakness of the business, VIP and head-of-state aircraft market, wedecided during the second quarter of fiscal 2002 to permanently close thetemporarily idled manufacturing facility. In connection with this decision, we recorded additional pre-tax chargesto operations totaling $6.9 million during the year ended December 31,2002, of which $3.8 million were noncash charges, for additional impairment oflong-lived assets, current asset write-downs and other related expenses.

 

Thisrestructuring plan was completed during the fourth quarter of fiscal 2002.

 

**SeatManufacturing Facilities Restructuring**

 

During thefirst quarter of fiscal 2002, we announced we would consolidate the productionof four seating and related manufacturing facilities into two, resulting in thepermanent closure of two facilities. This plan was designed to improve manufacturing efficiencies and tofurther reduce costs and conserve working capital.  In connection with this restructuring plan, we recorded pre-taxcharges to operations totaling $6.3 million during the year endedDecember 31, 2002, of which $3.6 million were noncash charges, forrestructuring, asset impairment and other related restructuring charges.

 

Therestructuring, asset impairment and other related expenses are comprised ofcharges for current asset write-downs, the impairment of long-lived assets,severance and lease termination costs and other restructuring-related expensespertaining to FAA retesting and recertification, moving, transportation andtravel costs and shutdown and startup costs.

 

Thisrestructuring plan was completed during the second quarter of fiscal 2002.

 

**Goodwill ImpairmentCharges**

 

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

 

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During thefirst quarter of fiscal 2003, we entered into a definitive agreement to sellthe Specialty Avionics Group.  Basedupon the fair value of the group implied in the definitive agreement, wedetermined that the carrying value of one of the reporting unit’s net assetswas not fully recoverable.  As a result,we recorded a goodwill impairment charge of $7.5 million during the threemonths ended March 31, 2003 to reduce the carrying value to theestimated net realizable value established by the definitive agreement.

 

See “—GoodwillImpairment Charges” below for additional information.

 

**Goodwill Impairment Charges**

 

The followingdiscussion should be read in conjunction with the Notes 3 and 5 accompanyingour financial statements included in this report.

 

Our results ofoperations for the three months and six months ended June 30, 2003 and2002 have been affected by the adoption of SFAS No. 142, “Goodwill and OtherIntangible Assets,” and goodwill impairment charges.

 

EffectiveJanuary 1, 2002, we adopted SFAS No. 142, “Goodwill and Other IntangibleAssets” and the provisions of SFAS No. 141, “Business Combinations,” which wererequired to be adopted concurrent with the adoption of SFAS No. 142.  Adoption of these accounting pronouncementsresulted in the following:

 

•                  *Reclassificationof Intangible Assets.* Intangible assets relating to acquired assembled workforce intangiblesnot meeting the criteria for recognition apart from goodwill were reclassifiedto goodwill, net of deferred income taxes.

 

•                  *Discontinuanceof Goodwill Amortization.* Goodwill is deemed to be an indefinite-lived asset.  As a result, and in accordance with SFAS No.142, the recording of periodic goodwill amortization charges was discontinuedeffective January 1, 2002.

 

•                  *AnnualTesting for Goodwill Impairment.* In lieu of periodic goodwill amortization charges, SFAS No. 142 requiresgoodwill to be tested annual for impairment, or when events or changes incircumstances indicate the carrying value may not be recoverable.

 

During 2002,we completed the transitional impairment testing of goodwill recorded as ofJanuary 1, 2002 as required under SFAS No. 142.  Fair value of each reporting unit wasdetermined using a discounted cash flow approach taking into considerationprojections based on the individual characteristics of the reporting units,historical trends, market multiples for comparable businesses and independentappraisals.  Our Cabin Management Groupconsists of three reporting units, our Systems Integration Group consists oftwo and the Specialty Avionics consists of three.  Unallocated goodwill was allocated to the reporting units forimpairment testing purposes.  Theresults indicated that the carrying value of goodwill was impaired at one ofthe reporting units within each of our operating groups.  The resulting impairment was primarilyattributable to a change in the evaluation criteria for goodwill utilized underprevious accounting guidance to the fair value approach stipulated in SFAS No.142.  In accordance with thetransitional provision of SFAS No. 142, we recorded a $17.8 million noncashwrite-down of goodwill (net of $0.9 million income tax benefit) as ofJanuary 1, 2002 as a cumulative effect of a change in accountingprinciple.  An additional $39.4 millionnoncash write-down of goodwill pertained to the Specialty Avionics Group and isincluded in the loss from discontinued operations.

 

45

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Changes in thecarrying amount of goodwill, by business segment, for the six months endedJune 30, 2003 are as follows:

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

 

During thefirst quarter of fiscal 2003, we entered into a definitive agreement to sellthe Specialty Avionics Group.  Basedupon the fair value of the group implied in the definitive agreement, wedetermined that the carrying value of the group’s net assets was not fullyrecoverable.  As required by SFAS No.142, we recorded a goodwill impairment charge of $7.5 million during the threemonths ended March 31, 2003 to reduce the carrying value to theestimated net realizable value established by the definitive agreement.  We recorded a modest $0.7 million gain onthe sale during the second quarter of fiscal 2003, based on the actualfinancial position of the group on the date of sale.  However, the ultimate gain or loss on the sale is subject tofinalizing the post-closing adjustment, which is not expected to be material,if any.

 

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

 

As a result ofthe continuing weakness in the business, VIP and head-of-state aircraft marketand our decision to down-size a furniture manufacturing facility in the secondquarter of fiscal 2003, we determined that we should reevaluate the carryingvalue of our goodwill prior to the annual October 31st testingdate.  Accordingly, we performed astep-one test of goodwill associated with our furniture manufacturing reportingunit for recoverability and found the goodwill to be impaired.  As a result, we recorded a pre-tax charge tooperations of $34.0 million during the three months ended June 30, 2003based on a comparison of the estimated book value of the net assets of thereporting unit to its fair value.  Thecharge was primarily a result of a decrease in fair value caused by using lowercash flow forecasts based on the most recently reduced industry estimates ofaircraft deliveries resulting from overall industry weakness.  The amount recorded is an estimate and maybe revised during the third quarter of fiscal 2003 upon completion of step twoof the goodwill impairment model, which measures the amount of impairment.

 

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**Liquidity and Capital Resources**

 

Our principalcash needs are for debt service, working capital, capital expenditures andpossible strategic acquisitions, as well as to provide DeCrane Holdings withcash to finance its needs, which consists primarily of cash dividends on itspreferred stock beginning in 2005.  Ourprincipal sources of liquidity are expected to be cash flow from operations,potential capital market transactions and third party borrowings, principallyunder our senior credit facility.

 

**Cash Flows During theSix Months Ended June 30, 2003**

 

Net cash usedby operating activities was $19.9 million for the six months ended June 30,2003 and consisted of $4.1 million of cash used by operations after adding backdepreciation, amortization, the noncash portion of our restructuring and assetimpairment charges and other noncash items and $21.0 million used for workingcapital, offset by a $5.2 million increase in other liabilities.  The following factors contributed to the$21.0 million working capital increase:

 

•                  a $12.7 millioninventory increase principally related to long-term contracts;

 

•                  a $13.0 milliondecrease in accounts payable and accrued expenses, primarily resulting fromreduced purchasing commensurate with lower revenues; offset by,

 

•                  a $0.5 milliondecrease in prepaid expenses and other assets; and

 

•                  a $4.2 milliondecrease in accounts receivables.

 

We expect workingcapital increases, if any, to moderate during the remainder of 2003.

 

Net cashprovided by investing activities was $130.2 million for the six months endedJune 30, 2003 and consisted of:

 

•                  $132.8 millionof net proceeds from the sale of the Specialty Avionics Group; offset by,

 

•                  $2.0 millionused for capital expenditures; and

 

•                  $0.6 millionused for the payment of contingent acquisition consideration.

 

We anticipatespending approximately $4.0 to $4.5 million for capital expenditures in2003.  As of June 30, 2003, thereare no remaining acquisition contingent consideration payment obligations.

 

Net cash usedby financing activities was $121.2 million for the six months endedJune 30, 2003.  Cash of $9.3million was provided by revolving line of credit borrowings under our seniorcredit facility.  Cash of $130.5 millionwas used for principal payments on our senior term debt, capitalized leaseobligations and other debt.

 

**Capital Resources andDebt Obligations as of June 30, 2003**

 

As ofJune 30, 2003, we had $50.2 million of working capital, compared to $55.4million as of December 31, 2002, excluding assets and liabilities of thediscontinued operations we sold in 2003. As of June 30, 2003, we also had $24.4 million of borrowingsavailable under our revolving line of credit, as amended in March 2003 anddescribed below, compared to $43.6 million available as of December 31,2002.  Our revolving line of creditexpires in September 2004.  We notbe able to replace it on commercially acceptable terms, or at all.  As of June 30, 2003, our senior creditfacility borrowings totaling $150.2 million are at variable interest ratesbased on defined margins over the current prime rate or LIBOR, compared to$270.2 million as of December 31, 2002. We also had $100.0 million of 12% senior subordinated notes as ofJune 30, 2003 and December 31, 2002 and other indebtedness totaling$9.7 million outstanding as of June 30, 2003 compared to $10.8 million asof December 31, 2002.

 

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The seniorcredit facility and senior subordinated notes indenture impose restrictive andfinancial covenants on us.  In the firstquarter of fiscal 2003, terms and financial covenants contained in our seniorcredit facility were amended to, among other things, permit the sale of theSpecialty Avionics Group which was consummated on May 23, 2003.  As required by the amendment, we repaid$130.0 million of senior credit facility borrowings with the proceeds from thesale.  See “–Recent DevelopmentsAffecting Financial Condition and Liquidity” below for additional information.

 

**Recent DevelopmentsAffecting Financial Condition and Liquidity**

 

As more fullydescribed in “—Industry Overview and Trends,” the acts and ongoing threats ofglobal terrorism, the current military conflicts, SARS epidemic and weak globaleconomic conditions are all adversely impacting our business.  In response, we have implemented a series ofrestructuring activities as described in “—Restructuring, Asset Impairment andOther Related Charges,” designed to reduce costs and conserve working capital.

 

During thefourth quarter of fiscal 2002, we further assessed our long-term businessstrategies in light of current aerospace industry conditions.  In addition, we subsequently determined thatwe would likely not be in compliance with our senior credit facility’sfinancial covenants in 2003.  We believethat when the aerospace industry recovers, the demand for our Cabin Managementand Systems Integration groups’ products and services for business, VIP andhead-of-state aircraft will return to historical levels and, accordingly, wedecided to focus our resources in these market segments.  To accomplish this objective, we embarked ona plan to sell the Specialty Avionics Group, which is highly dependent on thecommercial airline industry.

 

We consummatedthe sale of the Specialty Avionics Group on May 23, 2003 and, as requiredby the senior credit facility amendment, used $130.0 million of the proceedsfrom the sale to repay senior credit facility borrowings.  The senior credit facility amendment alsorelaxes various financial covenants for 2003 and beyond, decreases by $10.0million the maximum permitted revolving line of credit borrowings to $40.0 million,increases the prime rate and LIBOR interest margins by 1.5% and permits theissuance of specified types of additional indebtedness and the repurchase of upto $20.0 million aggregate principal amount of our 12% senior subordinatednotes with the proceeds from the sale of junior securities.  Junior securities means: (i) seniorsubordinated notes issued by us that are unsecured and do not provide for anyscheduled redemptions or prepayments or any sinking fund installment paymentsor maturities prior to the termination of the senior credit facility, or otherindebtedness subordinated in right of payment to our obligations under thesenior credit facility, and whose material terms are satisfactory to thelenders; and (ii) equity securities issued by us.

 

We believe ourexpected operating cash flows, together with borrowings under our senior creditfacility ($24.4 million of which was available as of June 30, 2003, thecommitment for which expires in September 2004), will be sufficient tomeet our future short- and long-term 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.

 

In addition,we are continually considering acquisitions that complement or expand ourexisting businesses or that may enable us to expand into new markets, some ofwhich may be material.  Futureacquisitions may require additional debt, equity financing or both.  We may not be able to obtain any additionalfinancing on acceptable terms.  We arenot currently party to any definitive acquisition agreements.

 

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**Disclosure of Contractual Obligations andCommitments**

 

The followingtable summarizes our known contractual obligations to make future cash paymentsas of June 30, 2003, as well an estimate of the periods during which thesepayments are expected to be made.

 
|                                                              |   |      |   | **Years Ending December 31,** |   |
|-------------------------------------------------------------------|--------|-----------|--------|------------------------------------|--------|
| **(In  millions)**                                                |   | **Total** |   | **2003**                           |   | **2004  and  2005** |   | **2006  and  2007** |   | **2008  and  Beyond** |   |
|                                                              |   |      |   |                               |   |   |   |   |   |   |   |
| Long-term debt (a):                                               |   |      |   |                               |   |   |   |   |   |   |   |
| Senior credit facility                                            |   | $         | 150.2  |                               | $      | — |   | $ | 93.8 |   | $ | 56.4 |   | $ | — |   |
| 12% senior subordinated notes                                     |   | 100.0     |   | —                             |   | — |   | — |   | 100.0 |   |
| Capital lease obligations and other  indebtedness                 |   | 9.7       |   | 0.5                                |   | 2.3 |   | 1.6 |   | 5.3 |   |
| Total long-term debt                                              |   | 259.9     |   | 0.5                                |   | 96.1 |   | 58.0 |   | 105.3 |   |
|                                                              |   |      |   |                               |   |   |   |   |   |   |   |
| Operating lease obligations                                       |   | 14.6      |   | 1.0                                |   | 3.2 |   | 2.5 |   | 7.9 |   |
| Mandatorily redeemable preferred stock  redemption obligation (b) |   | 40.0      |   | —                             |   | — |   | — |   | 40.0 |   |
| Total obligations as of June 30, 2003                        |   | $         | 314.5  |                               | $      | 1.5 |   | $ | 99.3 |   | $ | 60.5 |   | $ | 153.2 |   |

 

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

 

(b)                     Dividends accrue quarterly at theannual rate of 16% and are payable, at our option, either in cash or by theissuance of additional shares of preferred stock.  Since the issuance of the preferred stock in June 2000, wehave elected to issue additional shares in lieu of cash dividend payments andmay continue to do so until June 2005, after which time we are required topay quarterly dividends in cash.  If weelect to continue issuing additional shares until June 2005, our mandatoryredemption obligation on March 31, 2009, the mandatory redemption date,will be $54.8 million and our annual cash dividend payment obligation will be$8.8 million, payable quarterly, commencing September 2005.

 

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

 

We are awholly-owned subsidiary of DeCrane Holdings, whose capital structure alsoincludes mandatorily redeemable preferred stock.  Since we are DeCrane Holdings’ only operating subsidiary andsource of cash, we may be required to fund DeCrane Holdings’ redemptionobligation in the future, subject to limitations contained in our senior creditagreement and the senior subordinated notes indenture.  The DeCrane Holdings preferred stock has atotal redemption value of $66.7 million as of June 30, 2003 and thepreferred stock is mandatorily redeemable on September 30, 2009.

 

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

 

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In connectionwith the sale of the Specialty Avionics Group, we made indemnities to the buyerwith respect to a number of customary, and certain other specific,representations and warranties.  Ourindemnities with respect to some of these matters are limited in terms ofduration with the maximum of potential future payments capped at $14.0 millionand our indemnities with respect to specified environmental matters will expirenot later than October 2010 and provides for a maximum liability of $5.0million, while others will have no limitations.  In addition, the $140.0 million selling price is subject to apotential post-closing adjustment related to the amount of working capital atclosing.  Although we cannot be certain,we believe the potential adjustment will not be material.  The post-closing adjustment, if any, wouldbe payable by us in cash upon its final determination.

 

As ofJune 30, 2003, we also had an irrevocable standby letter of credit in theamount of $0.4 million issued and outstanding under our senior credit facility.

 

**Recent Accounting Pronouncements**

 

**AccountingPronouncements Adopted January 1, 2003**

 

As more fullydescribed in Note 1 accompanying our financial statements included in thisreport, we adopted the provisions of the following accounting pronouncementseffective January 1, 2003:

 

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

 

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

 

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

 

•                  FASBInterpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Other.”

 

**Recently Issued Accounting Pronouncement**

 

*SFAS No. 150 – Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity*

 

Issued inMay 2003, 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. We are currently evaluating the impact this new standard will have onour financial position, results of operations and cash flows.  However, we believe we will be required toreclassify our mandatorily redeemable preferred stock as a liability commencingJuly 1, 2003 and reflect subsequent changes in the redemption obligationas a charge against pre-tax income.

 

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

 

All statementsother than statements of historical facts included in this report areconsidered forward-looking statements within the meaning of the PrivateSecurities Litigation Reform Act of 1995. These forward-looking statements are subject to known and unknown risks,uncertainties and other factors, which are difficult to predict.  We are vulnerable to a variety of factorsthat 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;

 

•                  labor disturbances;and

 

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

 

Some of themore significant factors listed above are further described in our AnnualReport on Form 10-K (Amendment No. 1) and should be read in conjunction withthis report.  Changes in such factorscould cause our actual results to differ materially from those contemplated insuch forward-looking statements. Although we believe that the expectations reflected in suchforward-looking statements are reasonable, we can give no assurance that suchexpectations will prove to be correct. We undertake no obligation to release publicly any revisions to theseforward-looking statements to reflect events or circumstances after the datehereof or to reflect the occurrence of unanticipated events.  You should not rely on our forward-lookingstatements as if they were certainties.

 

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

 

We are exposedto various market risks, including interest rates and changes in foreigncurrency exchange rates.  Market risk isthe potential loss arising from adverse changes in prevailing market rates andprices.  From time to time, we usederivative financial instruments to manage and reduce risks associated withthese factors.  We do not enter intoderivatives or other financial instruments for trading or speculative purposes.

 

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

 

Market riskrelated to our variable-rate debt is estimated as the potential decrease inpre-tax earnings resulting from an increase in interest rates.  The interest rates applicable tovariable-rate debt are, at our option, based on defined margins over thecurrent prime rate or LIBOR.  As ofJune 30, 2003, the current prime rate was 4.00% and the current LIBOR was1.12%.  Based on $150.2 million ofvariable-rate debt outstanding as of June 30, 2003, a hypothetical onepercent rise in interest rates, to 5.00% for prime rate borrowings and 2.12%for LIBOR borrowings, would reduce our pre-tax earnings by $1.5 millionannually.

 

To limit aportion of our exposure related to rising interest rates, we have entered intoan interest rate swap contract to effectively convert $4.5 million ofvariable-rate industrial revenue bonds to 4.2% fixed-rate debt until maturityin 2008.  The contract is considered tobe a hedge against changes in the amount of future cash flows associated withinterest payments on this portion of our variable-rate debt.  Market risk related to this interest rateswap contract is estimated as the potential higher interest expense we willincur if the variable interest rate decreases below the 4.2% fixed rate.  Based on the $3.3 million of variable-ratedebt converted to fixed-rate debt outstanding as of June 30, 2003, ahypothetical one percent decrease in the variable interest rate to 3.2%, wouldreduce our pre-tax earnings by less than $0.1 million annually.

 

The estimatedfair value of our $100.0 million fixed-rate long-term debt increased $7.0million, or 17.5%, to approximately $47.0 million as of June 30, 2003 from$40.0 million as of December 31, 2002. Although we cannot be certain, we believe the increase may have been aresult of the sale of the Specialty Avionics Group.  Market risk related to our fixed-rate debt is deemed to be thepotential increase in fair value resulting from a decrease in interest rates.  For example, a hypothetical ten percentdecrease in the interest rates, from 12.0% to 10.8%, would increase the fairvalue of our fixed-rate debt by approximately $7.0 million.

 

**Foreign CurrencyExchange Rate Risk.** Our foreign customers are located in various parts of the world,primarily Canada, the Far and Middle East and Western Europe, and we havesubsidiaries 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 the SpecialtyAvionics Group’s exposure related to foreign inventory procurement andoperating costs.  While we have notentered into any such contracts since 1998, we may do so in the futuredepending on the volume of non-U.S. dollar denominated transactions and ourassessment of future foreign exchange rate trends.

 

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

 

The managementof DeCrane Aircraft Holdings, Inc. (the “Company”), under the supervision andwith the participation of the Company’s Chief Executive Officer and ChiefFinancial Officer, conducted an evaluation of the Company’s “disclosurecontrols and procedures” (as defined in Exchange Act Rules 13a-15(e) or15d-15(e)) as of the end of the period covered by the initial report filed onAugust 14, 2003.  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 the initial report.

 

There was nochange in the Company’s internal control over financial reporting identified inconnection with the evaluation required by paragraph (d) of Exchange Act Rules13a-15 or 15d-15 that occurred during the Company’s last fiscal quarter andprior to the date of the initial filing on August 14, 2003 that hasmaterially affected, or is reasonably likely to materially affect, theCompany’s internal control over financial reporting.

 

**PART II – OTHER INFORMATION**

 

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

 

As part of itsinvestigation of the crash of Swissair Flight 111 off the Canadian coast onSeptember 2, 1998, the Canadian Transportation Safety Board (the“CTSB”) initially notified us that it recovered burned wire that was attachedto the in-flight entertainment system installed on some of Swissair’s aircraftby one of our subsidiaries.  Oursubsidiary has worked vigorously over the last five years with the CTSBinvestigators in the fact-finding investigation of this catastrophicincident.  On March 27, 2003, theCTSB released its final report on its investigation.  This report indicated that the CTSB was unable to conclusivelydetermine the cause of the fire which led to the crash of the aircraft.

 

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

 

Boeing andSwissair have made a claim (but have not commenced litigation) against us tocontribute to the amounts paid to settle the cases.  As there is no litigation pending, no discovery has been taken byeither side as to liability for the crash. We believe that our subsidiary is not responsible for the crash and, inany event, we maintain insurance for such matters.  We further believe that any loss we may sustain upon the ultimateresolution of this matter, if any, will not exceed the amount of insurance coveragemaintained.  Accordingly, no accrual forloss has been recorded in our financial statements.

 

We are alsoinvolved in other routine legal and administrative proceedings incident to thenormal conduct of business.  We believethe ultimate disposition of all such matters will not have a material adverseeffect on our business, consolidated financial position, results of operationsor cash flows.

 

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

 

a.                                       Exhibits

 
| 3.1.2   | Bylaws of DeCrane Aircraft Holdings, Inc., as amended on July 9,  2003 (1)                                                                  |
|---------|--------------------------------------------------------------------------------------------------------------------------------------------------|
|    |                                                                                                                                             |
| 10.11.3 | Addendum 6-5723-03-064 to the Special Business Provisions between The  Boeing Company and PATS, Inc. dated April 16, 2003 (2)               |
|    |                                                                                                                                             |
| 31.1    | Chief Executive Officer Certification Pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002 *                                          |
|    |                                                                                                                                             |
| 31.2    | Chief Financial Officer Certification Pursuant to Section 302 of  the Sarbanes-Oxley Act of 2002 *                                          |
|    |                                                                                                                                             |
| 32      | Chief Executive Officer and Chief Financial Officer Certifications  Pursuant to Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 * |

 

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| *      | Filed herewith                                                                                                                                                    |
|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                              |
| (1)    | Filed as an exhibit to Registration Statement (Registration No.  333-106381) of Form S-1 (Amendment No. 2) filed with the Commission on  September 18, 2003. |
|   |                                                                                                                                                              |
| (2)    | Filed as an exhibit to Registration Statement (Registration No.  333-106381) of Form S-1 (Amendment No. 1) filed with the Commission on  August 12, 2003.    |

 

b.                                      Reports on Form 8-K

 

OnMarch 17, 2003, we filed a Form 8-K Current Report regarding DeCraneAircraft entering into a definitive agreement to sell its Specialty AvionicsGroup.  The text of the press release iscontained in the filing.

 

OnMay 23, 2003, we filed a Form 8-K Current Report regarding DeCraneAircraft consummating the sale of its Specialty Avionics Group.

 

OnJune 23, 2003, we filed a Form 8-K Current Report regarding DeCraneAircraft filing a Registration Statement on Form S-1 for its 12% Series BSenior Subordinated Notes due 2008 in order to register market-making sales tobe made by Credit Suisse First Boston LLC. The registration statement contains revised audited financial statementsfor DeCrane Aircraft that reflect the sale of the Specialty Avionics Group onMay 23, 2003 and includes a revised, unqualified report of our independentaccountants.  As previously disclosed, oursenior credit facility required us to file such revised financial statementsand independent accountants’ report by June 23, 2003 to avoid a defaultthereunder.

 

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**SIGNATURES**

 

 

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

 

 
|                 | **DECRANE AIRCRAFT HOLDINGS, INC.  (Registrant)** |
|----------------------|---------------------------------------------------|
|                 |                                              |
|                 |                                              |
| October 9, 2003 | By:                                               | /s/  RICHARD J. KAPLAN |
|                 | Name:                                             | Richard J. Kaplan |
|                 | Title:                                            | Senior Vice President, Chief Financial Officer,  Secretary, Treasurer and Director |

 

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