**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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** **

**FORM 10-Q**

 

**QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d)****OF THE SECURITIES EXCHANGEACT OF 1934**

 

**For thequarterly period ended June 30, 2003**

 

**CommissionFile Number 000-22371**

 

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**DECRANE AIRCRAFT HOLDINGS, INC.**

(Exact name of registrantas specified in its charter)

 

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

 

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Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.

 

**ý****  **Yes    o  No

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct). 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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**Table of Contents**

 

 
| **Part I – Financial Information** |
|-----------------------------------------|
|                                    |   |
| **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  of Off-Balance Sheet Commitments and Indemnities |
|                                    | Recent Accounting  Pronouncements |
|                                    | Special  Note Regarding Forward Looking Statements and Risk Factors |
| **Item  3.**                            | **Quantitative  and Qualitative Disclosure About Market Risk** |
| **Item 4.**                             | **Controls  and Procedures** |
|                                    |   |
| **Part II – Other Information**    |
|                                    |   |
| **Item 1.**                             | **Legal  Proceedings** |
| **Item 6.**                             | **Exhibits and Reports  on Form 8-K** |
|                                    | Exhibits |
|                                    | Reports on Form 8-K |
| **Signatures**                          |

 

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**PART I –FINANCIAL****INFORMATION**

 

**ITEM1.****                             FINANCIALSTATEMENTS**

 

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

** **

**ConsolidatedBalance Sheets**

** **
| **(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 notesare an integral part of the consolidated financial statements.

 

1

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

** **

**Consolidated Statements 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                      |   | 6,282                            |    | 11,336                              |   | 13,480 |   | 22,732 |   |
| Impairment of  goodwill                                            |   | 34,000                           |    | —                              |   | 34,000 |   | — |   |
| Amortization of  intangible assets                                 |   | 914                              |    | 874                                 |   | 1,826 |   | 1,717 |   |
| Total operating  expenses                                          |   | 41,196                           |    | 12,210                              |   | 49,306 |   | 24,449 |   |
|                                                               |   |                             |    |                                |   |   |   |   |   |
| Income (loss)  from operations                                     |   | (42,466                          | )       | 1,252                               |   | (39,579 | ) | 5,451 |   |
|                                                               |   |                             |    |                                |   |   |   |   |   |
| Other expenses:                                                    |   |                             |    |                                |   |   |   |   |   |
| Interest expense                                                   |   | 7,614                            |    | 7,997                               |   | 15,289 |   | 15,756 |   |
| Other expenses,  net                                               |   | 407                              |    | 86                                  |   | 746 |   | 199 |   |
|                                                               |   |                             |    |                                |   |   |   |   |   |
| Loss from  continuing operations before provision for income taxes |   | (50,487                          | )       | (6,831                              | )      | (55,614 | ) | (10,504 | ) |
| Income tax  benefit                                                |   | 9,702                            |    | 2,487                               |   | 11,399 |   | 4,040 |   |
|                                                               |   |                             |    |                                |   |   |   |   |   |
| Loss from  continuing operations                                   |   | (40,785                          | )       | (4,344                              | )      | (44,215 | ) | (6,464 | ) |
|                                                               |   |                             |    |                                |   |   |   |   |   |
| Discontinued  operations and change in accounting principle:       |   |                             |    |                                |   |   |   |   |   |
| Income (loss)  from discontinued operations, net of tax            |   | 1,266                            |    | 2,412                               |   | (4,464 | ) | (34,392 | ) |
| 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 notesare an integral part of the consolidated financial statements.

 

2

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

** **

**Consolidated Statement of Stockholder’s Equity (Deficit)**

 
|                                            |       |              |       |   |   | **Additional****Paid-in****Capital** |   | **Notes****Receivable****For Shares****Sold** |   | **Accumulated****Deficit** |   | **Accumulated****Other****Comprehensive****Loss** |   | **Total** |   |
|-------------------------------------------------|------------|-------------------|------------|--------|--------|--------------------------------------|--------|-----------------------------------------------|--------|----------------------------|--------|---------------------------------------------------|--------|-----------|--------|
|                                            |       |              |       |   |   |                                 |   |                                          |   |                       |
| **(In thousands, except share data)**           |       | **Common  Stock** |       |   |   |                                 |   |                                          |
|                                            | **Shares** |              | **Amount** |   |   |                                 |   |                                          |   |
|                                            |       |              |       |   |   |                                 |   |                                          |   |                       |   |                                              |   |      |   |
| Balance,  December 31, 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 notesare an integral part of the consolidated financial statements.

 

3

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

** **

**Consolidated Statements 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                                                 |   | 4,464                               |    | 34,392 |   |
| 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                                            |   | (21,128                             | )       | (5,160 | ) |
|                                                                               |   |                                |    |   |   |
| **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                                      |   | 3,380                               |    | 10,057 |   |
|                                                                               |   |                                |    |   |   |
| 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 notesare an integral part of the consolidated financial statements.

 

4

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

** **

**CondensedNotes to Consolidated Financia****l Statements**

**(Unaudited)**

 

**Note 1.           Summary of Significant AccountingPolicies**

** **

Basis of Presentation

 

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

 

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

 

The results of operations for interim periods do notnecessarily predict the operating results for any other interim period or forthe full year.  The consolidated balancesheet as of December 31, 2002 has been derived from audited financialstatements but does not include all disclosures required by accounting principlesgenerally accepted in the United States of America as permitted by interimreporting requirements.  Theseconsolidated interim financial statements should be read in conjunction withManagement’s Discussion and Analysis of Financial Condition and Results ofOperations and the audited financial statements and related notes included inthe Company’s 2002 Form 10-K.

 

Reclassifications have been made to prior periods’financial statements to conform to the 2003 presentation, principally toreflect the disposition of the Specialty Avionics Group as a discontinuedoperation (Note 2).

 

As the Company described in its Form 10-K for the yearended December 31, 2002 and Form 10-Q for the three months ended March 31,2003, its failure to consummate the sale of the Specialty Avionics Group byJune 30, 2003 would have been an event of default under the amended seniorcredit facility.  As a result, theCompany’s independent accountants qualified their report on its auditedfinancial statements for the year ended December 31, 2002 with respect to itsability to continue as a going concern. Consummation of the sale and repayment of $130.0 million of borrowingsalleviated the independent accountants doubt about the Company’s ability tocontinue as a going concern.  As aresult, the Company’s independent accountants issued a revised, unqualifiedreport on its financial statements that was included in a registrationstatement on Form S-1 regarding its 12% Series B Senior Subordinated Notes due2008 (Registration No. 333-106381, filed with Securities and ExchangeCommission on June 23, 2003 and amended on August 12, 2003).

 

**Stock Option Plan**

 

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

 

The following table illustrates the effect on netincome if the Company had applied the fair value recognition provisions of SFASNo. 123 to stock-based employee compensation.

 

5

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|                                                                                                                                           |   | **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**

 

Effective January 1, 2003 the Company adopted thefollowing accounting pronouncements.

 

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

 

Among other things, SFAS No. 145 rescinds variouspronouncements regarding early extinguishment of debt and allows extraordinaryaccounting treatment for early extinguishment only when the provisions ofAccounting Principles Board Opinion No. 30, “Reporting the Results ofOperations–Reporting the Effects of Disposal of a Segment of a Business, andExtraordinary, Unusual and Infrequently Occurring Events and Transactions” aremet.  Adoption of this new standard didnot have an impact on the Company’s consolidated financial position, or resultsof operations or cash flow.

 

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

 

SFAS No. 146 supersedes previous accounting guidance,principally Emerging Issues Task Force Issue No. 94-3, “Liability Recognitionfor Certain Employee Termination Benefits and Other Costs to Exit an Activity(including Certain Costs Incurred in a Restructuring).”  SFAS No. 146 requires that the liability forcosts associated with an exit or disposal activity be initially measured atfair value and recognized when the liability is incurred.  In periods subsequent to initialmeasurement, changes to the liability are measured using the credit-adjustedrisk-free rate that was used in the initial measurement of the liabilityrecorded.  The cumulative effect of achange resulting from revisions to either the timing or the amount of estimatedcash flows is recognized as an adjustment to the liability in the period of thechange and charged to the same line items in the statement of operations usedwhen the related costs were initially recognized.  Under EITF No. 94-3, a liability for an exit cost was recognizedat the date of a company’s commitment to an exit plan.

 

The Company believes SFAS No. 146 affects the timingof recognizing restructuring costs, as well as the amounts recognized,depending on the nature of the exit, disposal or restructuring activity and thetiming of the related estimated cash flows. As required by the provisions of SFAS No. 146, the Company applied itsprovisions to the restructuring activities initiated in June 2003 (Note 3).

 

6

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*FASBInterpretation No. 45 – Guarantor’s Accounting and Disclosure Requirements forGuarantees, Including Indirect Guarantees of Indebtedness of Others*

 

FIN No. 45 elaborates on the disclosures to be made bya guarantor in its interim and annual financial statements about itsobligations under certain guarantees that it has issued.  The interpretation also clarifies that aguarantor is required to recognize, at the inception of a guarantee, aliability for the fair value of the obligation undertaken in issuing theguarantee.  The initial recognition andinitial measurement provisions of FIN No. 45 are applicable to the Company on aprospective basis to guarantees issued or modified after December 31,2002.  However, the disclosurerequirements in FIN No. 45 are effective for the Company’s financial statementsfor periods ending after December 15, 2002. The Company is not a party to any agreement in which it is a guarantorof indebtedness of others therefore the adoption of interpretation did not havean impact on the Company’s financial position, results of operations or cash flows.  The disclosure requirements of thisinterpretation were adopted by the Company as of December 31, 2002.

 

**Recently Issued AccountingPronouncement**

 

*SFAS No. 150 – Accounting forCertain Financial Instruments with Characteristics of both Liabilities andEquity*

 

Issued in May 2003, SFAS No. 150 establishes standardsfor the classification and measurement of certain financial instruments withcharacteristics of both liabilities and equity.  SFAS No. 150 requires classification of financial instruments withinits scope as a liability, including financial instruments issued in the form ofshares that are mandatorily redeemable, because those financial instruments aredeemed to be, in essence, obligations of the issuer.  The Company will be required to reclassify its mandatorilyredeemable preferred 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.

 

**Note 2.           Disposition of Specialty AvionicsGroup**

 

During the fourth quarter of fiscal 2002 the Companyassessed its long-term business strategies in light of current aerospaceindustry conditions.  The Companybelieves that as the aerospace industry recovers, the demand for its CabinManagement and Systems Integration Groups’ products and services for business,VIP and head-of-state aircraft will return to historical levels and,accordingly, the Company decided to focus its resources in these marketsegments.  To accomplish this objective,the Company embarked on a plan to sell its Specialty Avionics Group, which ishighly dependent on the commercial airline industry.

 

On March 14, 2003, the Company entered into adefinitive agreement to sell its equity interests in the subsidiaries comprisingits Specialty Avionics Group to Wings Holdings, Inc., an affiliate of OdysseyInvestment Partners, LLC, for $140,000,000 in cash.  The sale was consummated on May 23, 2003.  The selling price is subject to apost-closing adjustment related to the amount of working capital atclosing.  Proceeds of $130,000,000 fromthe sale were used to repay senior credit facility borrowings (Note 8).  The sale of the Specialty Avionics Group isnot expected to affect the operations of the remaining operating groups.

 

7

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Based upon the fair value of the group implied in thedefinitive agreement, the Company determined that the carrying value of thegroup’s net assets was not fully recoverable. As a result, the Company recorded a goodwill impairment charge of$7,500,000 during the three months ended March 31, 2003 to reduce thecarrying value to the estimated net realizable value established by thedefinitive agreement.  The Companyrecorded a modest gain on the sale during the second quarter of fiscal 2003,based on the 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 of the sale, the Specialty Avionics Groupis presented as a discontinued operation in the accompanying consolidatedfinancial statements.  The financialstatements for prior periods have been reclassified to segregate the group’sassets and liabilities, results of operations and cash flows for allperiods.  The following tables summarizethe financial position, results operations and cash flows of the SpecialtyAvionics Group.

 
| **(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 (a)**                     |   | **2002**                            |   | **2003 (a)** |   | **2002** |   |
|                                                 |   | **(Unaudited)**                  |   |
| Results of  Operations:                              |   |                             |   |                                |   |   |   |   |   |
| Revenues                                             |   | $                                | 13,125 |                                | $      | 25,038 |   | $ | 36,595 |   | $ | 50,383 |   |
|                                                 |   |                             |   |                                |   |   |   |   |   |
| Operating  expenses:                                 |   |                             |   |                                |   |   |   |   |   |
| Costs and  expenses                                  |   | 11,867                           |   | 21,028                              |   | 32,426 |   | 41,991 |   |
| Impairment of  goodwill                              |   | —                           |   | —                              |   | 7,500 |   | — |   |
| Total operating  expenses                            |   | 11,867                           |   | 21,028                              |   | 39,926 |   | 41,991 |   |
|                                                 |   |                             |   |                                |   |   |   |   |   |
| Pre-tax income  (loss)                               |   | 1,258                            |   | 4,010                               |   | (3,331 | ) | 8,392 |   |
| Provision for  income taxes                          |   | 681                              |   | 1,598                               |   | 1,822 |   | 3,462 |   |
|                                                 |   |                             |   |                                |   |   |   |   |   |
| Income (loss)  before change in accounting principle |   | 577                              |   | 2,412                               |   | (5,153 | ) | 4,930 |   |
| Cumulative  effect of change in accounting principle |   | —                           |   | —                              |   | — |   | (39,322 | ) |
|                                                 |   |                             |   |                                |   |   |   |   |   |
| Income (loss)  from operations                       |   | 577                              |   | 2,412                               |   | (5,153 | ) | (34,392 | ) |
| Gain on sale,  net of tax                            |   | 689                              |   | —                              |   | 689 |   | — |   |
|                                                 |   |                             |   |                                |   |   |   |   |   |
| Net income  (loss) from discontinued operations      |   | $                                | 1,266  |                                | $      | 2,412 |   | $ | (4,464 | ) | $ | (34,392 | ) |

----

(a)  Reflects the results ofoperations through May 23, 2003, the date of sale.

8

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|                                                  |   | **Six Months Ended  June 30,** |   |
|-------------------------------------------------------|--------|-------------------------------------|--------|
| **(In thousands)**                                    |   | **2003**                            |   | **2002** |   |
|                                                  |   | **(Unaudited)**                     |   |
|                                                  |   |                                |   |   |   |
| Cash Flows  Provided By (Used For):                   |   |                                |   |   |   |
| Operating  activities                                 |   | $                                   | 4,946  |   | $ | 10,751 |   |
| 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         |   | $                                   | 3,380  |   | $ | 10,057 |   |

 

**Note 3.           Restructuring, Asset Impairment andOther Related Charges**

 

During the three months and six months ended June 30,2003 and 2002, the Company recorded restructuring, asset impairment and otherrelated 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 |   |

 

9

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During the second quarter of fiscal 2003, the Companyconsolidated its seating product line offerings and adopted a restructuringplan to down-size a furniture manufacturing facility in response to continuingweakness in the business, VIP and head-of-state aircraft market.  These actions were designed to reduceengineering, production and inventory carrying costs by supporting fewerproduct offerings and achieve profitability at the furniture manufacturingfacility based on its lower production levels. In connection with these actions, the Company recorded pre-tax chargesto operations totaling $13,394,000 during the second quarter of fiscal2003.  The charges are comprised of thefollowing:

 

•                  *Seating Product LineConsolidation. *Thecurtailment**of several seatingproduct offerings and conversion of seat products which incorporate a newsingle-design technology resulted in the write-off of $6,262,000 of inventoriedcosts related to the discontinued product offerings.

 

•                  *Excess and ObsoleteInventory Write-Downs. *Inventory waswritten down by $3,073,000 to reflect its net realizable value for quantitieson hand exceeding current and forecast order backlog requirements and obsoleteinventory related to the curtailed seating product offerings.

 

•                  *Lease Termination andRelated Charges. *Leasetermination costs related to future estimated rental payments under existinglong-term lease agreements for the facilities permanently vacated in connectionwith down-sizing a furniture manufacturing facility.  Future payments have been reduced by the expected subleaseincome.  The net future payments arebased on estimated current market rates and anticipated dates that thesefacilities will be subleased.  Ifmarket-rates decrease or should it take longer than expected to sublease thesefacilities, the actual loss could exceed these estimates.  Other related charges include the write-offof leasehold improvements related to the vacated facilities.

 

•                  *Severance and OtherCompensation Costs. *The Companyhas reduced its total workforce at the down-sized facility by 49 employees, or37%, between December 31, 2002 and June 30, 2003.

 

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

 
|                                                       |   | **Total  Charges** |                 |   |     |   |   | **Balance at  June 30,  2003** |   |
|------------------------------------------------------------|--------|--------------------|----------------------|--------|----------|--------|--------|-------------------------------------|--------|
|                                                       |   |               | **Amounts Incurred** |   |     |
| **(In  thousands)**                                        |   |               | **Noncash**          |   | **Cash** |   |   |
|                                                       |   | **(Unaudited)**    |                 |
| Product  development costs related to curtailed programs   |   | $                  | 6,262                |   | $        | (6,262 | )      | $                                   | — |   | $ | — |   |
| Excess and  obsolete inventory write-downs                 |   | 3,073              |                 | (3,073 | )        | — |   | —                              |   |
| Lease  termination and other related charges               |   | 4,436              |                 | (591   | )        | — |   | 3,845                               |   |
| 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 |   |

 

10

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As required by SFAS No. 146, the charges recorded werediscounted by $560,000 to initially measure and reflect the liabilitiesincurred as a result of the restructuring plan at their fair value as ofJune 30, 2003.  The cumulative effectof a changes resulting from revisions to either the timing or the amount ofestimated cash flows will be recognized as an adjustment to the liability inthe period of the change.  Future cashpayments will be funded from existing cash balances and internally generatedcash from operations.

 

**Seat Manufacturing FacilitiesRestructuring**

 

During the first quarter of fiscal 2002, the Companyannounced it would consolidate the production of four seating and relatedmanufacturing facilities into two, resulting in the permanent closure of twofacilities.  This plan was designed toimprove manufacturing efficiencies and to further reduce costs and conserveworking capital.  In connection withthis restructuring plan, the Company recorded pre-tax charges to operationstotaling $6,294,000 during 2002 for restructuring, asset impairment and otherrelated charges.  The charges werecomprised 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.  Ifmarket-rates decrease or should it take longer than expected to sublease thesefacilities, 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 components of the amounts incurred were asfollows:

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

 

This restructuring plan was completed during thesecond quarter of fiscal 2002.

 

11

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**Asset Realignment Restructuring**

 

During the second quarter of fiscal 2001, theCompany’s Cabin Management Group adopted a restructuring plan to realignproduction programs between its manufacturing facilities.  In response to the adverse impact on theaerospace industry resulting from the September 11th terroristattack and its aftermath, as well as the weakening of global economicconditions, the Company 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 the ongoing weaknessof the business, VIP and head-of-state aircraft market, the Company decidedduring the second quarter of fiscal 2002 to permanently close the temporarilyidled manufacturing facility.  Therestructuring, asset impairment and other related charges recorded duringfiscal 2002 were comprised of the following:

 

•                  *Impairment of Long-Lived Assets.*  The decision to permanently close theadditional manufacturing facility resulted in an additional impairment of propertyand equipment and, accordingly, these assets were written down to theirestimated net realizable value in 2002. Net realizable values are based on estimated current market values andthe actual 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 components of the amounts incurred were asfollows:

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

 

This restructuring plan was completed during thefourth quarter of fiscal 2002.

 

**GoodwillImpairment Charges**

** **

As a result of the continuing weakness in thebusiness, VIP and head-of-state aircraft market and the decision to down-size afurniture manufacturing facility, the goodwill associated with the furnituremanufacturing reporting unit was tested for recoverability and found to beimpaired (Note 5).  As a result,$34,000,000 of goodwill associated with the reporting unit was written off andcharged to operations.

 

As described in Note 2, on March 14, 2003, the Companyentered into a definitive agreement to sell its equity interests in thesubsidiaries comprising its Specialty Avionics Group for $140,000,000 incash.  Based upon the fair value of thegroup implied in the definitive agreement, the Company determined that thecarrying value of the group’s net assets was not fully recoverable.  As a result, the Company recorded a goodwillimpairment charge of $7,500,000 during the three months endedMarch 31, 2003 to reduce the carrying value to estimated netrealizable value.

 

12

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**Note 4.           Inventories**

 

Inventories are comprised of the following as ofJune 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 |   |
|                                                                              |        |                         |        |                             |        |  |  |  |

 

Periodic assessments are performed to ensurerecoverability of the program costs and adjustments are made, if necessary, toreduce inventoried costs to estimated realizable value.   In connection with the curtailment ofseveral seating product offerings (Note 3), all inventoried costs related theseprograms, which aggregated $6,262,000, were charged to cost of sales during thethree months ended June 30, 2003.  Inaddition, $3,073,000 of excess and obsolete inventory associated with thecurtailed seating product offerings and down-sizing of a furnituremanufacturing facility was also charged to cost of sales during the threemonths ended June 30, 2003.

 

Total costs and estimated earnings on all uncompletedcontracts as of June 30, 2003 and December 31, 2002 are comprised ofthe 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 and earnings for products manufactured underlong-term contracts are recognized under the percentage-of-completion methodusing total contract price, actual costs incurred to date and an estimate ofthe completion costs for each contract. Provisions for estimated losses on uncompleted contracts are made in theperiod in which such losses are determined.

 

13

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**Note 5.           Goodwill**

 

Effective January 1, 2002, the Company adopted SFASNo. 142, “Goodwill and Other Intangible Assets” and the provisions of SFAS No.141, “Business Combinations,” which were required to be adopted concurrent withthe adoption of SFAS No. 142.  During2002, the Company completed the transitional impairment testing of goodwillrecorded as of January 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, historicaltrends, market multiples for comparable businesses and independentappraisals.  Unallocated goodwill wasallocated to the reporting units for impairment testing purposes.

 

The results indicated that the carrying value ofgoodwill was impaired.  The resultingimpairment was primarily attributable to a change in the evaluation criteriafor goodwill utilized under previous accounting guidance to the fair valueapproach stipulated in SFAS No. 142.  Inaccordance with the transitional provision of SFAS No. 142, the Companyrecorded a $17,828,000 noncash write-down of goodwill (net of $878,000 incometax benefit) as of January 1, 2002 as a cumulative effect of a change inaccounting principle.  An additional$39,322,000 noncash write-down of goodwill pertained to the Specialty AvionicsGroup and is included in the loss from discontinued operations.

 

Changes in the carrying amount of goodwill, bybusiness segment (Note 12), for the six months ended June 30, 2003 are asfollows:

 
|                                |   | **Continuing Operations**    |    | **Discontinued**                |   |
|-------------------------------------|--------|------------------------------|---------|---------------------------------|--------|
| **(In  thousands)**                 |   | **Cabin  Management  Group** |    | **Systems  Integration  Group** |   | **Corporate** |   | **Total** |   | **Specialty  Avionics  Group** |   |
|                                |   |                         |    |                            |   |   |   |   |   |   |   |
| 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 described in Note 2, on March 14, 2003, the Companyentered into a definitive agreement to sell its equity interests in thesubsidiaries comprising its Specialty Avionics Group.  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.

 

As required by SFAS No. 142, the Company testsgoodwill for impairment annually, on October 31st of each year, orwhen events or changes in circumstances indicate the carrying amount may not berecoverable.  The goodwill impairmentmodel is a two-step process.  First, it requiresa comparison 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 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.

 

14

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As a result of the continuing weakness in thebusiness, VIP and head-of-state aircraft market and the Company’s decision todown-size a furniture manufacturing facility in the second quarter of fiscal2003, the Company determined that it should reevaluate the carrying value ofits goodwill prior to the annual October 31st testing date.  Accordingly, the Company performed astep-one test of goodwill associated with its furniture manufacturing reportingunit for recoverability and found the goodwill to be impaired.  As a result, the Company recorded a pre-taxcharge to operations of $34,000,000 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.

 

**Note 6.           Other Assets**

 

Other assets are comprised of the following as of June30, 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 withFinite Useful Lives**

 

Identifiable intangible assets with finite usefullives are comprised of the following as of June 30, 2003 andDecember 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 |   |

 

Estimated annual amortization expense for allidentifiable intangible assets with finite useful lives for the five-yearperiod ending December 31, 2007 is as follows: 2003 – $3,644,000; 2004 –$3,644,000; 2005 – $3,477,000; 2006 – $2,275,000; and 2007 – $2,175,000.

 

15

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**Note 7.           Accrued Liabilities**

 

Accrued liabilities are comprised of the following asof June 30, 2003 and December 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-Term Debt**

 

Long-term debt includes the following amounts as ofJune 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 creditfacility to permit the sale of its Specialty Avionics Group.  Upon consummation of the sale on May 23,2003, the Company repaid $130,000,000 of senior credit borrowings with theestimated net proceeds from the sale. The Company may be required to repay additional borrowings upon finaldetermination of the net proceeds from the sale.

 

The amendment also revised various financial covenants(which the Company would otherwise have not been able to meet), decreases by$10,000,000 the maximum permitted revolving line of credit borrowings to$40,000,000, increases the prime rate and LIBOR interest margins by 1.5% andpermits the issuance of specified types of additional indebtedness and therepurchase of up to $20,000,000 of the Company’s 12% senior subordinated noteswith the proceeds from the sale of junior securities.

 

16

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**Note 9.           Income Taxes**

 

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

 
|                                         |   | **Three Months Ended  June 30,** |    | **Six Months Ended  June 30,** |   |
|----------------------------------------------|--------|----------------------------------|---------|-------------------------------------|--------|
| **(In  thousands)**                          |   | **2003**                         |    | **2002**                            |   | **2003** |   | **2002** |   |
|                                         |   | **(Unaudited)**                  |    |
| Pre-tax income  (loss) reported by:          |   |                             |    |                                |   |   |   |   |   |
| Continuing  operations                       |   | $                                | (50,487 | )                                   | $      | (6,831 | ) | $ | (55,614 | ) | $ | (10,504 | ) |
| Discontinued  operations                     |   | 1,258                            |    | 4,010                               |   | (3,331 | ) | 8,392 |   |
| 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                       |   | $                                | (9,702  | )                                   | $      | (2,487 | ) | $ | (11,399 | ) | $ | (4,040 | ) |
| Discontinued  operations                     |   | 681                              |    | 1,598                               |   | 1,822 |   | 3,462 |   |
| Net provision for  income tax benefit        |   | $                                | (9,021  | )                                   | $      | (889 | ) | $ | (9,577 | ) | $ | (578 | ) |

 

For the three months and six months endedJune 30, 2003 and 2002, the provision for income taxes, based on thereported consolidated pre-tax loss, differs from the amount determined byapplying the applicable U.S. statutory federal rate to the pre-tax lossprimarily due to the effects of state and foreign income taxes and thenon-deductible portion of goodwill impairment charges.

 

During the three months and six months ended June 30,2003, the Company established a $13,056,000 valuation allowance for the netdeferred tax assets which may not be realized in the future.  The Company evaluated its deferred assetsfor expected recoverability based on the nature of the item, the associatedtaxing jurisdictions, the applicable expiration dates and future taxable incomeforecasts that would impact utilization. Based on its evaluation, the Company determined that recovery was notlikely in certain taxing jurisdictions and applied its judgment in estimatingthe amount of valuation allowance necessary under the circumstances to reducethe assets carrying value to realizable value. The Company will reduce the valuation allowance in the future for eachitem at such time when it determines that recoverability is more likely thannot.

 

17

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**Note 10.         Capital Structure**

 

**Mandatorily Redeemable PreferredStock**

 

The table below summarizes the increase in mandatorilyredeemable preferred stock during the 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 the preferred stock are entitled toreceive, when, as and if declared, dividends at a rate equal to 16% perannum.  Prior to June 30, 2005, theCompany may, at its option, pay dividends either in cash or by the issuance ofadditional shares of preferred stock. Since the preferred stock issuance date on June 30, 2000, the Companyhas elected to issue additional shares in lieu of cash dividends.

 

**Note 11.         Commitments and Contingencies**

 

**Litigation**

 

As part of its investigation of the crash of SwissairFlight 111 off the Canadian coast on September 2, 1998, the CanadianTransportation Safety Board (the “CTSB”) initially notified the Company that itrecovered burned wire that was attached to the in-flight entertainment systeminstalled on some of Swissair’s aircraft by one of the Company’ssubsidiaries.  The Company’s subsidiaryhas worked vigorously over the last five years with the CTSB investigators inthe fact-finding investigation of this catastrophic incident.  On March 27, 2003, the CTSB released its finalreport on its investigation.  Thisreport indicated that the CTSB was unable to conclusively determine the causeof the fire which led to the crash of the aircraft.

 

The Company was a defendant in most, but not all, ofthe actions brought by the estates of the 229 victims of the crash.  The actions, which sought damages and costsin unstated amounts, claimed negligence, strict liability, and breach ofwarranty.  Virtually all of the caseshave been settled by Boeing and Swissair’s insurers and both assignment of theclaims against, and releases in favor of, the Company have been obtained by theBoeing and Swissair insurers.

 

Boeing and Swissair have made a claim (but have notcommenced litigation) against the Company to contribute to the amounts paid tosettle the cases.  As there is nolitigation pending, no discovery has been taken by either side as to liabilityfor the crash.  The Company believesthat it is not responsible for the crash and, in any event, it maintainsinsurance for such matters.  The Companyfurther believes that any loss it may sustain upon the ultimate resolution ofthis matter, if any, will not exceed the amount of insurance coveragemaintained.  Accordingly, no accrual forloss has been recorded.

 

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

 

18

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**Fundingof DeCrane Holdings Preferred Stock Obligations**

 

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

 

DeCrane Holdings’ preferred stock dividends arepayable quarterly at a rate of 14% per annum. Prior to September 30, 2005, dividends are not paid in cash butinstead accrete to the liquidation value of the preferred stock, which, inturn, increases the redemption obligation. On or after September 30, 2005, preferred stock dividends arerequired to be paid in cash, if declared, and the preferred stock ismandatorily redeemable on September 30, 2009.  The DeCrane Holdings preferred stock has a total redemption valueof $66,654,000 as of June 30, 2003, including accumulated dividends.

 

**Note12.         Business Segment Information**

 

The Company supplies products and services to thebusiness, VIP and head-of-state aircraft market within the aerospace industry.  The Company’s subsidiaries are organizedinto two groups, each of which is a strategic business that develops,manufactures and sells distinct products and services.  The groups and a description of theirbusinesses are as follows:

 

•                  *CabinManagement –* manufactures interior cabin components, including cabininterior furnishings, cabin management systems, seating and compositecomponents;

 

•                  *SystemsIntegration –* manufactures auxiliary fuel systems and auxiliarypower units, provides system integration services, provides aircraft completionand refurbishment services and is a Boeing Business Jet authorized servicecenter.

 

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

 

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

 

19

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

 

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

 

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

 

The tables below summarize selected financial data bybusiness 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 |   |

 

20

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|                                          |   | **June 30,** |       |
|-----------------------------------------------|--------|-------------------|------------|
| **(In  thousands)**                           |   | **2003**          | ** ** | **2002** | ** ** |
|                                          |   | **(Unaudited)**   | ** ** |
| Total  assets (as of period end):             |   |              |       |   |   |
| Cabin  Management                             |   | $                 | 236,941    |   | $ | 288,543 |   |
| Systems  Integration                          |   | 69,049            |       | 68,242 |   |
| Corporate  (5)                                |   | 17,094            |       | 29,072 |   |
| Inter-group  elimination (6)                  |   | (438              | )          | (122 | ) |
| Continuing  operations                        |   | 322,646           |       | 385,735 |   |
| Discontinued  operations (Specialty Avionics) |   | —            |       | 177,191 |   |
| Consolidated  totals                          |   | $                 | 322,646    |   | $ | 562,926 |   |

 

----

(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 | ) |
| Corporate  overhead charged to discontinued operations     |   | 290                                   |       | 752                                 |       | 997 |   | 1,515 |   |
| Interest  expense                                          |   | (7,614                                | )          | (7,997                              | )          | (15,289 | ) | (15,756 | ) |
| Other  expenses, net                                       |   | (407                                  | )          | (86                                 | )          | (746 | ) | (199 | ) |
| Income  tax benefit                                        |   | 9,702                                 |       | 2,487                               |       | 11,399 |   | 4,040 |   |
| Income  (loss) from discontinued operations                |   | 1,266                                 |       | 2,412                               |       | (4,464 | ) | (34,392 | ) |
| Cumulative  effect of change in accounting principle       |   | —                                |       | —                              |       | — |   | (17,828 | ) |
| Net  loss                                                  |   | $                                     | (39,519    | )                                   | $          | (1,932 | ) | $ | (48,679 | ) | $ | (58,684 | ) |
|                                                            |        |                                       |            |                                     |            |  |  |  |  |  |  |  |  |  |  |  |

 

----

(a)          Reflects depreciationand amortization of long-lived assets and amortization of deferred financingcosts, which are classified as a component of interest expense, as follows:

 

21

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|                                        |   | **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)                                  Reflectsthe Company’s corporate headquarters assets, excluding investments in and notesreceivable from subsidiaries.

 

(6)                                  Reflectselimination of inter-group receivables and profits in inventory as of periodend.

 

**Note 13.         Supplemental Condensed ConsolidatingFinancial Information**

 

In conjunction with the 12% senior subordinated notesdescribed in Note 8, the following condensed consolidating financialinformation is presented segregating the Company, as the issuer, and guarantorand non-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 guarantor subsidiaries are wholly-ownedsubsidiaries of the Company and their guarantees are full and unconditional ona joint and several basis.  There are norestrictions on the ability of the guarantor subsidiaries to transfer funds tothe issuer in the form of cash dividends, loans or advances.  Separate financial statements of theguarantor subsidiaries are not presented because management believes that suchfinancial statements would not be material to investors.  Investments in subsidiaries in the followingcondensed consolidating financial information are accounted for under theequity method of accounting. Consolidating adjustments include the following:

 

(1)           Eliminationof investments in subsidiaries.

 

(2)           Eliminationof intercompany accounts.

 

(3)           Eliminationof equity in earnings of subsidiaries.

 

22

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**BalanceSheets**

 
|                                                                                                |   | **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                                                                        |   | 290,404                            |       | — |   | — |   | (290,404 | )(1) | — |   |
| Intercompany  receivables                                                                           |   | 55,073                             |       | 74,846 |   | — |   | (129,919 | )(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                             |       | 55,073 |   | — |   | (129,919(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                           | )          | (47,188 | ) | — |   | 47,188 | (1) | (131,988 | ) |
| Accumulated  other comprehensive loss                                                               |   | —                             |       | (364 | ) | — |   | — |   | (364 |   |
| Total  stockholder’s equity (deficit)                                                          |   | (16,695                            | )          | 290,040 |   | — |   | (290,404 | ) | (17,059 | )  |
| Total  liabilities, mandatorily redeemable preferred stock and stockholder’s equity  (deficit) |   | $                                  | 362,567    |   | $ | 380,402 |   | $ | — |   | $ | (420,323 | ) | $ | 322,646 |   |
|                                                                                                     |        |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

23

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|                                                                                     |   | **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                                                             |   | 351,502                    |       | — |   | — |   | (351,502 | )(1) | — |   |
| Intercompany  receivables                                                                |   | 273,178                    |       | 172,389 |   | 5,740 |   | (451,307 | )(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                    |       | 273,065 |   | — |   | (451,307 | )(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                    | )          | 13,910 |   | (4,477 | ) | (9,433 | )(1) | (83,309 | ) |
| Accumulated  other comprehensive loss                                                    |   | —                     |       | (361 | ) | — |   | — |   | (361 | ) |
| Total  stockholder’s equity                                                         |   | 35,312                     |       | 351,141 |   | 10,963 |   | (362,465 | ) | 34,951 |   |
| Total  liabilities, mandatorily redeemable preferred stock and stockholder’s equity |   | $                          | 668,927    |   | $ | 682,875 |   | $ | 10,937 |   | $ | (813,772 | ) | $ | 548,967 |   |

 

24

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**Statementsof 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 |   | 3,907                                               |       | 9,573 |   | — |   | — |   | 13,480 |   |
| Impairment  of goodwill                       |   | —                                              |       | 34,000 |   | — |   | — |   | 34,000 |   |
| Amortization  of intangible assets            |   | —                                              |       | 1,826 |   | — |   | — |   | 1,826 |   |
| Interest  expense                             |   | 15,068                                              |       | 221 |   | — |   | — |   | 15,289 |   |
| Intercompany  charges                         |   | (11,575                                             | )          | 11,575 |   | — |   | — |   | — |   |
| Equity  in loss of subsidiaries               |   | 33,429                                              |       | 218 |   | — |   | (33,647 | )(3) | — |   |
| Other  expenses, net                          |   | 586                                                 |       | 160 |   | — |   | — |   | 746 |   |
| Income  tax benefit                           |   | 7,264                                               |       | (18,663 | ) | — |   | — |   | (11,399 | ) |
| Loss  from discontinued operations            |   | —                                              |       | 4,246 |   | 218 |   | — |   | 4,464 |   |
| Net  loss                                     |   | $                                                   | (48,679    | ) | $ | (33,429 | ) | $ | (218 | ) | $ | 33,647 |   | $ | (48,769 | ) |

 
|                                                 |   | **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        |   | 4,273                                               |       | 18,459 |   | — |   | — |   | 22,732 |   |
| Amortization  of intangible assets                   |   | —                                              |       | 1,717 |   | — |   | — |   | 1,717 |   |
| Interest  expense                                    |   | 15,682                                              |       | 74 |   | — |   | — |   | 15,756 |   |
| Intercompany  charges                                |   | (14,310                                             | )          | 14,310 |   | — |   | — |   | — |   |
| Equity  in loss of subsidiaries                      |   | 52,977                                              |       | 9,510 |   | — |   | (62,487 | )(3) | — |   |
| Other  expenses, net                                 |   | 174                                                 |       | 25 |   | — |   | — |   | 199 |   |
| Income  tax benefit                                  |   | (1,596                                              | )          | (2,444 | ) | — |   | — |   | (4,040 | ) |
| Loss  from discontinued operations                   |   | —                                              |       | 24,882 |   | 9,510 |   | — |   | 34,392 |   |
| Cumulative  effect of change in accounting principle |   | 1,484                                               |       | 16,344 |   | — |   | — |   | 17,828 |   |
| Net  loss                                            |   | $                                                   | (58,684    | ) | $ | (52,977 | ) | $ | (9,510 | ) | $ | 62,487 |   | $ | (58,684 | ) |

 

25

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**Statementsof 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    | ) | $ | (33,429 | ) | $ | (218 | ) | $ | 33,647 | (3) | $ | (48,679 | ) |
| Loss  from discontinued operations                           |   | —                                              |       | 4,246 |   | 218 |   | — |   | 4,464 |   |
| Noncash  adjustments:                                        |   |                                                |       |   |   |   |   |   |   |   |   |
| Equity  in loss of subsidiaries                              |   | 33,429                                              |       | 218 |   | — |   | (33,647 | )(3) | — |   |
| Other  noncash adjustments                                   |   | (21,973                                             | )          | 61,060 |   | — |   | — |   | 39,087 |   |
| Changes  in working capital                                  |   | 16,951                                              |       | (32,951 | ) | — |   | — |   | (16,000 | ) |
| Net  cash used for operating activities                      |   | (20,272                                             | )          | (856 | ) | — |   | — |   | (21,128 | ) |
|                                                         |   |                                                |       |   |   |   |   |   |   |   |   |
| **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                |   | —                                              |       | 3,380 |   | — |   | — |   | 3,380 |   |
| 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 |   |
|                                                              |        |                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

26

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|                                                  |   | **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    | ) | $ | (52,977 | ) | $ | (9,510 | ) | $ | 62,487 | (3) | $ | (58,684 | ) |
| Loss  from discontinued operations                    |   | —                                              |       | 24,882 |   | 9,510 |   | — |   | 34,392 |   |
| Noncash  adjustments:                                 |   |                                                |       |   |   |   |   |   |   |   |   |
| Equity  in loss of subsidiaries                       |   | 52,977                                              |       | 9,510 |   | — |   | (62,487 | )(3) | — |   |
| Other  noncash adjustments                            |   | 2,318                                               |       | 27,367 |   | — |   | — |   | 29,685 |   |
| Changes  in working capital                           |   | 4,974                                               |       | (15,527 | ) | — |   | — |   | (10,553 | ) |
| Net  cash provided by (used for) operating activities |   | 1,585                                               |       | (6,745 | ) | — |   | — |   | (5,160 | ) |
|                                                  |   |                                                |       |   |   |   |   |   |   |   |   |
| **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         |   | —                                              |       | 10,057 |   | — |   | — |   | 10,057 |   |
| 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 |   |
|                                                       |        |                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

 

27

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

 

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

 

**Recent Developments**

 

On May 23, 2003, we consummated the sale of our equityinterests in the subsidiaries comprising the Specialty Avionics Group to WingsHoldings, Inc., an affiliate of Odyssey Investment Partners, LLC, for $140.0million in cash.  Proceeds of $130.0million from the sale were used to repay senior credit facility borrowings, inaccordance with the facility’s terms which were amended to permit the sale.

 

As we described in our Form 10-K for the year endedDecember 31, 2002 and Form 10-Q for the three months ended March 31, 2003, ourfailure to 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 a goingconcern.  Consummation of the sale andrepayment 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 we included ina registration statement on Form S-1 regarding our 12% Series B SeniorSubordinated Notes due 2008 (Registration No. 333-106381, filed with Securitiesand Exchange Commission on June 23, 2003 and amended on August 12, 2003).  See “—Liquidity and Capital Resources—RecentDevelopments Affecting Financial Condition and Liquidity” below for additionalinformation.

 

The sale of the Specialty Avionics Group is notexpected to affect the operations of the remaining operating groups.  As a result of the sale, the SpecialtyAvionics Group is presented as a discontinued operation in our consolidatedfinancial statements and our discussion below of our results of operationsreflects only continuing operations for all periods.

 

**Industry Overview and Trends**

 

We compete in the aircraft products and servicesmarket of the aerospace industry.  Themarket for our products and services is largely driven by demand in the threecivil aircraft markets: business, VIP and head-of-state aircraft and, to alesser extent, commercial and regional aircraft.  The September 11, 2001 terrorist attack on the UnitedStates, ongoing concerns about global terrorism, the current Middle-Easternmilitary conflicts, the Severe Acute Respiratory Syndrome (SARS) epidemic and weak globaleconomic conditions are all adversely impacting travel and, in turn, theaerospace industry and our business.  Inresponse to certain of these adverse conditions, we announced and implemented aseries of restructuring activities designed to reduce expenses and conserveworking capital.  See “—Restructuring,Asset Impairment and Other Related Charges” below for additional information.

 

The business, VIP and head-of-state aircraft portionof our business experienced weakness during 2002 and will continue toexperience weakness throughout 2003 as evidenced by various manufacturers’announced plans to temporarily suspend production at various times throughoutthe year in response to the weak demand for new aircraft.  However, we believe business, VIP andhead-of-state aircraft deliveries may reflect a modest recovery in 2004 andreflect 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 2004, withpotential recovery not expected to occur until at least 2005.  Our beliefs are based on the assumptionsthat we will experience economic recovery and there are no further negativegeo-political developments affecting our industry.

 

**Results of Operations**

 

### **Performance Measures**

### ** **

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

 

28

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

 

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

 

We define Adjusted EBITDA as earnings before interest,income taxes, depreciation and amortization, restructuring, asset impairmentand other related charges, acquisition related charges not capitalized andother noncash and nonoperating charges. We believe the presentation of this measure is relevant and useful toinvestors because it allows investors and analysts to view segment performancein a manner similar to the method we use, helps improve their ability tounderstand our core segment performance, adjusted for items we believe areunusual, and makes it easier to compare our results with other companies thathave different financing, capital structures and tax rates.  In addition, we believe these measures areconsistent with the manner in which our lenders and investors measure ouroverall performance and liquidity, including our ability to service debt andfund discretionary capital expenditure and product development programs.

 

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

 

**Bookings and Backlog.**  Bookings and backlog are 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.

 

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

 

29

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### **Three Months EndedJune 30, 2003** Compared to Three Months EndedJune 30, 2002

### ** **

Our results of operations have been affected byrestructuring, asset impairment and other related charges relating to a seriesof restructuring activities and goodwill impairment charges.  These charges, which affect thecomparability of our reported results of operations between periods, are morefully described in “—Restructuring, Asset Impairment and Other 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  | ) |   |   |

 

*CabinManagement. *Revenuesdecreased by $18.6 million, or 38.6% compared to the prior year.  The decrease, which is across all of ourproduct and services categories, is caused by the ongoing adverse impact ofweak global economic conditions which reduces the affordability of business,VIP and head-of-state aircraft and therefore demand for the products andservices we provide.  The 2003 decreaseconsists of:

 

•        a $18.0 million decrease in aircraftfurniture and related products revenues; and

 

•        a $1.2 million decrease in cabinmanagement and entertainment systems revenues;

 

•        a $0.2 million decrease in seatingproducts revenues; offset by,

 

•        a $0.8 million increase in other productand services revenues.

 

The revenue decrease was caused by lower order volumefrom our customers.  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.  We also experienced similarvolume decreases from our other customers during the period.

 

*SystemsIntegration.*  Revenuesincreased by $1.5 million, or 11.3% compared to the prior year, due to:

 

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

 

•                       a$0.6 million decrease in the commercial aircraft systems integrationengineering services provided in the aftermath of September 11th and resulting down-turn in thecommercial airline industry; the airline industry’s corresponding reductionin the size of its operating fleet and the delay or postponement of retrofitand refurbishment programs for the remaining operational fleet reduced demandfor our integration and engineering services.

 

30

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**Grossprofit. **Gross profit decreased $14.8 million to aloss of $1.3 million for the three months ended June 30, 2003 from $13.5million 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  | ) |   |   |

 

*CabinManagement.*  Grossprofit decreased by $13.8 million, or 182.5% compared to the prior year,primarily due to:

 

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

 

•                       a$0.6 million decrease in gross profit related to lower volume for our cabinmanagement and entertainment systems; and

 

•                       a$8.1 million decrease caused by restructuring charges incurred in 2003 ascompared to those recorded in 2002 related to the consolidation of our seatingand related manufacturing operations; offset by

 

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

 

*SystemsIntegration.*  Grossprofit decreased by $1.0 million, or 17.7% compared to the prior year,primarily due to:

 

•                       a$0.5 million decrease resulting from lower revenues and unfavorable overheadabsorption as a result of lower production and a change in product deliverymix; and

 

•                       a$0.5 million decrease in the commercial aircraft systems integrationengineering services provided.

 

**Selling,general and administrative expenses.**  Selling, general and administrative expensesdecreased $5.0 million, or 44.2%, to $6.3 million for the three months endedJune 30, 2003, from $11.3 million for the same period last year.  By segment, SG&A expenses changed asfollows:

 
|                 |   | **Increase (Decrease)** |   |
|----------------------|--------|-------------------------|--------|
|                 |   | **From 2002**           |   |
| **(In millions)**    |   | **Amount**              |   | **Percent** | ** ** |
|                 |   |                    |   |   |   |
| Cabin  Management    |   | $                       | (4.0   | ) | (49.5 | )% |
| Systems  Integration |   | (1.2                    | )      | (56.7 | ) |
| Corporate            |   | 0.2                     |   |   |   |
| Total                |   | $                       | (5.0   | ) |   |   |

 

*CabinManagement. *SG&Aexpenses decreased by $4.0 million, or 49.5% compared to the prior year, dueto:

 

•                       a$2.4 million reduction resulting from restructuring charges recorded in 2003 ascompared to those recorded in 2002 related to the consolidation of our seating andrelated manufacturing operations; and

 

31

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•                       a$1.6 million decrease in expenses resulting from cost reduction measuresimplemented in response to lower sales volume resulting from the weak globaleconomic conditions.

 

*SystemsIntegration. *SG&Aexpenses decreased by $1.2 million, or 56.7% compared to the prior year, due tolower labor and employee benefit costs resulting from workforce reductions in2003.

 

**Impairment of goodwill. **During the three months ended June 30, 2003, a$34.0 million charge was recorded to reflect the additional impairment ofgoodwill in connection with the impairment testing provision of SFAS No. 142,“Goodwill and Other Intangible Assets.” The additional impairment results from continued 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 impairment charge pertains to ourfurniture manufacturing reporting unit within our Cabin Management Group.  See “—Goodwill Impairment Charges” below foradditional information.

 

**Depreciationand amortization of intangibles.**  Depreciation and amortization expense decreased $0.2 million to$2.5 million for the three months ended June 30, 2003 from $2.7 millionfor the same period last year, primarily resulting from reduced capitalexpenditures and a lower depreciable base resulting from impairment chargesrecorded 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   | ) |   |   |

 

**AdjustedEBITDA.  **As described above in “—PerformanceMeasures–Adjusted EBITDA,” we use this financial measure to evaluate the coreeconomic performance of our operating segments.  The notes to our financial statements include additionalinformation about 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), a GAAP financial measure, to clarify the differences betweenthese two measures.

 

*CabinManagement. *Adjusted EBITDA decreased by $4.7 million, or 52.3%compared to the prior year primarily due to:

 

•                       a$5.3 million decrease in gross profit related to our business/VIP aircraftfurniture and seating operations; and

 

•                       a$0.6 million decrease in gross profit related our cabin management andentertainment systems; offset by,

 

•                       a$1.2 million increase in gross profit related to our other products andservices.

 

*SystemsIntegration. *AdjustedEBITDA increased by $0.1 million, or 2.1% over the prior year, due to reducedSG&A spending resulting from workforce reductions.

 

32

----

 

**Operatingincome.**  Operatingincome decreased $43.7 million to a loss of $42.5 million for the three monthsended June 30, 2003, from income of $1.3 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            |   | (0.1                    | )      |   |   |
| Total                |   | $                       | (43.7  | ) |   |   |

 

*CabinManagement. *Operatingincome decreased by $43.8 million, or 4380.0% compared to the prior year, dueto:

 

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

 

•        a $34.0 million increase in goodwillimpairment charges; and

 

•        a $5.7 million increase in restructuringcharges recorded in 2003 as compared to those recorded in 2002 related to theconsolidation of our seating and related manufacturing operations.

 

*SystemsIntegration.*Operating income increased by $0.2 million, or4.7% compared to the prior year, due to reduced SG&A spending resultingfrom workforce reductions in 2003.

 

**Interestexpense.**  Interestexpense decreased $0.4 million, or 4.8%, to $7.6 million for the three monthsended June 30, 2003 compared to $8.0 million for the same period lastyear.  The decrease is attributable tolower outstanding debt balances for a portion of the quarter in the currentyear.

 

**Provisionfor income taxes.**  Theprovision for income taxes, based on the reported consolidated pre-tax loss,differs from the amount determined by applying the applicable U.S. statutoryfederal rate to the pre-tax loss primarily due to the effects of state andforeign income taxes and the non-deductible portion of goodwill impairmentcharges.

 

During the three months ended June 30, 2003, weestablished a $13.1 million valuation allowance for the net deferred tax assetswhich may not be realized in the future. We evaluated our deferred assets for expected recoverability based onthe nature of the item, the associated taxing jurisdictions, the applicableexpiration dates and future taxable income forecasts that would impactutilization.  Based on 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.  We will reduce the valuationallowance in the future for each item at such time when we determine thatrecoverability is more likely than not.

 

**Loss from continuing operations.**  The loss from continuing operations increased$36.4 million to a loss of $40.8 million for the three months endedJune 30, 2003 compared to a loss of $4.4 million for the same period lastyear, primarily due to:

 

•                  a $43.7 million decrease in operatingincome, resulting, in part, from a $34.0 million goodwill impairment charge;offset by

 

•                  a $7.2 million increase in theprovision for income tax benefit.

 

**Income from discontinued operations.**  Income from discontinued operationsdecreased $1.1 million to $1.3 million for the three months ended June 30,2003 compared to $2.4 million for the same

 

33

----

 

period last year primarily the result of the disposition of theSpecialty Avionics Group on May 22, 2003 as compared to a full quarter ofresults included in the prior year.

 

**Netloss.**  Net lossincreased $37.6 million to a net loss of $39.5 million for the three monthsended June 30, 2003 compared to a net loss of $1.9 million for the sameperiod last year.  The increase isattributable to an increase in the loss from continuing operations of $36.4million and a decrease in the income from discontinued operations of $1.1million.

 

**Net lossapplicable to common stockholder.**  Net loss applicable to DeCrane Holdings, our common stockholder,increased $37.8 million to a net loss of $41.2 million for the three monthsended June 30, 2003 compared to a net loss of $3.4 million for the sameperiod last year.  The increase in thenet loss applicable to our common stockholder is attributable to:

 

•                       a$37.6 million increase in our net loss; and

 

•                       a$0.2 million increase in accrued 16% mandatorily redeemable preferred stockdividends resulting from the quarterly compounding of accrueddividends.

 

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

 

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

 

As described in “—Industry Overview and Trends,” theacts and ongoing threats of global terrorism, the current military conflicts,SARS epidemic and weak global economic conditions are having an adverse impacton our business, resulting in the decrease in bookings during 2003 and relatedbacklog at the end of the period.  Inaddition, we believe that some of our customers have substantially reducedtheir order lead times which may have adversely affected bookings during theperiod.

 

We are not able to predict the continuing impact theseevents will have on bookings and backlog in future periods.  However, given the magnitude of theseevents, the adverse impact could be material.

 

### **Six Months EndedJune 30, 2003** Compared to Six Months EndedJune 30, 2002

### ** **

**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  | ) |   |   |

 

*CabinManagement. *Revenuesdecreased by $33.8 million, or 36.0% compared to the prior year.  The decrease, which is across all of ourproduct and services categories, is caused by the ongoing adverse impact ofweak global economic conditions which reduces the affordability of business,VIP and head-of-state aircraft and therefore demand for the products andservices we provide.  The 2003 decreaseconsists of:

 

•        a $29.5 million decrease in aircraftfurniture and related products revenues;

 

34

----

 

•        a $2.8 million decrease in cabinmanagement and entertainment systems revenues;

 

•        a $1.8 million decrease in seatingproducts revenues; offset by,

 

•        a $0.3 million increase in other productand services revenues.

 

The revenuedecrease was caused by lower order volume from our customers.  Revenues from Textron and Bombardier, ourprincipal customers, decreased $24.4 million compared to the prior year as aresult of the decrease in orders and resulting lower production of aircraftthey are experiencing due to the economic downturn.  We also experienced similar volume decreases from our othercustomers during the period.

 

*SystemsIntegration*.  Revenuesdecreased by $1.5 million, or 5.1% compared to the prior year, due to:

 

•                       a$1.3 million decrease in the commercial aircraft systems integrationengineering services provided in the aftermath of September 11thand resulting down-turn in the commercial airline industry; the airlineindustry’s corresponding reduction in the size of its operating fleet and thedelay or postponement of retrofit and refurbishment programs for the remainingoperational fleet reduced demand for our integration and engineering services;and

 

•                       a$2.3 million decrease resulting from reduced production and delivery ofbusiness, VIP and head-of-state aircraft products and services due to theadverse impact weak global economic conditions are having on the demand forthose types of aircraft; offset by

 

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

 

**Grossprofit.**  Gross profitdecreased $20.2 million, or 67.5%, to $9.7 million for the six months endedJune 30, 2003 from $29.9 million 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  | ) |   |   |

 

*CabinManagement.*  Grossprofit decreased by $16.3 million, or 93.1% compared to the prior year,primarily due to:

 

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

 

•                       a$1.0 million decrease in gross profit related to lower volume for our cabinmanagement and entertainment systems; and

 

•                       a$6.9 million increase caused by restructuring charges incurred in 2003 ascompared to those recorded in 2002 related to the consolidation of our seatingand related manufacturing operations; offset by

 

•                       a$1.4 million increase in other products and services.  $0.2 million of the increase is the result of an increase inrevenues and the remaining increase of $1.2 million is due to a $2.1 milliondecrease in materials costs, offset by a $0.9 million increase in direct laborand overhead costs.

 

35

----

 

*SystemsIntegration.*  Grossprofit decreased by $3.9 million, or 32.3% compared to the prior year,primarily due to:

 

•                       a$3.0 million decrease resulting from lower revenues and unfavorable overheadabsorption as a result of lower production and a change in product deliverymix; and

 

•                       a$0.9 million decrease in the commercial aircraft systems integrationengineering services provided.

 

**Selling,general and administrative expenses.**  Selling, general and administrative expensesdecreased $9.3 million, or 40.7%, to $13.5 million for the six months endedJune 30, 2003, from $22.7 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            |   | 0.2                     |   |   |   |
| Total                |   | $                       | (9.3   | ) |   |   |

 

*CabinManagement. *SG&Aexpenses decreased by $7.5 million, or 47.5% compared to the prior year, dueto:

 

•                       a$5.3 million reduction caused by restructuring charges incurred in 2003 ascompared to those recorded in 2002 related to the consolidationof our seating and related manufacturing operations; and

 

•                       a$2.2 million decrease in expenses resulting from cost reduction measuresimplemented in response to lower sales volume resulting fromthe weak global economic conditions.

 

*SystemsIntegration. *SG&Aexpenses decreased by $2.0 million, or 47.2% compared to the prior year, due tolower labor and employee benefit costs resulting from workforce reductions in2003.

 

**Impairment of goodwill. **During the six months ended June 30, 2003, a$34.0 million charge was recorded to reflect the additional impairment ofgoodwill in connection with the impairment testing provision of SFAS No. 142,“Goodwill and Other Intangible Assets.” The additional impairment results from continued 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 impairment charge pertains to ourfurniture manufacturing reporting unit within our Cabin Management Group.  See “—Goodwill Impairment Charges” below foradditional information.

 

**Depreciationand amortization of intangibles.**  Depreciation and amortization expense decreased $0.5 million to$5.0 million for the six months ended June 30, 2003 from $5.5 million forthe same period last year, primarily resulting from reduced capitalexpenditures and a lower depreciable base resulting from impairment chargesrecorded 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   | ) |   |   |

 

36

----

 

**AdjustedEBITDA. **As described above in “—PerformanceMeasures–Adjusted EBITDA,” we use this financial measure to evaluate the coreeconomic performance of our operating segments.  The notes to our financial statements include additionalinformation about 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), a GAAP financial measure, to clarify the differences betweenthese two measures.

 

*CabinManagement.  *Adjusted EBITDA decreased by $7.6 million,or 46.3% compared to the prior year primarily due to:

 

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

 

•                       a$1.0 million decrease in gross profit related our cabin management andentertainment systems; offset by,

 

•                       a$1.4 million increase in gross profit related to our other productsand services.

 

*SystemsIntegration. *AdjustedEBITDA decreased by $2.1 million, or 24.5% over the prior year, due to lowersales volume partially offset by reduced SG&A spending resulting fromworkforce reductions.

 

**Operatingincome.**  Operatingincome decreased $45.1 million to a loss of $39.6 million for the six monthsended June 30, 2003, from $5.5 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 | ) |
| Total                |   | $                       | (45.1  | ) |   |   |

 

*CabinManagement. *Operatingincome decreased by $43.2 million, or 792.5% compared to the prior year, dueto:

 

•                       a$1.6 million increase in restructuring charges incurred in 2003 as compared tothose recorded in 2002 related to the consolidation of our seating and relatedmanufacturing operations; and

 

•                       a$34.0 million increase in goodwill impairment charges; and

 

•                       a$9.8 million decrease in gross profit, primarily due to lower revenues relatedto our furniture and seating operations; offset by

 

•                       a$2.2 million decrease in expenses resulting from cost reduction measuresimplemented in response to lower sales volume resulting from the weak globaleconomic conditions;

 

*SystemsIntegration.*Operating income decreased by $1.9 million, or27.8% compared to the prior year, due primarily to lower revenues, offset byreduced SG&A spending.

 

**Interestexpense.**  Interestexpense decreased $0.5 million, or 2.9%, to $15.3 million for the six monthsended June 30, 2003 compared to $15.8 million for the same period lastyear.  We expect interest expense todecrease in 2003 as a resulting of lower debt outstanding, partially offset byhigher interest rates charged by our lenders as a result of the amendment toour senior credit facility.

 

37

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**Provisionfor income taxes.**  Theprovision for income taxes, based on the reported consolidated pre-tax loss,differs from the amount determined by applying the applicable U.S. statutoryfederal rate to the pre-tax loss primarily due to the effects of state andforeign income taxes and the non-deductible portion of goodwill impairmentcharges.

 

During the six months ended June 30, 2003, weestablished a $13.1 million valuation allowance for the net deferred tax assetswhich may not be realized in the future. We evaluated our deferred assets for expected recoverability based onthe nature of the item, the associated taxing jurisdictions, the applicableexpiration dates and future taxable income forecasts that would impactutilization.  Based on 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 realizable value. We will reduce the valuation allowancein the future for each item at such time when we determine that recoverabilityis more likely than not.

 

**Loss from continuing operations.**  The loss from continuing operationsincreased $37.7 million to $44.2 million for the six months ended June 30,2003 compared to a loss of $6.5 million for the same period last year,primarily due to:

 

•                       a$45.1 million decrease in operating income resulting, in part, from a $34.0million goodwill impairment charge; offset by

 

•                       a$7.4 million increase in the provision for income tax benefit

 

**Loss from discontinued operations.**  Loss from discontinued operations decreased$29.9 million, to a loss of $4.5 million for the six months ended June 30,2003 compared to a loss of $34.4 million for the same period last year.  The decrease is primarily due to:

 

•                       a$39.4 million charge in 2002 to reflect the cumulative effect on discontinuedoperations of the change in accounting principle associated with initialadoption of SFAS No. 142, “Goodwill and Other Intangible Assets” as describedbelow; offset by

 

•                       a$7.5 million charge in 2003 to the impairment of goodwill to reduce thecarrying value of assets sold to their estimated net realizable value; and

 

•                       theresult of the disposition of the Specialty Avionics Group on May 22, 2003as compared to a full six months of results included in the prior year.

 

**Cumulative effect of change 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, the totalcharge to reflect the cumulative effect of the change in accounting principlewas $57.2 million.

 

**Netloss.**  Net lossdecreased $10.0 million to a net loss of $48.7 million for the six months endedJune 30, 2003 compared to a net loss of $58.7 million for the same periodlast year.  The decrease is attributableto:

 

•                       anincrease in loss from continuing operations of $37.7 million; offset by

 

•                       adecrease in loss from discontinued operations of $29.9 million; and

 

•                       adecrease in cumulative effect of change in accounting principle of $17.8million.

 

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**Net lossapplicable to common stockholder.**  Net loss applicable to DeCrane Holdings, our common stockholder,decreased $9.6 million to a net loss of $51.9 million for the six months endedJune 30, 2003 compared to a net loss of $61.5 million for the same periodlast year.  The decrease in the net lossapplicable to our common stockholder is attributable to:

 

•                  a $10.0 million decrease in our netloss; offset by

 

•                  a $0.4 million increase in accrued16% mandatorily redeemable preferred stock dividends resulting from thequarterly compounding of accrued dividends.

 

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

 

**Restructuring, Asset Impairment and Other RelatedCharges**

 

The following discussion should be read in conjunctionwith Note 3 accompanying our financial statements included in this report.

 

During the three months and six months endedJune 30, 2003, we recorded restructuring, asset impairment and otherrelated pre-tax charges related to a series of restructuring activities.  These charges, and the effect these chargeshad on our reported results of 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 |   |

 

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** **

**SeatingProduct Line and Furniture Manufacturing Facilities Restructuring**

 

During the second quarter of fiscal 2003, weconsolidated our seating product line offerings and adopted a restructuringplan to down-size a furniture manufacturing facility in response to continuingweakness in the business, VIP and head-of-state aircraft market.  These actions were designed to reduceengineering, production and inventory carrying costs by supporting fewerproduct offerings and achieve profitability at the furniture manufacturingfacility based on its lower production levels. In connection with these actions, we recorded pre-tax charges tooperations totaling $13,394,000 during the second quarter of fiscal 2003.  The charges are comprised of the following:

 

•                  *Seating Product LineConsolidation. *Thecurtailment**of several seatingproduct offerings and conversion of seat products which incorporate a newsingle-design technology resulted in the write-off of $6.3 million ofinventoried costs related to the discontinued product offerings.

 

•                  *Excess and ObsoleteInventory Write-Downs. *Inventory waswritten down by $3.1 million to reflect its net realizable value for quantitieson hand exceeding current and forecast order backlog requirements and obsoleteinventory related to the curtailed seating product offerings.

 

•                  *Lease Termination andRelated Charges. *Leasetermination costs related to future estimated rental payments under existinglong-term lease agreements for the facilities permanently vacated in connectionwith down-sizing a furniture manufacturing facility.  Future payments have been reduced by the expected subleaseincome.  The net future payments arebased on estimated current market rates and anticipated dates that thesefacilities will be subleased.  Ifmarket-rates decrease or should it take longer than expected to sublease thesefacilities, the actual loss could exceed these estimates.  Other related charges include the write-offof leasehold improvements related to the vacated facilities.

 

•                  *Severance and OtherCompensation Costs. *We havereduced our total workforce at the down-sized facility by 49 employees, or 37%,between December 31, 2002 and June 30, 2003.

 

During 2003, we paid $0.2 million of costs related tothis restructuring in cash and a $3.3 million restructuring reserve remained asof June 30, 2003 solely for the remaining lease termination and otherrelated costs.  Future cash paymentswill be funded from existing cash balances and internally generated cash fromoperations.

 

**AssetRealignment Restructuring**

 

During the second quarter of fiscal 2001, we adopted arestructuring plan to realign aircraft furniture production programs among ourmanufacturing facilities.  In addition,and in response to the adverse impact on the aerospace industry resulting fromthe September 11th terrorist attack and its aftermath, as wellas the weakening of global economic conditions, we announced and implemented afurther restructuring plan in December 2001 designed to reduce costs andconserve working capital.  This planincluded permanently closing one manufacturing facility and idling a secondfacility for an indefinite period, curtailing several product developmentprograms and instituting workforce reductions.

 

Due to the ongoing weakness of the business, VIP andhead-of-state aircraft market, we decided during the second quarter of fiscal2002 to permanently close the temporarily idled manufacturing

 

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facility.  In connection withthis decision, we recorded additional pre-tax charges to operations totaling$6.9 million during the year ended December 31, 2002, of which $3.8million were noncash charges, for additional impairment of long-lived assets,current asset write-downs and other related expenses.

 

This restructuring plan was completed during thefourth quarter of fiscal 2002.

 

**SeatManufacturing Facilities Restructuring**

 

During the first quarter of fiscal 2002, we announcedwe would consolidate the production of four seating and related manufacturingfacilities into two, resulting in the permanent closure of two facilities.  This plan was designed to improvemanufacturing efficiencies and to further reduce costs and conserve workingcapital.  In connection with thisrestructuring plan, we recorded pre-tax charges to operations totaling $6.3million during the year ended December 31, 2002, of which $3.6 millionwere noncash charges, for restructuring, asset impairment and other relatedrestructuring charges.

 

The restructuring, asset impairment and other relatedexpenses are comprised of charges for current asset write-downs, the impairmentof long-lived assets, severance and lease termination costs and otherrestructuring-related expenses pertaining to FAA retesting and recertification,moving, transportation and travel costs and shutdown and startup costs.

 

This restructuring plan was completed during thesecond quarter of fiscal 2002.

 

**GoodwillImpairment Charges**

 

As a result of the continuing weakness in thebusiness, VIP and head-of-state aircraft market and the decision to down-size afurniture manufacturing facility, the goodwill associated with the furnituremanufacturing reporting unit was tested for recoverability and found to beimpaired.  As a result, $34,000,000 ofgoodwill associated with the reporting unit was written off and charged tooperations.

 

During the first quarter of fiscal 2003, we enteredinto a definitive agreement to sell our Specialty Avionics Group.  Based upon the fair value of the groupimplied in the definitive agreement, we determined that the carrying value ofone of the reporting unit’s net assets was not fully recoverable.  As a result, we recorded a goodwillimpairment charge of $7.5 million during the three months endedMarch 31, 2003 to reduce the carrying value to the estimated netrealizable value established by the definitive agreement.

 

See “—Goodwill Impairment Charges” below foradditional information.

 

## **GoodwillImpairment Charges**

## ** **

The following discussion should be read in conjunctionwith the Notes 3 and 5 accompanying our financial statements.

 

Our results of operations for the three months and sixmonths ended June 30, 2003 and 2002 have been affected by the adoption ofSFAS No. 142, “Goodwill and Other Intangible Assets,” and goodwill impairmentcharges.

 

Effective January 1, 2002, we adopted SFAS No.142, “Goodwill and Other Intangible Assets” and the provisions of SFAS No. 141,“Business Combinations,” which were required to be adopted concurrent with theadoption of SFAS No. 142.  Adoption ofthese accounting pronouncements resulted in the following:

 

•                  *Reclassification of Intangible Assets.*  Intangible assets relating to acquiredassembled workforce intangibles not meeting the criteria for recognition apartfrom goodwill were reclassified to goodwill, net of deferred income taxes.

 

•                  *Discontinuance of Goodwill Amortization.*  Goodwill is deemed to be an indefinite-livedasset.  As a result, and in accordancewith SFAS No. 142, the recording of periodic goodwill amortization charges wasdiscontinued effective January 1, 2002.

 

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•                  *Annual Testing for Goodwill Impairment.*  In lieu of periodic goodwill amortizationcharges, SFAS No. 142 requires goodwill to be tested annual for impairment, orwhen events or changes in circumstances indicate the carrying value may not berecoverable.

 

During 2002, we completed the transitional impairmenttesting of goodwill recorded as of January 1, 2002 as required under SFASNo. 142.  Fair value of each reportingunit was determined using a discounted cash flow approach taking intoconsideration projections based on the individual characteristics of thereporting units, historical trends, market multiples for comparable businessesand independent appraisals.  Our CabinManagement Group consists of three reporting units, our Systems IntegrationGroup consists of two and the Specialty Avionics consists of three.  Unallocated goodwill was allocated to thereporting units for impairment testing purposes.  The results indicated that the carrying value of goodwill wasimpaired at one of the reporting units within each of our operatinggroups.  The resulting impairment wasprimarily attributable to a change in the evaluation criteria for goodwillutilized under previous accounting guidance to the fair value approachstipulated in SFAS No. 142.  Inaccordance with the transitional provision of SFAS No. 142, we recorded a $17.8million noncash write-down of goodwill (net of $0.9 million income tax benefit)as of January 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.

 

Changes in the carryingamount of goodwill, by business segment, for the six months ended June 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 the first quarter of fiscal 2003, we enteredinto a definitive agreement to sell our Specialty Avionics Group.  Based upon the fair value of the groupimplied in the definitive agreement, we determined that the carrying value ofthe group’s net assets was not fully recoverable.  As a result, we recorded a goodwill impairment charge of$7,500,000 during the three months ended March 31, 2003 to reduce thecarrying value to the estimated net realizable value established by thedefinitive agreement.  We recorded amodest gain on the sale during the second quarter of fiscal 2003, based on thefinancial position of the group on the date of sale.  The ultimate gain or loss on the sale is subject to finalizingthe post-closing adjustment, which is not expected to be material, if any.

 

As required by SFAS No. 142, we test goodwill forimpairment annually, on October 31st of each year, or whenevents or changes in circumstances indicate the carrying amount may not berecoverable.  The goodwill impairmentmodel is a two-step process.  First, it requiresa comparison 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 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.

 

As a result of the continuing weakness in thebusiness, VIP and head-of-state aircraft market and our decision to down-size afurniture manufacturing facility in the second quarter of fiscal 2003, wedetermined that we should reevaluate the carrying value of our goodwill priorto the annual October 31st testing date.  Accordingly, we performed a step-one test ofgoodwill associated with our furniture manufacturing reporting unit forrecoverability and found the goodwill to be impaired.  As a result, we recorded a pre-tax charge to

 

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operations of $34,000,000 during the three months ended June 30,2003 based 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.

 

**Liquidity and Capital Resources**

 

Our principal cash needs are for debt service, workingcapital, capital expenditures and possible strategic acquisitions, as well asto provide DeCrane Holdings with cash to finance its needs, which consistsprimarily of cash dividends on its preferred stock beginning in 2005.  Our principal sources of liquidity areexpected to be cash flow from operations, potential capital market transactionsand third party borrowings, principally under our senior credit facility.

 

**Cash Flows during the Six Months Ended June 30, 2003**

 

Net cash used by operating activities was $21.1million for the six months ended June 30, 2003 and consisted of $5.3million of cash used by operations after adding back depreciation,amortization, the noncash portion of our restructuring and asset impairmentcharges and other noncash items and $21.0 million used for working capital,offset by a $5.1 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 million decreasein accounts receivables.

 

We expect working capital increases, if any, tomoderate during the remainder of 2003.

 

Net cash provided by investing activities was $130.2million for the six months ended June 30, 2003 and consisted of:

 

•                          $132.8 million of net proceeds from thesale 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 anticipate spending approximately $4.0 to $4.5million for capital expenditures in 2003. As of June 30, 2003, there are no remaining acquisition contingentconsideration payment obligations.

 

Net cash used by financing activities was $121.2million for the six months ended June 30, 2003.  Cash of $9.3 million was provided byrevolving line of credit borrowings under our senior credit facility.  Cash of $130.5 million was used forprincipal payments on our senior term debt, capitalized lease obligations andother debt.

 

**Capital Resources and Debt Obligations at June 30, 2003**

 

At June 30, 2003, we had $50.2 million of workingcapital, compared to $55.4 million as of December 31, 2002, excludingassets and liabilities of the discontinued operations we sold in 2003.  At June 30, 2003, we also had $24.4 millionof borrowings available under

 

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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 maynot be able to replace it on commercially acceptable terms, or at all.  At 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 atJune 30, 2003 and December 31, 2002 and other indebtedness totaling$9.7 million outstanding at June 30, 2003 compared to $10.8 million as ofDecember 31, 2002.

 

The senior credit facility and senior subordinatednotes indenture impose restrictive and financial covenants on us.  In the first quarter of fiscal 2003, termsand financial covenants contained in our senior credit facility were amendedto, among other things, permit the sale of the Specialty Avionics Group whichwas consummated on May 23, 2003. As required by the amendment, we repaid $130.0 million of senior creditfacility borrowings with the proceeds from the sale.  See “—Recent Developments Affecting Financial Condition andLiquidity” below for additional information.

 

**Recent Developments Affecting Financial Condition andLiquidity**

 

As more fully described in “—Industry Overview andTrends,” the acts and ongoing threats of global terrorism, the current militaryconflicts, SARS epidemic and weak global economic conditions are all adverselyimpacting our business.  In response, wehave implemented a series of restructuring activities as described in “—Restructuring,Asset Impairment and Other Related Charges,” designed to reduce costs andconserve working capital.

 

During the fourth quarter of fiscal 2002, we furtherassessed our long-term business strategies in light of current aerospaceindustry conditions.  In addition, wesubsequently determined that we would likely not be in compliance with oursenior credit facility’s financial covenants in 2003.  We believe that when the aerospace industry recovers, the demandfor our Cabin Management and Systems Integration groups’ products and servicesfor business, VIP and head-of-state aircraft will return to historical levelsand, accordingly, we decided to focus our resources in these marketsegments.  To accomplish this objective,we embarked on a plan to sell the Specialty Avionics Group, which is highlydependent on the commercial airline industry.

 

We consummated the sale of our Specialty AvionicsGroup on May 23, 2003 and, as required by the senior credit facilityamendment, used $130.0 million of the proceeds from the sale to repay seniorcredit facility borrowings.  The seniorcredit facility amendment also relaxes various financial covenants for 2003 andbeyond, decreases by $10.0 million the maximum permitted revolving line ofcredit borrowings to $40.0 million, increases the prime rate and LIBOR interestmargins by 1.5% and permits the issuance of specified types of additionalindebtedness and the repurchase of up to $20.0 million aggregate principalamount of our 12% senior subordinated notes with the proceeds from the sale ofjunior securities.  Junior securitiesmeans: (i) senior subordinated notes issued by us that are unsecured and do notprovide for any scheduled redemptions or prepayments or any sinking fund installmentpayments or maturities prior to the termination of the senior credit facility,or other indebtedness subordinated in right of payment to our obligations underthe senior credit facility, and whose material terms are satisfactory to thelenders; and (ii) equity securities issued by us.

 

We believe our expected operating cash flows, togetherwith borrowings under our senior credit facility ($24.4 million of which wasavailable as of June 30, 2003 the commitment for which expires inSeptember 2004), will be sufficient to meet our future short- andlong-term operating expenses, working capital requirements, capitalexpenditures and debt service obligations for the next twelve months.  However, our ability to comply with our debtfinancial covenants, pay principal or interest and satisfy our other debtobligations will depend on our future operating performance as well ascompetitive, legislative, regulatory, business and other factors beyond ourcontrol.  Although we cannot be certain,we expect to be in compliance with the revised financial covenants through theend of the year based on our current operating plan.

 

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In addition, we are continually consideringacquisitions that complement or expand our existing businesses or that mayenable us to expand into new markets, some of which may be material.  Future acquisitions may require additionaldebt, equity financing or both.  We maynot be able to obtain any additional financing on acceptable terms.  We are not currently party to any definitiveacquisition agreements.

 

**Disclosureof Contractual Obligations an****d Commitments**

 

The following table summarizes our known obligationsto make future cash payments as of June 30, 2003, as well an estimate ofthe periods during which these payments 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      |   | $ | — |   | $ | 89.8 |   | $ | 60.5 |   | $ | — |   |
| 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 |   | 92.1 |   | 62.1 |   | 105.3 |   |
|                                                              |   |                               |       |   |   |   |   |   |   |   |   |
| Operating  lease obligations                                      |   | 14.6                               |       | 1.0 |   | 3.2 |   | 3.9 |   | 6.5 |   |
| Mandatorily  redeemable preferred stock redemption obligation (b) |   | 37.3                               |       | — |   | — |   | — |   | 37.3 |   |
| Total  obligations at June 30, 2003                          |   | $                                  | 311.8      |   | $ | 1.5 |   | $ | 95.3 |   | $ | 66.0 |   | $ | 149.1 |   |

 

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(a)                      Excludesinterest payments.  Interest on the 12%senior subordinated notes is payable semiannually.  The senior credit facility bears interest at a variable rate andtherefore the amount of future interest payments are uncertain.

 

(b)                     Dividendsaccrue quarterly at the annual rate of 16% and are payable, at our option,either in cash or by the issuance of additional shares of preferred stock.  Since the issuance of the preferred stock inJune 2000, we have elected to issue additional shares in lieu of cashdividend payments and may continue to do so until June 2005, after whichtime we are required to pay quarterly dividends in cash.  If we elect to continue issuing additionalshares until June 2005, our mandatory redemption obligation onMarch 30, 2009, the mandatory redemption date, will be $54.8 million andour annual cash dividend payment obligation will be $8.8 million, payablequarterly, commencing September 2005.

 

**Disclosureof Off-Balance Sheet Commitme****nts and Indemnities**

 

We are a wholly-owned subsidiary of DeCrane Holdings,whose capital structure also includes mandatorily redeemable preferredstock.  Since we are DeCrane Holdings’only operating subsidiary and source of cash, we may be required to fundDeCrane Holdings’ redemption obligation in the future, subject to limitationscontained in our senior credit agreement and the senior subordinated notesindenture.  The DeCrane Holdingspreferred stock has a total redemption value of $66.7 million as ofJune 30, 2003 and the preferred stock is mandatorily redeemable onSeptember 30, 2009.

 

During our normal course of business, we have enteredinto agreements containing indemnities pursuant to which we may be required tomake payments in the future.  Theseindemnities are in connection with facility leases and liabilities forspecified claims arising from investment banking services our financialadvisors provide to us.  The duration ofthese indemnities, commitments and guarantees varies, and in certain cases, isindefinite.  Substantially all of theseindemnities provide no

 

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limitation on the maximum potential future payments we could beobligated to make and is not quantifiable. We have not recorded any liability for these indemnities since no claimshave been asserted to date.

 

In connection with the sale of the Specialty AvionicsGroup, we made indemnities to the buyer with respect to a number of customary,and certain other specific, representations and warranties.  Our indemnities with respect to some ofthese matters are limited in terms of duration with the maximum of potentialfuture payments capped at $14.0 million and our indemnities with respect tospecified environmental matters will expire not later than October 2010and provides for a maximum liability of $5.0 million, while others will have nolimitations.  In addition, the $140.0million selling price is subject to a potential post-closing adjustment relatedto the amount of working capital at closing.

 

As of June 30, 2003, we also had an irrevocablestandby letter of credit in the amount of $0.4 million issued and outstandingunder our senior credit facility.

 

**Recent Accounting Pronouncements**

 

**Accounting Pronouncements Adopted January 1, 2003**

 

As more fully described in Note 1 accompanying ourfinancial statements included in this report, we adopted the provisions of thefollowing accounting pronouncements effective 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.”

 

**RecentlyIssued Accounting Pronouncement**

 

*SFASNo. 150 – Accounting for Certain Financial Instruments with Characteristics ofboth Liabilities and Equity*

 

Issued in May 2003, SFAS No. 150 establishesstandards for the classification and measurement of certain financialinstruments with characteristics of both liabilities and equity.  SFAS No. 150 requires classification offinancial instruments within its scope as a liability, including financialinstruments issued in the form of shares that are mandatorily redeemable,because those financial instruments are deemed to be, in essence, obligationsof the issuer.  We will be required toreclassify our mandatorily redeemable preferred stock as a liability commencingJuly 1, 2003 and reflect quarterly dividend and redemption value accretionon its 16% preferred stock as a charge against pre-tax income in futureperiods.

 

**SpecialNote Regarding Forward-Looking Statements and Risk Factors**

 

All statements other than statements of historicalfacts included in this report are considered forward-looking statements withinthe meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements are subjectto known and unknown risks, uncertainties and other factors, which aredifficult to predict.  We are vulnerableto a variety of factors that affect many businesses, such as:

 

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

 

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•                  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 businessfrom any one of them would have on our business;

 

•                  changes inprevailing interest rates and the availability of financingto fund our plans for continued growth;

 

•                  competition fromlarger companies;

 

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

 

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

 

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

 

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

 

•                  the ability toattract and retain qualified personnel;

 

•                  labordisturbances; and

 

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

 

Some of the more significant factors listed above arefurther described in our Annual Report on Form 10-K and should be read inconjunction with this report.  Changesin such factors could cause our actual results to differ materially from thosecontemplated in such 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.

 

**ITEM 3.****                                         QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

We are exposed to various market risks, includinginterest rates and changes in foreign currency exchange rates.  Market risk is the potential loss arisingfrom adverse changes in prevailing market rates and prices.  From time to time, we use derivativefinancial instruments to manage and reduce risks associated with these factors.  We do not enter into derivatives or otherfinancial 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 risk related to our variable-rate debt isestimated as the potential decrease in pre-tax earnings resulting from anincrease in interest rates.  Theinterest rates applicable to variable-rate debt are, at our option, based ondefined margins over the current prime rate or LIBOR.  At June 30, 2003, the current prime rate was 4.00% and thecurrent LIBOR was 1.12%.  Based on$150.2 million of variable-rate debt outstanding as of June 30, 2003, ahypothetical one percent rise in interest rates, to 5.00% for prime rateborrowings and 2.12% for LIBOR borrowings, would reduce our pre-tax earnings by$1.5 million annually.

 

To limit a portion of our exposure related to risinginterest rates, we have entered into an interest rate swap contract toeffectively convert $4.5 million of variable-rate industrial revenue bonds to4.2% fixed-rate debt until maturity in 2008. The contract is considered to be a hedge against changes in the amountof future cash flows associated with interest payments on this portion of ourvariable-rate debt.

 

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Market risk related to this interest rate swap contract is estimated asthe potential higher interest expense we will incur if the variable interestrate decreases below the 4.2% fixed rate. Based on the $4.5 million of variable-rate debt converted to fixed-ratedebt outstanding as of June 30, 2003, a hypothetical one percent decreasein the variable interest rate to 3.2%, would reduce our pre-tax earnings byless than $0.1 million annually.

 

The estimated fair value of our $100.0 millionfixed-rate long-term debt increased $7.0 million, or 17.5%, to approximately$47.0 million at June 30, 2003 from $40.0 million at December 31,2002.  Although we cannot be certain, webelieve the increase may have been a result of the sale of our SpecialtyAvionics Group.  Market risk related toour fixed-rate debt is deemed to be the potential increase in fair valueresulting from a decrease in interest rates. For example, a hypothetical ten percent decrease in the interest rates,from 12.0% to 10.8%, would increase the fair value of our fixed-rate debt byapproximately $7.0 million.

 

**Foreign Currency Exchange Rate Risk.**  Our foreign customers are located in variousparts of the world, primarily Western Europe, the Far East and Canada, and wehave subsidiaries with manufacturing facilities in Mexico.  To limit our foreign currency exchange raterisk related to sales to our customers, orders are primarily valued and sold inU.S. dollars.

 

**ITEM 4.****                                         CONTROLS AND PROCEDURES**

 

The management of DeCrane Aircraft Holdings, Inc. (the“Company”), under the supervision and with the participation of the Company’sChief Executive Officer and Chief Financial Officer, conducted an evaluation ofthe Company’s “disclosure controls and procedures” (as defined in Exchange ActRules 13a-15(e) or l5d-15(e)) as of the end of the period covered by thisreport.  Based on that evaluation, theChief Executive Officer and Chief Financial Officer concluded that theCompany’s disclosure controls and procedures were effective as of the end ofthe period covered by this report.

 

There was no change in the Company’s internal controlover financial reporting identified in connection with the evaluation requiredby paragraph (d) of Exchange Act Rules 13a-15 or l5d-I5 that occurred duringthe Company’s last fiscal quarter that has materially affected, or isreasonably likely to materially affect, the Company’s internal control overfinancial reporting.

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**PART II – OTHER INFORMATION**

 

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

 

As part of its investigation of the crash of SwissairFlight 111 off the Canadian coast on September 2, 1998, the CanadianTransportation Safety Board (the “CTSB”) initially notified us that itrecovered burned wire that was attached to the in-flight entertainment systeminstalled on some of Swissair’s aircraft by one of our subsidiaries.  Our subsidiary has worked vigorously overthe last five years with the CTSB investigators in the fact-findinginvestigation of this catastrophic incident. On March 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.

 

We were a defendant in most, but not all, of theactions brought by the estates of the 229 victims of the crash.  The actions, which sought damages and costsin unstated amounts, claimed negligence, strict liability, and breach ofwarranty.  Virtually all of the caseshave been settled by Boeing and Swissair’s insurers and both assignment of theclaims against, and releases in favor, of us have been obtained by the Boeingand Swissair insurers.

 

Boeing and Swissair have made a claim (but have notcommenced litigation) against us to contribute to the amounts paid to settlethe cases.  As there is no litigationpending, no discovery has been taken by either side as to liability for thecrash.  We believe that our subsidiaryis not responsible for the crash and, in any event, we maintain insurance forsuch matters.  We further believe thatany loss we may sustain upon the ultimate resolution of this matter, if any,will not exceed the amount of insurance coverage maintained.  Accordingly, no accrual for loss has beenrecorded in our financial statements.

 

We are also involved in other routine legal andadministrative proceedings incident to the normal conduct of business.  We believe the ultimate disposition of allsuch matters will not have a material adverse effect on our business, consolidatedfinancial position, results of operations or cash flows.

 

**ITEM 6.****                             EXHIBITS AND REPORTS ON FORM 8-K**

 

a.             Exhibits

 
| 31.1   |   | Chief Executive Officer  Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *                                           |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                         |
| 31.2   |   | Chief Financial Officer  Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 *                                           |
|   |   |                                                                                                                                         |
| 32     |   | Chief Executive Officer  and Chief Financial Officer Certifications Pursuant to Pursuant to Section  906 of the Sarbanes-Oxley Act of 2002 * |

 

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*              Filedherewith

 

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b.                          Reports on Form 8-K

 

On March 17, 2003, we filed a Form 8-K CurrentReport regarding DeCrane Aircraft entering into a definitive agreement to sellits Specialty Avionics Group.  The textof the press release is contained in the filing.

 

On May 23, 2003, we filed a Form 8-K CurrentReport regarding DeCrane Aircraft consummating the sale of its SpecialtyAvionics Group.

 

On June 23, 2003, we filed a Form 8-K CurrentReport regarding DeCrane Aircraft filing a Registration Statement on Form S-1for its 12% Series B Senior Subordinated Notes due 2008 in order to registermarket-making sales to be made by Credit Suisse First Boston LLC.  The registration statement contains revisedaudited financial statements for DeCrane Aircraft that reflect the sale of theSpecialty Avionics Group on May 23, 2003 and includes a revised,unqualified report of our independent accountants.  As previously disclosed, our senior credit facility required usto file such revised financial statements and independent accountants’ reportby June 23, 2003 to avoid a default thereunder.

 

**SIGNATURES**

 

 

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

 
|                 | **DECRANE  AIRCRAFT HOLDINGS, INC. (Registrant)** |
|----------------------|---------------------------------------------------|
|                 |                                              |   |
| August 14, 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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