**UNITED STATES****SECURITIES 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 EXCHANGE ACT OF 1934**

 

**For the quarterly period ended September30, 2004**

 

**Commission File 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 name, former  address and former fiscal year, if changed since last report) |

 

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

 

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

 

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The number ofshares of Registrant’s Common Stock, $.01 par value, outstanding as of November 8, 2004was 100 shares.

 

 

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**Table of Contents**

 
| **Part I – Financial Information** |                                                                                                           |
|-----------------------------------------|----------------------------------------------------------------------------------------------------------------|
|                                    |                                                                                                           |   |
| **Item  1.**                            | **Financial  Statements (Unaudited)**                                                                          |   |
|                                    |                                                                                                           |   |
|                                    | Consolidated Balance Sheets  as of September 30, 2004 and December 31, 2003                                    |   |
|                                    |                                                                                                           |   |
|                                    | Consolidated  Statements of Operations for the three months and nine months ended September  30, 2004 and 2003 |   |
|                                    |                                                                                                           |   |
|                                    | Consolidated  Statements of Stockholder’s Equity (Deficit) for the nine months ended  September 30, 2004  |   |
|                                    |                                                                                                           |   |
|                                    | Consolidated  Statements of Cash Flows for the nine months ended September 30, 2004 and  2003                  |   |
|                                    |                                                                                                           |   |
|                                    | Condensed  Notes to Consolidated Financial Statements                                                          |   |
|                                    |                                                                                                           |   |
| **Item 2.**                             | **Management’s Discussion and Analysis of  Financial Condition and Results of Operations**                | ** ** |
|                                    |                                                                                                           |   |
|                                    | Results of Operations                                                                                          |   |
|                                    |                                                                                                           |   |
|                                    | Performance Measures                                                                                           |   |
|                                    |                                                                                                           |   |
|                                    | Changes in Accounting  Principles                                                                              |   |
|                                    |                                                                                                           |   |
|                                    | Three months ended  September 30, 2004                                                                         |   |
|                                    |                                                                                                           |   |
|                                    | Nine months ended September  30, 2004                                                                          |   |
|                                    |                                                                                                           |   |
|                                    | Restructuring, Asset Impairment and Other  Related Charges                                                     |   |
|                                    |                                                                                                           |   |
|                                    | Liquidity and Capital  Resources                                                                               |   |
|                                    |                                                                                                           |   |
|                                    | Disclosure  of Contractual Obligations and Commitments                                                         |   |
|                                    |                                                                                                           |   |
|                                    | Disclosure  About Off-Balance Sheet Commitments and Indemnities                                                |   |
|                                    |                                                                                                           |   |
|                                    | Recent Accounting  Pronouncements                                                                              |   |
|                                    |                                                                                                           |   |
|                                    | Special  Note Regarding Forward Looking Statements and Risk Factors                                            |   |
|                                    |                                                                                                           |   |
| **Item 3.**                             | **Quantitative and Qualitative Disclosure About  Market Risk**                                                 |   |
|                                    |                                                                                                           |   |
| **Item 4.**                             | **Controls and Procedures**                                                                                    |   |
|                                    |                                                                                                           |   |
| **Part II – Other  Information**   |                                                                                                           |
|                                    |                                                                                                           |   |
| **Item 1.**                             | **Legal Proceedings**                                                                                          |   |
|                                    |                                                                                                           |   |
| **Item 2.**                             | **Unregistered Sales of  Equity Securities and Use of Proceeds**                                               |   |
|                                    |                                                                                                           |   |
| **Item 6.**                             | **Exhibits**                                                                                                   |   |
|                                    |                                                                                                           |   |
| **Signatures**                          |                                                                                                           |

 

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**PART I****– FINANCIALINFORMATION**

 

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

 

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

 

**Consolidated Balance Sheets**

 
| **(In  thousands, except share data)**                                                                                                       | ** ** | **September 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                   | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
|                                                                                                                                         |       |                         |       |                        |       |
| **Assets**                                                                                                                                   |       |                         |       |                        |       |
|                                                                                                                                         |       |                         |       |                        |       |
| Current assets:                                                                                                                              |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                                                   |       | $                            | 2,774      |                        | $          | 6,936 |   |
| Accounts  receivable, net                                                                                                                    |       | 21,842                       |       | 21,455                      |       |
| Inventories                                                                                                                                  |       | 55,699                       |       | 42,981                      |       |
| Prepaid expenses  and other current assets                                                                                                   |       | 1,254                        |       | 1,082                       |       |
| Total current  assets                                                                                                                        |       | 81,569                       |       | 72,454                      |       |
|                                                                                                                                         |       |                         |       |                        |       |
| Property and  equipment, net                                                                                                                 |       | 29,420                       |       | 30,900                      |       |
| Goodwill                                                                                                                                     |       | 162,430                      |       | 162,430                     |       |
| Other assets,  principally intangibles, net                                                                                                  |       | 33,172                       |       | 38,092                      |       |
| Total assets                                                                                                                                 |       | $                            | 306,591    |                        | $          | 303,876 |   |
|                                                                                                                                         |       |                         |       |                        |       |
| **Liabilities,  Mandatorily Redeemable Preferred Stock and Stockholder’s Equity (Deficit)**                                             |       |                         |       |                        |       |
|                                                                                                                                         |       |                         |       |                        |       |
| Current  liabilities:                                                                                                                        |       |                         |       |                        |       |
| Short-term  borrowings and current portion of long-term debt                                                                                 |       | $                            | 6,339      |                        | $          | 1,198 |   |
| Accounts payable                                                                                                                             |       | 17,147                       |       | 15,462                      |       |
| Accrued  liabilities                                                                                                                         |       | 18,132                       |       | 17,890                      |       |
| Income taxes  payable                                                                                                                        |       | 63                           |       | —                      |       |
| Total current  liabilities                                                                                                                   |       | 41,681                       |       | 34,550                      |       |
|                                                                                                                                         |       |                         |       |                        |       |
| Long-term debt                                                                                                                               |       | 288,890                      |       | 268,208                     |       |
| Mandatorily  redeemable preferred stock                                                                                                      |       | 47,303                       |       | —                      |       |
| Other long-term  liabilities                                                                                                                 |       | 8,346                        |       | 5,464                       |       |
|                                                                                                                                         |       |                         |       |                        |       |
| Commitments and  contingencies (Note 10)                                                                                                     |       |                         |       |                        |       |
|                                                                                                                                         |       |                         |       |                        |       |
| Mandatorily  redeemable preferred stock                                                                                                      |       | —                       |       | 40,835                      |       |
|                                                                                                                                         |       |                         |       |                        |       |
| Stockholder’s  equity (deficit):                                                                                                        |       |                         |       |                        |       |
| Common stock,  $.01 par value, 1,000 shares authorized and 100 shares issued and outstanding  as of September 30, 2004 and December 31, 2003 |       | —                       |       | —                      |       |
| Additional  paid-in capital                                                                                                                  |       | 112,991                      |       | 112,987                     |       |
| Notes receivable  for shares sold                                                                                                            |       | (1,321                       | )          | (1,268                      | )          |
| Accumulated  deficit                                                                                                                         |       | (191,163                     | )          | (156,632                    | )          |
| Accumulated  other comprehensive loss                                                                                                        |       | (136                         | )          | (268                        | )          |
| Total  stockholder’s equity (deficit)                                                                                                   |       | (79,629                      | )          | (45,181                     | )          |
| Total  liabilities, mandatorily redeemable preferred stock and stockholder’s equity  (deficit)                                          |       | $                            | 306,591    |                        | $          | 303,876 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

1

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

 

**Consolidated Statements ofOperations**

 
| ** **                                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|
| **(In  thousands)**                                                | ** ** | **2004**                              | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                         | ** ** | **(Unaudited)**                       | ** ** |
|                                                               |       |                                  |       |                                      |       |   |   |   |   |
| Revenues                                                           |       | $                                     | 50,645     |                                      | $          | 44,273 |   | $ | 154,059 |   | $ | 130,286 |   |
| Cost of sales                                                      |       | 37,645                                |       | 34,494                                    |       | 121,801 |   | 102,086 |   |
|                                                               |       |                                  |       |                                      |       |   |   |   |   |
| Gross profit                                                       |       | 13,000                                |       | 9,779                                     |       | 32,258 |   | 28,200 |   |
|                                                               |       |                                  |       |                                      |       |   |   |   |   |
| Operating  expenses:                                               |       |                                  |       |                                      |       |   |   |   |   |
| Selling, general  and administrative expenses                      |       | 7,811                                 |       | 4,787                                     |       | 22,836 |   | 21,696 |   |
| Research and  development expenses                                 |       | 1,681                                 |       | 2,211                                     |       | 5,863 |   | 7,062 |   |
| Impairment of  goodwill                                            |       | —                                |       | —                                    |       | — |   | 34,000 |   |
| Amortization of  intangible assets                                 |       | 913                                   |       | 912                                       |       | 2,738 |   | 2,738 |   |
| Total operating  expenses                                          |       | 10,405                                |       | 7,910                                     |       | 31,437 |   | 65,496 |   |
|                                                               |       |                                  |       |                                      |       |   |   |   |   |
| Income (loss)  from operations                                     |       | 2,595                                 |       | 1,869                                     |       | 821 |   | (37,296 | ) |
|                                                               |       |                                  |       |                                      |       |   |   |   |   |
| Other expenses:                                                    |       |                                  |       |                                      |       |   |   |   |   |
| Interest expense                                                   |       | 9,555                                 |       | 6,546                                     |       | 27,007 |   | 18,883 |   |
| Mandatorily  redeemable preferred stock dividends                  |       | 478                                   |       | —                                    |       | 4,011 |   | — |   |
| Loss on debt and  preferred stock restructuring                    |       | 3,898                                 |       | —                                    |       | 3,898 |   | — |   |
| Other expenses,  net                                               |       | 143                                   |       | 134                                       |       | 346 |   | 880 |   |
|                                                               |       |                                  |       |                                      |       |   |   |   |   |
| Loss from  continuing operations before provision for income taxes |       | (11,479                               | )          | (4,811                                    | )          | (34,441 | ) | (57,059 | ) |
| Provision for  income (taxes) benefit                              |       | (30                                   | )          | (143                                      | )          | (90 | ) | 10,487 |   |
|                                                               |       |                                  |       |                                      |       |   |   |   |   |
| Loss from  continuing operations                                   |       | (11,509                               | )          | (4,954                                    | )          | (34,531 | ) | (46,572 | ) |
|                                                               |       |                                  |       |                                      |       |   |   |   |   |
| Discontinued  operations and change in accounting principle:       |       |                                  |       |                                      |       |   |   |   |   |
| Loss from  discontinued operations, net of tax                     |       | —                                |       | —                                    |       | — |   | (5,650 | ) |
| Cumulative  effect of change in accounting principle               |       | —                                |       | —                                    |       | — |   | (13,764 | ) |
|                                                               |       |                                  |       |                                      |       |   |   |   |   |
| Net loss                                                           |       | (11,509                               | )          | (4,954                                    | )          | (34,531 | ) | (65,986 | ) |
|                                                               |       |                                  |       |                                      |       |   |   |   |   |
| Accrued  preferred stock dividends                                 |       | —                                |       | (1,601                                    | )          | — |   | (4,621 | ) |
| Preferred stock  redemption value accretion                        |       | —                                |       | (117                                      | )          | — |   | (351 | ) |
|                                                               |       |                                  |       |                                      |       |   |   |   |   |
| Net loss  applicable to common stockholder                         |       | $                                     | (11,509    | )                                         | $          | (6,672 | ) | $ | (34,531 | ) | $ | (70,958 | ) |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

2

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

 

**Consolidated Statement ofStockholder’s Equity (Deficit)**

 
| **(In thousands, except share  data)**          | ** ** | **Common Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Notes  Receivable  For Shares  Sold** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Loss** | ** ** | **Total**  | ** ** |
|-------------------------------------------------|------------|------------------|------------|----------------------------------|------------|-----------------------------------------|------------|--------------------------|------------|---------------------------------------------|------------|------------|------------|
| ** **                                      | ** ** | ** **       | ** ** | ** **                       | ** ** | ** **                              |
| ** **                                      | ** ** | ** **       | ** ** | ** **                       | ** ** | ** **                              |
| ** **                                      | **Shares** | ** **       | **Amount** | ** **                       | ** ** | ** **                              | ** ** | ** **               | ** ** |
| ** **                                      | ** ** | ** **       | ** ** | ** **                       | ** ** | ** **                              | ** ** | ** **               | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance,  December 31, 2003                |       | 100              |       | $                                | —     |                                    | $          | 112,987                  |       | $                                           | (1,268     | )          | $          | (156,632 | ) | $ | (268 | ) | $ | (45,181 | ) |
|                                            |       |             |       |                             |       |                                    |       |                     |       |                                        |       |       |       |   |   |
| Comprehensive  income (loss):                   |       |             |       |                             |       |                                    |       |                     |       |                                        |       |       |       |   |   |
| Net loss                                        |       | —           |       | —                           |       | —                                  |       | —                   |       | (34,531                                     | )          | —     |       | (34,531 | ) |
| Unrealized gain  on interest rate swap contract |       | —           |       | —                           |       | —                                  |       | —                   |       | —                                      |       | 132        |       | 132 |   |
|                                            |       |             |       |                             |       |                                    |       |                     |       |                                        |       |       |       | (34,399 | ) |
|                                            |       |             |       |                             |       |                                    |       |                     |       |                                        |       |       |       |   |   |
| Capital  contribution                           |       | —           |       | —                           |       | 4                                       |       | —                   |       | —                                      |       | —     |       | 4 |   |
|                                            |       |             |       |                             |       |                                    |       |                     |       |                                        |       |       |       |   |   |
| Notes receivable  interest accrued              |       | —           |       | —                           |       | —                                  |       | (53                      | )          | —                                      |       | —     |       | (53 | ) |
|                                            |       |             |       |                             |       |                                    |       |                     |       |                                        |       |       |       |   |   |
| Balance,  September 30, 2004 (Unaudited)        |       | 100              |       | $                                | —     |                                    | $          | 112,991                  |       | $                                           | (1,321     | )          | $          | (191,163 | ) | $ | (136 | ) | $ | (79,629 | ) |

 

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 CashFlows**

 
| ** **                                                                    | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| **(In  thousands)**                                                           | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                                                                    | ** ** | **(Unaudited)**                      | ** ** |
| ** **                                                                    |       |                                 |       |   |   |
| **Cash  flows from operating activities:**                                    |       |                                 |       |   |   |
| Net loss                                                                      |       | $                                    | (34,531    | ) | $ | (65,986 | ) |
| Adjustments to  reconcile net loss to net cash used for operating activities: |       |                                 |       |   |   |
| Cumulative  effect of change in accounting principles                         |       | —                               |       | 13,764 |   |
| Loss from  discontinued operations                                            |       | —                               |       | 5,650 |   |
| Depreciation and  amortization                                                |       | 9,188                                |       | 9,401 |   |
| Mandatorily  redeemable preferred stock dividends                             |       | 4,011                                |       | — |   |
| Loss on debt and  preferred stock restructuring                               |       | 3,898                                |       | — |   |
| Long-term debt  interest accretion                                            |       | 3,880                                |       | — |   |
| Noncash portion  of restructuring, asset impairment and other related charges |       | 3,073                                |       | 37,664 |   |
| Preferred stock  redemption value accretion                                   |       | 264                                  |       | — |   |
| Deferred income  taxes                                                        |       | —                               |       | (11,654 | ) |
| Other, net                                                                    |       | (12                                  | )          | 228 |   |
| Changes in  assets and liabilities:                                           |       |                                 |       |   |   |
| Accounts  receivable                                                          |       | (387                                 | )          | 950 |   |
| Inventories                                                                   |       | (15,669                              | )          | (6,961 | ) |
| Prepaid expenses  and other assets                                            |       | (10                                  | )          | (734 | ) |
| Accounts payable                                                              |       | 1,685                                |       | 1,159 |   |
| Accrued  liabilities                                                          |       | 374                                  |       | (14,902 | ) |
| Income taxes  payable                                                         |       | 161                                  |       | 276 |   |
| Other long-term  liabilities                                                  |       | 2,882                                |       | 3,620 |   |
| Net cash used  for operating activities                                       |       | (21,193                              | )          | (27,525 | ) |
|                                                                          |       |                                 |       |   |   |
| **Cash  flows from investing activities:**                                    |       |                                 |       |   |   |
| Net proceeds  from sale of Specialty Avionics Group                           |       | —                               |       | 132,800 |   |
| Capital  expenditures                                                         |       | (2,740                               | )          | (3,090 | ) |
| Cash paid for  acquisition contingent consideration                           |       | —                               |       | (600 | ) |
| Net cash  provided by (used for) investing activities                         |       | (2,740                               | )          | 129,110 |   |
|                                                                          |       |                                 |       |   |   |
| **Cash  flows from financing activities:**                                    |       |                                 |       |   |   |
| Debt borrowings:                                                              |       |                                 |       |   |   |
| Revolving line  of credit, net                                                |       | 17,800                               |       | 17,400 |   |
| Short-term  promissory notes                                                  |       | 5,000                                |       | — |   |
| Debt repayments:                                                              |       |                                 |       |   |   |
| First-lien term  debt                                                         |       | —                               |       | (129,275 | ) |
| Other secured  long-term debt                                                 |       | (892                                 | )          | (1,600 | ) |
| Deferred  financing costs                                                     |       | (2,137                               | )          | — |   |
| Net cash  provided by (used for) financing activities                         |       | 19,771                               |       | (113,475 | ) |
|                                                                          |       |                                 |       |   |   |
| Net cash  provided by discontinued operations                                 |       | —                               |       | 2,194 |   |
|                                                                          |       |                                 |       |   |   |
| Net decrease in  cash and cash equivalents                                    |       | (4,162                               | )          | (9,696 | ) |
| Cash and cash  equivalents at beginning of period                             |       | 6,936                                |       | 12,421 |   |
| Cash and cash  equivalents at end of period                                   |       | $                                    | 2,774      |   | $ | 2,725 |   |

 

The accompanying notesare an integral part of the consolidated financial statements.

 

4

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

 

**Condensed Notes to ConsolidatedFinancial Statements**

 

**(Unaudited)**

 

**Note 1.**       Summaryof Significant Accounting Policies

** **

**Basis ofPresentation**

** **

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

 

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

 

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

 

**Changes inAccounting Principles**

** **

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

** **

Effective January 1, 2004, the Company adopted SFASNo. 150, “Accounting for Certain Financial Instruments with Characteristics ofboth Liabilities and Equity.”  SFAS No.150 establishes standards for the classification and measurement of certainfinancial instruments with characteristics of both liabilities and equity.  SFAS No. 150 requires classification offinancial instruments within its scope as a liability, including financialinstruments issued in the form of shares that are mandatorily redeemable,because those financial instruments are deemed to be, in essence, obligationsof the issuer.  As a result of adoptingSFAS No. 150 on January 1, 2004, the 16% mandatorily redeemable preferred stockwas reclassified as a liability and the quarterly dividends and redemptionvalue accretion are reflected as charges against pre-tax income.  In periods prior to January 1, 2004, thesecharges were deducted in arriving at the net income or loss applicable to theCompany’s common stockholder.

 

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

 
| ** **                       | ** ** | **Three Months Ended  September 30, 2003** | ** ** | **Nine Months Ended  September 30, 2003** | ** ** |
|----------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| **(In  thousands)**              | ** ** | **As Reported**                            | ** ** | **Pro Forma**                             | ** ** | **As Reported** | ** ** | **Pro Forma** | ** ** |
| ** **                       | ** ** | **(Unaudited)**                            | ** ** |
| Loss from  continuing operations |       | $                                          | (4,954     | )                                         | $          | (6,672 | ) | $ | (46,572 | ) | $ | (51,544 | ) |
| Net loss                         |       | (4,954                                     | )          | (6,672                                    | )          | (65,986 | ) | (70,958 | ) |
|                                  |            |                                            |            |                                           |            |  |  |  |  |  |  |  |  |

 

5

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The pro forma data reflects preferred stock dividends andredemption value accretion totaling $1,718,000 for three months ended September30, 2003 and $4,972,000 for the nine months ended September 30, 2003 as chargesagainst income during the periods.

 

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

** **

As more fully described in “Note 1—Change inAccounting Principle” to the audited financial statements included in the Company’s2003 Form 10-K, the Company elected to discontinue the use of programaccounting for the costs of products manufactured for delivery underproduction-type contracts.  As a result,certain deferred program costs are no longer included in inventory commencingJanuary 1, 2003.

 

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

 

**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-based employeecompensation cost is reflected in net income (loss), as all options grantedunder the plan had an exercise price equal to the value of the underlyingcommon stock on the date of grant.

 

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

 
| ** **                                                                                                                                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|
| **(In  thousands)**                                                                                                                            | ** ** | **2004**                              | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                                     | ** ** | **(Unaudited)**                       | ** ** |
| Net loss, as  reported                                                                                                                         |       | $                                     | (11,509    | )                                         | $          | (4,954 | ) | $ | (34,531 | ) | $ | (65,986 | ) |
| Less total  stock-based employee compensation expense determined under the fair value  based method for all awards, net of related tax effects |       | (81                                   | )          | (94                                       | )          | (243 | ) | (282 | ) |
| Pro forma net  loss                                                                                                                            |       | $                                     | (11,590    | )                                         | $          | (5,048 | ) | $ | (34,774 | ) | $ | (66,268 | ) |
|                                                                                                                                                |            |                                       |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

6

----

 

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

** **

During the three months and nine months ended September30, 2004 and 2003, the Company recorded restructuring, asset impairment andother related charges as follows:

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

 

7

----

 

**Operational Realignmentand Facilities Consolidation**

** **

During the second quarter of fiscal 2004, the Companyadopted plans to restructure the operations of its Cabin Management and SystemsIntegration groups.  The restructuringplan for Cabin Management involves the realignment of production between itsmanufacturing facilities and the relocation and consolidation of the group’sheadquarters to Wichita, Kansas.  Theplan for Systems Integration involves combining the manufacturing activities oftwo facilities into a single facility and eliminating some product offeringsand service capabilities resulting in a partial downsizing of certainoperations.  These actions are designedto reduce engineering, production and inventory carrying costs by supportingfewer manufacturing locations and product offerings.  In connection with these actions, the Companyrecorded pre-tax charges to operations totaling $7,306,000 through September30, 2004, including $405,000 during the third quarter, comprised of thefollowing:

 

•      *Lease Termination and Related Charges. *Lease termination and otherrelated charges are comprised of the net losses expected to be incurred underthe existing long-term lease agreements for facilities permanentlyvacated.  The losses have been reduced bythe expected sublease income.  Theseexpected losses were based on estimated current market rates and anticipateddates that these facilities are subleased. If market rates decrease or should it take longer than expected tosublease these facilities, the actual loss could exceed these estimates.  Otherrelated charges include the write-off of leasehold improvements related to thevacated facilities.

 

•      *Write-Down of Surplus Inventory. *Inventory was written down to reflect its net realizable value forquantities on hand exceeding current and forecast order backlog requirementsrelated to the curtailed product offerings.

 

•      *Severance and Other Compensation Costs. *The Company’s total workforce will be reduced by 25 employees, or 2%,from December 31, 2003 levels when the restructuring is completed during the fourthquarter of fiscal 2004.

 

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

 

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

 

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

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

 

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

 

8

----

 

**Seating Product Line andFurniture Manufacturing Facilities Restructuring**

** **

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

 

•      *Lease Termination and Related Charges. *Lease termination charges reflect lease cancellation costs for thefacilities vacated and possession returned to the lessor in connection withdown-sizing a furniture manufacturing facility. Other related charges include the write-off of leasehold improvementsrelated to the vacated facilities.

 

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

 

•      *Severance and Other Compensation Costs. *The Company reduced its total workforce at the down-sized facility by49 employees, or 37%, from December 31, 2002 levels.

 

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

 
| **(In thousands)**                           | ** ** | **Total  Charges** | ** ** | ** ** | ** ** | **Balance at  December 31,  2003** | ** ** |
|----------------------------------------------|------------|--------------------|------------|------------|------------|-----------------------------------------|------------|
| **Amounts Incurred**                         |
| **Noncash**                                  | ** ** | **Cash**           |
|                                         |       |               |       |       |       |                                    |       |   |   |
| Lease  termination and other related charges |       | $                  | 3,876      |       | $          | (591                                    | )          | $ | (3,285 | ) | $ | — |   |
| Excess inventory  write-downs                |       | 3,073              |       | (3,073     | )          | —                                  |       | — |   |
| Severance and  other compensation costs      |       | 183                |       | —     |       | (183                                    | )          | — |   |
| Total                                        |       | $                  | 7,132      |       | $          | (3,664                                  | )          | $ | (3,468 | ) | $ | — |   |

 

The restructuring activities were completed during2003.

 

**Goodwill Impairment Charges**

 

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

 

As described in Note 3, on March 14, 2003, 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.

 

9

----

 

**Note 3.**       Dispositionof Specialty Avionics Group

** **

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

 

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

 

The following tables summarize the results of operationsand cash flows of the Specialty Avionics Group for the five months ended May 23,2003, the date of sale.

 
| **(In  thousands)**                                 | ** ** | **Five  Months Ended  May 23,  2003** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                          | ** ** | **(Unaudited)**                       | ** ** |
| Revenues                                            |       | $                                     | 36,595     |   |
|                                                |       |                                  |       |
| Operating  expenses:                                |       |                                  |       |
| Costs and  expenses                                 |       | 30,128                                |       |
| Impairment of  goodwill                             |       | 7,500                                 |       |
| Amortization of  intangible assets                  |       | 878                                   |       |
| Total operating  expenses                           |       | 38,506                                |       |
|                                                |       |                                  |       |
| Loss from  operations                               |       | (1,911                                | )          |
|                                                |       |                                  |       |
| Other expenses:                                     |       |                                  |       |
| Interest  expense:                                  |       |                                  |       |
| Debt required to  be repaid with proceeds from sale |       | 2,952                                 |       |
| Debt obligations  assumed by the buyer              |       | 270                                   |       |
| Other expenses,  net                                |       | 153                                   |       |
|                                                |       |                                  |       |
| Pre-tax income  (loss)                              |       | (5,286                                | )          |
| Provision for  income taxes                         |       | 1,053                                 |       |
|                                                |       |                                  |       |
| Loss from operations,  net of tax                   |       | (6,339                                | )          |
| Gain on sale,  net of tax                           |       | 689                                   |       |
|                                                |       |                                  |       |
| Net loss from  discontinued operations              |       | $                                     | (5,650     | ) |

 

10

----

 
| **(In  thousands)**                             | ** ** | **Five  Months Ended  May 23,  2003** | ** ** |
|-------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                      | ** ** | **(Unaudited)**                       | ** ** |
| Cash Flows  Provided By (Used For):             |       |                                  |       |
| Operating  activities                           |       | $                                     | 3,760      |   |
| Investing  activities                           |       | (902                                  | )          |
| Financing  activities                           |       | (649                                  | )          |
| Net increase in  cash and cash equivalents      |       | (13                                   | )          |
| Effect of  foreign currency translation on cash |       | (2                                    | )          |
| Net cash  provided by discontinued operations   |       | $                                     | 2,194      |   |

 

**Note 4.**       Inventories

** **

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

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

 

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

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

 

11

----

 

**Note 5.**       OtherAssets, Principally Intangibles

** **

Other assets are comprised of the following as of September30, 2004 and December 31, 2003:

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

 

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

 

**Identifiable IntangibleAssets with Finite Useful Lives**

** **

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

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

 

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

 

**Note 6.**       AccruedLiabilities

** **

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

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

 

12

----

 

**Note 7.**       Short-TermBorrowings and Long-Term Debt

** **

Short-term borrowings and long-term debt is comprisedof the following amounts as of September 30, 2004 and December 31,2003:

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

 

During the third quarter of fiscal 2004, holders of$65,000,000 of the Company’s 12% senior subordinated notes due September 30,2008 (the “existing notes”) exchanged their notes for new 17% senior discountnotes due September 30, 2008 (the “new notes”). The new notes do not bear cash interest and have an initial accretedvalue equal to the principal amount of the notes exchanged.  The new notes accrete in value at a 17%annual rate and will have a $128,772,000 aggregate accreted principal value atmaturity.  The new notes are seniorunsecured obligations of the Company and are guaranteed by its subsidiaries.  Except for the changes in the interest rate,payment and ranking described above, the new notes have terms substantiallyidentical to those contained in the existing notes, although covenants limitingthe incurrence of indebtedness, the granting of liens and the making ofrestricted payments are more restrictive.

 

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

 

In September 2004, the Company received the proceedsfrom the issuance of 13.5% senior unsecured promissory notes in the aggregateprinciple amount of $5,000,000 to DLJ Merchant Banking Partners II, L.P. andaffiliated funds, who are also stockholders of DeCrane Holdings and, as aresult, related parties (see Note 16 to the audited financial statementsincluded in the Company’s 2003 Form 10-K for additional information on therelated party relationship).  Unlessextended, the notes, plus accrued interest, are due on November 29, 2004.  The notes contain covenants identical tothose in the new 17% notes.

 

As of September 30, 2004, the Company had irrevocablestandby letters of credit in the amount of $318,000 issued and outstanding underthe first-lien credit facility, which reduces borrowings available under the$24,000,000 revolving line of credit.

 

13

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**Note 8.**       MandatorilyRedeemable Preferred Stock

** **

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

 

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

 
| **(In  thousands, except share and per share data)**              | ** ** | **Number  of  Shares** | ** ** | **Mandatory  Redemption  Value** | ** ** | **Unamortized  Issuance  Discount** | ** ** | **Net  Book  Value** | ** ** |
|-------------------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|-------------------------------------|------------|----------------------|------------|
| ** **                                                        | ** ** | ** **             | ** ** | ** **                       | ** ** | ** **                          | ** ** | ** **           | ** ** |
| Balance,  December 31, 2003                                  |       | 432,919                |       | $                                | 43,292     |                                | $          | (2,457               | )          | $ | 40,835 |   |
| Preferred stock  dividends                                        |       | 40,113                 |       | 4,011                            |       | —                              |       | 4,011                |       |
| Redemption value  accretion                                       |       | —                 |       | —                           |       | 264                                 |       | 264                  |       |
| Write-off of  unamortized discount                                |       | —                 |       | —                           |       | 2,193                               |       | 2,193                |       |
| Balance,  September 30, 2004 (Unaudited)                          |       | 473,032                |       | $                                | 47,303     |                                | $          | —               |       | $ | 47,303 |   |
|                                                              |       |                   |       |                             |       |                                |       |                 |       |
| Per share liquidation  value as of September 30, 2004 (Unaudited) |       |                   |       | $                                | 100.00     |                                |       |                 |       |   |

 

During the third quarter of fiscal 2004, the Companyamended the terms of its 16% senior preferred stock.  The amended terms provide that further preferredstock dividends, if any, accrue at rates dependent on a specified financialratio or if certain triggering events occur. All dividends accrued through the amendment date and future dividends,if any, are not payable until redemption. The amendment accelerates the mandatory redemption date from March 31,2009 to December 31, 2008 and also adds several restrictive covenants.

 

The holders of the preferred stock were issued 348,945shares of DeCrane Holdings common stock in connection with the amendment.  The common stock had a nominal fair marketvalue on the issuance date and was therefore recorded at its $0.01 per sharepar value.  In connection with preferred stockrestructuring, the Company recorded a noncash charge of $2,193,000 during thethree months ended September 30, 2004 to write-off the unamortized issuancediscount associated with the initial issuance of the preferred stock.

 

**Preferred Stock Dividends**

** **

Future preferred stock dividends, if any, aredependent, in part, upon a defined leverage ratio the Company achieves as ofeach quarterly testing date.  Dependingon the ratio achieved, and provided certain triggering events have notoccurred, dividends for the succeeding quarter accrue at a 0%, 4% or 16% annualrate.  If certain triggering eventsoccur, such as failure to discharge any mandatory redemption obligations orcomply with certain restrictive covenants and the like, dividends accrue at a16% annual rate.  Based upon the leverageratio achieved as of September 30, 2004, no dividends will accrue on thepreferred stock from the amendment date through December 31, 2004.

 

14

----

 

**Note 9.**       IncomeTaxes

** **

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

 
| ** **                                   | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| **(In  thousands)**                          | ** ** | **2004**                              | ** ** | **2003**                             | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                   | ** ** | **(Unaudited)**                       | ** ** |
|                                         |       |                                  |       |                                 |       |   |   |   |   |
| Pre-tax income  (loss) reported by:          |       |                                  |       |                                 |       |   |   |   |   |
| Continuing  operations                       |       | $                                     | (11,479    | )                                    | $          | (4,811 | ) | $ | (34,441 | ) | $ | (57,059 | ) |
| Discontinued  operations                     |       | —                                |       | —                               |       | — |   | (5,286 | ) |
| Consolidated  pre-tax loss                   |       | $                                     | (11,479    | )                                    | $          | (4,811 | ) | $ | (34,441 | ) | $ | (62,345 | ) |
|                                         |       |                                  |       |                                 |       |   |   |   |   |
| Total provision  for income taxes (benefit): |       |                                  |       |                                 |       |   |   |   |   |
| Income tax  benefit based on pre-tax loss    |       | $                                     | (5,521     | )                                    | $          | (1,188 | ) | $ | (12,664 | ) | $ | (23,821 | ) |
| Net deferred tax  assets valuation allowance |       | 5,551                                 |       | 1,331                                |       | 12,754 |   | 14,387 |   |
| Net provision  for income taxes (benefit)    |       | $                                     | 30         |                                 | $          | 143 |   | $ | 90 |   | $ | (9,434 | ) |
|                                         |       |                                  |       |                                 |       |   |   |   |   |
| Allocation of  total provision:              |       |                                  |       |                                 |       |   |   |   |   |
| Continuing  operations                       |       | $                                     | 30         |                                 | $          | 143 |   | $ | 90 |   | $ | (10,487 | ) |
| Discontinued  operations                     |       | —                                |       | —                               |       | — |   | 1,053 |   |
| Net provision  for income taxes (benefit)    |       | $                                     | 30         |                                 | $          | 143 |   | $ | 90 |   | $ | (9,434 | ) |

 

For the three months and nine months ended September30, 2004, the provision for income taxes, based on the reported consolidatedpre-tax loss, differs from the amount determined by applying the applicableU.S. statutory federal rate to the pre-tax loss primarily due to the effects ofstate and foreign income taxes and non-deductible expenses, principallymandatorily redeemable preferred stock dividends due to the adoption of SFASNo. 150 effective January 1, 2004 (Note 1).

 

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

 

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

 

As required by SFAS No. 109, the Company evaluated itsdeferred tax assets for expected recoverability based on the nature of theitem, the associated taxing jurisdictions, the applicable expiration dates andfuture taxable income forecasts that would impact utilization.  Since there is no loss carry back potentialand the Company does not have any tax planning strategies to assure recoverability,the only possibility for recovery of the net deferred assets is future taxableincome.  Since there have been prior yearlosses, the Company believes it was not prudent to rely on future taxable incomeas the means to support the carrying value of the net deferred tax assets.  Based upon the results of operations for the ninemonths ended September 30, 2004, the Company determined that an additional $12,754,000valuation allowance was required as of that date, $5,551,000 of which isapplicable to the three-month period.

 

15

----

 

**Note 10.**    Commitmentsand Contingencies

** **

**Litigation**

** **

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

 

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

 

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

 

**Funding of DeCraneHoldings 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.

 

Preferred stock dividends, if any, are dependent uponthe leverage ratio (as defined) achieved as of each quarterly testingdate.  Depending on the ratio achieved,dividends for the succeeding quarter accrue at a 0%, 3.5% or 14% annualrate.  Based upon the leverage ratio asof September 30, 2004, no dividends will accrue on the preferred stock duringthe three months ending December 31, 2004. All future dividends, if any, are not payable until September 30, 2009,the mandatory preferred stock redemption date. The DeCrane Holdings preferred stock has a total redemption value of$77,172,000 as of September 30, 2004, including accumulated dividends.

 

16

----

 

**Note 11.**    BusinessSegment Information

** **

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

 

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

 

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

 

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

 

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

 

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

 

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

 

17

----

 

The accounting policies of the groups aresubstantially the same as those described in the summary of significantaccounting policies in Note 1 to the audited financial statements included inthe Company’s 2003 Form 10-K.  Sometransactions are recorded at the Company’s corporate headquarters and are notallocated to the groups, such as most of the Company’s cash and cashequivalents, debt and related net interest expense, corporate headquarterscosts and income taxes.

 

The tables below summarize selected financial data bybusiness segment.

 
| ** **                     | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|
| **(In  thousands)**            | ** ** | **2004**                              | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                     | ** ** | **(Unaudited)**                       | ** ** |
|                           |       |                                  |       |                                      |       |   |   |   |   |
| Revenues:                      |       |                                  |       |                                      |       |   |   |   |   |
| Cabin Management               |       | $                                     | 39,429     |                                      | $          | 29,655 |   | $ | 114,757 |   | $ | 89,910 |   |
| Systems  Integration           |       | 12,221                                |       | 13,807                                    |       | 42,132 |   | 40,657 |   |
| Inter-group  elimination (1)   |       | (1,005                                | )          | 811                                       |       | (2,830 | ) | (281 | ) |
| Consolidated  totals           |       | $                                     | 50,645     |                                      | $          | 44,273 |   | $ | 154,059 |   | $ | 130,286 |   |
|                           |       |                                  |       |                                      |       |   |   |   |   |
| Adjusted EBITDA  (as defined): |       |                                  |       |                                      |       |   |   |   |   |
| Cabin Management               |       | $                                     | 7,675      |                                      | $          | 3,909 |   | $ | 17,297 |   | $ | 12,769 |   |
| Systems  Integration           |       | 1,784                                 |       | 3,698                                     |       | 7,212 |   | 10,035 |   |
| Corporate (2)                  |       | (1,738                                | )          | (1,133                                    | )          | (3,944 | ) | (4,640 | ) |
| Inter-group  elimination (3)   |       | 1                                     |       | (1                                        | )          | 2 |   | 111 |   |
| Consolidated  totals           |       | 7,722                                 |       | 6,473                                     |       | 20,567 |   | 18,275 |   |
| Reconciling  items (4)         |       | (19,231                               | )          | (11,427                                   | )          | (55,098 | ) | (84,261 | ) |
| Net loss                       |       | $                                     | (11,509    | )                                         | $          | (4,954 | ) | $ | (34,531 | ) | $ | (65,986 | ) |

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

 

----

(1)       Inter-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.

 

18

----

 

(4)       AdjustedEBITDA (as defined) excludes the following income and (expenses) reflected inthe Company’s financial statements which are prepared in accordance withgenerally accepted accounting principles:

 
| ** **                                                                                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|
| **(In  thousands)**                                                                                                    | ** ** | **2004**                              | ** ** | **2003**                                  | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                             | ** ** | **(Unaudited)**                       | ** ** |
|                                                                                                                   |       |                                  |       |                                      |       |   |   |   |   |
| Depreciation and  amortization of long-lived assets (a)                                                                |       | $                                     | (2,247     | )                                         | $          | (2,383 | ) | $ | (6,850 | ) | $ | (7,350 | ) |
| Adjustment to  reflect program costs as research and development expenses and nonrecurring program  start-up costs (b) |       | (2,445                                | )          | (2,211                                    | )          | (5,542 | ) | (7,062 | ) |
| Restructuring,  asset impairment and other related charges                                                             |       | (405                                  | )          | —                                    |       | (7,306 | ) | (41,132 | ) |
| Acquisition  related charges not capitalized                                                                           |       | (30                                   | )          | (10                                       | )          | (48 | ) | (27 | ) |
| Interest expense                                                                                                       |       | (9,555                                | )          | (6,546                                    | )          | (27,007 | ) | (18,883 | ) |
| Mandatorily  redeemable preferred stock dividends                                                                      |       | (478                                  | )          | —                                    |       | (4,011 | ) | — |   |
| Loss on debt and  preferred stock restructuring                                                                        |       | (3,898                                | )          | —                                    |       | (3,898 | ) | — |   |
| Other expenses,  net                                                                                                   |       | (143                                  | )          | (134                                      | )          | (346 | ) | (880 | ) |
| Provision for  income (taxes) benefit                                                                                  |       | (30                                   | )          | (143                                      | )          | (90 | ) | 10,487 |   |
| Income (loss)  from discontinued operations                                                                            |       | —                                |       | —                                    |       | — |   | (5,650 | ) |
| Cumulative effect  of change in accounting principle                                                                   |       | —                                |       | —                                    |       | — |   | (13,764 | ) |
| Total  reconciling items                                                                                               |       | $                                     | (19,231    | )                                         | $          | (11,427 | ) | $ | (55,098 | ) | $ | (84,261 | ) |

 

----

(a)       Reflectsdepreciation and amortization of long-lived assets but excludes amortization ofdeferred financing costs, which are classified as a component of interestexpense, as follows:

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

 

(b)       Underprogram accounting, which the Company is required to use for determiningcovenant compliance under its credit agreements, certain product development andnonrecurring program start-up costs incurred in connection with specificcontracted programs are deferred and charged to cost of sales as revenuesrelated to the program are recognized. For financial reporting purposes, these costs are charged to expense asincurred.  This adjustment reflects thenet difference between these two methods of accounting.

 

(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.

 

19

----

 

**Note 12.**    SupplementalCondensed Consolidating Financial Information

** **

In conjunction with the 12% and 17% notes described inNote 7, the following condensed consolidating financial information ispresented segregating the Company, as the issuer, and the guarantor andnon-guarantor subsidiaries.  Theaccompanying financial information in the guarantor subsidiaries columnreflects the financial position, results of operations and cash flows for thosesubsidiaries guaranteeing the notes.  Thenon-guarantor subsidiaries are companies within the Specialty Avionics Groupwhich was sold in May 2003 and are therefore classified as a component ofdiscontinued operations.

 

The guarantor subsidiaries are wholly-ownedsubsidiaries of the Company and their guarantees are full and unconditional on ajoint 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.  Consolidatingadjustments include the following:

 

(1)        Eliminationof investments in subsidiaries.

 

(2)       Eliminationof intercompany accounts.

 

(3)       Eliminationof equity in earnings of subsidiaries.

 

20

----

 

**Balance Sheets**

 
| ** **                                                 | ** ** | **September 30, 2004 (Unaudited)** | ** ** |
|------------------------------------------------------------|------------|------------------------------------|------------|
| **(In  thousands)**                                        | ** ** | **Issuer**                         | ** ** | **Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
|                                                       |       |                               |       |   |   |   |   |   |   |
| **Assets**                                                 |       |                               |       |   |   |   |   |   |   |
|                                                       |       |                               |       |   |   |   |   |   |   |
| Current assets:                                            |       |                               |       |   |   |   |   |   |   |
| Cash and cash  equivalents                                 |       | $                                  | 1,915      |   | $ | 859 |   | $ | — |   | $ | 2,774 |   |
| Accounts  receivable, net                                  |       | —                             |       | 21,842 |   | — |   | 21,842 |   |
| Inventories                                                |       | —                             |       | 55,699 |   | — |   | 55,699 |   |
| Other current  assets                                      |       | 75                                 |       | 1,179 |   | — |   | 1,254 |   |
| Total current  assets                                      |       | 1,990                              |       | 79,579 |   | — |   | 81,569 |   |
|                                                       |       |                               |       |   |   |   |   |   |   |
| Property and  equipment, net                               |       | 793                                |       | 28,627 |   | — |   | 29,420 |   |
| Other assets,  principally goodwill                        |       | 11,500                             |       | 184,102 |   | — |   | 195,602 |   |
| Investments in  subsidiaries                               |       | 78,555                             |       | — |   | (78,555 | )(1) | — |   |
| Intercompany  receivables                                  |       | 228,878                            |       | 55,209 |   | (284,087 | )(2) | — |   |
| Total assets                                               |       | $                                  | 321,716    |   | $ | 347,517 |   | $ | (362,642 | ) | $ | 306,591 |   |
|                                                       |       |                               |       |   |   |   |   |   |   |
| **Liabilities  and Stockholder’s Equity (Deficit)**   |       |                               |       |   |   |   |   |   |   |
|                                                       |       |                               |       |   |   |   |   |   |   |
| Current  liabilities:                                      |       |                               |       |   |   |   |   |   |   |
| Current portion  of long-term debt                         |       | $                                  | 5,046      |   | $ | 1,293 |   | $ | — |   | $ | 6,339 |   |
| Other current  liabilities                                 |       | 7,967                              |       | 27,375 |   | — |   | 35,342 |   |
| Total current  liabilities                                 |       | 13,013                             |       | 28,668 |   | — |   | 41,681 |   |
|                                                       |       |                               |       |   |   |   |   |   |   |
| Long-term debt,  less current portion                      |       | 282,327                            |       | 6,563 |   | — |   | 288,890 |   |
| Mandatorily  redeemable preferred stock                    |       | 47,303                             |       | — |   | — |   | 47,303 |   |
| Intercompany  payables                                     |       | 55,209                             |       | 228,878 |   | (284,087 | )(2) | — |   |
| Other long-term  liabilities                               |       | 3,357                              |       | 4,989 |   | — |   | 8,346 |   |
|                                                       |       |                               |       |   |   |   |   |   |   |
| Stockholder’s  equity (deficit):                      |       |                               |       |   |   |   |   |   |   |
| Paid-in capital                                            |       | 111,670                            |       | 151,492 |   | (151,492 | )(1) | 111,670 |   |
| Retained  earnings (deficit)                               |       | (191,163                           | )          | (72,937 | ) | 72,937 | (1) | (191,163 | ) |
| Accumulated  other comprehensive loss                      |       | —                             |       | (136 | ) | — |   | (136 | ) |
| Total  stockholder’s equity (deficit)                 |       | (79,493                            | )          | 78,419 |   | (78,555 | ) | (79,629 | ) |
| Total  liabilities and stockholder’s equity (deficit) |       | $                                  | 321,716    |   | $ | 347,517 |   | $ | (362,642 | ) | $ | 306,591 |   |
|                                                            |            |                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

21

----

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

 

22

----

 

**Statements of Operations**

 
| ** **                                        | ** ** | **Three Months Ended September 30, 2004 (Unaudited)** | ** ** |
|---------------------------------------------------|------------|-------------------------------------------------------|------------|
| **(In  thousands)**                               | ** ** | **Issuer**                                            | ** ** | **Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
|                                              |       |                                                  |       |   |   |   |   |   |   |
| Revenues                                          |       | $                                                     | —     |   | $ | 50,645 |   | $ | — |   | $ | 50,645 |   |
| Cost of sales                                     |       | —                                                |       | 37,645 |   | — |   | 37,645 |   |
|                                              |       |                                                  |       |   |   |   |   |   |   |
| Gross profit                                      |       | —                                                |       | 13,000 |   | — |   | 13,000 |   |
|                                              |       |                                                  |       |   |   |   |   |   |   |
| Operating and  other expenses (income):           |       |                                                  |       |   |   |   |   |   |   |
| Selling, general  and administrative expenses     |       | 2,121                                                 |       | 5,690 |   | — |   | 7,811 |   |
| Research and  development expenses                |       | —                                                |       | 1,681 |   | — |   | 1,681 |   |
| Amortization of  intangible assets                |       | —                                                |       | 913 |   | — |   | 913 |   |
| Interest expense                                  |       | 9,348                                                 |       | 207 |   | — |   | 9,555 |   |
| Mandatorily  redeemable preferred stock dividends |       | 478                                                   |       | — |   | — |   | 478 |   |
| Loss on debt and  preferred stock restructuring   |       | 3,898                                                 |       | — |   | — |   | 3,898 |   |
| Intercompany  charges                             |       | (5,630                                                | )          | 5,630 |   | — |   | — |   |
| Equity in loss  of subsidiaries                   |       | 690                                                   |       | — |   | (690 | )(3) | — |   |
| Other expenses,  net                              |       | 126                                                   |       | 17 |   | — |   | 143 |   |
| Provision for  income taxes (benefit)             |       | 478                                                   |       | (448 | ) | — |   | 30 |   |
| Total operating  and other expense, net           |       | 11,509                                                |       | 13,690 |   | (690 | ) | 24,509 |   |
|                                              |       |                                                  |       |   |   |   |   |   |   |
| Net loss                                          |       | $                                                     | (11,509    | ) | $ | (690 | ) | $ | 690 |   | $ | (11,509 | ) |
|                                                   |            |                                                       |            |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                    | ** ** | **Three Months Ended September 30, 2003 (Unaudited)** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------------|------------|
| **(In  thousands)**                           | ** ** | **Issuer**                                                 | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
| ** **                                    | ** ** | ** **                                                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                      |       | $                                                          | —     |   | $ | 44,273 |   | $ | — |   | $ | — |   | $ | 44,273 |   |
| Cost of sales                                 |       | —                                                     |       | 34,494 |   | — |   | — |   | 34,494 |   |
|                                          |       |                                                       |       |   |   |   |   |   |   |   |   |
| Gross profit                                  |       | —                                                     |       | 9,779 |   | — |   | — |   | 9,779 |   |
|                                          |       |                                                       |       |   |   |   |   |   |   |   |   |
| Operating and  other expenses (income):       |       |                                                       |       |   |   |   |   |   |   |   |   |
| Selling, general  and administrative expenses |       | 313                                                        |       | 4,474 |   | — |   | — |   | 4,787 |   |
| Research and  development expenses            |       | —                                                     |       | 2,211 |   | — |   | — |   | 2,211 |   |
| Amortization of  intangible assets            |       | —                                                     |       | 912 |   | — |   | — |   | 912 |   |
| Interest expense                              |       | 6,419                                                      |       | 127 |   | — |   | — |   | 6,546 |   |
| Intercompany  charges                         |       | (6,690                                                     | )          | 6,690 |   | — |   | — |   | — |   |
| Equity in loss  of subsidiaries               |       | 4,045                                                      |       | — |   | — |   | (4,045 | )(3) | — |   |
| Other expenses  (income), net                 |       | (553                                                       | )          | 687 |   | — |   | — |   | 134 |   |
| Provision for  income taxes (benefit)         |       | 1,420                                                      |       | (1,277 | ) | — |   | — |   | 143 |   |
| Total operating  and other expenses, net      |       | 4,954                                                      |       | 13,824 |   | — |   | (4,045 | ) | 14,733 |   |
|                                          |       |                                                       |       |   |   |   |   |   |   |   |   |
| Net loss                                      |       | $                                                          | (4,954     | ) | $ | (4,045 | ) | $ | — |   | $ | 4,045 |   | $ | (4,954 | ) |
|                                               |            |                                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

23

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| ** **                                        | ** ** | **Nine Months Ended September 30, 2004 (Unaudited)** | ** ** |
|---------------------------------------------------|------------|------------------------------------------------------|------------|
| **(In  thousands)**                               | ** ** | **Issuer**                                           | ** ** | **Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
|                                              |       |                                                 |       |   |   |   |   |   |   |
| Revenues                                          |       | $                                                    | —     |   | $ | 154,059 |   | $ | — |   | $ | 154,059 |   |
| Cost of sales                                     |       | —                                               |       | 121,801 |   | — |   | 121,801 |   |
|                                              |       |                                                 |       |   |   |   |   |   |   |
| Gross profit                                      |       | —                                               |       | 32,258 |   | — |   | 32,258 |   |
|                                              |       |                                                 |       |   |   |   |   |   |   |
| Operating and  other expenses (income):           |       |                                                 |       |   |   |   |   |   |   |
| Selling, general  and administrative expenses     |       | 4,543                                                |       | 18,293 |   | — |   | 22,836 |   |
| Research and  development expenses                |       | —                                               |       | 5,863 |   | — |   | 5,863 |   |
| Amortization of  intangible assets                |       | —                                               |       | 2,738 |   | — |   | 2,738 |   |
| Interest expense                                  |       | 26,439                                               |       | 568 |   | — |   | 27,007 |   |
| Mandatorily  redeemable preferred stock dividends |       | 4,011                                                |       | — |   | — |   | 4,011 |   |
| Loss on debt and  preferred stock restructuring   |       | 3,898                                                |       | — |   | — |   | 3,898 |   |
| Intercompany  charges                             |       | (16,509                                              | )          | 16,509 |   | — |   | — |   |
| Equity in loss  of subsidiaries                   |       | 7,113                                                |       | — |   | (7,113 | )(3) | — |   |
| Other expenses,  net                              |       | 340                                                  |       | 6 |   | — |   | 346 |   |
| Provision for  income taxes (benefit)             |       | 4,696                                                |       | (4,606 | ) | — |   | 90 |   |
| Total operating  and other expense, net           |       | 34,531                                               |       | 39,371 |   | (7,113 | ) | 66,789 |   |
|                                              |       |                                                 |       |   |   |   |   |   |   |
| Net loss                                          |       | $                                                    | (34,531    | ) | $ | (7,113 | ) | $ | 7,113 |   | $ | (34,531 | ) |
|                                                   |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                    | ** ** | **Nine Months Ended September 30, 2003 (Unaudited)** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------------|------------|
| **(In  thousands)**                           | ** ** | **Issuer**                                                | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
| ** **                                    | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                      |       | $                                                         | —     |   | $ | 130,286 |   | $ | — |   | $ | — |   | $ | 130,286 |   |
| Cost of sales                                 |       | —                                                    |       | 102,086 |   | — |   | — |   | 102,086 |   |
|                                          |       |                                                      |       |   |   |   |   |   |   |   |   |
| Gross profit                                  |       | —                                                    |       | 28,200 |   | — |   | — |   | 28,200 |   |
|                                          |       |                                                      |       |   |   |   |   |   |   |   |   |
| Operating and  other expenses (income):       |       |                                                      |       |   |   |   |   |   |   |   |   |
| Selling, general  and administrative expenses |       | 5,217                                                     |       | 16,479 |   | — |   | — |   | 21,696 |   |
| Research and  development expenses            |       | —                                                    |       | 7,062 |   | — |   | — |   | 7,062 |   |
| Impairment of  goodwill                       |       | —                                                    |       | 34,000 |   | — |   | — |   | 34,000 |   |
| Amortization of  intangible assets            |       | —                                                    |       | 2,738 |   | — |   | — |   | 2,738 |   |
| Interest expense                              |       | 18,535                                                    |       | 348 |   | — |   | — |   | 18,883 |   |
| Intercompany  charges                         |       | (18,265                                                   | )          | 18,265 |   | — |   | — |   | — |   |
| Equity in loss  of subsidiaries               |       | 51,013                                                    |       | 218 |   | — |   | (51,231 | )(3) | — |   |
| Other expenses,  net                          |       | 33                                                        |       | 847 |   | — |   | — |   | 880 |   |
| Provision for  income taxes (benefit)         |       | 9,453                                                     |       | (19,940 | ) | — |   | — |   | (10,487 | ) |
| Loss from  discontinued operations            |       | —                                                    |       | 5,432 |   | 218 |   | — |   | 5,650 |   |
| Change in  accounting principle               |       | —                                                    |       | 13,764 |   | — |   | — |   | 13,764 |   |
| Total operating  and other expenses, net      |       | 65,986                                                    |       | 79,213 |   | 218 |   | (51,231 | ) | 94,186 |   |
|                                          |       |                                                      |       |   |   |   |   |   |   |   |   |
| Net loss                                      |       | $                                                         | (65,986    | ) | $ | (51,013 | ) | $ | (218 | ) | $ | 51,231 |   | $ | (65,986 | ) |

** **

**24**

----

** **

**Statements of Cash Flows**

 
| ** **                                            | ** ** | **Nine Months Ended September 30, 2004 (Unaudited)** | ** ** |
|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| **(In  thousands)**                                   | ** ** | **Issuer**                                           | ** ** | **Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| **Cash  flows from operating activities:**            |       |                                                 |       |   |   |   |   |   |   |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| Net loss                                              |       | $                                                    | (34,531    | ) | $ | (7,113 | ) | $ | 7,113 |   | $ | (34,531 | ) |
| Noncash  adjustments:                                 |       |                                                 |       |   |   |   |   |   |   |
| Equity in loss  of subsidiaries                       |       | 7,113                                                |       | — |   | (7,113 | )(3) | — |   |
| Other noncash  adjustments                            |       | 14,625                                               |       | 9,677 |   | — |   | 24,302 |   |
| Changes in  working capital                           |       | (12,487                                              | )          | 1,523 |   | — |   | (10,964 | ) |
| Net cash  provided by (used for) operating activities |       | (25,280                                              | )          | 4,087 |   | — |   | (21,193 | ) |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| **Cash  flows from investing activities:**            |       |                                                 |       |   |   |   |   |   |   |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| Capital  expenditures                                 |       | (1                                                   | )          | (2,739 | ) | — |   | (2,740 | ) |
| Net cash used  for investing activities               |       | (1                                                   | )          | (2,739 | ) | — |   | (2,740 | ) |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| **Cash  flows from financing activities:**            |       |                                                 |       |   |   |   |   |   |   |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| Debt borrowings:                                      |       |                                                 |       |   |   |   |   |   |   |
| Revolving line  of credit, net                        |       | 17,800                                               |       | — |   | — |   | 17,800 |   |
| Short-term  promissory notes                          |       | 5,000                                                |       | — |   | — |   | 5,000 |   |
| Debt repayments:                                      |       |                                                 |       |   |   |   |   |   |   |
| Other secured  long-term debt                         |       | (7                                                   | )          | (885 | ) | — |   | (892 | ) |
| Deferred  financing costs                             |       | (2,137                                               | )          | — |   | — |   | (2,137 | ) |
| Net cash  provided by (used for) financing activities |       | 20,656                                               |       | (885 | ) | — |   | 19,771 |   |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| Net increase  (decrease) in cash and equivalents      |       | (4,625                                               | )          | 463 |   | — |   | (4,162 | ) |
| Cash and  equivalents at beginning of period          |       | 6,540                                                |       | 396 |   | — |   | 6,936 |   |
|                                                  |       |                                                 |       |   |   |   |   |   |   |
| Cash and  equivalents at end of period                |       | $                                                    | 1,915      |   | $ | 859 |   | $ | — |   | $ | 2,774 |   |
|                                                       |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

25

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| ** **                                            | ** ** | **Nine Months Ended September 30, 2003 (Unaudited)** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| **(In  thousands)**                                   | ** ** | **Issuer**                                                | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-Guarantor  Subsidiaries** | ** ** | **Consolidating  Adjustments** | ** ** | **Consolidated  Total** | ** ** |
| ** **                                            | ** ** | ** **                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Cash  flows from operating activities:**            |       |                                                      |       |   |   |   |   |   |   |   |   |
|                                                  |       |                                                      |       |   |   |   |   |   |   |   |   |
| Net loss                                              |       | $                                                         | (65,986    | ) | $ | (51,013 | ) | $ | (218 | ) | $ | 51,231 | (3) | $ | (65,986 | ) |
| Loss from  discontinued operations                    |       | —                                                    |       | 5,432 |   | 218 |   | — |   | 5,650 |   |
| Noncash  adjustments:                                 |       |                                                      |       |   |   |   |   |   |   |   |   |
| Change in  accounting principle                       |       | —                                                    |       | 13,764 |   | — |   | — |   | 13,764 |   |
| Equity in loss  of subsidiaries                       |       | 51,013                                                    |       | 218 |   | — |   | (51,231 | )(3) | — |   |
| Other noncash  adjustments                            |       | (9,168                                                    | )          | 44,807 |   | — |   | — |   | 35,639 |   |
| Changes in  working capital                           |       | (5,350                                                    | )          | (11,242 | ) | — |   | — |   | (16,592 | ) |
| Net cash  provided by (used for) operating activities |       | (29,491                                                   | )          | 1,966 |   | — |   | — |   | (27,525 | ) |
|                                                  |       |                                                      |       |   |   |   |   |   |   |   |   |
| **Cash  flows from investing activities:**            |       |                                                      |       |   |   |   |   |   |   |   |   |
|                                                  |       |                                                      |       |   |   |   |   |   |   |   |   |
| Net proceeds  from sale of Specialty Avionics Group   |       | 132,800                                                   |       | — |   | — |   | — |   | 132,800 |   |
| Capital  expenditures                                 |       | (26                                                       | )          | (3,064 | ) | — |   | — |   | (3,090 | ) |
| Cash paid for  acquisitions                           |       | (600                                                      | )          | — |   | — |   | — |   | (600 | ) |
| Net cash  provided by (used for) investing activities |       | 132,174                                                   |       | (3,064 | ) | — |   | — |   | 129,110 |   |
|                                                  |       |                                                      |       |   |   |   |   |   |   |   |   |
| **Cash  flows from financing activities:**            |       |                                                      |       |   |   |   |   |   |   |   |   |
|                                                  |       |                                                      |       |   |   |   |   |   |   |   |   |
| Debt borrowings:                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| Revolving line  of credit, net                        |       | 17,400                                                    |       | — |   | — |   | — |   | 17,400 |   |
| Debt repayments:                                      |       |                                                      |       |   |   |   |   |   |   |   |   |
| First-lien term  debt                                 |       | (129,275                                                  | )          | — |   | — |   | — |   | (129,275 | ) |
| Other secured  long-term debt                         |       | (618                                                      | )          | (982 | ) | — |   | — |   | (1,600 | ) |
| Net cash used  for financing activities               |       | (112,493                                                  | )          | (982 | ) | — |   | — |   | (113,475 | ) |
|                                                  |       |                                                      |       |   |   |   |   |   |   |   |   |
| Net cash  provided by discontinued Operations         |       | —                                                    |       | 2,194 |   | — |   | — |   | 2,194 |   |
|                                                  |       |                                                      |       |   |   |   |   |   |   |   |   |
| Net increase  (decrease) in cash and equivalents      |       | (9,810                                                    | )          | 114 |   | — |   | — |   | (9,696 | ) |
| Cash and  equivalents at beginning of period          |       | 12,343                                                    |       | 78 |   | — |   | — |   | 12,421 |   |
|                                                  |       |                                                      |       |   |   |   |   |   |   |   |   |
| Cash and  equivalents at end of period                |       | $                                                         | 2,533      |   | $ | 192 |   | $ | — |   | $ | — |   | $ | 2,725 |   |

 

26

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

 

Thefollowing discussions should be read in conjunction with our financialstatements and accompanying notes included in this report.

 

**Resultsof Operations**

** **

### **PerformanceMeasures**

### ** **

Thefollowing discussion of our results of operations includes discussions offinancial measures and operating statistics that we use to evaluate theperformance of, and trends in, our businesses. We believe the presentation of these measures and statistics arerelevant and useful to investors because it allows them to view performance andtrends 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.

 

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

 

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

 

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

 

Ourmethod 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.  Adjusted EBITDAshould not be viewed as substitutes for or superior to net income (loss), cashflow from operations or other data prepared in accordance with GAAP as ameasure of our profitability or liquidity. The notes to our financial statements include information about ouroperating segments, including Adjusted EBITDA, and should be read inconjunction with the discussions presented herein.  The notes to our financial statements

 

27

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also include areconciliation of Adjusted EBITDA to net income (loss) to clarify thedifferences between these financial measures.

 

**Bookingsand Backlog.**  Bookingsand backlog are operating statistics we use as leading trend indicators offuture demand for our products and services. Bookings and backlog are based upon the value of purchase ordersreceived from our customers, which will result in revenues, if and when suchorders are filled.

 

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

 

### **Changes inAccounting Principles**

### ** **

**Adoptionof SFAS No. 150.**  EffectiveJanuary 1, 2004, we adopted SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity.”  SFAS No. 150 establishes standards for theclassification and measurement of certain financial instruments withcharacteristics of both liabilities and equity. SFAS No. 150 requires classification of financial instruments within itsscope as a liability, including financial instruments issued in the form ofshares that are mandatorily redeemable, because those financial instruments aredeemed to be, in essence, obligations of the issuer.  As a result of adopting SFAS No. 150 on January 1,2004, the 16% mandatorily redeemable preferred stock was reclassified as aliability and the quarterly dividend and redemption value accretion arereflected as charges against pre-tax income. In periods prior to January 1, 2004, these charges were deducted inarriving at the net income or loss applicable to our common stockholder.

 

Thefollowing table summarizes the results of operations for the three months and ninemonths ended September 30, 2003 as if SFAS No. 150 had been in effect asof the beginning of 2003.

 
| ** **                      | ** ** | **Three Months Ended  September 30, 2003** | ** ** | **Nine Months Ended  September 30, 2003** | ** ** |
|---------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------|------------|
| **(In millions)**               | ** ** | **As Reported**                                 | ** ** | **Pro Forma**                                  | ** ** | **As Reported** | ** ** | **Pro Forma** | ** ** |
|                            |       |                                            |       |                                           |       |   |   |   |   |   |   |   |   |
| Loss from continuing operations |       | $                                               | (5.0       | )                                              | $          | (6.7 | ) | $ | (46.6 | ) | $ | (51.6 | ) |
| Net loss                        |       | (5.0                                            | )          | (6.7                                           | )          | (66.0 | ) | (71.0 | ) |

 

Thepro forma data reflects preferred stock dividends and redemption valueaccretion totaling $1.7 million for three months ended September 30, 2003and $5.0 million for the nine months ended September 30, 2003 as chargesagainst income during the periods.

 

**Change inAccounting for Product Development Costs.**  In addition, and as more fully described in “Note1—Change in Accounting Principle” to the audited financial statements includedin the Company’s 2003 Form 10-K, we elected to discontinue the use of programaccounting for the costs of products manufactured for delivery underproduction-type contracts.  As a result,certain deferred program costs are no longer included in inventory commencing January 1, 2003.

 

Thischange in accounting policy was made after concluding the 2003 fiscal year butwas applied retroactively to the beginning of the year, January 1, 2003, asrequired by generally accepted accounting principles.  As a result of the change, program-relatedproduct development costs are now classified as a component of research anddevelopment expenses in the consolidated financial statements rather thanclassified as a component of inventory cost. We have restated the results of operations by charging previouslyinventoried costs totaling $2.2 million and $7.1 million for the three monthsand nine months ended September 30, 2003, respectively, to research and developmentexpense and recording a $13.8 million charge as of January 1, 2003 toreflect the cumulative effect of the change in accounting principle.

 

28

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### **Restructuring, Asset Impairment and Other Related Charges**

 

Ourresults of operations for 2003 and 2004 have been affected by restructuring,impairment and other related charges pertaining to a series of restructuringactivities.  These charges, which affectthe comparability of our reported results of operations between periods, aremore fully described in “—Restructuring, Asset Impairment and Other RelatedCharges” below.

 

### **Three Months EndedSeptember** 30,2004 Compared to Three Months Ended September 30, 2003

### ** **

**Revenues.* ***Revenuesincreased $6.3 million, or 14.4%, to $50.6 million for the three months ended September 30,2004 from $44.3 million for the three months ended September 30,2003.  By segment, revenues changed asfollows:

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

 

*Cabin Management. *Revenuesincreased by $9.7 million, or 33% compared to the prior year, due to a highervolume of business, VIP and head-of-state jet production by aircraftmanufacturers.  The increase consisted ofthe following:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

•      a$4.5 million increase in completion revenues; and

 

•      a$0.3 million increase in revenues from integration kits and related servicesfor commercial aircraft.

 

BBJ has exercised its option to convert the supplycontract to a “requirements” contract, from a guaranteed “take-or-pay” contract,commencing January 1, 2005. Production under the “take-or-pay” portion of the contract for 2004 wascompleted during the second quarter of fiscal 2004 and no new orders have beenplaced pursuant to the new “requirements” contract.  Based upon the number of auxiliary fuelsystems BBJ has in its inventory, we believe we may not receive any orders foradditional systems until fiscal 2005. During the three months ended September 30, 2004, auxiliary fuelsystems revenues were $0.8 million compared to $5.7 million for the same periodlast year.

 

29

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**Gross profit.**  Gross profit increased $3.2 million, or32.9%, to $13.0 million for the three months ended September 30, 2004 from$9.8 million for the same period in the prior year.  By segment, gross profit changed as follows:

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

 

*Cabin Management.*  Gross profit increased by $4.5 million, or88.9% compared to the prior year, primarily due to:

 

•      a$4.8 million increase related to higher volume for our aircraft furniture andrelated products;

 

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

 

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

 

•      $1.4million of program start-up costs related to the interior of a customer’srecently introduced new model aircraft, a portion of which are nonrecurring;and

 

•      a$0.1 million increase in restructuring charges incurred in 2004 compared tothose incurred during the same period in 2003 related to our furniture andseating operations.

 

*Systems Integration.*  Gross profit decreased by $1.3 million, or26.4% compared to the prior year, primarily due to:

 

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

 

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

 

•      a$0.4 million increase resulting from the increase in revenue commercialaircraft integration kits and a change in delivery mix to higher marginproducts.

 

**Selling, general and administrative expenses.**  Selling, general and administrative expensesincreased $3.0 million, or 63.2%, to $7.8 million for the three months ended September 30,2004, from $4.8 million for the same period in the prior year.  By segment, SG&A expenses changed asfollows:

 
| ** **          | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|---------------------|------------|------------------------------------|------------|
| **(In millions)**   | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
|                |       |                               |       |   |   |   |
| Cabin Management    |       | $                                  | 1.6        |   | 71.6 | % |
| Systems Integration |       | 0.6                                |       | 49.3 |   |
| Corporate           |       | 0.8                                |       |   |   |
| Total               |       | $                                  | 3.0        |   |   |   |

 

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

 

•      a$1.4 million increase attributable to a change in corporate allocations forinsurance and incentive compensation; and

 

•      $0.2million of program start-up costs related to the interior of a customer’srecently introduced new model aircraft, a portion of which are nonrecurring.

 

30

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*Systems Integration. *SG&A expenses increasedby $0.6 million, or 49.3% compared to the prior year, primarily as a result ofhigher sales and marketing activities associated with the aircraft completionportion of our business and to changes in corporate allocations for insuranceand incentive compensation.

 

*Corporate. *SG&A expenses increasedby $0.8 million compared to the prior year due principally to higher costspursuant to the incentive compensation plan and $0.2 million of restructuringcharges incurred in 2004 related to the reorganization of our manufacturingoperations.

 

**Research and development expenses. **Research and development expenses decreased $0.5 million, or 24.0%, to$1.7 million for the three months ended September 30, 2004 compared to$2.2 million in the prior year.  Bysegment, research and development expenses changed as follows:

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

 

*Cabin Management. *R&D expenses decreased $0.8 million, or 51.6%compared to the prior year.  The decreaseis primarily related to the near completed development of our new single-designseat technology and design of new interior furnishing components for a majorcustomer’s recently introduced new model aircraft.

 

*Systems Integration. *R&D expenses increased$0.3 million, or 42.9% compared to the prior year.  The increase is principally due to theongoing development of our cockpit door video surveillance system for differentmodels of commercial aircraft and a design modification to an existing product.

 

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

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

 

**Adjusted EBITDA. **Wedefine Adjusted EBITDA as earnings, determined using program accounting forproduct development costs, before interest, income taxes, depreciation andamortization, restructuring, asset impairment and other related charges,acquisition related charges not capitalized and other noncash and nonoperatingcharges.  As described above in “—Performance Measures—Adjusted EBITDA,” we usethis financial measure to evaluate the core economic performance of ouroperating segments.  The notes to ourfinancial statements include additional information about Adjusted EBITDA, andshould be read in conjunction with the discussions presented herein.  The notes to our financial statements alsoinclude a reconciliation of Adjusted EBITDA to net income (loss), a GAAP financialmeasure, to clarify the differences between these two measures.

 

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*Cabin Management. *Adjusted EBITDAincreased by $3.8 million, or 96.3%, to $7.7 million for the three months endedSeptember 30, 2004 compared to $3.9 million for the same period in theprior year.  Adjusted EBITDA as a percentof revenues improved to 19.5 % for the three months ended September 30,2004 compared to 13.2% for the same period last year.  The $3.8 million increase is comprised of:

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

**Operating income.**  Operating income increased $0.7 million, or39.0%, to $2.6 million for the three months ended September 30, 2004, from$1.9 million for the same period in the prior year.  By segment, the operating loss changed asfollows:

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

 

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

 

•      a$4.8 million increase in gross profit, primarily due to lower revenues relatedto our furniture and seating operations;

 

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

 

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

 

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

 

•      $1.6million of program start-up costs incurred in 2004, a portion of which arenonrecurring;

 

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

 

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

 

32

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

 

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

 

•      a$0.6 million increase in SG&A spending; and

 

•      a$0.3 million increase in research and development expenses.

 

**Interest expense.**  Interest expense increased $3.1 million, or46.0%, to $9.6 million for the three months ended September 30, 2004compared to $6.5 million for the same period in the prior year.  The increase is attributable to:

 

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

 

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

 

•      a$0.2 million increase in other interest expense; offset by

 

•      a$0.8 million decrease in our first-lien interest expense due to lower principalbalances outstanding resulting from the repayment with the proceeds from our second-liendebt financing in December 2003, offset, in part, by a 1.5% increase ininterest rate margins charged by our lenders based on our consolidated debtleverage ratio.

 

**Mandatorilyredeemable preferred stock dividends. **Dividendson our 16% mandatorily redeemable preferred stock totaled $0.5 million for thethree months ended September 30, 2004. As more fully described in “—Changes in Accounting Principles” above,effective January 1, 2004 we adopted SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity.”  As a result of adopting SFAS No. 150, the 16%quarterly preferred stock dividends are reflected as a charge against pre-taxincome.  In periods prior to January 1,2004, preferred stock dividends were deducted in arriving at the net income orloss applicable to our common stockholder and amounted to $1.6 million for thethree months ended September 30, 2003. The $1.1 million decrease in dividends between the periods is a resultof an amendment to the terms of the preferred stock.

 

Duringthe third quarter of fiscal 2004, the terms of the 16% preferred stock wereamended to provide that further preferred stock dividends, if any, accrue atrates dependent on a specified financial ratio or if certain triggering eventsoccur.  Future preferred stock dividends,if any, are dependent, in part, upon a defined leverage ratio achieved as ofeach quarterly testing date.  Dependingon the ratio achieved, and provided certain triggering events have notoccurred, dividends for the succeeding quarter accrue at a 0%, 4% or 16% annualrate.  If certain triggering eventsoccur, dividends accrue at a 16% annual rate. Based upon the leverage ratio achieved as of September 30, 2004, nodividends will accrue on the preferred stock from the amendment date through December 31,2004.  See “—Liquidity and Capital Resources–Debt and Preferred Stock Restructuring” for additional information.

 

**Loss on debt and preferred stock restructuring. **The loss on debt and preferred stock restructuring of $3.9 million forthe three months ended September 30, 2004 reflects the write-off ofdeferred financing costs attributable to the $65.0 million of 12% seniorsubordinated notes exchanged for 17% senior discount notes and the write-off ofthe remaining unamortized original issuance discount related to our 16% preferredstock.  See “—Liquidity andCapital Resources–Debt and PreferredStock Restructuring” for additional information.

 

33

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

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

 

Forthe three months ended September 30, 2003, the provision for income taxes,based on the reported consolidated pre-tax loss, differs from the amountdetermined by applying the applicable U.S. statutory federal rate to thepre-tax loss primarily due to the effects of state and foreign income taxes andnon-deductible expenses, principally the non-deductible portion of goodwillimpairment charges.

 

Forthe three months ended September 30, 2004, the provision for income taxes,based on the reported consolidated pre-tax loss, differs from the amountdetermined by applying the applicable U.S. statutory federal rate to thepre-tax loss primarily due to the effects of state and foreign income taxes andnon-deductible expenses, principally mandatorily redeemable preferred stockdividends due to the adoption of SFAS No. 150 effective January 1, 2004,as described above.

 

Asmore fully described in Note 11 to the audited financial statements included inour 2003 Form 10-K, there were net deferred tax asset of $19.5 million fullyoffset by a valuation allowance of the same amount as of December 31,2003.  Based upon the results ofoperations for the nine months ended September 30, 2004, we determinedthat an additional $14.4 million valuation allowance was required as of thatdate, $5.5 million of which is applicable to the three-month period.

 

**Loss fromcontinuing operations and net loss.**  The loss from continuing operations and netloss increased $6.5 million to a loss of $11.5 million for the three monthsended September 30, 2004 compared to a loss of $5.0 million for the sameperiod in the prior year, primarily due to:

 

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

 

•      a$3.0 million increase in interest and other expenses (net); and

 

•      $0.5million of preferred stock dividends resulting from the adoption of SFAS No.150, “Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity” as described above; offset by

 

•      a$0.7 million increase in operating income; and

 

•      a$0.1 million decrease in income tax expense.

 

**Net loss applicable to common stockholder.**  Net loss applicable to DeCrane Holdings, ourcommon stockholder, increased $4.8 million to a net loss of $11.5 million forthe three months ended September 30, 2004 compared to a net loss of $6.7million for the same period in the prior year. The increase in the net loss applicable to our common stockholder isattributable to:

 

•      a$6.5 million increase in our net loss; offset by

 

•      a$1.7 million decrease in preferred stock dividends and redemption valueaccretion resulting from the January 1, 2004 adoption of SFAS No. 150which requires preferred stock dividends be deducted from the net income orloss for the period.

 

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

 

34

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

 

Cabin Management’sbookings and backlog increase is a result of the increase in our customers’aircraft production schedules during the period.  Systems Integration’s bookings and backlog increaseis a result of booking an order for an aircraft completion during the quarteras well as an increase in orders for our cockpit door video surveillancesystem.

 

### **Nine months ended September** 30, 2004 Compared to Nine monthsended September 30, 2003

### ** **

**Revenues.* ***Revenuesincreased $23.8 million, or 18.2%, to $154.1 million for the nine months ended September 30,2004 from $130.3 million for the nine months ended September 30,2003.  By segment, revenues changed asfollows:

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

 

*Cabin Management. *Revenuesincreased by $24.8 million, or 27.6% compared to the prior year due to a highervolume of business, VIP and head-of-state jet production by aircraftmanufacturers.  The increase consisted ofthe following:

 

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

 

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

 

•      a$3.0 million increase in seating products revenues; offset by

 

•      a$1.9 million decrease in other product and services revenues.

 

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

 

•      a$6.2 million increase in completion and service center revenues; and

 

•      a$2.3 million increase in revenues from integration kits and related servicesfor commercial aircraft; offset by

 

•      a$7.0 million decrease resulting from lower production of auxiliary fuel systemspursuant to our supply contract with BBJ.

 

35

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BBJ has exercised its option to convert the supplycontract to a “requirements” contract, from a guaranteed “take-or-pay”contract, commencing January 1, 2005.  Production under the “take-or-pay” portion ofthe contract for 2004 is complete and no new orders have been placed pursuantto the new “requirements” contract. Based upon the number of auxiliary fuel systems BBJ has in itsinventory, we believe we may not receive any orders for additional systemsuntil fiscal 2005.  During the ninemonths ended September 30, 2004, auxiliary fuel systems revenues were$12.7 million compared to $19.7 million for the same period last year.  During the year ended December 31, 2003,BBJ auxiliary fuel systems provided approximately $26.4 million, or 15.5%, ofour consolidated revenues.

 

**Gross profit.**  Gross profit increased $4.1 million, or14.4%, to $32.3 million for the nine months ended September 30, 2004 from$28.2 million for the same period in the prior year.  By segment, gross profit changed as follows:

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

 

*Cabin Management.*  Gross profit increased by $12.3 million, or96.6% compared to the prior year, primarily due to:

 

•      a$5.7 million increase related to higher volume in aircraft furniture andrelated products revenues;

 

•      a$5.7 million decrease in restructuring charges incurred in 2004 compared tothose incurred during the same period in 2003 related to our furniture andseating operations;

 

•      a$2.2 million increase in gross profit related to higher volume for our cabinmanagement and entertainment systems; and

 

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

 

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

 

*Systems Integration.*  Gross profit decreased by $8.2 million, or53.4% compared to the prior year, primarily due to:

 

•      $5.3million of restructuring charges incurred in 2004 related to the reorganizationof our manufacturing operations;

 

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

 

•      a$0.3 million decrease resulting from the change in product delivery mix; offsetby

 

•      a$1.0 million increase resulting from the increase in revenues from integrationkits and related services for commercial aircraft.

 

**Selling, general and administrative expenses.**  Selling, general and administrative expenses increased$1.1 million, or 5.3%, to $22.8 million for the nine months ended September 30,2004, from $21.7 million for the same period in the prior year.  By segment, SG&A expenses changed asfollows:

 

36

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

 

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

 

•      a$1.1 million increase in SG&A spending in support of higher productionlevels and new programs;

 

•      a$0.3 million increase in restructuring charges incurred in 2004 versus the sameperiod last year;

 

•      a$0.3 million increase attributable to a change in corporate allocations forinsurance and incentive compensation; and

 

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

 

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

 

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

 

•      a$0.5 million decrease resulting from cost reduction measures;

 

•      a$0.4 million decrease in insurance expense resulting from higher allocations tothe operating groups; offset by

 

•      $0.2million of 2004 restructuring charges.

 

**Research and development expenses. **Research and development expenses decreased $1.2 million, or 17.0%, to$5.9 million for the nine months ended September 30, 2004 compared to $7.1million in the prior year.  Bysegment, research and development expenses changed as follows:

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

 

*Cabin Management. *R&D expenses decreased $2.4 million, or 39.9%compared to the prior year.  The decreaseis primarily related to the near completed development of our new single-designseat technology and the design and engineering of new interior furnishingcomponents for a major customer’s recently introduced new model aircraft.

 

*Systems Integration. *R&D expenses increased$1.2 million, or 122.9% compared to the prior year.  The increase is principally due to theongoing development of our cockpit door video surveillance system for differentmodels of commercial aircraft and a design modification to an existing product.

 

37

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**Depreciation and amortization of intangibles.**  Depreciation and amortization expensedecreased $0.6 million to $6.8 million for the nine months ended September 30,2004 from $7.4 million for the same period in the prior year.  The decline is attributable to reducedcapital expenditures and a lower depreciable base resulting from restructuringcharges.  Depreciation and amortizationchanged as follows:

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

 

**Adjusted EBITDA. **Wedefine Adjusted EBITDA as earnings, determined using program accounting forproduct development costs, before interest, income taxes, depreciation andamortization, restructuring, asset impairment and other related charges,acquisition related charges not capitalized and other noncash and nonoperatingcharges.  As described above in “—Performance Measures—Adjusted EBITDA,” we usethis financial measure to evaluate the core economic performance of ouroperating segments.  The notes to ourfinancial statements include additional information about Adjusted EBITDA, andshould be read in conjunction with the discussions presented herein.  The notes to our financial statements alsoinclude a reconciliation of Adjusted EBITDA to net income (loss), a GAAPfinancial measure, to clarify the differences between these two measures.

 

*Cabin Management. *Adjusted EBITDAincreased by $4.5 million, or 35.5%, to $17.3 million for the nine months endedSeptember 30, 2004 compared to $12.8 million for the same period in theprior year.  Adjusted EBITDA as a percentof revenues improved to 15.1 % for the nine months ended September 30,2004 compared to 14.2% for the same period last year.  The $4.5 million increase is comprised of:

 

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

 

•      a$1.0 million increase from improved margins which result, in part, from fixedcosts being absorbed over a higher revenue base.

 

Our furniture and seating operations contributed $3.3million of the increase and our cabin management and entertainment systemscontributed $1.2 million of the increase.

 

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

 

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

 

•      a$0.4 million increase resulting from a 3.6% revenue increase.

 

The decline in margin is attributable to a change inproduct delivery mix, principally resulting from auxiliary fuel systemsrevenues being replaced with revenues from lower margin products and services.  A $3.7 million decline in auxiliary fueltank, service center and aircraft completion margins was partially offset by a$0.9 million increase in the margins for integration kits and related servicesfor commercial aircraft.

 

38

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**Impairment of goodwill.  **During the nine months ended September 30, 2003, a $34.0 millioncharge was recorded to reflect the impairment of goodwill in connection withthe impairment testing provision of SFAS No. 142, “Goodwill and OtherIntangible Assets.”  See “—Restructuring,Asset Impairment and Other Related Charges.”

 

**Operating income (loss).**  Operating income increased $38.1 million, or102.2%, to income of $0.8 million for the nine months ended September 30,2004, compared to a loss of $37.3 million for the same period in the prioryear.  By segment, the operating losschanged as follows:

 
| ** **          | ** ** | **Increase (Decrease)  From 2003** | ** ** |
|---------------------|------------|------------------------------------|------------|
| **(In millions)**   | ** ** | **Amount**                         | ** ** | **Percent** | ** ** |
|                |       |                               |       |   |   |   |
| Cabin Management    |       | $                                  | 46.8       |   | 119.3 | % |
| Systems Integration |       | (9.3                               | )          | (131.6 | ) |
| Corporate           |       | 0.6                                |       |   |   |
| Total               |       | $                                  | 38.1       |   |   |   |

 

*Cabin Management. *Theoperating income increased by $46.8 million, or 119.3% compared to the prioryear, primarily due to:

 

•      a$34.0 million decrease in impairment charges;

 

•      a$5.7 million increase in gross profit, primarily due to lower revenues relatedto our furniture and seating operations;

 

•      a$5.4 million decrease in restructuring charges incurred in 2004 as compared to2003;

 

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

 

•      a$2.2 million increase in gross profit related to higher volume for our cabinmanagement and entertainment systems; offset by

 

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

 

•      a$1.6 million increase in SG&A spending.

 

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

 

•      $5.4million of restructuring charges incurred in 2004;

 

•      a$4.3 million decrease resulting from reduced gross profit; and

 

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

 

•      anet $1.5 million increase resulting from the conversion of a major customersupply contract to a requirements-only contract;

 

•      a$0.1 million decrease in SG&A spending.

 

**Interest expense.**  Interest expense increased $8.1 million, or43.0%, to $27.0 million for the nine months ended September 30, 2004compared to $18.9 million for the same period in the prior year.  The increase is attributable to:

 

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

 

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

 

•      a$0.5 million increase in other interest expense; offset by

 

39

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•      a$2.0 million decrease in our first-lien interest expense due to lower principalbalances outstanding resulting from the repayment with the proceeds from our second-liendebt financing in December 2003, offset, in part, by a 1.5% increase ininterest rate margins charged by our lenders based on our consolidated debtleverage ratio.

 

**Mandatorilyredeemable preferred stock dividends. **Dividendson our 16% mandatorily redeemable preferred stock totaled $4.0 million for thenine months ended September 30, 2004. As more fully described in “—Changes in Accounting Principles” above,effective January 1, 2004 we adopted SFAS No. 150, “Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity.”  As a result of adopting SFAS No. 150, the 16%quarterly preferred stock dividends are reflected as a charge against pre-taxincome.  In periods prior to January 1,2004, preferred stock dividends were deducted in arriving at the net income orloss applicable to our common stockholder and amounted to $4.6 million for thenine months ended September 30, 2003. The $0.6 million decrease in dividends between the periods is a resultof an amendment to the terms of the preferred stock.

 

Duringthe third quarter of fiscal 2004, the terms of the 16% preferred stock wereamended to provide that further preferred stock dividends, if any, accrue atrates dependent on a specified financial ratio or if certain triggering eventsoccur.  Future preferred stock dividends,if any, are dependent, in part, upon a defined leverage ratio achieved as ofeach quarterly testing date.  Dependingon the ratio achieved, and provided certain triggering events have notoccurred, dividends for the succeeding quarter accrue at a 0%, 4% or 16% annualrate.  If certain triggering eventsoccur, dividends accrue at a 16% annual rate. Based upon the leverage ratio achieved as of September 30, 2004, nodividends will accrue on the preferred stock from the amendment date through December 31,2004.  See “—Liquidity and Capital Resources–Debt and Preferred Stock Restructuring” for additional information.

 

**Loss on debt and preferred stock restructuring. **The loss on debt and preferred stock restructuring of $3.9 million forthe nine months ended September 30, 2004 reflects the write-off ofdeferred financing costs attributable to the $65.0 million of 12% seniorsubordinated notes exchanged for 17% senior discount notes and the write-off ofthe remaining unamortized original issuance discount related to our 16%preferred stock.  See “—Liquidityand Capital Resources–Debt andPreferred Stock Restructuring” for additional information.

 

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

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

 

Forthe nine months ended September 30, 2003, the provision for income taxes,based on the reported consolidated pre-tax loss, differs from the amountdetermined by applying the applicable U.S. statutory federal rate to thepre-tax loss primarily due to the effects of state and foreign income taxes andnon-deductible expenses, principally the non-deductible portion of goodwillimpairment charges.

 

Forthe nine months ended September 30, 2004, the provision for income taxes,based on the reported consolidated pre-tax loss, differs from the amountdetermined by applying the applicable U.S. statutory federal rate to thepre-tax loss primarily due to the effects of state and foreign income taxes andnon-deductible expenses, principally mandatorily redeemable preferred stockdividends due to the adoption of SFAS No. 150 effective January 1, 2004,as described above.

 

40

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Asmore fully described in Note 11 to the audited financial statements included inthe Company’s 2003 Form 10-K, there were net deferred tax asset of $19.5million fully offset by a valuation allowance of the same amount as of December 31,2003.  Based upon the results ofoperations for the nine months ended September 30, 2004, we determinedthat an additional $14.4 million valuation allowance was required as of thatdate.

 

**Loss fromcontinuing operations.** The loss from continuing operations decreased $12.1 million to a loss of$34.5 million for the nine months ended September 30, 2004 compared to aloss of $46.6 million for the same period in the prior year, primarily due to:

 

•      a$38.1 million operating income increase; offset by

 

•      a$10.6 million decrease in income tax benefit;

 

•      a$7.5 million increase in interest and other expenses (net);

 

•      $4.0million of preferred stock dividends resulting from the adoption of SFAS No.150, “Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity” as described above; and

 

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

 

**Loss fromdiscontinued operations. **Theloss from discontinued operations was $5.6 million for the nine months ended September 30,2003 and reflects the results of operations of our Specialty Avionics Group forthe period from January 1, 2003 through May 22, 2003, the date on which itwas sold.

 

**Cumulativeeffect of change in accounting principle.**  As more fully described in “—Changes inAccounting Principles” above, the $13.8 million charge in 2003 was to reflectthe cumulative effect of the change in accounting for product development costsas of January 1, 2003.

 

**Net loss.** Net loss decreased $31.5 million to a net loss of $34.5 million for thenine months ended September 30, 2004 compared to a net loss of $66.0million for the same period in the prior year. The decrease is attributable to:

 

•      adecrease in cumulative effect of change in accounting principle of $13.8million;

 

•      adecrease in loss from continuing operations of $12.1 million; and

 

•      adecrease in the loss from discontinued operations of $5.6 million.

 

**Net loss applicable to common stockholder.**  Net loss applicable to DeCrane Holdings, ourcommon stockholder, decreased $36.5 million to a net loss of $34.5 million forthe nine months ended September 30, 2004 compared to a net loss of $71.0million for the same period in the prior year. The decrease in the net loss applicable to our common stockholder isattributable to:

 

•      a$31.5 million decrease in our net loss; and

 

•      a$5.0 million decrease in preferred stock dividends and redemption valueaccretion resulting from the January 1, 2004 adoption of SFAS No. 150which requires preferred stock dividends be deducted from the net income orloss for the period.

 

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

 

41

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

 

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

 

**Restructuring**,Asset Impairment and Other Related Charges

** **

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

 

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

 

42

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**Operational Realignment and FacilitiesRestructuring**

 

Duringthe second quarter of fiscal 2004, we adopted plans to restructure theoperations of our Cabin Management and Systems Integration groups.  The restructuring plan for Cabin Managementinvolves the realignment of production between its manufacturing facilities andthe relocation and consolidation of the group’s headquarters to Wichita,Kansas.  The plan for Systems Integrationinvolves combining the manufacturing activities of two facilities into a singlefacility and eliminating some product offerings and service capabilitiesresulting in a partial downsizing of certain operations.  These actions are designed to reduceengineering, production and inventory carrying costs by supporting fewermanufacturing locations and product offerings. In connection with these actions, we recorded pre-tax charges tooperations totaling $7.3 million during the second and third quarters of fiscal2004, of which $3.1 million were noncash charges.

 

Thecharges are comprised of the write-down of surplus inventory, lease terminationand related charges, and severance and other compensation costs.  We also expect to incur additionalrestructuring-related expenses of approximately $1.6 million during the fourthquarter of fiscal 2004 to complete the restructuring plans.  These expenses, which are primarilyrelocation and travel costs, will be expensed as incurred.  Future cash payments, which will aggregateapproximately $5.1 million through 2013 because of lease termination costs, willbe funded from existing cash balances and internally generated cash fromoperations.

 

**Seating Product Line and Furniture ManufacturingFacilities Restructuring**

 

Duringthe second quarter of fiscal 2003, we consolidated our seating product lineofferings and adopted a restructuring plan to down-size a furnituremanufacturing facility in response to continuing weakness in the business, VIPand head-of-state aircraft market.  Theseactions were designed to reduce engineering, production and inventory carryingcosts by supporting fewer product offerings and achieve profitability at thefurniture manufacturing facility based on its lower production levels.  In connection with these actions, we recordedpre-tax charges to operations totaling $7.1 million during the second quarterof fiscal 2003, of which $3.6 million were noncash charges.  The charges are comprised of the write-off ofexcess and obsolete inventory costs related to the discontinued product offerings,lease termination and related charges, and severance and other compensationcosts.  These restructuring activitieswere completed by the end of fiscal 2003.

 

**Goodwill Impairment Charges**

** **

As aresult of the weakness in the business, VIP and head-of-state aircraft market in2003 and the decision to down-size a furniture manufacturing facility, thegoodwill associated with the furniture manufacturing reporting unit was testedfor recoverability in June 2003 and found to be impaired.  As a result, $34.0 million of goodwillassociated with the reporting unit was written off and charged to operationsduring the three months ended June 30, 2003.

 

In March 2003,we entered into a definitive agreement to sell our equity interests in thesubsidiaries comprising the Specialty Avionics Group for $140.0 million incash.  Based upon the fair value of thegroup implied in the definitive agreement, we determined that the carryingvalue of the group’s net assets was not fully recoverable.  As a result, we recorded a goodwillimpairment charge of $7.5 million during the three months ended March 31, 2003to reduce the carrying value to estimated net realizable value.

 

43

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**Liquidityand Capital Resources**

** **

Ourprincipal cash needs are for debt service, working capital, capitalexpenditures and possible strategic acquisitions, as well as to provide DeCraneHoldings with cash to finance its needs, which consists primarily of fundingits preferred stock redemption and accrued dividend payment obligations on September 30,2009.  Our principal sources of liquidityare expected to be cash flow from operations, potential capital markettransactions and third party borrowings, principally under our first-liencredit facility.

 

**Cash Flows During the Nine months ended September 30,2004**

** **

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

 

•      a$15.6 million increase in inventory commensurate with higher revenues and orderbacklog; and

 

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

 

•      a$2.2 million increase in accounts payable, accrued expenses and income taxespayable.

 

The $2.8 million increase in other liabilities isprincipally a result of accruing lease termination costs in connection with our2004 operation realignment and facilities restructuring.

 

Net cash used for investing activities consisted ofcapital expenditures of $2.7 million for the nine months ended September 30,2004.  We anticipate spendingapproximately $3.0 to $5.0 million for capital expenditures in 2004.

 

Net cash provided by financing activities was $19.8million for the nine months ended September 30, 2004 and consisted of:

 

•      $17.8million of net borrowings under our revolving line of credit;

 

•      $5.0million of proceeds from the issuance of 13.5% senior unsecured promissorynotes; offset by

 

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

 

•      $2.1million of financing costs related to our debt and preferred stockrestructuring.

 

**Debt and Preferred Stock Restructuring**

 

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

 

44

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Concurrentwith the note exchange, we amended the terms of our 16% senior preferredstock.  DeCrane Holdings, our parent,also amended the terms of its 14% preferred stock as well.  The amended terms provide that furtherdividends do not accrue on the preferred stock, except if a leverage ratio (asdefined) falls below certain specified levels or if certain triggering eventsoccur, such as failure to discharge any mandatory redemption obligations orcomply with certain restrictive covenants and the like.  Depending upon the future leverage ratioachieved, and provided that certain triggering events have not occurred, dividendsaccrue at a 0%, 4% or 16% annual rate on the 16% preferred stock and 0%, 3.5%or 14% on the 14% preferred stock.  Ifcertain triggering events occur, dividends accrue at the 16% and 14% annualrates.  Based upon the leverage ratioachieved as of September 30, 2004, no dividends will accrue on either the16% or 14% preferred stock from the amendment dates through December 31,2004.

 

Alldividends accrued through the amendment date and future dividends, if any, arenot payable until redemption.  Theamendment for the 16% preferred stock accelerates the mandatory redemption datefrom March 31, 2009 to December 31, 2008 while the September 30,2009 mandatory redemption date for the 14% preferred stock remainedunchanged.  The amendment to the 16%preferred stock also adds several restrictive covenants.  The holders of the 16% preferred stock wereissued 348,945 shares of DeCrane Holdings common stock in connection with theamendment.

 

**Short-Term Borrowings**

 

In September 2004,we received the proceeds from the issuance of 13.5% senior unsecured promissorynotes in the aggregate principle amount of $5.0 million to DLJ Merchant BankingPartners II, L.P. and affiliated funds, who are also stockholders of DeCraneHoldings and, as a result, related parties (see Note 16 to the auditedfinancial statements included in our 2003 Form 10-K for additional informationon the related party relationship). Unless extended, the notes, plus accrued interest, are due on November 29,2004.  The notes may be extended for upto three thirty-day periods, at the option of the noteholders.  While we believe the noteholders would extendthe notes beyond the current due date if requested, they are under noobligation to do so.  The notes containcovenants identical to those in the new 17% notes.

 

**Future Liquidity Improvements**

 

Wecontinue to explore transactions that would improve our liquidity and reduceour cash needs.  We have not entered intoany commitments to do so and cannot assure you that we will be able to do so inthe future.

 

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

 

**Debt Obligations and Capital Resources as of September 30,2004**

 

As of September 30,2004, first-lien credit facility borrowings and second-lien term debt totaling$108.3 million are at variable interest rates based on defined margins over thecurrent prime rate or LIBOR.  We also had$71.9 million of 15% second-lien term debt, $67.0 million of 17% seniordiscount notes, $35.0 million of 12% subordinated notes, $8.0 million of othersecured indebtedness, and $5.0 million of 13.5% senior unsecured promissorynotes outstanding as of September 30, 2004.  In addition, our 16% mandatorily redeemablepreferred stock, which has characteristics of both a liability and equity, hada $47.3 million mandatorily redemption value as of September 30, 2004.

 

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As of September 30,2004, we had $39.9 million of working capital and $5.9 million of borrowingsavailable under our $24.0 million revolving line of credit, which expires in March 2006.

 

**Financial Condition and Liquidity**

 

Webelieve our expected operating cash flows, together with borrowings under ourfirst-lien credit facility ($5.9 million of which was available as of September 30,2004, the commitment for which expires in March 2006), will be sufficientto meet our operating expenses, working capital requirements, capitalexpenditures and debt service obligations for the next twelve months.  However, our working capital needs generallyincrease as our order backlog and revenues increase, particularly with respectto orders where we must incur development costs and build inventory but we maynot receive full payment until delivery. Any significant delay in payments could increase our working capitalneeds beyond our expectations.  Further,our ability to comply with our debt financial covenants, pay principal orinterest and satisfy such cash obligations will depend on our future operatingperformance as well as competitive, legislative, regulatory, business and otherfactors beyond our control.  Although wecannot be certain, we expect to be in compliance with the revised financialcovenants through the end of the year based on our current operating plan.  See “Special Note Regarding Forward-LookingStatements and Risk Factors.”

 

**Disclosure of Contractual Obligations and Commitments**

 

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

 
| ** **                                      | ** ** | **Years Ending December 31,** | ** ** |
|-------------------------------------------------|------------|------------------------------------|------------|
| **(In millions)**                               | ** ** | **Total**                          | ** ** | **2004** | ** ** | **2005  and  2006** | ** ** | **2007  and  2008** | ** ** | **2009  and  Beyond** | ** ** |
|                                            |       |                               |       |   |   |   |   |   |   |   |   |
| Short-term borrowings:                          |       |                               |       |   |   |   |   |   |   |   |   |
| 13.5% senior unsecured promissory notes (a)     |       | $                                  | 5.0        |   | $ | 5.0 |   | $ | — |   | $ | — |   | $ | — |   |
| Long-term debt (b):                             |       |                               |       |   |   |   |   |   |   |   |   |
| First-lien credit facility (c):                 |       |                               |       |   |   |   |   |   |   |   |   |
| Term debt                                       |       | 80.5                               |       | — |   | 15.0 |   | 65.5 |   | — |   |
| Revolving line of credit                        |       | 17.8                               |       | — |   | 17.8 |   | — |   | — |   |
| Second-lien term debt (d)                       |       | 81.9                               |       | — |   | — |   | 81.9 |   | — |   |
| 17% senior discount notes (e)                   |       | 67.0                               |       | — |   | — |   | 67.0 |   | — |   |
| 12% subordinated notes (f)                      |       | 35.0                               |       | — |   | — |   | 35.0 |   | — |   |
| Capital lease obligations (g)                   |       | 3.1                                |       | 0.2 |   | 0.9 |   | 0.6 |   | 1.4 |   |
| Other indebtedness (g)                          |       | 4.9                                |       | 0.2 |   | 1.7 |   | 0.6 |   | 2.4 |   |
| Total short-term borrowings and long-term debt  |       | 295.2                              |       | 5.4 |   | 35.4 |   | 250.6 |   | 3.8 |   |
| Mandatorily redeemable preferred stock (h)      |       | 47.3                               |       | — |   | — |   | 47.3 |   | — |   |
| Other long-term liabilities                     |       | 8.3                                |       | — |   | 5.5 |   | 2.4 |   | 0.4 |   |
| Operating lease obligations                     |       | 9.8                                |       | 0.7 |   | 3.4 |   | 2.1 |   | 3.6 |   |
| Total obligations as of September 30, 2004 |       | $                                  | 360.6      |   | $ | 6.1 |   | $ | 44.3 |   | $ | 302.4 |   | $ | 7.8 |   |

 

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(a)       Excludes interestof $0.1 million payable at maturity.

 

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

 

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

 

(d)       Thesecond-lien term debt is comprised of $70.0 million of fixed rate debt and$10.0 million of variable rate debt.  Thefixed rate debt bears interest at 15%; 12% payable quarterly in cash and 3%pay-in-kind or “accreted” interest, payable at maturity.  The variable rate debt bears cash interest,at our option, at the prime rate plus 7.5% or LIBOR plus 8.5%, plus 3%pay-in-kind interest payable at maturity. The weighted-average interest rate on all second-lien debt was 14.77% asof September 30, 2004.  All of thesecond-lien debt matures on June 30, 2008, at which time the cash paymentobligation will be $91.7 million, including the 3% pay-in-kind interestobligation.

 

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

 

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

 

(g)       Interest isgenerally payable monthly.

 

(h)       Dividends donot accrue on the preferred stock unless a defined leverage ratio falls belowcertain specified levels as of each quarterly testing date or if certaintriggering events occur.  Depending onthe future leverage ratio achieved, and provided certain triggering events havenot occurred, dividends accrue at a 0%, 4% or 16% annual rate for thesucceeding quarter.  If certaintriggering events occur, such as failure to discharge any mandatory redemptionobligations or comply with certain restrictive covenants and the like,dividends accrue at a 16% annual rate.  Basedon the leverage ratio achieved as of September 30, 2004, no dividends willaccrue on the preferred stock through December 31, 2004.  Future dividends, if any, are not payableuntil redemption.  The mandatoryredemption date is December 31, 2008. Our debt instruments restrict our ability to make payments on ourpreferred stock.

 

**Disclosure About Off-Balance Sheet Commitments andIndemnities**

** **

We area wholly-owned subsidiary of DeCrane Holdings, whose capital structure alsoincludes mandatorily redeemable preferred stock.  Since we are DeCrane Holdings’ only operatingsubsidiary and source of cash, we may be required to fund DeCrane Holdings’redemption obligation in the future, subject to significant limitationscontained in our first-lien credit agreement, second-lien term notes and the seniordiscount notes and subordinated notes indentures.  The DeCrane Holdings preferred stock has atotal redemption value of $77.2 million as of September 30, 2004 and thepreferred stock is mandatorily redeemable on September 30, 2009.

 

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

 

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Inconnection with the sale of the Specialty Avionics Group, we made indemnitiesto the buyer with respect to a number of customary, and certain other specific,representations and warranties.  Ourindemnities with respect to some of these matters are limited in terms ofduration with the maximum of potential future payments capped at $14.0 millionand our indemnities with respect to specified environmental matters will expirenot later than October 2010 and provides for a maximum liability of $5.0million, while others will have no limitations.

 

As of September 30,2004, we also had irrevocable standby letters of credit in the amount of $0.3million issued and outstanding under our first-lien credit facility.

 

**Recent Accounting Pronouncements**

** **

**Accounting Pronouncements Adopted January 1,2004**

 

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

 

**Special Note Regarding Forward-Looking Statements andRisk Factors**

** **

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

 

•      fuelprices and general economic conditions that affect demand for aircraft and airtravel, which in turn affect demand for our products and services;

 

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

 

•      ourreliance on key customers and the adverse effect a significant decline inbusiness from any one of them would have on our business;

 

•      ourreliance on large projects, where unanticipated needs to incur developmentcosts and acquire inventory or delays in payment could increase our workingcapital needs;

 

•      changesin prevailing interest rates and the availability of financing to fund ourplans for continued growth;

 

•      competitionfrom larger companies;

 

•      FederalAviation Administration prescribed standards and licensing requirements, whichapply to many of the products and services we provide;

 

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

 

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

 

•      liabilityand other claims asserted against us that exceeds our insurance coverage;

 

•      theability to attract and retain qualified personnel;

 

•      labordisturbances; and

 

•      changesin operating strategy, or our acquisition and capital expenditure plans.

 

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Someof the more significant factors listed above are further described in our 2003 AnnualReport on Form 10-K and should be read in conjunction with this report.  Changes in such factors could cause ouractual results to differ materially from those contemplated in suchforward-looking statements.  Although webelieve that the expectations reflected in such forward-looking statements arereasonable, we can give no assurance that such expectations will prove to becorrect.  We undertake no obligation torelease publicly any revisions to these forward-looking statements to reflectevents or circumstances after the date hereof or to reflect the occurrence ofunanticipated events.  You should notrely on our forward-looking statements as if they were certainties.

 

**ITEM3**.          QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

** **

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

 

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

 

Marketrisk related to our variable-rate debt is estimated as the potential decreasein pre-tax earnings resulting from an increase in interest rates.  The interest rates applicable tovariable-rate debt are, at our option, based on defined margins over thecurrent prime rate or LIBOR.  As of September 30,2004, the current prime rate was 4.75% and the current LIBOR was 2.12%.  Based on $108.3 million of variable-rate debtoutstanding as of September 30, 2004, a hypothetical one percent rise ininterest rates, to 5.75% for prime rate borrowings and 3.12% for LIBORborrowings, would reduce our pre-tax earnings by $1.1 million annually.

 

Tolimit a portion of our exposure related to rising interest rates, we haveentered into an interest rate swap contract to effectively convert ourvariable-rate industrial revenue bonds to 4.2% fixed-rate debt until maturityin 2008.  The contract is considered tobe a hedge against changes in the amount of future cash flows associated withinterest payments on this portion of our variable-rate debt.  Market risk related to this interest rateswap contract is estimated as the potential higher interest expense we willincur if the variable interest rate decreases below the 4.2% fixed rate.  Based on the $3.0 million of variable-ratedebt converted to fixed-rate debt outstanding as of September 30, 2004, ahypothetical one percent decrease in the variable interest rate to 3.2%, wouldreduce our pre-tax earnings by less than $0.1 million annually.

 

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

 

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

 

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**ForeignCurrency Exchange Rate Risk.** Our foreign customers are located in various parts of the world,primarily Canada, the Far and Middle East and Western Europe, and we have asubsidiary with manufacturing facilities in Mexico.  To limit our foreign currency exchange raterisk related to sales to our customers, orders are almost always valued andsold in U.S. dollars.  We have enteredinto forward foreign exchange contracts in the past, primarily to limitexposure related to foreign inventory procurement and operating costs.  While we have not entered into any suchcontracts since 1998, we may do so in the future depending on the volume ofnon-U.S. dollar denominated transactions and our assessment of future foreignexchange rate trends.

 

**ITEM4**.          CONTROLS AND PROCEDURES

** **

Themanagement of DeCrane Aircraft Holdings, Inc. (the “Company”), under thesupervision and with the participation of the Company’s Chief Executive Officerand Chief Financial Officer, conducted an evaluation of the Company’s “disclosurecontrols and procedures” (as defined in Exchange Act Rules 13a-15(e) or15d-15(e)) as of the end of the period covered by this report.  Based on that evaluation, the Chief ExecutiveOfficer and Chief Financial Officer concluded that the Company’s disclosurecontrols and procedures were effective as of the end of the period covered bythis report.

 

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

 

**PART II****– OTHER INFORMATION**

 

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

 

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

 

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

 

Aspart of our 16% preferred stock restructuring, the preferred stockholders wereissued 348,945 shares of DeCrane Holdings common stock.  No cash proceeds were received from thisissuance.

 

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

 

3.2.1.2         Certificateof Amendment of Certificate of Incorporation of DeCrane AircraftHoldings, Inc. dated July 23, 2004 *

 

4.5.1            DeCraneAircraft Holdings, Inc. 17% Senior Discount Notes Due 2008 (Note No. 1 dated July 23,2004)*

 

4.5.1.1         DeCraneAircraft Holdings, Inc. 17% Senior Discount Notes Due 2008 (Note No. 2 dated September 9,2004)*

 

4.6.2            Certificateof Amendment to Certificate of Designations, Preferences and Rights of 16%Senior Redeemable Exchangeable Preferred Stock Due 2009 (now designated asSenior Redeemable Exchangeable Preferred Stock Due 2008) of DeCrane AircraftHoldings, Inc. dated July 23, 2004 *

 

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4.7.2            AmendmentNo. 2 to the Senior Preferred Stock Registration Rights Agreement dated as of June 30,2000 among DeCrane Aircraft Holdings, Inc. and the holders of Senior PreferredStock dated July 23, 2004 *

 

4.8               Indenturedated July 23, 2004 between DeCrane Aircraft Holdings, Inc. and U.S. BankNational Association for 17% Senior Discount Notes Due 2008 *

 

4.8.1            FirstSupplemental Indenture dated September 9, 2004 between DeCrane AircraftHoldings, Inc. and U.S. Bank National Association for 17% Senior Discount NotesDue 2008 *

 

10.2.1          AmendmentNo. 1 to the Amended and Restated Investors’ Agreement dated as of October 6,2000 by and among DeCrane Holdings Co., DeCrane Aircraft Holdings, Inc. and thestockholders named therein dated December 31, 2001 *

 

10.2.2          AmendmentNo. 2 to the Amended and Restated Investors’ Agreement dated as October 6,2000 by and among DeCrane Holdings Co., DeCrane Aircraft Holdings, Inc. and thestockholders named therein dated July 23, 2004 *

 

10.10.8        FifthAmendment to the Third Amended and Restated Credit Agreement dated as of June 9,2004 among DeCrane Aircraft Holdings, Inc., the lenders listed therein andCredit Suisse First Boston, acting through its Cayman Islands Branch (successorto DLJ Capital Funding, Inc.), as syndication agent and administrative agentfor the lenders *

 

10.10.9        SixthAmendment to the Third Amended and Restated Credit Agreement dated as of July 16,2004 among DeCrane Aircraft Holdings, Inc., the lenders listed therein andCredit Suisse First Boston, acting through its Cayman Islands Branch (successorto DLJ Capital Funding, Inc.), as syndication agent and administrative agentfor the lenders *

 

10.12.1        FirstAmendment to the Credit Agreement dated as of December 22, 2003 amongDeCrane Aircraft Holdings, Inc., the lenders listed therein and Credit SuisseFirst Boston, acting through its Cayman Islands Branch (successor to DLJCapital Funding, Inc.), as syndication agent and administrative agent for thelenders dated June 9, 2004 *

 

10.12.2        SecondAmendment to the Credit Agreement dated as of December 22, 2003 amongDeCrane Aircraft Holdings, Inc., the lenders listed therein and Credit SuisseFirst Boston, acting through its Cayman Islands Branch (successor to DLJCapital Funding, Inc.), as syndication agent and administrative agent for thelenders dated July 16, 2004 *

 

10.13           ExchangeAgreement dated as of July 23, 2004, among DeCrane Aircraft Holdings,Inc., the affiliates of DeCrane Aircraft set forth on the signature pageshereto as Guarantors, and certain holders of DeCrane Aircraft’s 12% SeniorSubordinated Notes due 2008 (the “Old Notes”) set forth on the signature pageshereto *

 

10.13.1        ExchangeAgreement dated as of September 9, 2004, among DeCrane Aircraft Holdings,Inc., the affiliates of DeCrane Aircraft set forth on the signature pageshereto as Guarantors, and certain holders of DeCrane Aircraft’s 12% SeniorSubordinated Notes due 2008 (the “Old Notes”) set forth on the signature pageshereto *

 

10.14           16%Senior Preferred Stock Amendment Agreement dated as of July 23, 2004,among DeCrane Aircraft Holdings, Inc., DeCrane Holdings Co., and the otherpersons set forth on the signature pages hereto *

 

21.1             List ofSubsidiaries of Registrant *

 

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31.1             ChiefExecutive Officer Certification Pursuant to Section 302 of theSarbanes-Oxley Act of 2002 *

 

31.2             ChiefFinancial Officer Certification Pursuant to Section 302 of theSarbanes-Oxley Act of 2002 *

 

32                ChiefExecutive Officer and Chief Financial Officer Certifications Pursuant to Pursuantto Section 906 of the Sarbanes-Oxley Act of 2002 *

 

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*                  Filedherewith

 

**SIGNATURES**

 

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

 

 
|                   | **DECRANE AIRCRAFT HOLDINGS, INC.  (Registrant)** |
|------------------------|---------------------------------------------------|
|                   |                                              |   |
|                   |                                              |   |
|                   |                                              |   |
| November 12, 2004 | By:                                               | /s/ RICHARD J. KAPLAN |   |
|                   | Name:                                             | Richard J. Kaplan |
|                   | Title:                                            | Senior Vice President, Chief Financial Officer,  Secretary, Treasurer and Director |

 

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