UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003

 

COMMISSION FILE NUMBER 000-22371

 

 

DECRANE AIRCRAFT HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

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

 

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: Nil

 

The number of shares of Common Stock outstanding on March 25, 2004 was 100.

 

DOCUMENTS INCORPORATED BY REFERENCE:

 

None.

 

 

Table of Contents

 

Part I
Item 1.		Business
Item 2.		Properties
Item 3.		Legal Proceedings
Item 4.		Submission of Matters to a Vote of Security Holders
Part II
Item 5.		Market for Registrant’s Common Equity and Related Stockholder Matters
Item 6.		Selected Financial Data
Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.		Quantitative and Qualitative Disclosures About Market Risk
Item 8.		Financial Statements and Supplementary Data
Item 9.		Changes In and Disagreements With Accountants On Accounting and Financial Disclosure
Item 9A.		Controls and Procedures
Part III
Item 10.		Directors and Executive Officers of the Registrant
Item 11.		Executive Compensation
Item 12.		Security Ownership of Certain Beneficial Owners and Management
Item 13.		Certain Relationships and Related Transactions
Item 14.		Principal Accounting Fees and Services
Part IV
Item 15.		Exhibits, Financial Statement Schedules, and Reports on Form 8-K
Signatures
Index to Financial Statements and Financial Statement Schedules

 

 

All statements other than statements of historical facts included in this report are considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements are subject to known and unknown risks, uncertainties and other factors, which are difficult to predict.  Changes in such factors could cause actual results to differ materially from those contemplated in such forward-looking statements as we describe in “Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations—Forward-Looking Statements and Risk Factors.”  Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct.  We undertake no obligation to release publicly any revisions to these forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

 

PART I

ITEM 1.                                         BUSINESS

Company Overview

 

DeCrane Aircraft Holdings, Inc., a Delaware corporation founded in 1989, is a provider of integrated assemblies, sub-assemblies and component parts to the aerospace industry.  Since our founding in 1989, we have experienced both internal growth and external growth by identifying fragmented, high-growth niche segments within the aerospace industry and acquiring market-leading companies in those niches.  Today, we have product capability within two specific segments of the aerospace industry: cabin interiors for business, VIP and head-of-state aircraft and systems integration services, including auxiliary fuel tanks, retrofit and aircraft completion services.  Within these markets, our customers include original manufacturers of business, VIP and head-of-state aircraft, commonly referred to as OEM’s, and aircraft repair and modification centers.

 

Our Operating Groups

 

We are organized into two operating groups, consistent with the segments in which we operate: Cabin Management and Systems Integration.  Through our operating groups, we offer a complete line of cabinetry, galleys, seating and cabin management systems for business, VIP and head-of-state aircraft, as well as systems integration services.

 

During the first five months of 2003, we also had a third strategic business, the Specialty Avionics Group.  As described in “Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included in this report, we sold our equity interests in the companies comprising this group on May 23, 2003.  As a result of the sale, the Specialty Avionics Group is presented as a discontinued operation in our consolidated financial statements for all periods and our discussion below reflects only our continuing operations.

 

Cabin Management Group

 

DeCrane’s Cabin Management Group contributed approximately 70% of our revenues from continuing operations for the year ended December 31, 2003.

 

1

 

Business Description

 

Our Cabin Management Group is a leading independent provider of cabin products, with a primary focus on serving the business, VIP and head-of-state aircraft market.  Since 1997, our Cabin Management Group has acquired nine companies involved in the engineering, manufacturing and assembly of the key components for the interior of a business, VIP and head-of-state aircraft, including cabin interior furnishings, veneer, cabin management systems, seating and composite components.  Our Cabin Management Group serves major manufacturers of business, VIP and head-of-state aircraft, including Boeing Business Jet, Bombardier, Cessna, Dassault, Gulfstream and Raytheon.

 

The Cabin Management Group introduced the concept of modularity to the business, VIP and head-of-state aircraft market by offering totally integrated interior products.  In our view, one of the greatest challenges facing the industry’s aircraft manufacturers is minimizing the production cycle time necessary to complete an unfinished “green” aircraft.  We believe our distinctive approach of delivering integrated assemblies and sub-assemblies addresses this challenge by providing our customers with entire pre-engineered, pre-wired and pre-plumbed modular cabin interiors and management systems ready for final integration into the aircraft.  We believe our totally integrated interior products enable our customers to reduce their lead times, supplier base and overall costs.

 

The Cabin Management Group is guided by our overall strategy to gain market leadership positions in high-growth segments of the aerospace industry by building more related product capabilities than any other company in the industry.  To that end, our Cabin Management Group has focused on pursuing two, closely related, strategic imperatives:

 

•                  Building Critical Mass in Cabin Interior Furnishings, Cabin Management Systems and Seating for the Business, VIP and Head-of-State Aircraft Markets.  Our Cabin Management Group is aggressively focused on broadening and deepening its product offerings to the business, VIP and head-of-state aircraft markets.  As a result of this strategy, we have increased revenue content per plane with our existing customer base and have successfully attracted new customers.

 

•                  Developing Capabilities to Provide Modular “Total Cabin Solutions” to the Business, VIP and Head-of-State Aircraft Market.  Consistent with our overall corporate strategy to build integrated system solutions, the Cabin Management Group is focused on aggregating its capabilities to provide partial or fully assembled modular business, VIP and head-of-state aircraft cabin interiors to its customers.

 

In order to meet these strategic objectives, we have aggressively pursued growth in our Cabin Management Group through selective acquisitions.

 

Products and Services

 

Our Cabin Management Group designs, engineers and manufactures a full line of customized, pre-fit products and provides related services.  Approximately 39% of our Cabin Management Group’s revenues in 2003 were from two customers, Textron and Bombardier.  Our products and services are in four broad categories, as summarized below.

 

2

 

Interior Furnishings

•      entertainment and refreshment centers

•      conference tables

•      hi-low dining and coffee tables

•      end tables

•      cabinets

•      arm and side ledges

•      galleys

•      lavatories

•      vanities

•      room enclosures

•      cabinetry refurbishment services

•      veneers

 

Seating

•      executive track and swivel seats

•      jump-seats

•      divans, including models that convert to beds or contain storable tables

•      upholstery services

 

Cabin Management Systems

•      in-flight entertainment systems

•      in-flight data network and communication systems

•      cabin controls

•      switches, controls and lighting

 

Composite Components

•      sound-dampening side walls and headliners

•      environmental (HVAC) ducting

•      passenger service units

•      closets

 

Our interior furnishings products and services provided approximately 36% of our consolidated revenues during 2003 and 47% of our consolidated revenues during 2002 and 2001.  Seating provided approximately 13% of our consolidated revenues during 2003 and 10% of our consolidated revenues during 2002 and 2001.  The decrease in interior furnishings products and services is primarily caused by lower revenues from our major customers, Textron and Bombardier, as described in “—Customers” below.

 

Competition

 

The markets served by our Cabin Management Group are fragmented, with several competitors offering similar products and services.  Due to the global nature of the aerospace industry, competition comes from both U.S. and foreign companies.  Our Cabin Management Group generally faces competition from a group of smaller companies and enterprises, except for the business, VIP and head-of-state aircraft manufacturers and independent completion centers.  We believe that the principal competitive factors in the markets we serve are quality, price, timely deliveries and overall customer service.  Our principal competitors are summarized below.

 

Interior Furnishings

•      BE Aerospace

•      C & D Interiors

•      Global Technology

•      Hiller Aircraft

•      The Nordam Group

•      Independent completion centers

•      Business, VIP and head-of-state aircraft manufacturers and completion centers

 

Seating

•      BE Aerospace

•      Fisher (Germany)

•      IPECO

 

Cabin Management Systems

•      DPI Labs

•      Honeywell Cabin Management Systems and Services

•      IEC, International

•      Rockwell Collins / Airshow

 

Composite Components

•      AAR

•      Fibre Art

•      Plastic Fab

•      Scale Composite Works

•      The Nordam Group

3

 

Systems Integration Group

 

DeCrane’s Systems Integration Group contributed approximately 30% of our revenues from continuing operations for the year ended December 31, 2003.

 

Business Description

 

Our Systems Integration Group provides a range of aircraft retrofit, completion and refurbishment services, from conceptual design to Federal Aviation Administration certification, including engineering, manufacturing and installation.  One of our largest businesses in this group is the design, production and installation of auxiliary fuel systems, which extend the range of an aircraft.  We are presently the sole-source provider of auxiliary fuel systems to Boeing Business Jet (“BBJ”) for its BBJ, a Boeing 737-700IGW, and the BBJ2, a Boeing 737-800, and are one of only four world-wide approved BBJ/BBJ2 service centers.  During 2003, we delivered our second aircraft interior completion on a BBJ aircraft.

 

We also focus on regulatory authority safety mandates and believe we are the major supplier of integration kits for smoke detection and fire suppression in the cargo hold, and perform structural, avionics and mechanical systems modifications, including FAA certification of those modifications before returning an aircraft to service.

 

The aerospace industry is highly regulated in the United States by the FAA and similar regulatory agencies abroad, such as the European Joint Aviation Authorities (commonly referred to as the JAA), to ensure that aviation products and services meet stringent safety and performance standards.  There are approximately 35 companies world-wide that have the necessary Designated Alteration Station authorization to offer aircraft certification on behalf of the FAA.  Two companies within our Systems Integration Group are authorized to provide the full spectrum of services, from design to FAA certification, needed for timely retrofitting of an aircraft, thus providing a significant competitive advantage.

 

Our Systems Integration Group has adopted a two-pronged strategic approach to managing its operations:

 

•                  Develop the Most Comprehensive Integrated Retrofit Offering.  For the last thirteen years, our Systems Integration Group has focused on developing the capabilities necessary to provide a fully integrated offering with respect to aircraft refurbishing and aircraft retrofitting with FAA mandated changes and technological innovations.  Through several related acquisitions and aggressive internal product development, our Systems Integration Group has become one of the few non-OEM related operations with the authority to provide alteration services and to offer FAA certification of aircraft that undergo overhaul.  This certification ability represents a significant competitive advantage, as we can offer all the products and services required to re-commission an aircraft in a timely and cost efficient manner.  We believe we have developed the most comprehensive offering in retrofitting aircraft with auxiliary fuel systems in the industry.

 

•                  Target Development of Specialty Products and Services Relating to Regulatory Authority Mandates.  Consistent with its first strategic imperative, our Systems Integration Group is also growing its capabilities in providing solution “kits” in response to FAA and JAA mandated aircraft upgrades.  Our Systems Integration Group has demonstrated the ability to identify and quickly respond to probable new regulatory authority mandates.  For example:

 

•                  Many domestic commercial airlines believe the FAA will issue a safety mandate requiring cockpit door video surveillance on every commercial aircraft traveling in U.S. domestic airspace by no later than a specific compliance date.  In response, we consulted with commercial airlines and developed what we believe to be a low-cost, high quality cockpit

 

4

 

door video surveillance system.  Our Sentry One™ system is based on an in-house developed camera control unit with integral power supplies and is combined with state-of-the-art extreme low light cameras and 5.6” video monitors.  Some airlines are voluntarily electing to install surveillance systems on their aircraft prior to the expected FAA mandate.  We have received FAA approval for our Sentry One™ system on Boeing 737-NG and Embraer EMB 135, 140 and 145 aircraft.  We believe we will also receive FAA approval on Boeing 737-400 and 747-400 aircraft in May 2004.  We are also working on approval for Boeing 737-400, 747-400 and 747-Classics model aircraft as well as several models of 767 and 777 aircraft.  We believe we will be successful in obtaining FAA approval for our system on these and other types of aircraft as well.

 

•                  We believe the JAA will mandate new fire safety measures for all aircraft in Europe, similar to the FAA mandate in the United States.  We expect to develop a stand-alone kit, similar to our FAA approved kit, which can be quickly incorporated into an aircraft to ensure compliance with the JAA ruling with minimal downtime.

 

Products and Services

 

Our Systems Integration Group provides auxiliary fuel systems, auxiliary power units and system integration services, including engineering, kit manufacturing, installation and certification.  Customers include Boeing (Boeing Business Jet, Boeing’s Commercial Airplane Group and Boeing Integrated Defense Systems), Bombardier, Cessna, Gulfstream, Honeywell, Raytheon and Rockwell Collins.  Approximately 50% of our Systems Integration Group’s revenues in 2003 were from Boeing.  The products and services we provide are described below.

 

Auxiliary Fuel Systems and Power Units.  We design, engineer, manufacture and install auxiliary fuel systems for business, VIP, head-of-state and commercial aircraft.  Our unique design and construction have made us a leader in the auxiliary fuel system market.  We also manufacture auxiliary power units, which provide ground power to corporate jets made by Bombardier, Cessna, Gulfstream, Learjet and Raytheon.  These products and services provided approximately 16% of our consolidated revenues during 2003, 15% during 2002 and 14% during 2001.

 

Cabin and Flight Deck Systems Integration.  We have designed and patented avionics support structures we sell under the Box-Mount™ name.  These structures are used to support and environmentally cool avionics equipment, including navigation, communication and flight control equipment.  These support structures are sold to aircraft and related electronics manufacturers, airlines and major modification centers.  In addition, these products are essential components of the installation kits used in our systems integration operations.

 

Aircraft Completion and Modification Services.  We are one of only four world-wide approved Boeing Business Jet Service Centers providing extensive completion, modification and integration services to the business, VIP and head-of-state aircraft market.

 

Retrofit and Refurbishment Services.  We also provide retrofit and refurbishment services, including engineering, kit manufacturing, installation and certification, to both commercial and business, VIP and head-of-state aircraft customers.

 

5

 

Competition

 

The markets served by our Systems Integration Group are fragmented with several competitors offering similar products and services.  Due to the global nature of the aerospace industry, competition comes from both U.S. and foreign companies.  Our Systems Integration Group generally faces competition from a group of smaller companies and enterprises, except for the business, VIP and head-of-state aircraft manufacturers and independent completion centers.  We believe that the principal competitive factors in the markets we serve are quality, price, timely deliveries and overall customer service.  Our principal competitors are summarized below.

 

Auxiliary Fuel Systems and Power Units

•      Marshalls (United Kingdom)

•      Pfalz Flugewerke (Germany)

 

Auxiliary Power Units (Integration Only)

•      Honeywell

•      Sundstrand

 

Aircraft Modification Services

•      Associated Air Center

•      Jet Aviation (United States and Switzerland)

•      Lufthansa Technik (Germany)

 

Cabin and Flight Deck Systems Integration and Retrofit and Refurbishment Services

•      ARINC

•      Aviation Sales

•      Boeing Aircraft Services

•      Flight Structures

•      In-house engineering departments of commercial airlines

•      Numerous independent airframe maintenance and modification companies

 

Other Information

 

Acquisitions and Dispositions

 

Disposition of the Specialty Avionics Group

 

On May 23, 2003, we consummated the sale of our equity interests in the companies comprising the Specialty Avionics Group to Wings Holdings, Inc., an affiliate of Odyssey Investment Partners, LLC. for $140.0 million in cash.  We used $130.7 million of the proceeds from the sale to repay borrowings under our first-lien credit facility, as amended.  The Specialty Avionics Group consisted of Avtech Corporation of Seattle, Washington, Aerospace Display Systems, LLC of Hatfield, Pennsylvania, and Tri-Star Electronics International, Inc. of El Segundo, California.

 

The sale of the Specialty Avionics Group is not expected to affect the operations of our remaining operating groups and is reflected as a discontinued operation in this report.  See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information.

 

Companies Acquired by DeCrane Aircraft

 

During the five years ended December 31, 2003, DeCrane Aircraft has acquired the stock or assets of seven significant businesses, as such term is defined by Securities and Exchange Commission rules, as follows:

 

Cabin Management Group

 

•                  all of the common stock of Precision Pattern, Inc., a Kansas-based designer and manufacturer of interior furniture components for business, VIP and head-of-state aircraft, on April 23, 1999;

 

•                  substantially all of the assets of Custom Woodwork & Plastics, Inc., a Georgia-based designer and manufacturer of interior furniture components for business, VIP and head-of-state aircraft, on August 5, 1999;

 

6

 

•                  substantially all of the assets of PCI NewCo, Inc., a Kansas-based manufacturer of composite material and components for business, VIP and head-of-state aircraft, on October 6, 1999;

 

•                  substantially all of the assets of The Infinity Partners, Ltd., a Texas-based designer and manufacturer of interior furniture components for middle- and high-end business, VIP and head-of-state aircraft, on December 17, 1999;

 

•                  substantially all of the assets of Carl F. Booth & Co., an Indiana-based manufacturer of wood veneer panels primarily used in aircraft interior cabinetry, on May 11, 2000;

 

•                  all of the common stock of ERDA, Inc. (subsequently renamed DeCrane Aircraft Seating Co., Inc.), a Wisconsin-based designer and manufacturer of aircraft seating, on June 30, 2000; and

 

Systems Integration Group

 

•                  all of the common stock of PATS, Inc., a Maryland-based designer, manufacturer and installer of auxiliary fuel systems for business, VIP and head-of-state aircraft and a manufacturer of aircraft auxiliary power units, on January 22, 1999.

 

All of the acquisitions were accounted for as purchases.  We have used the acquired assets to manufacture products similar to those previously manufactured by the companies prior to their acquisition.  Our financial statements reflect the acquired companies subsequent to their respective acquisition dates.

 

Customers

 

We estimate that our Cabin Management Group currently sells its products and services to approximately 800 customers and our Systems Integration Group sells its products and services to approximately 200 customers.  Our primary customers include manufacturers of business, VIP and head-of-state aircraft, airlines and aircraft repair and modification companies.

 

The following customers accounted for 10% or more of our consolidated revenues from continuing operations for the year ended December 31, 2003.  Historical data for the three years ended December 31, 2003 is presented in Note 17 accompanying our consolidated financial statements included in this report.

 

Significant Customers		Cabin Management Group		Systems Integration Group		Consolidated Total
Percent of consolidated revenues:
Year ended December 31, 2003:
Boeing (1)		2.4	%	15.1	%	17.5	%
Textron (2)		16.2		0.1		16.3
Bombardier		11.0		1.6		12.6
Consolidated revenues		29.6	%	16.8	%	46.4	%
Year ended December 31, 2002:
Boeing (1)		1.4	%	14.0	%	15.4	%
Textron (2)		23.5		—		23.5
Bombardier		16.0		1.4		17.4
Consolidated revenues		40.9	%	15.4	%	56.3	%

 

7

 

Significant Customers		Cabin Management Group		Systems Integration Group
Percent of group revenues (3):
Year ended December 31, 2003:
Boeing (1)		3.4	%	50.1	%
Textron (2)		23.2		0.1
Bombardier		15.7		5.3
Group revenues		42.3	%	55.5	%
Year ended December 31, 2002:
Boeing (1)		1.9	%	56.0	%
Textron (2)		31.3		—
Bombardier		21.4		5.4
Group revenues		54.6	%	61.4	%

 

(1)                      Reflects only our direct revenues from Boeing.  Our Systems Integration Group’s revenues from Boeing result from auxiliary fuel systems for the Boeing Business Jet.

 

(2)                      Includes Cessna.

 

(3)                      Inter-group revenues are eliminated against the group originating the sale.

 

Revenues from Textron and Bombardier, as a percentage of total consolidated revenues, decreased during the year ended December 31, 2003 compared to our revenues from these customers during the prior year.  The decrease is caused by both companies temporarily suspending production of various models of aircraft for several weeks during fiscal 2003 in response to their low order backlog resulting from the weak demand for new aircraft as described in “—Backlog” below.  Complete loss of any of the customers identified above could have a significant adverse impact on our results of operations expected in future periods.

 

Significant portions of our revenues from our major customers are pursuant to contracts that may include a variety of terms favorable to the customer.  Such terms may include our agreement to one or more of the following:

 

•                  the customer is not required to make purchases, and may terminate such contract at any time;

 

•                  we make substantial expenditures to develop products for customers that we may not recoup if we do not receive sufficient orders;

 

•                  on a prospective basis, we must extend to the customers any reductions in prices or lead times that we provide to other customers;

 

•                  we must match other suppliers’ price reductions or delete the affected products from the contract; and

 

•                  we must grant irrevocable non-exclusive worldwide licenses to use our designs, tooling and other intellectual property rights to products sold to a customer if we default, or suffer a bankruptcy filing, or transfer our manufacturing rights to a third party.

 

8

 

Backlog

 

As of December 31, 2003, we had an aggregate sales order backlog of $58.0 million compared to $66.8 million as of December 31, 2002, as follows:

 

		December 31,
(In thousands)		2003			2002
Cabin Management		$	33,679		$	31,679
Systems Integration		24,323			35,126
Consolidated totals		$	58,002		$	66,805

 

Orders are usually filled within twelve months; however, backlog totaling $2.5 million as of December 31, 2003 is scheduled for delivery in 2005 and beyond as follows: Cabin Management – $1.4 million; and Systems Integration – $1.1 million.  Orders may be subject to cancellation by the customer prior to shipment.  The level of unfilled orders at any given date will be materially affected by when we receive orders and how fast we fill them.  Period-to-period comparisons of backlog figures may not be meaningful.  For that reason, our backlogs do not necessarily accurately predict actual shipments or sales for any future period.

 

As described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Industry Overview and Trends,” the acts and ongoing threats of global terrorism, the current military conflicts, health epidemics and weak global economic conditions are all adversely impacting the aerospace industry.  We are not able to predict the continuing impact these events will have in future periods.  However, given the magnitude of these events, the adverse impact could be material.

 

Employees

 

As of December 31, 2003, we had 1,296 employees: 1,018 in our Cabin Management Group; 266 in our Systems Integration Group; and 12 in our corporate office.  None of our employees is subject to a collective bargaining agreement, and we have not experienced any material business interruption as a result of labor disputes.  We believe that we generally have a good relationship with our employees.

 

Research and Development

 

We continually evaluate opportunities to improve our product offerings and develop new products that incorporate new technologies to meet the demands of our customers and the FAA.  Total research and development expense was $10.4 million for the year ended December 31, 2003, $0.1 million for the year ended December 31, 2002 and $0.7 million during the year ended December 31, 2001.

 

Commencing January 1, 2003, we elected to change our accounting policy and discontinued the use of program accounting, which resulted in product development costs being expensed as incurred.  Prior to January 1, 2003, such costs were deferred and charged to cost of sales over the expected production cycle of the program.  Product development costs are now reflected as research and development expenses.  If the new accounting policy was in effect during the prior years, total research and development expense would have been $5.0 million for the year ended December 31, 2002 and $11.7 million during the year ended December 31, 2001.

 

Financial Information About Geographic Areas

 

Financial information about our revenues and assets by geographic area are included in Note 17 accompanying our financial statements included in this report.

 

9

 

Seasonality

 

Our businesses generally are not seasonal in nature.

 

Sales and Marketing

 

Our Cabin Management Group has designated relationship managers who are responsible for maintaining and cultivating relationships with customers.  In addition, a dedicated sales force is utilized for some of our products and services.

 

Our Systems Integration Group has a dedicated sales force that handles most of its sales activities.

 

We are continuously seeking opportunities to combine our sales efforts across all of our operating groups in order to ensure that all sales opportunities are explored and that we maximize our revenue content per plane.  We may also assign marketing and sales responsibilities for key customers to one of our senior corporate executives.

 

Raw Materials and Component Parts

 

The components we manufacture require the use of various raw materials including aluminum, hardwoods and plastics.  The availability and prices of these materials may fluctuate.  The cost of such raw materials is a significant component in, and part of, the sales price of many of our products.  Although some of our contracts have prices tied to raw materials prices, we cannot always recover raw material price increases in our product sale price.  We also purchase a variety of manufactured sub-component parts from various suppliers.  Raw materials and component parts are generally available from multiple suppliers at competitive prices.  However, any delay in our ability to obtain necessary raw materials and component parts may affect our ability to meet customer production needs.

 

Intellectual Property and Proprietary Information

 

We have various trade secrets, proprietary information, trademarks, tradenames, patents, copyrights and other intellectual property rights we believe are important to our business in the aggregate, but not individually.

 

Government Regulation

 

Federal Aviation Administration

 

The aerospace industry is highly regulated in the United States by the Federal Aviation Administration and in other countries by similar agencies to ensure that aviation products and services meet stringent safety and performance standards.  In addition, many of our customers impose their own compliance and quality requirements on us.  The FAA prescribes standards and licensing requirements for aircraft components, issues designated alteration station authorizations, and licenses private repair stations.  We hold various FAA approvals and licenses, which may only be used by our subsidiary obtaining such approval.  If material FAA or customer authorizations or approvals were revoked or suspended, our operations could be adversely affected.

 

The FAA can authorize or deny authorization of many of the services and products we provide.  Any such denial would preclude our ability to provide the pertinent service or product.  If we failed to comply with applicable FAA standards or regulations, the FAA could exercise a wide range of remedies, including a warning letter, a letter of correction, a civil penalty action, and emergency or non-emergency suspension or revocation of a certificate or approval.

 

10

 

Each type of aircraft operated by airlines in the United States must possess an FAA type certificate, generally held by the aircraft manufacturer, indicating that the type design meets applicable airworthiness standards.  When someone else develops a major modification to an aircraft already type-certificated, that person must obtain an FAA-issued Supplemental Type Certificate for the modification.  Historically, we have obtained several hundred of these Supplemental Type Certificates, most of which we obtained on behalf of our customers as part of our systems integration services.  Some of these certificates we obtain were or eventually will be transferred to our customers.  As of December 31, 2003, we own and/or manage on behalf of our customers approximately 300 Supplemental Type Certificates.  Many are multi-aircraft certificates, which apply to all of the aircraft of a single type.  We foresee the need to obtain additional Supplemental Type Certificates so that we can expand the services we provide and the customers we serve and believe we will be able to obtain such certificates as the need arises.

 

Supplemental Type Certificates can be issued for proposed aircraft modifications directly by the FAA, or on behalf of the FAA by a Designated Alteration Station.  The FAA designates what types of Supplemental Type Certificates can be issued by each Designated Alteration Station.  Two subsidiaries within our Systems Integration Group are FAA-authorized Designated Alteration Stations and can directly issue many of the Supplemental Type Certificates our customers and we require for our systems integration operations.

 

After obtaining a Supplemental Type Certificate, a manufacturer must apply for a Parts Manufacturer Approval from the FAA, or a supplement to an existing Parts Manufacturer Approval, which permits the holder to manufacture and sell installation kits according to the approved design and data package.  We have six Parts Manufacturer Approvals and approximately 160 supplements to those approvals.  In general, each initial Parts Manufacturer Approval is an approval of a manufacturing or modification facility’s production quality control system.  Each Parts Manufacturer Approval supplement authorizes the manufacture of a particular part in accordance with the requirements of the corresponding Supplemental Type Certificate.  We routinely apply for and receive such Parts Manufacturer Approval supplements.  In order to perform the actual installations of a modification, we are also required to have FAA approval.  This authority is contained either in our Parts Manufacturer Approvals and related supplements, or in our repair station certificates.  In order for a company to perform most kinds of repair, engineering, installation or other services on aircraft, its facility must be designated as an FAA-authorized repair station.  As of December 31, 2003, we had seven authorized repair stations and employed approximately 100 FAA certified representatives.

 

Occupational Safety and Health Administration

 

Our manufacturing operations in the United States are subject to a variety of worker and community safety laws.  The Occupational Safety and Health Act of 1970 mandates general requirements for safe workplaces for all employees.  In addition, OSHA provides special procedures and measures for the handling of hazardous and toxic substances and has established specific safety standards for workplaces engaged in the treatment, disposal or storage of hazardous waste.  We believe that our operations are in material compliance with OSHA’s health and safety requirements.

 

Environmental Matters

 

Our facilities and operations are subject to various federal, state, local, and foreign environmental laws and regulations, including those relating to discharges to air, water, and land, the handling and disposal of solid and hazardous waste, and the cleanup of properties affected by hazardous substances.  In addition, some environmental laws, such as the federal Comprehensive Environmental Response, Compensation and Liability Act, as amended (“CERCLA”) and similar state laws, impose strict liability upon persons responsible for releases or potential releases of hazardous substances.  That liability generally is retroactive, and may create “joint and several” liability among multiple parties who have

 

11

 

some relationship to a site or a source of waste, such as a current or former owner or operator of real property or a party who arranges to transport wastes to a third-party site.  We have sent waste to treatment, storage, or disposal facilities that have been designated as National Priority List sites under CERCLA or equivalent listings under state laws.  We have received CERCLA requests for information or allegations of potential responsibility from the Environmental Protection Agency regarding our use of several of those sites.  In addition, some of our operations are located on properties that may be contaminated to varying degrees.

 

We have not incurred, nor do we expect to incur, liabilities in any significant amount as a result of the foregoing matters because in most of these cases other entities have been held primarily responsible, the levels of contamination are sufficiently low so as not to require remediation, or we are indemnified against such costs.  However, in a few cases, we do not have sufficient information to assess our potential liability, if any.  In addition, it is possible, given the potentially retroactive nature of environmental liability, that we will receive additional notices of potential liability relating to current or former activities.

 

We believe that we have no liabilities under environmental laws and regulations, except for liabilities which we do not expect would likely have a material adverse effect on our business, financial position, results of operations or cash flows.  However, some risk of environmental liability is inherent in the nature of our business, and we might in the future incur material costs to meet current or more stringent compliance, cleanup, or other obligations pursuant to environmental laws and regulations.

 

In connection with the sale of the Specialty Avionics Group, we have agreed to indemnify the buyer for all pre-closing releases of hazardous materials at any of Avtech’s facilities up to a maximum amount of $5.0 million.

 

ITEM 2.                                         PROPERTIES

 

We operate in a number of manufacturing, engineering and office facilities in the United States and abroad.  At December 31, 2003, we utilized approximately 0.9 million square feet of floor space, approximately 96% of which is located in the United States.  We believe that our facilities are in good condition and are adequate to support our operations for the foreseeable future.  Our operating groups’ facilities at December 31, 2003 are summarized below.

 

(In thousands of square feet)		Leased		Owned		Total
Cabin Management		441		204		645
Systems Integration		136		150		286
Corporate		8		—		8
Total in use		585		354		939
Not in use, subleased to others		88		—		88
Total		673		354		1,027

 

ITEM 3.                                         LEGAL PROCEEDINGS

 

As part of its investigation of the crash of Swissair Flight 111 off the Canadian coast on September 2, 1998, the Canadian Transportation Safety Board (the “CTSB”) initially notified us that it recovered burned wire that was attached to the in-flight entertainment system installed on some of Swissair’s aircraft by one of our subsidiaries.  Our subsidiary has worked vigorously over the last five years with the CTSB investigators in the fact-finding investigation of this catastrophic incident.  On March 27, 2003, the CTSB released its final report on its investigation.  This report indicated that the CTSB was unable to conclusively determine the cause of the fire which led to the crash of the aircraft.

 

12

 

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

 

On September 22, 2003, the Company and our insurers entered into an agreement with Boeing, Swissair and each of their respective insurers, in which the Company received a release from those parties and an indemnification by Boeing and Swissair’s insurers against claims asserted on behalf of passengers for compensatory damage and by others for contribution and/or indemnity claims.  We believe the agreement adequately protects the Company from all existing litigation pending against the Company arising from this catastrophic incident.  Punitive damages are not subject to the indemnity; however, while some of the passenger actions originally asserted punitive damages, by virtue of a court order, claims for punitive damages may not be prosecuted.  The aforementioned agreement did not result in the Company incurring a loss and, accordingly, no charge to operations was required.

 

ITEM 4.                                         SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None.

 

PART II

 

ITEM 5.                                         MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

 

Market Information

 

There is no established public trading market for our shares.

 

Holders

 

As of March 29, 2004, DeCrane Holdings is our only common stockholder.

 

Dividends

 

We have not paid dividends to date on our common stock and do not anticipate paying any cash dividends in the foreseeable future.  The terms of our first-lien credit facility, second-lien term notes and subordinated note indenture restrict our ability to pay dividends if we do not meet certain financial criteria.

 

Recent Sale of Unregistered Securities

 

None.

 

13

 

ITEM 6.                                         SELECTED FINANCIAL DATA

 

		Year Ended December 31, (1)
(In thousands)		2003			2002			2001			2000			1999
Statement of Operations Data:
Revenues		$	170,109		$	229,841		$	272,112		$	236,501		$	131,547
Cost of sales (2)		134,953			170,485			196,866			155,134			90,103
Gross profit		35,156			59,356			75,246			81,367			41,444
Selling, general and administrative expenses (3)		24,896			40,262			44,731			31,730			23,465
Research and development expenses (4)		10,440			56			698			1,615			3,347
Impairment of goodwill (5)		34,000			—			8,583			—			—
Amortization of intangible assets (6)		3,651			3,540			12,436			10,628			5,938
Operating income (loss)		(37,831		)	15,498			8,798			37,394			8,694
Interest expense (7)		26,219			25,376			29,645			27,181			15,889
Loss on extinguishment of debt (8)		1,439			—			—			—			—
Other expenses, net		945			505			634			277			855
Income (loss) from continuing operations before income taxes		(66,434		)	(10,383		)	(21,481		)	9,936			(8,050		)
Provision for income taxes (benefit) (9)		(13,496		)	(3,621		)	(3,933		)	4,607			(2,102		)
Income (loss) from continuing operations		(52,938		)	(6,762		)	(17,548		)	5,329			(5,948		)
Income (loss) from discontinued operations, net of tax (10)		(6,621		)	(41,396		)	3,546			(1,727		)	1,578
Cumulative effect of changes in accounting principles (11)		(13,764		)	(17,828		)	—			—			—
Net income (loss)		$	(73,323	)	$	(65,986	)	$	(14,002	)	$	3,602		$	(4,370	)
Net income (loss) applicable to common stockholder		$	(80,077	)	$	(71,827	)	$	(19,063	)	$	1,328		$	(4,370	)
Other Financial Data:
Restructuring, asset impairment and other related charges (12)		$	41,886		$	17,255		$	25,834		$	—		$	9,935
Depreciation and amortization (13)		9,781			10,612			20,364			15,086			8,315
Capital expenditures:
Paid in cash		4,797			4,356			10,191			20,193			4,077
Financed with capital lease obligations		14			67			4,376			105			1,012
Ratio of earnings to fixed charges (14):
Ratio		—			—			—			1.4		x	—
Deficiency of earnings to fixed charges		$	66,434		$	10,383		$	21,481		$	—		$	8,050
Other Operating Data:
Bookings (15)		$	161,306		$	197,132		$	252,800		$	238,546		$	170,547
Backlog at end of period (16)		58,002			66,805			99,518			118,830			107,634

 

		As of December 31, (1)
(In thousands)		2003			2002			2001			2000			1999
Balance Sheet Data:
Cash and cash equivalents		$	6,936		$	12,421		$	9,478		$	7,706		$	7,899
Working capital (17)		37,904			196,176			81,656			61,398			32,412
Total assets (17)		303,876			548,967			645,711			664,254			531,842
Total debt (18)		269,406			381,017			399,268			381,513			314,936
Mandatorily redeemable securities (19)		40,835			34,081			28,240			23,179			—
Stockholder’s equity (deficit)		(45,181		)	34,951			102,390			121,442			107,773

 

See accompanying Notes to Selected Financial Data.

 

14

 

Notes to Selected Financial Data:

 

(1)                      Reflects historical selected consolidated financial data derived from the audited consolidated financial statements and related notes for the periods, reclassified to reflect the Specialty Avionics Group as a discontinued operation.

 

Also reflects the results of operations and financial position of companies we acquired for all periods subsequent to their respective acquisition dates as follows:

 

Company Acquired			Date Acquired
•	DeCrane Aircraft Seating Co. (formerly ERDA)		June 30, 2000
•	Carl F. Booth & Co.		May 11, 2000
•	Infinity		December 17, 1999
•	International Custom Interiors		October 8, 1999
•	PCI NewCo		October 6, 1999
•	Custom Woodwork		August 5, 1999
•	Precision Pattern		April 23, 1999
•	PATS		January 22, 1999

 

(2)                      Includes charges to reflect:

 

•                  our restructuring activities as follows:

 

•                  a $4.2 million charge related to lease termination and related expenses and a $3.1 non-cash inventory write-down during the twelve months ended December 31, 2003;

 

•                  a $6.9 million noncash inventory write-down, a $2.6 million charge for estimated losses on uncompleted long-term contracts and $1.2 million of other charges during the twelve months ended December 31, 2002;

 

•                  a $1.8 million noncash inventory write-down, a noncash write-off of $7.9 million of curtailed product development costs and charges totaling $3.9 million for the realignment of production programs between facilities during the twelve months ended December 31, 2001; and

 

•                  a $6.0 million noncash inventory write-down during the twelve months ended December 31, 1999; and

 

•                  cost of sales based on the purchase accounting write-up to fair value of inventory acquired of $1.6 million during the twelve months ended December 31, 1999 in connection with the Precision Pattern and Custom Woodworks acquisitions.

 

(3)                      Includes charges to reflect our restructuring activities as follows:

 

•                  $0.6 million during the year ended December 31, 2003;

 

•                  $6.5 million during the year ended December 31, 2002, $3.9 million of which was a noncash asset impairment write-down;

 

•                  $3.7 million during the year ended December 31, 2001, $1.3 million of which was a noncash asset impairment write-down; and

 

•                  $3.9 million during the year ended December 31, 1999, $1.3 million of which was a noncash asset impairment write-down.

 

(4)                      Reflects research and development expenses and, commencing January 1, 2003, includes product development costs.  In 2003, we elected to change our accounting policy and discontinue the use of program accounting, which resulted in product development costs being expensed as incurred.  See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information.

 

15

 

(5)                      Reflects noncash goodwill impairment charges, including charges resulting from our restructuring activities.

 

(6)                      For the five years ended December 31, 2003, reflects the amortization of identifiable intangible assets.  For periods prior to January 1, 2002, also reflects the amortization of goodwill as follows: 2001 — $9.1 million; 2000 — $7.8 million; and 1999 — $3.8 million.  Starting January 1, 2002, goodwill is no longer amortized but instead subject to annual impairment testing with a loss charged to operations in the period in which impairment occurs, as required by SFAS No. 142, “Goodwill and Other Intangible Assets.”

 

(7)                      Excludes interest expense attributable to the Specialty Avionics Group, which is classified as a component of the income or loss from discontinued operations, as described in Note 10 below.

 

(8)                      Reflects the write-off of deferred financing costs associated with debt repaid during the year ended December 31, 2003.

 

(9)                      For the year ended December 31, 2003, includes a $19.5 million charge resulting from establishing a net deferred tax asset valuation allowance.  Excluding the effect of the valuation allowances, the provision for income taxes differs from the amount determined by applying the applicable U.S. statutory federal rate to the income before income taxes primarily due to the effects of state income taxes and non-deductible expenses, principally goodwill impairment charges and amortization (for periods prior to January 1, 2002).  The difference in the effective tax rates between periods is mostly a result of the relationship of non-deductible expenses to the loss before income taxes.

 

(10)                Reflects the net income or loss of the Specialty Avionics Group, which was sold on May 23, 2003 and therefore classified as a discontinued operation during the periods.  Includes charges to reflect:

 

•                  a $39.3 million noncash charge during the year ended December 31, 2002 to reflect the cumulative effect of the change in accounting principle for the impairment of goodwill upon adoption of SFAS No. 142 on January 1, 2002; and

 

•                  interest expense attributable to the Specialty Avionics Group as follows:

 

		Year Ended December 31,
(In thousands)		2003			2002			2001			2000			1999
Interest expense associated with:
First-lien credit facility debt required to be repaid		$	3,297		$	7,720		$	8,439		$	13,337		$	10,875
Debt obligations assumed by the buyer		270			798			917			1,105			1,154
Interest expense attributable to discontinued operations		$	3,567		$	8,518		$	9,356		$	14,442		$	12,029

 

Interest expense on first-lien credit facility debt required to be repaid reflects allocated interest expense attributable to the debt which was required to be repaid with the proceeds from the sale.  The allocation is based upon $130.7 million of debt repaid and the historical interest rates charged during each of the periods.  Interest expense for 2003 is through May 23, 2003, the date of sale.

 

(11)                Reflects:

 

•                  a $13.8 million noncash charge to reflect the cumulative effect on prior years of changing our accounting policy and discontinuing the use of program accounting.  See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information.

 

•                  a $17.8 million noncash charge, net of $0.9 million tax benefit, for the impairment of goodwill upon adoption of SFAS No. 142 on January 1, 2002.

 

(12)                Reflects the total restructuring, asset impairment and other related charges incurred during the periods related to our restructuring activities.

 

16

 

(13)                Reflects depreciation and amortization of plant and equipment, goodwill (for periods prior to the January 1, 2002 adoption of SFAS No. 142) and other intangible assets.  Excludes amortization of deferred financing costs, which are classified as a component of interest expense.

 

(14)                For the purposes of calculating the ratio of earning to fixed charges, earnings represent net income or loss from continuing operations before income taxes, extraordinary items and fixed charges.  Fixed charges consist of:

 

•                  interest;

 

•                  amortization of debt expense and discount or premium relating to any indebtedness; and

 

•                  one-third of rental expenses under operating leases which is considered to be a reasonable approximation of the interest portion of such expense.

 

(15)                Bookings represent the total invoice value of purchase orders received during the period.

 

(16)                Backlog represents the total invoice value of unfilled purchase orders at the end of the period.  Orders may be subject to cancellation by the customer prior to shipment.  The level of unfilled orders at any given date during the year will be materially affected by the timing of our receipt of orders and the speed with which those orders are filled.

 

(17)                Includes amounts attributable to the Specialty Avionics Group, which is reflected as a discontinued operation, as follows:

 

		As of December 31,
(In thousands)		2003			2002			2001			2000			1999
Working capital:
Continuing operations		$	37,904		$	55,363		$	39,862		$	20,480		$	(1,992	)
Discontinued operations		—			140,813			41,794			40,918			34,404
Total working capital		$	37,904		$	196,176		$	81,656		$	61,398		$	32,412
Total assets:
Continuing operations		$	303,876		$	388,226		$	423,272		$	429,812		$	305,685
Discontinued operations		—			160,741			222,439			234,442			226,157
Total assets		$	303,876		$	548,967		$	645,711		$	664,254		$	531,842

 

(18)                Total debt is defined as long-term debt, including current portion.

 

(19)                Reflects mandatorily redeemable 16% preferred stock.

 

17

 

ITEM 7.       MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussions should be read in conjunction with our financial statements and accompanying notes included in this report.

 

Industry Overview and Trends

 

We compete in the aircraft products and services market of the aerospace industry.  The market for our products and services is largely driven by demand in the three civil aircraft markets: (1) business, VIP and head-of-state aircraft and, to a lesser extent, (2) commercial and (3) regional aircraft.  Weak global economic conditions, which were exacerbated by the September 11, 2001 terrorist attack on the United States, ongoing concerns about global terrorism and health epidemics, and the current Middle Eastern military conflicts are all adversely impacting the aerospace industry and have led to a decrease in demand for business, VIP and head-of-state aircraft.  In response to certain of these adverse conditions, we have announced and implemented a series of restructuring activities designed to reduce expenses and conserve working capital.  See “—Restructuring, Asset Impairment and Other Related Charges” below for additional information.

 

The business, VIP and head-of-state aircraft portion of our business experienced weakness during 2003 as evidenced by various manufacturers’ decision to temporarily suspend production at various times throughout 2003 in response to the weak demand for new aircraft.  While global economic conditions appeared to improve during the second half of 2003, the improvement did not affect the markets we serve, which we believe lag trends in the general economy by six to twelve months.  As a result, we believe orders for business, VIP and head-of-state aircraft may experience a modest recovery in 2004 and reflect continuing strengthening thereafter.  The commercial aircraft portion of our business, which subsequent to the sale of the Specialty Avionics Group accounts for less than 5% of consolidated revenues, also experienced significant weakness in 2003 and we believe this condition will continue into 2004, with potential recovery not expected to occur until at least 2005.  Our beliefs are based on the assumptions that we will experience economic recovery and there are no further negative geo-political developments affecting our industry.

 

Results of Operations

 

Performance Measures

 

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

 

Adjusted EBITDA.  Our discussion of the results of operations includes discussions of financial measures determined in accordance with accounting principles generally accepted in the United States of America (“GAAP”) as well as the financial measure Adjusted EBITDA, which excludes certain charges reflected in our GAAP basis financial statements.  Our presentation of Adjusted EBITDA is in accordance with the GAAP requirements of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” which requires us to report the primary measure of segment performance we use to evaluate and manage our businesses.

 

We utilize more than one measurement to evaluate segment performance and allocate resources among our operating segments; however, we consider Adjusted EBITDA, as defined below, to be the primary measurement of overall operating segment core economic performance and return on invested

 

18

 

capital.  We also use Adjusted EBITDA in the annual budgeting and planning for future periods, as one of the decision-making criteria for funding discretionary capital expenditure and product development programs and as the measure for determining the value of acquisitions and dispositions.  Our board of directors uses Adjusted EBITDA as one of the performance metrics for determining the amount of bonuses awarded to pursuant to the cash incentive bonus plan and as an indicator of enterprise value used in determining the exercise price of stock options granted and the acceleration of stock option vesting pursuant the incentive stock option plan.

 

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

 

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

 

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

 

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

 

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

 

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

 

Change in Accounting Principle.  Inventories are stated at the lower of cost or market.  Costs include materials, labor, including direct engineering labor, tooling costs and manufacturing overhead.  As described below, measurement of the costs of inventories associated with products manufactured for delivery under production-type contracts in prior periods was made pursuant to the use of program accounting.  As such, the cost of inventories included certain deferred program costs, which were principally comprised of engineering costs.

 

19

 

The events of September 11, 2001 and its aftermath have impacted the predictability of demand for our business, VIP and head-of-state aircraft products.  The ability to make reliable estimates of future demand for these products is critical to the use of program accounting and the deferral of engineering and production costs.  Under program accounting, certain product development costs incurred in connection with specific contracted programs were deferred and charged to cost of sales when revenues from the sale of products related to the program were recorded.  Because of the changing economic conditions affecting the markets we serve, demand for our products has exhibited an increased degree of volatility not seen in the past.  In order to improve the reliability of our financial reporting, we decided to discontinue the use of program accounting which requires us to make long-term estimates of future sales for each program.  Therefore, product development costs not specifically reimbursable through contractual terms or recoverable through firm orders will no longer be deferred and included in program inventory.

 

We concluded that the new method of accounting for program costs is preferable based, in part, on the aforementioned improvement in the reliability of our financial reporting.  This new accounting method will also have the advantage of enhancing investor understanding of our performance since cash flows from operations will now more closely align with Adjusted EBITDA, our primary measurement of overall economic performance and return on invested capital.

 

This change in accounting policy was made after concluding the 2003 fiscal year but has been applied retroactively to the beginning of the year, January 1, 2003, as required by generally accepted accounting principles.  As a result of the change, program-related product development costs are now classified as a component of research and development expenses in the consolidated financial statements for 2003 rather than classified as a component of inventory cost.  The effect of this accounting change was to increase the Company’s net loss by $17,942,000 through a charge for the cumulative effect of a change in accounting principle in 2003 of $13,764,000 and increase by $4,178,000 the reported loss from continuing operations.

 

As a result of the change, we have restated the quarterly results of operations for 2003.  Restated condensed quarterly data is in Note 19 accompanying our financial statements included in this report.  The following pro forma data summarizes the results of operations for the years ended December 31, 2002 and 2001 as if the new accounting policy had been in effect during those years.

 

		Year Ended December 31,
(In millions)		2002			2001
As reported:
Loss from continuing operations		$	(6.8	)	$	(17.5	)
Net loss		(66.0		)	(14.0		)
Pro forma:
Loss from continuing operations		$	(9.7	)	$	(19.4	)
Net loss		(69.0		)	(15.9		)

 

Revenues.  Revenues decreased $59.7 million, or 26.0%, to $170.1 million for the year ended December 31, 2003 from $229.8 million for the year ended December 31, 2002.  By segment, revenues changed as follows:

 

		Increase (Decrease) From 2002
(In millions)		Amount			Percent
Cabin Management		$	(53.8	)	(31.1	)%
Systems Integration		(6.4		)	(11.0	)
Inter-group elimination		0.5
Total		$	(59.7	)

 

20

 

Cabin Management.  Revenues decreased by $53.8 million, or 31.1% compared to the prior year.  The decrease, which is across substantially all of our product and services categories, is caused by the ongoing adverse impact of weak global economic conditions which reduces the affordability of business, VIP and head-of-state aircraft and therefore demand for the products and services we provide.  As a result, the manufacturers of these aircraft have experienced a decrease in orders for new aircraft which, in turn, reduces the orders our customers place with us.  The 2003 decrease consists of:

 

•                  a $50.9 million decrease in aircraft furniture and related products revenues;

 

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

 

•                  a $0.5 million decrease in seating products revenues; offset by

 

•                  a $1.0 million increase in other product and services revenues.

 

The revenue decrease was caused by lower order volume (as described above) from our customers as opposed to a loss of customers or price reductions.

 

Revenues from Textron and Bombardier, our principal customers, decreased $44.6 million compared to the prior year as a result of the decrease in orders and resulting lower production of aircraft they are experiencing during the economic downturn.  Both companies temporarily suspended production of various aircraft models for several weeks during fiscal 2003 in response to their low order backlog.  We also experienced similar volume decreases from our other customers during the period.

 

Systems Integration.  Revenues decreased by $6.4 million, or 11.0% compared to the prior year, due to:

 

•                  a $8.6 million decrease resulting from reduced demand for almost all of our products and services as a result of reduced production and delivery of business, VIP and head-of-state aircraft; offset by

 

•                  a $0.1 million increase in the commercial aircraft systems integration engineering services; and

 

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

 

Gross profit.  Gross profit decreased $24.2 million, or 40.8%, to $35.2 million for the year ended December 31, 2003 from $59.4 million for the same period in the prior year.  By segment, gross profit changed as follows:

 

		Increase (Decrease) From 2002
(In millions)		Amount			Percent
Cabin Management		$	(20.2	)	(52.2	)%
Systems Integration		(4.0		)	(19.7	)
Total		$	(24.2	)

 

Cabin Management.  Gross profit decreased by $20.2 million, or 52.2% compared to the prior year, primarily due to:

 

•                  a $20.1 million decrease resulting from lower volume for our business, VIP and head-of-state aircraft furniture and seating products; and

 

•                  a $1.2 million decrease in gross profit related to lower volume for our cabin management and entertainment systems; offset by

 

•                  a $1.1 million increase from our other products and services.

 

21

 

Systems Integration.  Gross profit decreased by $4.0 million, or 19.7% compared to the prior year, primarily due to:

 

•                  a $7.0 million decrease resulting from lower revenues and unfavorable overhead absorption as a result of lower production and a change in product delivery mix; and

 

•                  a $0.3 million decrease in the commercial aircraft systems integration engineering services provided; offset by

 

•                  a $3.3 million decrease in restructuring charges incurred in 2003 as compared to those recorded in 2002 related to our restructuring activities.

 

Selling, general and administrative expenses.  Selling, general and administrative expenses decreased $15.4 million, or 38.2%, to $24.9 million for the year ended December 31, 2003, from $40.3 million for the same period in the prior year.  By segment, SG&A expenses changed as follows:

 

		Increase (Decrease) From 2002
(In millions)		Amount			Percent
Cabin Management		$	(11.2	)	(46.2	)%
Systems Integration		(2.8		)	(36.6	)
Corporate		(1.4		)
Total		$	(15.4	)

 

Cabin Management.  SG&A expenses decreased by $11.2 million, or 46.2% compared to the prior year, due to:

 

•                  a $6.0 million decrease in restructuring charges incurred in 2003 as compared to those recorded in 2002 related to our restructuring activities; and

 

•                  a $5.2 million decrease in expenses resulting from cost reduction measures implemented in response to lower sales volume resulting from the weak demand for our products and services.

 

Systems Integration.  SG&A expenses decreased by $2.8 million, or 36.6% compared to the prior year, due to lower labor and employee benefit costs resulting from workforce reductions in 2003.

 

Research and development expenses.  Research and development expenses were $10.4 million for the year ended December 31, 2003 compared to $0.1 million in the prior year.  As more fully described in “—Change in Accounting Principle,” we elected to change our accounting policy for product development costs incurred for long-term programs after concluding the 2003 fiscal year but retroactively applied the change to the beginning of the year, January 1, 2003.  Commencing January 1, 2003, such costs are classified as a component of research and development expenses.  Expenses would have been $5.0 million in 2002 if the new accounting policy had been in effect during that year.

 

Cabin Management.  R&D expenses were $8.1 million for the year ended December 31, 2003, principally incurred for the development our new single-design seat technology and new interior furnishing components for a major customer’s new model of aircraft they recently introduced.

 

Systems Integration.  R&D expenses were $2.3 million for the year ended December 31, 2003, principally for development of several new products.

 

Impairment of goodwill.  During the year ended December 31, 2003, a $34.0 million charge was recorded to reflect the additional impairment of goodwill in connection with the impairment testing provision of SFAS No. 142, “Goodwill and Other Intangible Assets.”  The additional impairment results from continuing weak global economic conditions which reduces the affordability of business, VIP and head-of-state aircraft and therefore demand for the products and services we provide.  The impairment

 

22

 

charge pertains to our furniture manufacturing reporting unit within our Cabin Management Group.  See “—Goodwill Impairment Charges” below for additional information.

 

Depreciation and amortization of intangibles.  Depreciation and amortization expense decreased $0.8 million to $9.8 million for the year ended December 31, 2003 from $10.6 million for the same period in the prior year, primarily resulting from reduced capital expenditures and a lower depreciable base resulting from impairment charges recorded during 2002 as follows.

 

		Increase (Decrease) From 2002
(In millions)		Amount			Percent
Depreciation charged to:
Cost of sales		$	(0.3	)	(6.6	)%
Selling, general and administrative expense		(0.6		)	(26.2	)
Amortization of intangible assets		0.1			3.1
Total		$	(0.8	)

 

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

 

Cabin Management.  Adjusted EBITDA decreased by $23.6 million, or 72.5%, to $9.0 million for the year ended December 31, 2003 compared to $32.6 million for the same period in the prior year primarily due to:

 

•                  a $13.6 million decrease in gross profit related to our business, VIP and head-of-state aircraft furniture and seating operations;

 

•                  an $8.1 million increase in research and development expenses;

 

•                  a $1.1 million decrease in gross profit related our cabin management and entertainment systems; and

 

•                  a $0.8 million decrease in gross profit related to our other products and services.

 

Systems Integration.  Adjusted EBITDA decreased by $7.1 million, or 39.1%, to $11.0 million for the year ended December 31, 2003 compared to $18.1 million for the same period in the prior year due to lower sales volume and a $2.3 million increase in research and development expenses, partially offset by reduced SG&A spending resulting from workforce reductions.

 

Operating income (loss).  Operating income decreased $53.3 million to a loss of $37.8 million for the year ended December 31, 2003, from operating income of $15.5 million for the same period in the prior year.  By segment, operating income changed as follows:

 

		Increase (Decrease) From 2002
(In millions)		Amount			Percent
Cabin Management		$	(51.2	)	(401.8	)%
Systems Integration		(3.6		)	(32.3	)
Corporate		1.5
Total		$	(53.3	)

 

23

 

Cabin Management.  Operating income decreased by $51.2 million, or 401.8% compared to the prior year, due to:

 

•                  a $34.0 million goodwill impairment charge in 2003;

 

•                  a $20.1 million decrease in gross profit, primarily due to lower revenues related to our furniture and seating operations; and

 

•                  an $8.1 million increase in research and development expenses; offset by

 

•                  a $6.0 million decrease in restructuring charges incurred in 2003 as compared to those recorded in 2002 related to our restructuring activities; and

 

•                  a $5.0 million decrease in expenses resulting from cost reduction measures implemented in response to lower sales volume resulting from the weak global economic conditions.

 

Systems Integration. Operating income decreased by $3.6 million, or 32.3% compared to the prior year, due to:

 

•                  a $7.0 million decrease in gross profit resulting from lower revenues and unfavorable overhead absorption as a result of lower production and a change in product delivery mix;

 

•                  a $2.3 million increase in research and development expenses; and

 

•                  a $0.3 million decrease in gross profit in the commercial aircraft systems integration engineering services provided; offset by

 

•                  a $3.0 million decrease in restructuring charges incurred in 2003 as compared to those recorded in 2002 related to our restructuring activities; and

 

•                  a $3.0 million decrease in expenses resulting from cost reduction measures implemented in response to lower sales volume resulting from the weak global economic conditions.

 

Interest expense.  Interest expense increased $0.8 million, or 3.3%, to $26.2 million for the year ended December 31, 2003 compared to $25.4 million for the same period in the prior year.  The increase is attributable to a 1.5% increase in interest rate margins charged by our lenders pursuant to the March 28, 2003 first-lien bank credit facility amendment, partially offset by lower principal balances outstanding during 2003 compared to the prior year.

 

Loss on extinguishment of debt.  Loss on extinguishment of debt was $1.4 million for the year ended December 31, 2003 and reflects the write-off of deferred financing costs attributable to debt repaid during the year.

 

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

 

		Year Ended December 31,
(In millions)		2003			2002
Income tax benefit based on reported pre-tax loss		$	33.0		$	2.9
Net deferred tax asset valuation allowance		(19.5		)	—
Net income tax benefit		$	13.5		$	3.6

 

The provision for income taxes, based on the reported consolidated pre-tax loss, differs from the amount determined by applying the applicable U.S. statutory federal rate to the pre-tax loss primarily due to the effects of state and foreign income taxes and non-deductible expenses, principally the non-deductible portion of goodwill impairment charges.

 

As of December 31, 2003, we had net deferred tax assets of $19.5 million, prior to recording a valuation allowance; net deferred tax liabilities existed in prior periods.  The change to a net asset position

 

24

 

was primarily caused by the $34.0 million goodwill impairment charge recorded during fiscal 2003.  SFAS No. 109, “Accounting for Income Taxes,” requires the recognition of a deferred tax asset for the future income tax benefit of goodwill deductions that will be taken for income tax purposes (i.e. the goodwill that has been written off in the financial statements for book purposes will continue to be amortized and deducted for tax purposes and, accordingly, represents a new deferred tax asset).

 

As required by SFAS No. 109, we evaluated our deferred assets for expected recoverability based on the nature of the item, the associated taxing jurisdictions, the applicable expiration dates and future taxable income forecasts that would impact utilization.  Since there is no loss carry back potential and we do not have any tax planning strategies to assure recoverability, the only possibility for recovery of the net deferred assets is future taxable income.  Since there have been prior year losses, we believe it is not prudent to rely on future income as the means to support the carrying value of the net assets.  As a result of our evaluation, we recorded a $19.5 million valuation allowance, eliminating the net deferred asset, as of December 31, 2002.

 

We had net deferred tax liability of $16.6 million as of December 31, 2002.  The full realization of the deferred assets was achieved through the reversal of the deferred tax liabilities in future periods.  As a result, a valuation allowance was not required for periods ending on or prior to December 31, 2003.

 

Loss from continuing operations.  The loss from continuing operations increased $46.1 million to a loss of $52.9 million for the year ended December 31, 2003 compared to a loss of $6.8 million for the same period in the prior year, primarily due to:

 

•                  a $53.3 million decrease in operating income resulting, in part, from a $34.0 million goodwill impairment charge;

 

•                  a $1.4 million increase in loss on extinguishment of debt; and

 

•                  a $1.3 million increase in interest and other expenses (net); offset by

 

•                  a $9.9 million increase in income tax benefit.

 

Loss from discontinued operations.  Loss from discontinued operations decreased $34.8 million, to a loss of $6.6 million for the year ended December 31, 2003 compared to a loss of $41.4 million for the same period in the prior year.  The decrease is primarily due to:

 

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

 

•                  the result of operations of the Specialty Avionics Group through May 22, 2003 compared to a full year of operating results included in the prior year.

 

Cumulative effect of change in accounting principle.  The $13.8 million charge during the year ended December 31, 2003 was to reflect the cumulative effect on continuing operations of the change in accounting for product development costs.  See “—Change in Accounting for Product Development Costs” for additional information.

 

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

 

25

 

Net loss.  Net loss increased $7.3 million to a net loss of $73.3 million for the year ended December 31, 2003 compared to a net loss of $66.0 million for the same period in the prior year.  The decrease is attributable to:

 

•                  an increase in loss from continuing operations of $46.1 million; offset by

 

•                  a decrease in loss from discontinued operations of $34.8 million; and

 

•                  a decrease in cumulative effect of change in accounting principle of $4.0 million.

 

Net loss applicable to common stockholder.  Net loss applicable to DeCrane Holdings, our common stockholder, increased $8.3 million to a net loss of $80.1 million for the year ended December 31, 2003 compared to a net loss of $71.8 million for the same period in the prior year.  The increase in the net loss applicable to our common stockholder is attributable to:

 

•                  a $7.3 million increase in our net loss; offset by

 

•                  a $1.0 million increase in accrued 16% mandatorily redeemable preferred stock dividends resulting from the quarterly compounding of accrued dividends.

 

Bookings.  Bookings decreased $35.8 million, or 18.2%, to $161.3 million for the year ended December 31, 2003 compared to $197.1 million for the same period in the prior year.  The decrease in bookings for 2003 is due to decreases in orders for all of our business segments.

 

Backlog at end of period.  Backlog decreased $8.8 million to $58.0 million as of December 31, 2003 compared to $66.8 million as of December 31, 2002.

 

As described in “—Industry Overview and Trends,” the acts and ongoing threats of global terrorism, the current military conflicts, health epidemics and weak global economic conditions are having an adverse impact on our business, resulting in the decrease in bookings during 2003.  In addition, we believe that some of our customers have substantially reduced their order lead times which may have adversely affected bookings during the period.

 

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

 

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

 

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

 

Revenues.  Revenues decreased $42.3 million, or 15.5%, to $229.8 million for the year ended December 31, 2002 from $272.1 million for the year ended December 31, 2001.  By segment, revenues changed as follows:

 

		Increase (Decrease) From 2001
(In millions)		Amount			Percent
Cabin Management		$	(33.2	)	(16.1	)%
Systems Integration		(9.5		)	(14.0	)
Inter-group elimination		0.4
Total		$	(42.3	)

 

26

 

Cabin Management.  Revenues decreased by $33.2 million, or 16.1% compared to the prior year.  The decrease, which is across most of our product and services categories, is caused by the ongoing adverse impact of weak global economic conditions which reduces the affordability of business, VIP and head-of-state aircraft and therefore demand for the products and services we provide.  The 2002 decrease consists of:

 

•                  a $22.4 million decrease in aircraft furniture and related products revenues;

 

•                  a $9.8 million decrease in cabin management and entertainment systems revenues; and

 

•                  a $6.1 million decrease in seating products revenues; offset by

 

•                  a $5.1 million increase in other product and services revenues.

 

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

 

Revenues from Textron and Bombardier, our principal customers, decreased $15.0 million compared to the prior year as a result of the decrease in orders and resulting production of aircraft they are experiencing due to the economic downturn.  We also experienced similar volume decreases from our other customers during the period.

 

Systems Integration.  Revenues decreased by $9.5 million, or 14.0% compared to the prior year, due to:

 

•                  a $7.5 million decrease in the commercial aircraft systems integration and engineering services we provide resulting from the aftermath of September 11^th, and resulting down-turn in the commercial airline industry; the airline industry’s corresponding reduction in the size of its operating fleet and the delay or postponement retrofit and refurbishment programs for the remaining operational fleet reduced demand for our integration and engineering services; and

 

•                  a $2.0 million decrease resulting from reduced demand for our business, VIP and head-of-state aircraft products and services due to the adverse impact weak global economic conditions are having on the demand for those types of aircraft as follows:

 

•                  a $5.6 million decrease in BBJ auxiliary fuel systems revenues; offset by

 

•                  a $3.6 million increase in our aircraft completion and modification revenues, principally resulting for our first aircraft interior completion during 2002.

 

Gross profit.  Gross profit decreased $15.9 million, or 21.1%, to $59.3 million for the year ended December 31, 2002 from $75.2 million for the same period in the prior year.  By segment, gross profit changed as follows:

 

		Increase (Decrease) From 2001
(In millions)		Amount			Percent
Cabin Management		$	(10.7	)	(21.7	)%
Systems Integration		(5.3		)	(20.3	)
Inter-group elimination		0.1
Total		$	(15.9	)

 

27

 

Cabin Management.  Gross profit decreased by $10.7 million, or 21.7% compared to the prior year, primarily due to:

 

•                  a $6.6 million net decrease caused by charges related to our 2001 and 2002 restructuring activities;

 

•                  a $3.8 million decrease in profit margins due to lower volume for our business, VIP and head-of-state aircraft furniture and seating products, and

 

•                  a $0.3 million decrease in gross profit related to lower volume for our cabin management and entertainment systems.

 

Systems Integration.  Gross profit decreased by $5.3 million, or 20.3% compared to the prior year, primarily due to $4.1 million of other asset impairment related charges and lower sales volume.

 

Selling, general and administrative expenses.  Selling, general and administrative expenses decreased $4.4 million, or 10.0%, to $40.3 million for the year ended December 31, 2002, from $44.7 million for the same period in the prior year.  By segment, SG&A expenses changed as follows:

 

		Increase (Decrease) From 2001
(In millions)		Amount			Percent
Cabin Management		$	(1.2	)	(7.3	)%
Systems Integration		(2.1		)	(22.0	)
Corporate		(1.1		)
Total		$	(4.4	)

 

Cabin Management.  SG&A expenses decreased by $1.2 million, or 7.3% compared to the prior year, due to:

 

•                  a $4.0 million decrease in expenses as a result of cost reduction measures implemented in 2001 and 2002 in response to lower sales volume resulting from the weak global economic conditions; offset by

 

•                  a $2.8 million increase caused by charges relating to our 2001 and 2002 restructuring activities.

 

Systems Integration.  SG&A expenses decreased by $2.1 million, or 22.0% compared to the prior year, due to lower labor and employee benefit costs resulting from workforce reductions implemented during the fourth quarter of fiscal 2001.

 

Corporate.  SG&A expenses decreased by $1.1 million compared to the prior year, primarily due to workforce and travel expense reductions offset by increases in insurance and employee benefit costs.

 

Research and development expenses.  Research and development expenses were $0.1 million for the year ended December 31, 2002 compared to $0.7 million in the prior year.  As more fully described in “—Change in Accounting Principle,” we elected to change our accounting policy for product development costs incurred for long-term programs.  Commencing January 1, 2003, such costs are classified as a component of result, research and development expenses.  Expenses would have been $5.0 million in 2002 and $11.7 million in 2001 if the new accounting policy had been in effect during those years.

 

Impairment of goodwill.  In 2001, an $8.6 million impairment charge was recognized pursuant to the provisions of SFAS No. 121, “Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,” to reflect the impairment resulting from our restructuring activities.  See “—Goodwill Impairment Charges” below for additional information.

 

28

 

Depreciation and amortization of intangibles.  Depreciation and amortization expense decreased $9.8 million to $10.6 million for the year ended December 31, 2002 compared to $20.4 million for the same period in the prior year, primarily resulting from the adoption of new accounting standards, as follows:

 

		Increase (Decrease) From 2001
(In millions)		Amount			Percent
Depreciation charged to:
Cost of sales		$	(0.7	)	(14.2	)%
Selling, general and administrative expense		(0.2		)	(5.1	)
Amortization of intangible assets:
Goodwill		(9.1		)	(100.0	)
Identifiable intangible assets		0.2			5.0
Total		$	(9.8	)

 

Effective January 1, 2002, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets” and the provisions of SFAS No. 141, “Business Combinations,” which were required to be adopted concurrent with the adoption of SFAS No. 142.  Under these new standards, goodwill is deemed to be an indefinite-lived asset and, as a result, the recording of periodic goodwill amortization charges was discontinued effective January 1, 2002.  In addition, SFAS No. 141 requires that intangible assets relating to acquired assembled workforce intangibles not meeting the criteria for recognition apart from goodwill be reclassified to goodwill.  Goodwill amortization was $9.1 million for the year ended December 31, 2001, which includes $1.1 million of assembled workforce amortization, now deemed part of goodwill.  See “—Goodwill Impairment Charges” below for additional information.

 

Excluding the effect of the accounting change, depreciation and amortization decreased $0.9 million as a result of lower depreciable costs resulting from the impairment of long-lived assets recorded during the fourth quarter of fiscal 2001 and 2002, partially offset by additional depreciation resulting from capital expenditures during the period.

 

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

 

Cabin Management.  Adjusted EBITDA decreased by $12.9 million, or 28.3% compared to the prior year, primarily due to:

 

•                  a $9.3 million decrease related principally to lower revenues in our business, VIP and head-of-state aircraft furniture and seating operations; and

 

•                  a $3.6 million decrease resulting from lower sales volume for our cabin management and entertainment systems.

 

Systems Integration.  Adjusted EBITDA increased by $0.9 million, or 5.4% compared to the prior year, primarily the result of reduced SG&A spending resulting from workforce reductions.

 

29

 

Operating income.  Operating income increased $6.7 million to $15.5 million for the year ended December 31, 2002, from $8.8 million for the same period in the prior year.  Operating income changed as follows:

 

		Increase (Decrease) From 2001
(In millions)		Amount			Percent
Cabin Management		$	2.7		55.9	%
Systems Integration		1.4			18.1
Corporate		2.5
Inter-group elimination		0.1
Total		$	6.7

 

Cabin Management.  Operating income increased by $2.7 million, or 55.9% compared to the prior year, primarily due to:

 

•                  a $10.7 million decrease in gross profit primarily caused by charges related to our restructuring activities and due to lower volume for our business, VIP and head-of-state aircraft furniture and seating products; offset by

 

•                  a $1.9 million decrease in SG&A resulting from cost reduction measures and restructuring charges;

 

•                  a $5.0 million decrease in goodwill impairment; and

 

•                  a $6.7 million decrease in amortization of intangibles.

 

Systems Integration.  Operating income increased by $1.4 million, or 18.1% compared to the prior year, primarily due to:

 

•                  a $5.2 million decrease in gross profit due to other asset impairment related charges and lower sales volumes; offset by

 

•                  a $2.2 million decrease in SG&A resulting from lower labor and employee benefit costs;

 

•                  a $3.5 million decrease in goodwill impairment; and

 

•                  a $0.9 million decrease in amortization of intangibles.

 

Corporate.  Operating income increased $2.5 million compared to the prior year, due to principally to reduced SG&A spending.

 

Interest expense.  Interest expense decreased $4.3 million, or 14.4%, to $25.4 million for the year ended December 31, 2002 compared to $29.7 million for the same period in the prior year due almost entirely to lower average interest rates charged by our lenders.

 

Provision for income taxes.  The provision for income taxes differs from the amount determined by applying the applicable U.S. statutory federal rate to the income before income taxes primarily due to the effects of state and foreign income taxes and non-deductible expenses, principally goodwill impairment charges and amortization (for periods prior to the January 1, 2002 adoption of SFAS No. 142).  The difference in the effective tax rates between periods is mostly the result of the adoption of SFAS No. 142.

 

30

 

Loss from continuing operations.  Loss from continuing operations decreased $10.8 million to a loss of $6.8 million for the year ended December 31, 2002, compared to a loss of $17.6 million for the same period in the prior year.  The decrease in loss from continuing operations is attributable to:

 

•                  an $8.9 million decrease in amortization of goodwill and intangible assets resulting from the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets,” on January 1, 2002;

 

•                  an $8.6 million decrease in goodwill impairment charges; and

 

•                  a $4.3 million decrease in interest expense; offset by

 

•                  an $11.0 million loss increase principally resulting from reduced profits caused by lower revenues.

 

Income (loss) from discontinued operations.  Income from discontinued operations decreased $44.9 million to a loss of $41.4 million for the year ended December 31, 2002 compared to income of $3.5 million for the same period in the prior year.  The change in income (loss) from discontinued operations is attributable to:

 

•                  a $39.4 million charge in 2002 to reflect the cumulative effect on discontinued operations of the change in accounting principle associated with initial adoption of SFAS No. 142, “Goodwill and Other Intangible Assets;” and

 

•                  a $7.7 million charge in 2002 to reflect the additional impairment of goodwill in connection with the annual impairment testing provisions of SFAS No. 142; and

 

•                  a $3.1 million loss increase principally resulting from reduced profits caused by lower revenues; offset by

 

•                  a $5.3 million reduction in goodwill amortization expense resulting from discontinuance of periodic amortization charges pursuant to SFAS No. 142.

 

The $39.4 million and $7.7 million charges in 2002 are attributable to the goodwill impairment of one of the three reporting units within the Specialty Avionics Group.  Aggregate goodwill was $126.5 million as of December 31, 2001 and $80.7 million as of December 31, 2002, after the $47.1 million 2002 impairment charges and a $1.3 million reclassification of intangible assets in connection with the adoption of SFAS No. 142.  See “—Goodwill Impairment Charges” below for additional information.

 

Cumulative effect of change in accounting principle.  The $17.8 million charge to reflect the cumulative effect of change in accounting principle for the year ended December 31, 2002 was a result of transitional goodwill impairment charges recognized upon initial adoption of SFAS No. 142, “Goodwill and Other Intangible Assets.”  See “—Goodwill Impairment Charges” below for additional information.

 

Net income (loss).  Net loss increased $52.0 million to a net loss of $66.0 million for the year ended December 31, 2002 compared to a net loss of $14.0 million for the same period in the prior year.  The increase over the prior year is a result of a $10.7 million decrease in loss from continuing operations offset by an increase in loss from discontinued operations of $44.9 million and the cumulative effect of change in accounting principle of $17.8 million.

 

Net income (loss) applicable to common stockholder.  Net loss applicable to DeCrane Holdings, our common stockholder, increased $52.7 million to a net loss of $71.8 million for the year ended December 31, 2002 compared to a net loss of $19.1 million for the same period in the prior year.  The increase in the net loss applicable to our common stockholder is attributable to:

 

•                  a $52.0 million net loss increase; and

 

•                  a $0.7 million increase in accrued 16% mandatorily redeemable preferred stock dividends resulting from the quarterly compounding of accrued dividends.

 

31

 

Bookings.  Bookings decreased $55.7 million, or 22.0%, to $197.1 million for the year ended December 31, 2002 compared to $252.8 million for the same period in the prior year.  The decrease in bookings for 2002 is due to decreases in orders for all of our business segments.

 

Backlog at end of period.  Backlog decreased $32.7 million to $66.8 million as of December 31, 2002 compared to $99.5 million as of December 31, 2001.

 

Restructuring, Asset Impairment and Other Related Charges

 

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

 

During the three years ended December 31, 2003, we recorded restructuring, asset impairment and other related pre-tax charges, principally relating to our restructuring activities.  These charges are summarized below.

 

		Year Ended December 31,
(In millions)		2003			2002			2001
Nature of charges:
Seating Product Line and Furniture Manufacturing Facilities Restructuring		$	7.1		$	—		$	—
Asset Realignment Restructuring		—			6.9			20.1
Seat Manufacturing Facilities Restructuring		—			6.3			—
Adjustment of Previous Restructuring Charge		0.8			—			—
Goodwill impairment charges		41.5			7.7			8.6
Other asset impairment related charges		—			4.3			—
Total pre-tax charges		$	49.4		$	25.2		$	28.7
Business segment recording the charges:
Cabin Management		$	41.1		$	13.2		$	22.4
Systems Integration		0.8			4.0			3.5
Total charged to continuing operations		41.9			17.2			25.9
Discontinued operations (Specialty Avionics)		7.5			8.0			2.8
Total pre-tax charges		$	49.4		$	25.2		$	28.7
Charged to operations:
Cost of sales		$	7.3		$	10.7		$	13.6
Selling, general and administrative expenses		0.6			6.5			3.7
Impairment of goodwill		34.0			—			8.6
Total charged to operations		41.9			17.2			25.9
Charged to discontinued operations (Specialty Avionics)		7.5			8.0			2.8
Total pre-tax charges		$	49.4		$	25.2		$	28.7
Components of charges:
Noncash charges		$	37.7		$	11.4		$	19.6
Cash charges		4.2			5.8			6.3
Total charged to continuing operations		41.9			17.2			25.9
Charged to discontinued operations		7.5			8.0			2.8
Total pre-tax charges		$	49.4		$	25.2		$	28.7

 

32