SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
Commission file number 33-96190
AEARO CORPORATION
(Exact name of registrant as specified in its charter)
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Delaware 13-3840450
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
5457 West 79th Street 46268
Indianapolis, Indiana (Zip Code)
(Address of principal executive offices)
(317) 692-6666
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) 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. Yes X No__
The number of shares of the registrant's common stock, par value $.01
per share, outstanding as of August 14, 2002 was 101,912.5.
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Aearo Corporation
TABLE OF CONTENTS
Form 10-Q for the Quarterly Period Ended June 30, 2002
PART I-FINANCIAL INFORMATION...................................................3
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Item 1. Financial Statements................................................3
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Condensed Consolidated Balance Sheets - Assets......................3
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Condensed Consolidated Balance Sheets
- Liabilities and Stockholders' Equity..............................4
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Condensed Consolidated Statements of Operations.....................5
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Condensed Consolidated Statements of Cash Flows.....................6
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Notes To Condensed Consolidated Financial Statements................7
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Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..........................................14
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.........23
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PART II - OTHER INFORMATION...................................................25
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Item 1. Legal Proceedings..................................................25
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Item 2. Changes in Securities and Use of Proceeds..........................26
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Item 3. Defaults Upon Senior Securities....................................26
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Item 4. Submission of Matters to a Vote of Security Holders................26
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Item 5. Other Information..................................................26
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Item 6. Exhibits and Reports on Form 8-K...................................26
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SIGNATURES....................................................................27
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CERTIFICATIONS................................................................28
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EXHIBIT INDEX.................................................................29
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- 2 -
PART I-FINANCIAL INFORMATION
Item 1. Financial Statements
AEARO CORPORATION
Condensed Consolidated Balance Sheets - Assets
(Dollars in Thousands)
-------------- --------------
June 30, September 30,
2002 2001
-------------- --------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 11,459 $ 18,233
Accounts receivable (net of reserve for doubtful accounts of
$1,249 and $831 respectively) 48,724 42,428
Inventories 33,666 29,564
Deferred and prepaid expenses 3,656 2,325
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Total current assets 97,505 92,550
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PROPERTY, PLANT AND EQUIPMENT, NET 48,929 47,003
INTANGIBLE ASSETS, NET 123,046 118,200
OTHER ASSETS 2,652 3,549
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Total assets $ 272,132 $ 261,302
============ =============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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AEARO CORPORATION
Condensed Consolidated Balance Sheets - Liabilities and Stockholders' Equity
(Dollars in Thousands)
-------------------- -- ------------------
June 30, September 30,
2002 2001
-------------------- ------------------
(Unaudited)
CURRENT LIABILITIES:
Current portion of long-term debt $ 11,314 $ 8,393
Accounts payable and accrued liabilities 41,276 37,896
Accrued interest 5,663 2,691
U.S. and foreign income taxes 2,813 2,265
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Total current liabilities 61,066 51,245
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LONG-TERM DEBT 186,134 193,836
DEFERRED INCOME TAXES 429 383
OTHER LIABILITIES 6,503 5,982
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Total liabilities $ 254,132 $ 251,446
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COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value-
(Redemption value of $106,102 and $96,801, respectively)
Authorized--200,000 shares
Issued and outstanding--45,000 shares - -
Common stock, $.01 par value-
Authorized--200,000 shares
Issued and outstanding--101,913 and 102,088 shares, respectively 1 1
Additional paid-in capital 32,226 32,374
Accumulated earnings (deficit) 1,094 (2,494)
Accumulated other comprehensive loss (15,321) (20,025)
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Total stockholders' equity 18,000 9,856
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Total liabilities and stockholders' equity $ 272,132 $ 261,302
================ ==============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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Condensed Consolidated Statements of Operations
(DOLLARS IN THOUSANDS)
(Unaudited)
------------------------------------ --- -------------------------------------
For the Three Months Ended For the Nine Months Ended
June 30, June 30,
------------------------------------ -------------------------------------
2002 2001 2002 2001
---------------- ---------------- ---------------- -----------------
NET SALES $ 76,435 $ 72,138 $ 208,761 $ 214,542
COST OF SALES 40,024 39,007 110,312 115,676
--------------- --------------- --------------- ---------------
Gross profit 36,411 33,131 98,449 98,866
SELLING AND ADMINISTRATIVE 24,914 19,570 68,602 65,664
RESEARCH AND TECHNICAL SERVICES 1,493 1,138 4,251 3,987
AMORTIZATION OF INTANGIBLES 1,570 1,593 4,686 4,882
OTHER CHARGES (INCOME), NET 330 (87) 368 437
--------------- --------------- --------------- ---------------
Operating income 8,104 10,917 20,542 23,896
INTEREST EXPENSE, NET 4,972 5,451 15,018 17,131
--------------- --------------- --------------- ---------------
Income before provision for income taxes
3,132 5,466 5,524 6,765
PROVISION FOR INCOME TAXES 850 454 1,936 1,105
--------------- --------------- --------------- ---------------
Net income $ 2,282 $ 5,012 $ 3,588 $ 5,660
=============== =============== =============== ===============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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Condensed Consolidated Statements of Cash Flows
(DOLLARS IN THOUSANDS)
(Unaudited)
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For the Nine Months Ended
June 30,
-----------------------------------------
2002 2001
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,588 $ 5,660
Adjustments to reconcile net income to cash provided by operating activities-
Depreciation 7,976 7,695
Amortization of intangible assets and deferred financing costs 5,842 5,990
Deferred income taxes -- (150)
Other, net 288 186
Changes in assets and liabilities-(net of effects of acquisitions)
Accounts receivable (2,226) 1,276
Inventories (1,385) (1,178)
Accounts payable and accrued liabilities 829 (4,809)
Other, net (21) (731)
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Net cash provided by operating activities 14,891 13,939
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CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (5,846) (5,804)
Cash paid for Iron Age Vision (706) --
Cash paid for Leader (3,636) --
Cash paid for Chesapeake (3,000) --
Proceeds provided by disposals of property, plant and equipment 13 36
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Net cash used by investing activities (13,175) (5,768)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from revolving credit facility, net -- 11,750
Repayment of bonds (2,000) --
Repayment of term loans (6,097) (13,301)
Repayment of capital lease obligations (100) --
Repayment of long-term debt (102) (97)
Other (147) 173
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Net cash used by financing activities (8,446) (1,475)
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EFFECT OF EXCHANGE RATE CHANGES ON CASH (44) (1,237)
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INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (6,774) 5,459
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 18,233 3,495
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CASH AND CASH EQUIVALENTS, END OF PERIOD $ 11,459 $ 8,954
============= =============
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Capital lease obligations $ 1,421 $ --
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CASH PAID FOR:
Interest $ 10,952 $ 13,646
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Income taxes $ 1,536 $ 1,557
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The accompanying notes are an integral part of these condensed consolidated
financial statements.
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Notes To Condensed Consolidated Financial Statements
JUNE 30, 2002
(Unaudited)
1) CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments necessary to
present fairly, in accordance with accounting principles generally accepted
in the United States of America, the Company's financial position, results
of operations and cash flows for the interim periods presented. The results
of operations for the interim periods shown in this report are not
necessarily indicative of results for any future interim period or for the
entire year. These condensed consolidated financial statements do not
include all disclosures associated with annual financial statements and
accordingly should be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's Annual Report on
Form 10-K405.
2) COMPANY BACKGROUND
Aearo Corporation, a Delaware corporation, and its direct wholly owned
subsidiary, Aearo Company, a Delaware corporation (collectively referred to
herein as "the Company") manufactures and sells products under the brand
names: AOSafety(R), E-A-R(R), and Peltor(R). These products are sold
through three reportable segments, which are Safety Products, Safety
Prescription Eyewear and Specialty Composites.
3) SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates. The preparation of the condensed consolidated financial
statements in conformity with accounting principles generally accepted in
the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those
estimates.
Revenue Recognition. The Company recognizes revenue upon shipment of its
products to customers.
Foreign Currency Translation. Assets and liabilities of the Company's
foreign operations are translated at period-end exchange rates. Income and
expenses are translated at the approximate average rate during the period.
Foreign currency translation adjustments are recorded as a separate
component of stockholders' equity. Foreign currency gains and losses
arising from transactions by any of the Company's subsidiaries are
reflected in net income.
Shipping and Handling Fees and Costs. Shipping and handling costs include
payments to third parties for the delivery of products to customers, as
well as internal salaries and overhead costs incurred to store, move and
prepare finished products for shipment. Shipping and handling costs are
included with selling and administrative expenses in the accompanying
condensed consolidated statement of operations. Shipping and handling costs
in the three months ended June 30, 2001 and 2002 were $4.3 million and $4.6
million, respectively. Shipping and handling costs in the nine months ended
June 30, 2001 and 2002 were $12.8 and $12.8 million, respectively. The
Company recovers a portion of its shipping and handling costs from its
customers and records this recovery in net sales.
Income Taxes. Deferred tax assets and liabilities are determined based on
the difference between the financial statement and tax basis of assets and
liabilities using enacted tax rates.
Intangible Assets. Intangible assets consist primarily of the goodwill,
patents, and trademarks purchased in business acquisitions. Intangible
assets are amortized over their estimated useful lives.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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AEARO CORPORATION
Notes To Condensed Consolidated Financial Statements
JUNE 30, 2002
(Unaudited)
Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections. In April 2002, the FASB issued
SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment
of FASB Statement No. 13, and Technical Corrections". This statement
rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of
Debt", and an amendment of that Statement, SFAS No. 64, "Extinguishments of
Debt Made to Satisfy Sinking-Fund Requirements". This Statement also
rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers".
This Statement amends SFAS No. 13, "Accounting for Leases", to eliminate an
inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications
that have economic effects that are similar to sale-leaseback transactions.
This Statement also amends other existing authoritative pronouncements to
make various technical corrections, clarify meanings or describe their
applicability under changed conditions. The provisions of this statement
related to the rescission of SFAS No. 4 will be applied in fiscal years
beginning after May 15, 2002. The Company is in the process of evaluating
the impact of this statement on its financial statements and will adopt the
provisions of this statement in the first quarter of fiscal year 2003.
Impairment or Disposal of Long-Lived Assets. In August 2001, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial
Accounting Standards ("SFAS") No. 144 "Accounting for the Impairment or
Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting
and reporting for the impairment or disposal of long-lived assets and
superceded SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" and Accounting
Principles Board ("APB") No. 30, "Reporting the Results of
Operations-Reporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions". SFAS No 144 is effective in fiscal years beginning after
December 15, 2001, with early adoption permitted. The Company is currently
assessing the impact of adopting this standard and has not yet determined
the effect of adoption on its financial position and results of operations.
Asset Retirement Obligations. In July 2001, the FASB issued SFAS No. 143,
"Accounting for Asset Retirement Obligations". SFAS No. 143 is effective
for fiscal years beginning after June 15, 2002, and establishes accounting
standards requiring the recording of the fair value of liabilities
associated with the retirement of long-lived assets in the period in which
they are incurred. The Company is currently assessing the impact of
adopting this standard and has not yet determined the effect of adoption on
its financial position and results of operations.
Business Combinations, Goodwill and Other Intangibles. In June 2001, the
FASB issued two new pronouncements: SFAS No. 141, "Business Combinations"
and SFAS No. 142 "Goodwill and Other Intangibles." SFAS No. 141 requires
that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 and that the use of the
pooling-of-interest method is no longer allowed. SFAS No. 142 requires that
upon adoption, amortization of goodwill of approximately $3.2 million
annually will cease and instead, the carrying value of goodwill be
evaluated for impairment on an annual basis. Identifiable intangible assets
will continue to be amortized over their useful lives and reviewed for
impairment in accordance with SFAS No. 121 "Accounting for the Impairment
of Long-Lived Assets to be Disposed Of". SFAS No. 142 is effective for
fiscal years beginning after December 15, 2001. The Company is evaluating
the impact of the adoption of these standards and has not yet determined
the effect of adoption on its financial position and results of operations.
Accounting for Derivative Instruments and Hedging Activities. The Company
adopted the provisions of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" on October 1, 2000. SFAS No. 133
requires that every derivative instrument be recorded in the balance sheet
as either an asset or a liability measured at its fair value.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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AEARO CORPORATION
Notes To Condensed Consolidated Financial Statements
JUNE 30, 2002
(Unaudited)
The Company has formally documented its hedging relationships, including
identification of the hedging instruments and the hedge items, as well as
its risk management objectives and strategies for undertaking each hedge
transaction. From time to time the Company enters into foreign currency
forward contracts and interest rate swap and collar agreements, which are
derivatives as defined by SFAS No. 133. The Company enters into foreign
currency forward contracts to mitigate the effects of changes in foreign
currency rates on profitability and enters into interest rate swap and
collar agreements to hedge its variable interest rate risk. These
derivatives are cash flow hedges. For all qualifying and highly effective
cash flow hedges, the changes in the fair value of the derivatives are
recorded in other comprehensive income. Amounts accumulated in other
comprehensive income will be reclassified as earnings when the related
product sales affect earnings for foreign currency forward contracts or
when related interest payments affect earnings for interest rate collar
agreements. As a result of the foreign currency forward contracts, the
Company has recorded a derivative liability of $0.6 million at June 30,
2002. All foreign currency forward contracts are executed in exchange
traded markets for which quoted prices exist and will expire over the next
3 months.
During the nine month period ending June 30, 2002, amounts reclassified
into earnings resulting from foreign currency forward contracts were
minimal. All foreign currency forward contracts were determined to be
highly effective; therefore no ineffectiveness was recorded.
The Company also executes foreign currency forward contracts for up to
30-day terms to protect against the adverse effects that exchange rate
fluctuations may have on the foreign-currency-denominated trade activities
(receivables, payables and cash) of foreign subsidiaries. These contracts
have not been designated as hedges under SFAS No. 133 and accordingly, the
gains and losses on both the derivative and foreign-currency-denominated
trade activities are recorded as transaction adjustments in current
earnings. The impact on earnings was a loss of approximately $0.1 million
for the nine month period ended June 30, 2002.
The Company also entered into an interest rate collar arrangement during
October 2001 to protect $25.0 million of adjustable Term Loan debt (as
defined below in Note 6). The collar was not designated as a hedge under
SFAS No. 133. The fair value of the interest rate collar remained unchanged
and accordingly there was no charge to earnings in the nine month period
ended June 30, 2002.
4) COMPREHENSIVE INCOME
Comprehensive income consisted of the following (Dollars in thousands):
For the Three Months For the Nine Months
Ended June 30, Ended June 30,
------------------------ -------------------------
2002 2001 2002 2001
---------- ---------- ---------- -----------
Net income $ 2,282 $ 5,012 $ 3,588 $ 5,660
Foreign currency translation adjustment 4,622 (1,633) 5,320 (5,027)
Unrealized gain (loss) on derivative instruments (752) 613 (616) (70)
---------- ---------- ---------- -------=---
Comprehensive income $ 6,152 $ 3,992 $ 8,292 $ 563
========== ========== ========== ===========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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AEARO CORPORATION
Notes To Condensed Consolidated Financial Statements
JUNE 30, 2002
(Unaudited)
5) INVENTORIES
Inventories consisted of the following (Dollars in thousands):
June 30, September 30,
2002 2001
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Raw materials $ 8,634 $ 7,259
Work in process 8,733 8,364
Finished goods 16,299 13,941
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$ 33,666 $ 29,564
============ ==============
Inventories, which include materials, labor and manufacturing overhead, are
stated at the lower of cost or market, cost being determined using the
first-in, first-out method.
6) DEBT
The Company's debt structure includes: (a) $98.0 million of Senior
Subordinated Notes (Notes) due 2005, which are publicly held and redeemable
at the option of the Company, in whole or in part, at various redemption
prices, and (b) up to an aggregate of $135.0 million under a Credit
Agreement with various banks to provide Senior Bank Facilities comprised of
(i) a secured term loan facility consisting of loans providing for up to
$100.0 million of term loans (collectively the Term Loans) with a portion
of the Term Loans denominated in foreign currencies, (ii) a secured
revolving credit facility (Revolving Credit Facility) providing for up to
$30.0 million of revolving loans for general corporate purposes, and (iii)
a U.K. overdraft facility of up to an equivalent of $5.0 million in Great
Britain Pounds for working capital requirements as needed. The amount
outstanding on the Term Loans at June 30, 2002, was approximately $95.6
million. No amounts were outstanding under the Revolving Credit Facility or
the U.K. overdraft facility.
Under the terms of both the Senior Bank Facilities and the Notes indenture,
Aearo Company is required to comply with certain financial covenants and
restrictions. Aearo Company was in compliance with all financial covenants
and restrictions at June 30, 2002.
7) COMMITMENTS AND CONTINGENCIES
Lease Commitments. The Company leases certain transportation vehicles,
warehouse facilities, office space, and machinery and equipment under
cancelable and non-cancelable leases, most of which expire within 10 years
and may be renewed by the Company.
Contingencies. Various lawsuits and claims arise against the Company in the
ordinary course of its business. Most of these lawsuits and claims are
product liability matters that arise out of the use of safety eyewear and
respiratory product lines manufactured by the Company as well as products
purchased for resale. In addition, the Company may be contingently liable
with respect to numerous lawsuits involving respirators sold by its
predecessors, American Optical Corporation and Cabot Corporation ("Cabot"),
arising out of agreements entered into when the AOSafety(R) Division was
sold by American Optical Corporation to Cabot in April 1990 and when later
sold by Cabot to the Company in 1995. These lawsuits typically involve
plaintiffs alleging that they suffer from asbestosis or silicosis, and that
such condition results in part from respirators which were negligently
designed or manufactured. The defendants in these lawsuits are often
numerous, and include, in addition to respirator manufacturers, employers
of the plaintiffs and manufacturers of sand (used in sand blasting) and
asbestos. Responsibility for legal costs, as well as for settlements and
judgments, is shared
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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AEARO CORPORATION
Notes To Condensed Consolidated Financial Statements
JUNE 30, 2002
(Unaudited)
contractually by the Company, Cabot, American Optical Corporation and a
prior owner of American Optical Corporation. Liability is allocated among
the parties based on the number of years each company owned the AOSafety
Division and the alleged years of exposure of the individual plaintiff. The
Company's share of the contingent liability is further limited by an
agreement entered into between the Company and Cabot whereby, so long as
the Company pays to Cabot an annual fee of $400,000, Cabot will retain
responsibility and liability for, and indemnify the Company against,
asbestos and silicosis related legal claims asserted after July 11, 1995
(the date of the Company's formation) alleged to arise out of the use of
respirators manufactured prior to July 11, 1995. This annual fee was
negotiated as part of the 1995 agreement between the Company and Cabot. To
date, the Company has elected to pay the annual fee. The Company could
potentially be liable for these exposures if the Company elects to
discontinue its participation in this arrangement, or if Cabot is no longer
able to meet its obligations in these matters. With these arrangements in
place, however, the Company's potential liability is limited to exposures
alleged to arise from the use of respirators manufactured after July 11,
1995. The Company may also be responsible for certain claims of acquired
companies other than the AOSafety(R) Division that are not covered by, and
are unrelated to, the agreement with Cabot.
At June 30, 2002, the Company has reserved approximately $5.0 million for
product liabilities including those arising from asbestosis or silicosis
litigation. The reserve is reevaluated periodically and may result in
additional charges to operations if additional information becomes
available. As is standard in the insurance industry, the Company's product
liability insurance excludes asbestos and silicosis related respiratory
claims. Therefore, the Company's accrual has not been reduced for estimated
insurance recoveries. Consistent with the general environment experienced
by other companies involved in asbestos-related litigation, there has been
an increase in the number of asserted legal claims that could potentially
involve the Company. Since the Company, until recently, has not been
directly named in the lawsuits, it has very little available information
regarding specific numbers of claims that affect the Company directly.
Various factors increase the difficulty in determining the Company's
potential liability, if any, in such claims, including the fact that the
defendants in these lawsuits are often numerous and the claims generally do
not specify the amount of damages sought. Additionally, the bankruptcy
filings of other companies with asbestos-related litigation could affect
the Company's cost over time. However, it is management's opinion, taking
into account currently available information, historical experience,
uncertainties, the Cabot agreement and the Company's reserve, that these
suits and claims should not result in final judgments or settlements that,
in the aggregate, would have a material effect on the Company's financial
condition or results of operation.
8) SEGMENT REPORTING
The Company manufactures and sells products under the brand names:
AOSafety(R), E-A-R(R), and Peltor(R). These products are sold through three
reportable segments, which are Safety Products, Safety Prescription Eyewear
and Specialty Composites. The Safety Products segment manufactures and
sells hearing protection devices, non-prescription safety eyewear, face
shields, reusable and disposable respirators, hard hats and first aid kits.
The Safety Prescription Eyewear segment manufactures and sells prescription
eyewear products that are designed to protect the eyes from the typical
hazards encountered in the industrial work environment. The Company's
Safety Prescription Eyewear segment purchases component parts (lenses and
the majority of its frames) from various suppliers, grinds, shapes and
applies coatings to the lenses in accordance with the customer's
prescription, and then assembles the glasses using the customer's choice of
frame. The Specialty Composites segment manufactures a wide array of
energy-absorbing materials that are incorporated into other manufacturers'
products to control noise, vibration and shock.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
- 11 -
AEARO CORPORATION
Notes To Condensed Consolidated Financial Statements
JUNE 30, 2002
(Unaudited
Net Sales by Business Segment (Dollars in thousands):
For the Three Months Ended For the Nine Months Ended
June 30, June 30,
---------------------------- ---------------------------
------------- ------------ ------------ ------------
2002 2001 2002 2001
------------- ------------ ------------ -----------
Safety Products $ 55,034 $ 52,901 $ 150,417 $ 155,149
Safety Prescription Eyewear 11,118 10,074 30,662 29,716
Specialty Composites 10,283 9,163 27,682 29,677
------------- ------------ ------------ -----------
Total $ 76,435 $ 72,138 $ 208,761 $ 214,542
============= ============ ============ ===========
Inter-segment sales of the Specialty Composites segment to the Safety
Products segment totaled $1.3 million and $1.1 million for the three months
ended June 30, 2002 and 2001, respectively. Inter-segment sales totaled
$2.6 million and $3.1 million for the nine months ended June 30, 2002 and
2001, respectively. The inter-segment sales value is determined at fully
absorbed inventory cost at standard rates plus 25%.
EBITDA by Business Segment and reconciliation to income before provision
for income taxes (Dollars in thousands):
For the Three Months Ended For the Nine Months Ended
June 30, June 30,
------------------------------------ --------------------------------
2002 2001 2002 2001
---------------- --------------- ------------- ---------------
Safety Products $ 10,940 $ 11,367 $ 29,122 $ 28,953
Safety Prescription Eyewear 484 650 1,484 1,724
Specialty Composites 1,468 408 2,452 1,622
Reconciling Items (285) 2,655 415 4,059
---------------- --------------- ------------- ---------------
Total EBITDA 12,607 15,080 33,473 36,358
Depreciation 2,868 2,574 7,976 7,695
Amortization 1,570 1,593 4,686 4,882
Non-operating Costs (Income) 65 (4) 269 (115)
Interest 4,972 5,451 15,018 17,131
---------------- --------------- ------------- ---------------
Income before provision for income taxes
$ 3,132 $ 5,466 $ 5,524 $ 6,765
================ =============== ============= ===============
The Company evaluates the performance of its operating entities based on
EBITDA, which is defined by the Company as earnings before interest, taxes,
depreciation, amortization, and non-operating income or expense.
Non-operating income or expense is further defined as extraordinary gains
or losses, or gains or losses from sales of assets other than in the
ordinary course of business. While the Company believes EBITDA is a useful
indicator of its ability to service debt, EBITDA should not be considered
as a substitute for net income (loss) determined in accordance with
accounting principles generally accepted in the United States of America as
an indicator of operating performance or as an alternative to cash flow as
a measure of liquidity. Investors should be aware that EBITDA as presented
above may not be comparable to similarly titled measures presented by other
companies and comparisons could be misleading unless all companies and
analysts calculate this measure in the same fashion.
Reconciling items include unallocated selling, administrative, research and
technical expenses as well as manufacturing profit realized on intercompany
transactions not allocable to a specific segment.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
- 12 -
AEARO CORPORATION
Notes To Condensed Consolidated Financial Statements
JUNE 30, 2002
(Unaudited
9) RESTRUCTURING CHARGE
During fiscal 2001, the Company recorded an unusual charge of $11.4 million
relating to a restructuring plan announced by the Company to improve its
competitive position and long-term profitability. The plan includes the
closure of its Ettlingen, Germany plant, significantly reorganizing
operations at the Company's Varnamo, Sweden plant, rationalizing the
manufacturing assets and product mix of its Specialty Composites business
unit and a reduction of products and product lines.
The unusual charge includes cash charges of $2.3 million, which includes
$1.8 million for severance and other separation costs to cover the
reduction of 5% of the Company's work force and $0.5 million for other
costs associated with this plan. The unusual charge also includes non-cash
charges of $9.1 million, which includes $3.2 million for non-cancelable
long-term lease obligations, $2.9 million for asset impairments, $2.4
million for inventory disposals and $0.6 million related to the sale of the
Company's Ettlingen, Germany location. As of June 30, 2002, there is
approximately $ 5.6 million accrued related to the restructuring.
10) ACQUISITIONS
On December 14, 2001, the Company acquired Iron Age Vision from Iron Age
Corporation of Pittsburgh, Pennsylvania for approximately $0.7 million.
Iron Age Vision was the safety prescription eyewear division of Iron Age
Corporation. The transaction was accounted for using the purchase method of
accounting in accordance with SFAS No. 141, "Business Combinations", and
accordingly, the operating results of Iron Age Vision have been included
with those of the Company subsequent to December 14, 2001.
On January 21, 2002 the Company acquired the industrial safety business of
Montreal, Canada based Leader Industries, Inc. for approximately $3.6
million. The transaction was accounted for using the purchase method of
accounting in accordance with SFAS No. 141, "Business Combinations", and
accordingly, the operating results of Leader Industries, Inc. have been
included with those of the Company subsequent to January 22, 2002.
On May 7, 2002, the Company acquired the assets of Chesapeake Optical
Company of Baltimore, Maryland for approximately $3.0 million. The
transaction was accounted for using the purchase method of accounting in
accordance with SFAS No. 141, "Business Combinations", and accordingly, the
operating results of Chesapeake Optical have been included with those of
the Company subsequent to May 7, 2002.
The accompanying notes are an integral part of these condensed
consolidated financial statements.
- 13 -
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion should be read in conjunction with the
Consolidated Financial Statements of the Company, including notes thereto.
This Report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The Company's actual results could differ materially
from those set forth in such forward-looking statements. The factors that
might cause such a difference include, among others, the following: risks
associated with indebtedness; risks related to acquisitions; risks
associated with the conversion to a new management information system; high
level of competition in the Company's markets; importance and costs of
product innovation; risks associated with international operations; product
liability exposure; unpredictability of patent protection and other
intellectual property issues; dependence on key personnel; the risk of
adverse effect of economic and regulatory conditions on sales; and risks
associated with environmental matters.
Critical Accounting Policies
The Company's discussion and analysis of its financial condition and
results of operations are based upon the Company's condensed consolidated
financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States of America
(GAAP). GAAP requires the use of estimates, judgments and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses.
The Company believes its use of estimates and underlying accounting
assumptions adhere to GAAP and are consistently applied. The Company
revises its estimates and assumptions as new information becomes available.
The Company believes that of its significant accounting policies (see Notes
to the Consolidated Financial Statements in the Company's Annual Report on
Form 10-K405) the following policies involve a higher degree of judgment
and/or complexity.
Income Taxes - The Company accounts for income taxes in accordance with
SFAS No. 109, "Accounting for Income Taxes", which requires deferred tax
assets and liabilities be recognized using enacted tax rates for the effect
of temporary differences between book and tax bases of recorded assets and
liabilities. SFAS No. 109 also requires deferred tax assets be reduced by a
valuation allowance if it is more likely than not that some portion or all
of the deferred tax assets will not be realized. Recognition of a deferred
tax asset is dependent on generating sufficient future taxable income prior
to the expiration of the tax loss and credit carryforwards. Due to the
uncertainties of realizing these tax benefits, the Company has recorded a
full valuation allowance against these losses and credit carryforwards. The
Company evaluates the adequacy of the valuation allowance by assessing
prudent and feasible tax planning strategies. The ultimate amount of
deferred tax assets realized could be different from those recorded, as
influenced by potential changes in enacted tax laws and the availability of
future taxable income.
Accrued Liabilities -The Company has established reserves for potential
liabilities. A significant amount of judgment and use of estimates is
required to quantify the Company's ultimate exposure in these matters and
the valuation of reserves is periodically reviewed. While the Company
believes that the current level of reserves is adequate, changes in the
future could impact these determinations.
Restructuring - The Company recorded an unusual charge in fiscal 2001 based
on a restructuring plan to improve its competitive position and long-term
profitability. The provision recorded was based on estimates of the
expected costs associated with site closures, consolidation of products and
product lines, disposal of assets, contract terminations or other costs
directly related to the restructuring. To the extent that actual costs may
differ from amounts recorded, revisions to the estimated reserves would be
required.
- 14 -
Impairment of Long-Lived Assets - The Company evaluates long-lived assets,
including other intangibles and related goodwill, of identifiable business
activities for impairment when events or changes in circumstances indicate,
in management's judgment, that the carrying value of such assets may not be
recoverable. Cash flows used in the potential impairment evaluation are
based on management's estimates and assumptions. Changes in business
conditions could potentially require future adjustments to asset
valuations.
Results of Operations -- Three Months Ended June 30, 2002 Compared to Three
Months Ended June 30, 2001
Results of Operations
(Dollars in Thousands)
(Unaudited)
Three Months Ended June 30,
------------------------------------------------
2002 % 2001 %
---------------------- -----------------------
Safety Products $ 55,034 72.0 $ 52,901 73.3
Safety Prescription Eyewear 11,118 14.5 10,074 14.0
Specialty Composites 10,283 13.5 9,163 12.7
----------- --------- ----------- -----------
Total net sales 76,435 100.0 72,138 100.0
Cost of Sales 40,024 52.4 39,007 54.1
Gross profit 36,411 47.6 33,131 45.9
Operating Expenses-
Selling and administrative 24,914 32.6 19,570 27.1
Research and technical services 1,493 2.0 1,138 1.6
Amortization of intangibles 1,570 2.1 1,593 2.2
Other charges (income), net 330 -- (87) --
----------- --------- ----------- -----------
Total operating expenses 28,307 37.0 22,214 30.8
Operating income 8,104 10.6 10,917 15.1
Interest expense, net 4,972 6.5 5,451 7.6
----------- --------- ----------- -----------
Income before provision for income taxes 3,132 4.1 5,466 7.6
Provision for income taxes 850 1.1 454 0.6
----------- --------- ----------- -----------
Net income 2,282 3.0 5,012 6.9
=========== ========= =========== ===========
EBITDA $ 12,607 16.5 $ 15,080 20.9
=========== ========= =========== ===========
Net Sales. Net sales in the three months ended June 30, 2002 increased 6.0%
to $76.4 million from $72.1 million in the three months ended June 30,
2001. The increase in sales was primarily driven by the recent acquisitions
and improvement in the Specialty Composites segment. The Safety Products
segment net sales in the three months ended June 30, 2002 increased 4.0% to
$55.0 million from $52.9 million in the three months ended June 30, 2001.
The weakness of the U.S. dollar had the impact of increasing sales by $0.5
million in the three months ended June 30, 2002 as compared to the three
months ended June 30, 2001. The Safety Products segment sales for the three
months ended June 30, 2002 included $1.8 million of sales due to the
acquisition of Leader Industries on January 22, 2002. The Safety
Prescription Eyewear
- 15 -
segment net sales in the three months ended June 30, 2002 increased 10.4%
to $11.1 million from $10.0 million in the three months ended June 30,
2001. The Safety Prescription Eyewear segment sales for the three months
ended June 30, 2002 included $1.1 million of sales due to the acquisitions
of Iron Age Vision on December 14, 2001 and Chesapeake Optical on May 7,
2002. The Specialty Composites segment net sales in the three months ended
June 30, 2002 increased 12.2% to $10.3 million from $9.2 million in the
three months ended June 30, 2001. The increase was primarily driven by
volume in the electronics segment of the precision equipment market, which
includes computers and personal communications system (PCS) applications.
Gross Profit. Gross profit in the three months ended June 30, 2002
increased 9.9% to $36.4 million from $33.1 million in the three months
ended June 30, 2001. The increase in gross profit is primarily due to
increased productivity and acquisitions. Gross profit as a percentage of
net sales in the three months ended June 30, 2002 increased to 47.6% from
45.9% in the three months ended June 30, 2001. The improvement in gross
profit as a percentage of net sales is primarily due to increased
productivity and the positive impacts resulting from the 2001 restructuring
plan partially offset by a less favorable product mix.
Operating Expenses. Operating expenses in the three months ended June 30,
2002 increased 27.3% to $28.3 million from $22.2 million in the three
months ended June 30, 2001. The increase was primarily driven by an
increase in selling and administrative expenses and other charges, net.
Selling and administrative expenses in the three months ended June 30, 2002
included approximately $1.0 million of incremental expenses due to
acquisitions as well as increased spending for brand support. For the three
months ended June 30, 2001, operating expenses were lower due to salary
reductions, deferral of the Company's 401k match and other discretionary
spending cuts made to offset the impact of the weak economy in the last
half of fiscal 2001. The increase in other charges, net was primarily
driven by foreign exchange losses in the three months ended June 30, 2002
as compared to foreign exchange gains in the three months ended June 30,
2001.
Operating Income. As a result of the factors mentioned above, operating
income decreased 25.8% to $8.1 million in the three months ended June 30,
2002 from $10.9 million in the three months ended June 30, 2001. Operating
income as a percentage of net sales in the three months ended June 30, 2002
decreased to 10.6% as compared to 15.1% in the three months ended June 30,
2001.
Interest Expense, Net. Interest expense, net in the three months ended June
30, 2002 decreased 8.8% to $5.0 million from $5.5 million in the three
months ended June 30, 2001. The decrease is attributed to lower weighted
average interest rates in effect for the three months ended June 30, 2002
as compared to the three months ended June 30, 2001.
Provision For Income Taxes. The provision for income taxes increased to
$0.9 million in the three months ended June 30, 2002 from $0.5 million in
the three months ended June 30, 2001. Certain of the Company's foreign
subsidiaries had taxable income in their foreign jurisdictions while the
Company's domestic subsidiaries generated a net operating loss. The
domestic subsidiaries have net operating loss carry-forwards for income tax
purposes. Due to the uncertainty of realizing these tax benefits, the tax
benefits generated by the net operating losses have been fully reserved
with a valuation allowance.
Net Income. For the three months ended June 30, 2002, the Company had net
income of $2.2 million as compared to $5.0 million for the three months
ended June 30, 2001.
EBITDA. EBITDA is defined by the Company as earnings before interest,
taxes, depreciation, amortization, and non-operating income or expense.
Non-operating income or expense is further defined as extraordinary gains
or losses, or gains or losses from sales of assets other than in the
ordinary course of business. While the Company believes EBITDA is a useful
indicator of its ability to service debt,
- 16 -
EBITDA should not be considered as a substitute for net income determined
in accordance with GAAP as an indicator of operating performance or as an
alternative to cash flow as a measure of liquidity. Investors should be
aware that EBITDA as presented below may not be comparable to similarly
titled measures presented by other companies and comparisons could be
misleading.
EBITDA Calculation
Three Months Ended June 30, 2002
(Dollars in Thousands)
(Unaudited)
Three Months Ended Change
June 30, Favorable (Unfavorable)
----------------------------- ------------------------
2002 2001 Amount Percent
-------------- -------------- ----------- ------------
Operating Income $ 8,104 $ 10,917 $ (2,813) (25.8%)
Add Backs:
Depreciation 2,868 2,574 294 11.4
Amortization of intangibles 1,570 1,593 (23) (1.4)
Non-operating costs, net 65 (4) 69 --
---------- ---------- --------- -------------
EBITDA $ 12,607 $ 15,080 $ (2,473) (16.4%)
========== ========== ========= =============
By Segment
Safety Products $ 10,940 $ 11,367 $ (427) (3.8%)
Safety Prescription Eyewear 484 650 (166) (25.5)
Specialty 1,468 408 1,060 --
Reconciling Items (285) 2,655 (2,940) --
---------- ---------- --------- -------------
EBITDA $ 12,607 $ 15,080 $(2,473) (16.4%)
========== ========== ========= =============
EBITDA for the three months ended June 30, 2002 decreased 16.4% to $12.6
million from $15.1 million in the three months ended June 30, 2001. EBITDA
as a percentage of net sales in the three months ended June 30, 2002 was
16.5% as compared to 20.9% in the three months ended June 30, 2001. The
decrease in EBITDA is primarily attributed to higher operating expenses as
compared to the prior period which benefited from salary reductions,
deferral of the Company's 401k match and other discretionary spending cuts
that were taken to offset the unfavorable impact of foreign currencies and
the weak economy. These actions impacted each of the Company's three
operating segments. The Safety Products segment EBITDA in the three months
ended June 30, 2002 decreased 3.8% to $10.9 million from $11.4 million in
the three months ended June 30, 2001. This decrease was primarily due to
higher operating expenses due to last year's actions as mentioned above and
increased brand support. The Safety Prescription Eyewear segments EBITDA in
the three months ended June 30, 2002 decreased 25.5% to $0.5 from $0.7
million in the three months ended June 30, 2001. This decrease was
primarily driven by higher operating expenses due to last year's actions as
mentioned above, product mix and higher distribution costs. The Specialty
Composites segments EBITDA for the six months ended June 30, 2002 increased
259.8% to $1.5 million from $0.4 million in the three months ended June 30,
2001. This increase was primarily driven by improved sales volume and the
positive impacts of productivity improvements partially offset by the
relative increase in operating expenses due to last year's actions as
mentioned above.
- 17 -
Results of Operations -- Nine Months Ended June 30, 2002 Compared to Nine
Months Ended June 30, 2001
Results of Operations
(Dollars in Thousands)
(Unaudited)
Nine Months Ended June 30,
------------------------------------------
2002 % 2001 %
------------- -------- ----------- ------
Net Sales
Safety Products $ 150,417 72.1 $ 155,149 72.3
Safety Prescription Eyewear 30,662 14.7 29,716 13.9
Specialty Composites 27,682 13.2 29,677 13.8
----------- ------ ----------- ------
Total net sales 208,761 100.0 214,542 100.0
Cost of Sales 110,312 52.8 115,676 53.9
Gross profit 98,449 47.2 98,866 46.1
Operating Expenses-
Selling and administrative 68,602 32.9 65,664 30.6
Research and technical services 4,251 2.0 3,987 1.9
Amortization of intangibles 4,686 2.2 4,882 2.3
Other charges, net 368 0.2 437 0.2
----------- ------ ----------- ------
Total operating expenses 77,907 37.3 74,970 34.9
Operating income 20,542 9.8 23,896 11.1
Interest expense, net 15,018 7.2 17,131 8.0
----------- ------ ----------- ------
Income before provision for
income taxes 5,524 2.6 6,765 3.2
Provision for income taxes 1,936 0.9 1,105 0.5
----------- ------ ----------- -------
Net income 3,588 1.7 5,660 2.6
=========== ====== =========== =======
EBITDA $ 33,473 16.0 $ 36,358 16.9
=========== ====== =========== =======
Net Sales. Net sales in the nine months ended June 30, 2002 decreased 2.7%
to $208.8 million from $214.5 million in the nine months ended June 30,
2001. The favorable impact of acquisitions was not sufficient enough to
offset the unfavorable impact of the significant slowdown in the
manufacturing sector of the economy in which the Company markets its
products that was exacerbated by the impact of the terrorist events of
September 11, 2001 and the strong U.S. dollar. The Safety Products segment
net sales in the nine months ended June 30, 2002 decreased 3.0% to $150.4
million from $155.1 million in the nine months ended June 30, 2001. This
decrease was primarily driven by the continued effects of a weak economy as
mentioned above. The strength of the U.S. dollar had the impact of reducing
sales by $1.1 million in the nine months ended June 30, 2002 as compared to
the nine months ended June 30, 2001. The Safety Products segment sales for
the nine months ended June 30, 2002 included $3.3 million of sales due to
the acquisition of Leader Industries on January 22, 2002. The Safety
Prescription Eyewear segment net sales in the nine months ended June 30,
2002 increased by 3.2% to $30.7 million from $29.7 million in the nine
months ended June 30, 2001. The Safety Prescription Eyewear segment sales
for the
- 18 -
nine months ended June 30, 2002 included $1.5 million of sales due to the
acquisitions of Iron Age Vision on December 14, 2001 and Chesapeake Optical
on May 7, 2002. The Specialty Composites segment net sales in the nine
months ended June 30, 2002 decreased 6.7% to $27.7 million from $29.7
million in the nine months ended June 30, 2001. The decrease was primarily
driven by volume declines in the industrial equipment markets due to the
weak economy.
Gross Profit. Gross profit in the nine months ended June 30, 2002 decreased
0.4% to $98.5 million from $98.9 million in the nine months ended June 30,
2001. The slight decline in gross profit is primarily due to lower sales
volumes caused by the events of September 11, 2001 and the weak economy
offset by strong ongoing productivity improvements within the manufacturing
plants. Gross profit as a percentage of net sales in the nine months ended
June 30, 2002 improved to 47.2% as compared to 46.1% in the nine months
ended June 30, 2001. The increase in the Gross Profit percentage of net
sales is primarily due to continued productivity improvements in
manufacturing operations and the positive impact of the restructuring plan
announced on September 30, 2001 partially offset by unfavorable product
mix, lower capacity utilization and a stronger U.S. dollar.
Operating Expenses. Operating expenses in the nine months ended June 30,
2002 increased 3.9% to $77.9 million from $75.0 million in the nine months
ended June 30, 2001. The increase in operating expenses was primarily
driven by higher selling and administrative expenses. Selling and
administrative expenses in the nine months ended June 30, 2002 included
approximately $1.6 million of incremental expenses due to acquisitions as
well as increased spending for brand support. For the nine months ended
June 30, 2001, operating expenses were lower due to salary reductions,
deferral of the Company's 401k match and other discretionary spending cuts
made to offset the impact of the weak economy in the last half of fiscal
2001. Selling and administrative expenses as a percentage of net sales
increased to 32.9% in the nine months ended June 30, 2002 as compared to
30.6% in the nine months ended June 30, 2001.
Operating Income. As a result of the factors mentioned above, operating
income decreased 14.0% to $20.5 million in the nine months ended June 30,
2002 from $23.9 million in the nine months ended June 30, 2001. Operating
income as a percentage of net sales in the nine months ended June 30, 2002
decreased to 9.8% as compared to 11.1% in the nine months ended June 30,
2001.
Interest Expense, Net. Interest expense, net in the nine months ended June
30, 2002 decreased 12.4% to $15.0 million from $17.1 million in the nine
months ended June 30, 2001. The decrease is attributed to lower weighted
average interest rates in effect for the nine months ended June 30, 2002 as
compared to the nine months ended June 30, 2001.
Provision For Income Taxes. The provision for income taxes increased to
$1.9 million in the nine months ended June 30, 2002 from $1.1 million in
the nine months ended June 30, 2001. Certain of the Company's foreign
subsidiaries had taxable income in their foreign jurisdictions while the
Company's domestic subsidiaries generated a net operating loss. The
domestic subsidiaries have net operating loss carry-forwards for income tax
purposes. Due to the uncertainty of realizing these tax benefits, the tax
benefits generated by the net operating losses have been fully reserved for
by a valuation allowance.
Net Income. For the nine months ended June 30, 2002 the Company had net
income of $3.6 million as compared to $5.7 million for the nine months
ended June 30, 2001.
EBITDA. EBITDA is defined by the Company as earnings before interest,
taxes, depreciation, amortization, and non-operating income or expense.
Non-operating income or expense is further defined as extraordinary gains
or losses, or gains or losses from sales of assets other than in the
ordinary course of business. While the Company believes EBITDA is a useful
indicator of its ability to service debt, EBITDA should not be considered
as a substitute for net income determined in accordance with GAAP as an
indicator of operating performance or as an alternative to cash flow as a
measure of liquidity.
- 19 -
Investors should be aware that EBITDA as presented below may not be
comparable to similarly titled measures presented by other companies and
comparisons could be misleading.
EBITDA Calculation
Nine Months Ended June 30
(Dollars in Thousands)
(Unaudited)
Nine Months Ended Change
June 30, Favorable(Unfavorable)
--------------------- ----------------------
2002 2001 Amount Percent
---------- ---------- ----------- ----------
Operating Income $ 20,542 $ 23,896 $ (3,354) (14.0%)
Add Backs:
Depreciation 7,976 7,695 281 3.7
Amortization of intangibles 4,686 4,882 (196) (4.0)
Non-operating costs, net 269 (115) 384 --
---------- ---------- --------- ---------
EBITDA $ 33,473 $ 36,358 $ (2,885) (7.9%)
========== ========== ========= ==========
By Segment
Safety Products $ 29,122 $ 28,953 $ 169 0.6%
Safety Prescription Eyewear 1,484 1,724 (240) (13.9)
Specialty 2,452 1,622 830 51.2
Reconciling Items 415 4,059 (3,644) (89.8)
---------- --------- --------- ---------
EBITDA $ 33,473 $ 36,358 $ (2,885) (7.9%)
========== ========== ========= =========
EBITDA for the nine months ended June 30, 2002 decreased 7.9% to $33.5
million from $36.4 million for the nine months ended June 30, 2001. EBITDA
as a percentage of net sales in the nine months ended June 30, 2002 was
16.0% as compared to 16.9% in the nine months ended June 30, 2001. The
decrease in EBITDA is primarily attributed to higher operating expenses as
compared to the prior period which benefited from salary reductions,
deferral of the Company's 401k match and other discretionary spending cuts
that were taken to offset the unfavorable impact of foreign currencies and
the weak economy. These actions impacted each of the Company's operating
segments. The Safety Products segment EBITDA in the nine months ended June
30, 2002 increased 0.6% to $29.1 million from $29.0 million in the nine
months ended June 30, 2001. This increase was primarily driven by improved
gross margin due to productivity improvements and the acquisition of Leader
Industries on January 22, 2002 partially offset by increased operating
expenses due to the actions mentioned above. The Safety Prescription
Eyewear segment EBITDA in the nine months ended June 30, 2002 decreased
13.9% to $1.5 million from $1.7 million in the nine months ended June 30,
2001. This decrease was primarily driven by higher operating expenses due
to last year's actions as mentioned above, product mix and higher
distribution costs. The Specialty Composites segment EBITDA for the nine
months ended June 30, 2002 increased 51.2% to $2.5 million from $1.6
million in the nine months ended June 30, 2001. This increase was primarily
driven by productivity improvements and the positive impacts of the 2001
restructuring plan partially offset by lower sales volume.
Effects of Changes in Exchange Rates
In general, the Company's results of operations are affected by changes in
exchange rates. Subject to market conditions, the Company prices its
products in Europe and Canada in local currencies. While
- 20 -
many of the Company's selling and distribution costs are also denominated
in these currencies, a large portion of product costs are U.S. Dollar
denominated. As a result, a decline in the value of the U.S. Dollar
relative to other currencies can have a favorable impact on the
profitability of the Company and an increase in the value of the U.S.
Dollar relative to these other currencies can have a negative effect on the
profitability of the Company. As a result of the acquisition of Peltor, the
Company's operations are also affected by changes in exchange rates
relative to the Swedish Krona. In contrast to the above, a decline in the
value of the Krona relative to other currencies can have a favorable impact
on the profitability of the Company and an increase in the value of the
Krona relative to other currencies can have a negative impact on the
profitability of the Company. The Company utilizes forward foreign currency
contracts and other hedging instruments to mitigate the effects of changes
in foreign currency rates on profitability.
Effects of Inflation
In recent years, inflation has been modest and has not had a material
impact upon the results of the Company's operations.
Effects of Economic Conditions
Softening of the North American economy began during the first fiscal
quarter of 2001. Since that time the overall economic downturn has resulted
in many companies announcing layoffs which has also had an impact on
overall consumer confidence. The announced layoffs have had a significant
impact on the number of employed industrial workers. As a result of this it
is expected that the Company will continue to operate in a challenging
sales environment.
Liquidity and Capital Resources
The Company's sources of funds have consisted primarily of operating cash
flow and debt financing. The Company's uses of those funds consist
principally of debt service, capital expenditures and acquisitions.
The Company's debt structure includes: (a) $98.0 million of Senior
Subordinated Notes (Notes) due 2005, which are publicly held and are
redeemable at the option of the Company, in whole or in part, at various
redemption prices, and (b) up to an aggregate of $135.0 million under a
Credit Agreement with various banks to provide Senior Bank Facilities
comprised of (i) a secured term loan facility consisting of loans providing
for up to $100.0 million of term loans (collectively the Term Loans) with a
portion of the Term Loans denominated in foreign currencies, (ii) a secured
revolving credit facility (Revolving Credit Facility) providing for up to
$30.0 million of revolving loans for general corporate purposes, and (iii)
a U.K. overdraft facility of up to an equivalent of $5.0 million in Great
Britain Pounds for working capital requirements as needed. The amount
outstanding on the Term Loans at June 30, 2002, was approximately $95.6
million. No amounts were outstanding under the Revolving Credit Facility or
the U.K. overdraft facility.
Under the terms of both the Senior Bank Facilities and the Notes indenture,
Aearo Company is required to comply with certain financial covenants and
restrictions. Aearo Company was in compliance with all financial covenants
and restrictions at June 30, 2002.
On October 17, 2001 the Company executed a First Amendment to the Credit
Agreement, which allowed the Company the option to purchase, on or before
December 21, 2001, up to $10.0 million of the Notes at or below par. Prior
to December 21, 2001, the Company purchased and retired $2.0 million of the
Notes.
Maturities under the Company's Term Loans are: $2.1 million for the
remainder of fiscal 2002, $12.4 million in fiscal 2003, and $81.0 million
thereafter. Other than upon a change of control or as a result of certain
asset sales, or in the event that certain excess funds exist at the end of
a fiscal year, the Company
- 21 -
will not be required to make additional principal payments in respect of
the Term Loans until maturity in 2005. The Company is required to make
interest payments with respect to both the Senior Bank Facilities and the
Notes. The Company's Revolving Credit Facility and Term Loans mature in
March 2005.
The Company's net cash provided by operating activities for the nine months
ended June 30, 2002 totaled $14.9 million as compared to $13.9 million for
the nine months ended June 30, 2001. The increase of $1.0 million was
primarily due to a $2.6 million net change in assets and liabilities
partially offset by a $1.7 million decrease in net income adjusted for non
cash charges (depreciation, amortization, deferred taxes and other). The
Company's net changes in assets and liabilities was primarily driven by a
$6.4 million increase in accounts payable and accrued liabilities and
other, net, partially offset by a $3.7 million reduction of cash from
accounts receivables and inventory compared to a $0.1 million increase in
cash from accounts receivable and inventory for the nine months ended June
30, 2001.
Net cash used by investing activities was $13.2 million for the nine months
ended June 30, 2002 as compared to $5.8 million for the nine months ended
June 30, 2001. The increase of $7.4 million in net cash used by investing
activities is primarily attributed to the acquisitions of Iron Age Vision
for $0.7 million in December 2001, the acquisition of Leader Industries for
$3.6 million in January 2002 and the acquisition of Chesapeake Optical for
$3.0 million in May 2002.
Net cash used by financing activities for the nine months ended June 30,
2002 was $8.5 million compared with net cash used by financing activities
for the nine months ended June 30, 2001 of $1.5 million. The change of $7.0
million is primarily due to no borrowings from the Revolving Credit
Facility during the nine months ended June 30, 2002, as compared to a net
draw of $11.8 million during the nine months ended June 30, 2001, partially
offset by a decrease in Term Loans and Notes repayments of $5.2 million.
The Company has no financing arrangements involving special purpose
entities.
The Company has a substantial amount of indebtedness. The Company relies on
internally generated funds, and to the extent necessary, on borrowings
under the Revolving Credit Facility (subject to certain customary drawing
conditions) to meet its liquidity needs. The Company anticipates that
operating cash flow will be adequate to meet its operating and capital
expenditure requirements for the next several years, although there can be
no assurances that existing levels of sales and normalized profitability,
and therefore cash flow, will be maintained. In particular, during fiscal
2001 and the nine months ended June 30, 2002, the Company was affected by
the significant slowdown in the manufacturing sector of the economies in
which the Company markets its products that began in earnest during the
first fiscal quarter of fiscal 2001, exacerbated by the impact of the
terrorist events of September 11, 2001. As a result, it is expected that
the Company will continue to operate in a challenging sales environment.
The Company expects to arrange for new financing of both the Senior Bank
Facilities and the Notes before the maturity of the Senior Bank Facilities
in March 2005. There can be no assurances that any additional financing or
other sources of capital will be available to the Company at acceptable
terms, or at all. The inability to obtain additional financing would have a
material adverse effect on the Company's business, financial condition and
results of operations.
- 22 -
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risks related to changes in foreign
currencies, interest rates and commodity pricing. The Company uses
derivatives to mitigate the impact of changes in foreign currencies and
interest rates. All derivatives are for purposes other than trading. The
Company adopted the provisions of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" on October 1, 2000. The Company has
formally documented its hedging relationships, including identification of
hedging instruments and the hedge items, as well as its risk management
objectives.
Foreign Currency Risk
The Company's results of operations are subject to risks associated with
operating in foreign countries, including fluctuations in currency exchange
rates. While many of the Company's selling and distribution costs are
denominated in Canadian and European currencies, a large portion of product
costs are U.S. Dollar denominated. As a result, a decline in the value of
the U.S. Dollar relative to other currencies can have a favorable impact on
the profitability of the Company and an increase in the value of the U.S.
Dollar relative to these other currencies can have a negative effect on the
profitability of the Company. As a result of the acquisition of Peltor, the
Company's operations are also affected by changes in exchange rates
relative to the Swedish Krona. In contrast with the above, a decline in the
value of the Krona relative to other currencies can have a favorable impact
on the profitability of the Company and an increase in the value of the
Krona relative to other currencies can have a negative impact on the
profitability of the Company. The Company executes two hedging programs,
one for transaction exposures, and the other for cash flow exposures in
European operations. The Company has utilized forward foreign currency
contracts for transaction and cash flow exposures. During the nine months
ended June 30, 2002, net transaction losses were $0.1 million and there
were no cash flow hedge gains or losses. In addition, the Company limits
foreign exchange impact on the balance sheet with foreign denominated debt
in Great Britain Pound Sterling, Euros and Canadian dollars.
SFAS No. 133 requires that every derivative instrument be recorded in the
balance sheet as either an asset or liability measured at its fair value.
As a result of forward foreign currency contracts, the Company has recorded
a derivative payable of $0.6 million as of June 30, 2002. The forward
foreign currency contracts will expire over the next 3 months.
Interest Rates
The Company is exposed to market risk changes in interest rates through its
debt. The Company utilizes interest rate instruments to reduce the impact
of either increases or decreases in interest rates on its floating rate
debt.
As a result of the current economic slowdown and corresponding interest
rate reductions, the Company entered into an interest rate collar
arrangement in October 2001 to protect $25.0 million of the outstanding
variable rate term loan debt from future interest rate volatility. The
collar floor is set at 2% LIBOR (London Interbank Offering Rate) and cap at
6.25% LIBOR. The collar was not designated as a hedge under SFAS No. 133
and accordingly, the fair value of gains or losses were charged to
earnings.
The Company is of the opinion that it is well positioned to manage interest
exposures in the short term. The Company continues to monitor interest rate
movements and has mitigated the risks of potential interest rate
fluctuations through the use of the aforementioned interest rate
instruments.
- 23 -
Commodity Risk
The Company is subject to market risks with respect to industry pricing in
paper and crude oil as it relates to various commodity items. The Company
is also exposed to market risks for electricity, fuel oil and natural gas
consumed in its operations. Items with potential impact are paperboard,
packaging films, nylons, resins, propylene, ethylene, plasticizer and
freight. The Company manages pricing exposures on larger volume commodities
such as polycarbonate, polyols and polyvinyl chloride via price
negotiations utilizing alternative supplier competitive pricing. The
Company sources some products and parts from Far East sources where
resource availability, competition, and infrastructure stability has
provided a favorable purchasing environment. The Company does not enter
into derivative instruments to manage commodity risks.
- 24 -
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Contingencies. Various lawsuits and claims arise against the Company in the
ordinary course of its business. Most of these lawsuits and claims are
product liability matters that arise out of the use of safety eyewear and
respiratory product lines manufactured by the Company as well as products
purchased for resale. In addition, the Company may be contingently liable
with respect to numerous lawsuits involving respirators sold by its
predecessors, American Optical Corporation and Cabot Corporation, arising
out of agreements entered into when the AOSafety(R) Division was sold by
American Optical Corporation to Cabot in April 1990 and when later sold by
Cabot to the Company in 1995. These lawsuits typically involve plaintiffs
alleging that they suffer from asbestosis or silicosis, and that such
condition results in part from respirators which were negligently designed
or manufactured. The defendants in these lawsuits are often numerous, and
include, in addition to respirator manufacturers, employers of the
plaintiffs and manufacturers of sand (used in sand blasting) and asbestos.
Responsibility for legal costs, as well as for settlements and judgments,
is shared contractually by the Company, Cabot, American Optical Corporation
and a prior owner of American Optical Corporation. Liability is allocated
among the parties based on the number of years each company owned the
AOSafety Division and the alleged years of exposure of the individual
plaintiff. The Company's share of the contingent liability is further
limited by an agreement entered into between the Company and Cabot whereby,
so long as the Company pays to Cabot an annual fee of $400,000, Cabot will
retain responsibility and liability for, and indemnify the Company against,
asbestos and silicosis related legal claims asserted after July 11, 1995
(the date of the Company's formation) alleged to arise out of the use of
respirators manufactured prior to July 11, 1995. This annual fee was
negotiated as part of the 1995 agreement between the Company and Cabot. To
date, the Company has elected to pay the annual fee. The Company could
potentially be liable for these exposures if the Company elects to
discontinue its participation in this arrangement, or if Cabot is no longer
able to meet its obligations in these matters. With these arrangements in
place, however, the Company's potential liability is limited to exposures
alleged to arise from the use of respirators manufactured after July 11,
1995. The Company may also be responsible for certain claims of acquired
companies other than the AOSafety(R) Division that are not covered by, and
are unrelated to, the agreement with Cabot.
At June 30, 2002, the Company has reserved approximately $5.0 million for
product liabilities including those arising from asbestosis or silicosis
litigation. The reserve is reevaluated periodically and may result in
additional charges to operations if additional information becomes
available. As is standard in the insurance industry, the Company's product
liability insurance excludes asbestos and silicosis related respiratory
claims. Therefore, the Company's accrual has not been reduced for estimated
insurance recoveries. Consistent with the general environment experienced
by other companies involved in asbestos-related litigation, there has been
an increase in the number of asserted legal claims that could potentially
involve the Company. Since the Company, until recently, has not been
directly named in the lawsuits, it has very little available information
regarding specific numbers of claims that affect the Company directly.
Various factors increase the difficulty in determining the Company's
potential liability, if any, in such claims, including the fact that the
defendants in these lawsuits are often numerous and the claims generally do
not specify the amount of damages sought. Additionally, the bankruptcy
filings of other companies with asbestos-related litigation could affect
the Company's cost over time. However, it is management's opinion, taking
into account currently available information, historical experience,
uncertainties, the Cabot agreement and the Company's reserve, that these
suits and claims should not result in final judgments or settlements that,
in the aggregate, would have a material effect on the Company's financial
condition or results of operation.
- 25 -
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
None.
- 26 -
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 14, 2002 AEARO CORPORATION
/s/ Jeffrey S. Kulka
---------------------------------------
Jeffrey S. Kulka Vice President,
Chief Financial Officer, Treasurer,and Secretary
(Principal Financial and Accounting Officer)
- 27 -
CERTIFICATIONS
In connection with the Quarterly Report of the Company on Form 10-Q for the
period ending June 30, 2002 as filed with the Securities and Exchange
Commission on the date hereof (the "Report"), I, Michael A. McLain, Chief
Executive Officer of the Company, certify, pursuant to 18 U.S.C ss.1350, as
adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that:
1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934, and
2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company
/s/Michael A. McLain
---------------------------------------
Michael A. Mclain
Chief Executive Officer, President, and Chairman
of the Board of Directors
In connection with the Quarterly Report of the Company on Form 10-Q for the
period ending June 30, 2002 as filed with the Securities and Exchange
Commission on the date hereof, I, Jeffrey S. Kulka, Chief Financial Officer
of the Company, certify, pursuant to 18 U.S.C ss.1350, as adopted pursuant
to ss. 906 of the Sarbanes-Oxley Act of 2002, that:
1) The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934, and
2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company
/s/ Jeffrey S. Kulka
--------------------------------------
Jeffrey S. Kulka
Vice President, Chief Financial Officer,
Treasurer, and Secretary (Principal Financial
and Accounting Officer)
- 28 -
EXHIBIT INDEX
EXHIBITS DESCRIPTION
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