SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K405
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended September 30, 2002
Commission file number 33-96190
Aearo Corporation
(Exact name of registrant as specified in its charter)
--------------------------
Delaware
(State or other jurisdiction of 13-3840450
incorporation or organization) (I.R.S. Employer Identification No.)
5457 West 79th Street
Indianapolis, Indiana 46268
(Address of principal executive offices) (Zip Code)
(317) 692-6666
(Registrant's telephone number, including area code)
--------------------------
Securities registered pursuant to Section 12(b) of the Act: none
Securities registered pursuant to Section 12(g) of the Act: none
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 [ ] No [X]
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. [X]
As of December 1, 2002, all voting and non-voting common equity of the
Registrant was held by affiliates of the Registrant.
The number of shares of the Registrant's common stock, par value $.01
per share, outstanding as of December 1, 2002 was 101,912.5.
TABLE OF CONTENTS
Part I.........................................................................3
Item 1. Business...........................................................3
Item 2. Properties........................................................11
Item 3. Legal Proceedings.................................................13
Item 4. Submission of Matters to a Vote of Security Holders...............14
Part II.......................................................................15
Item 5. Market for Registrant's Common Equity
and Related Stockholder Matters...................................15
Item 6. Selected Financial Data...........................................16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................18
Item 7A. Quantative and Qualitative Disclosures about Market Risk..........27
Item 8. Financial Statements and Supplementary Data.......................29
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure..........................................55
PART III......................................................................56
Item 10. Directors and Executive Officers.................................56
Item 11. Executive Compensation...........................................59
Item 12. Security Ownership of Certain Beneficial Owners and Management...64
Item 13. Certain Relationships and Related Transactions...................66
Item 14. Controls and Procedures..........................................70
PART IV.......................................................................71
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.71
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PART I
Item 1. Business
General
Aearo Corporation, a Delaware corporation ("Aearo"), and its direct wholly owned
subsidiary, Aearo Company I, doing business as Aearo Company, a Delaware
corporation (the "Subsidiary"), are collectively referred to herein as the
"Company". The Company is one of the leaders in the hearing, eye, face, head and
respiratory protection segments of the personal protection equipment ("PPE")
market worldwide. PPE encompasses all articles of equipment and clothing worn
for the purpose of protecting against bodily injury, including safety eyewear
and goggles, earmuffs and earplugs, respirators, hard hats, gloves, safety
clothing and safety shoes. The Company manufactures and sells hearing protection
devices, communication headsets, prescription and non-prescription safety
eyewear, face shields, reusable and disposable respirators, hard hats and first
aid kits in more than 85 countries under its well-known brand names:
AOSafety(R), E-A-R(R), and Peltor(R). The Company attributes its leading market
positions to:
- - Strong, well-recognized brand names
- - A reputation for providing innovative, quality products
- - Intensive coverage of multiple distribution channels targeting a
wide array of end-users
- - One of the industry's broadest product offerings, and
- - A commitment to providing the highest level of customer service.
The Company also manufactures a wide array of energy-absorbing
materials that are incorporated into other manufacturers' products to control
noise, vibration and shock. These products are marketed under its brand name
E-A-R(R) Specialty Composites. Aearo derives all of its operating income and
cash flow from the Subsidiary, and its only material assets are the shares of
common stock of the Subsidiary that Aearo owns. Other than its ownership of the
Subsidiary and its guarantee of the indebtedness of the Subsidiary, Aearo has no
business or operations. Aearo was incorporated in the State of Delaware in June
1995. Detailed information with respect to the Company's segment reporting is
presented in Note 15 of Notes to Consolidated Financial Statements of Aearo
Corporation contained in Item 8 hereof.
Recent Developments
On October 7, 2002, the Company acquired the assets of Industrial Protective
Products, Inc. ("IPP") of Wilmington, Massachusetts for approximately $1.2
million. IPP will be operated within the Safety Prescription Eyewear segment of
the Company.
Segments
The Company operates three business segments. The Safety Products segment
manufactures and sells hearing protection devices, communication headsets,
non-prescription safety eyewear, face shields, reusable and disposable
respirators, hard hats and first aid kits in more than 70 countries under its
well-known brand names: AOSafety(R), E-A-R(R), and Peltor(R). The Safety
Products segment accounted for approximately 73% of the Company's net sales in
fiscal 2002 and fiscal 2001, and approximately 72% in fiscal 2000.
The Safety Prescription Eyewear segment manufactures and sells products that are
designed to protect the eyes from the typical hazards encountered in the
industrial work environment. The Company purchases component parts (lenses and
the majority of its frames) from various suppliers, grinds and shapes the lenses
to the end-user's prescription, and then assembles the glasses using the
end-user's choice of frame. The Safety Prescription Eyewear segment accounted
for approximately 14% of the Company's net sales in fiscal 2002 and fiscal 2001
and approximately 13% in fiscal 2000.
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 problems in other manufacturers' products. Specific
product applications for Specialty Composites' materials, technology and
engineering expertise include thermal acoustic systems in business and regional
jet aircraft; protective and performance-enhancing components in precision
electronic equipment; thermal and acoustic treatments for heavy-duty trucks; and
treatments to control
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noise, vibration and shock in a wide range of industrial and commercial
equipment. Specialty Composites also produces specially formulated foam used in
the manufacture of the Safety Products segment's polyvinyl chloride ("PVC")
earplugs. Specialty Composites accounted for approximately 13% of the Company's
net sales in fiscal 2002 and fiscal 2001, and approximately 15% in fiscal 2000.
Products - Safety Products Segment
Within Safety Products, the Company classifies its products in five main
categories: hearing protection and communication headsets; eye protection; face
and head protection; respiratory protection; and other protection products.
Hearing Protection and Communication Headsets: The Company's hearing protection
products primarily consist of disposable earplugs, reusable earplugs, earmuffs,
and communication headsets. The Company has been a leader in hearing
conservation research and development since 1972, when it first introduced the
PVC disposable earplug. Today, this product is known as the "Classic(R)" and its
color yellow is a registered trademark of the Company in the United States of
America and Canada. This product, and the recently introduced and patented
SuperFit(R) product, is designed to be "rolled down" or compressed before being
inserted into the ear, and, as a result of its unique slow recovery
characteristics, the plug slowly expands (or "recovers") to fill the ear canal
and provide the desired protection. The Company's disposable PVC earplugs are
available corded and uncorded and in a variety of packaging options. In
addition, the Company manufactures a full line of disposable polyurethane
earplugs, including its E-Z-Fit(R), TaperFit(R), and E-A-Rsoft(R) products.
In the reusable earplug segment of the market, the Company offers its patented
UltraFit(R) and E-A-R(R) Express(R) products. The E-A-R(R) Express(R) product
features a polyurethane pod and a short plastic stem to facilitate sanitary and
easy insertion of the plug into the ear. The Company also offers the "Flex"(TM)
line of "semi-aural" banded products. These products feature articulating arms
that allow for use in multiple positions and for easy storage around the neck.
The Company manufactures, assembles and sells a broad line of earmuffs and
communication headsets under its Peltor brand. The Company is a leader in
providing noise attenuating headsets and wireless and hardwire communication
headsets. These products serve a variety of end user markets where protection
from harmful high and low frequency noise is sought or the need for easy
communication in noisy or remote environments exist, such as in the
construction, heavy machinery, airport, forestry, textile and mining industries.
The Company also offers auditory systems products, which are sold to
audiologists and are used in the testing of hearing.
Eye Protection: Non-prescription eye protection is used in work environments
where a number of hazards present a danger to the eyes including dust, flying
particles, metal fragments, chemicals, extreme glare and optical radiation. The
Company offers a large number of task-specific non-prescription safety eyewear
products under the AOSafety(R) brand. The basic categories of non-prescription
eyewear protection products are non-prescription (or "plano") eyewear and
goggles:
Plano (Non-prescription) Eyewear. Plano eyewear accounts for the majority
of the Company's sales in this category and encompasses a full range of
protective needs including visitor spectacles, over-the-glass, single lens
and dual lens products. Within these categories are a variety of styles,
frame colors and lens options in addition to a number of adjustability and
comfort options. Many of these AOSafety(R) products feature our DX(R)
coating, combining the benefits of chemical and scratch resistance with
anti-fog. X-SeriesTM, MetaliksTM and X.SportTM eyewear offer modern sport
styling with numerous comfort features. NuvoTM eyewear has the classic dual
lens look reinterpreted for today's worker. Lexa(R) eyewear blends a
wrapping, single lens with a lightweight, frameless design. Visitor
spectacles and over-the-glass products are represented by Seepro(R) and
Tourguard(R) eyewear.
Goggles. The Company manufactures and sells a broad line of goggles, which
are typically required in work environments where a higher degree of impact
protection is required, where increased protection against dust, mist or
chemical splash is needed and/or for use in welding operations. To meet
these requirements, the Company offers a variety of vented and non-vented
goggles with varying fields of view including Dust GoggleGearTM for
Lexa(R), Splash GoggleGearTM for Lexa(R) and Centurion(R), all under the
AOSafety(R) brand. The Company also carries goggles for protection in
foundry and welding applications.
Face and Head Protection: Face and head protection is used in work environments
where a number of hazards present a danger to the face and head, including dust,
flying particles, metal fragments, chemicals, extreme glare,
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optical radiation and items dropped from above. The basic categories of face and
head protection are faceshields and hard hats:
Faceshields. Faceshields are designed to protect against heat, splash and
flying particles and are worn in conjunction with other protective
equipment, such as Plano eyewear and respirators. The Company offers a wide
variety use specific faceshield windows under both AOSafety(R) and
Peltor(R) brands. The patented AO TuffMaster(R) line of faceshields is one
of the leading brands in the market.
Hard Hats. The Company manufactures and sells a broad line of hard hats,
including "bump" caps, full-brim hats and traditional hard hats, featuring
four or six point suspension, ratchet adjustment, and a wide selection of
colors and custom imprinting. The XLR8(R) line of hard hats represents the
latest design and functionality under the AOSafety(R) brand.
Respiratory Protection: Respiratory protection products are used to protect
against the harmful effects of contamination and pollution caused by dust,
gases, fumes, sprays and other contaminants. The Company offers a broad line of
disposable dust and mist masks, cartridge-equipped quarter-, half- and full-face
respirators, and "escape" respirators (a single-use respirator for emergencies)
under the AOSafety(R) brand. Pleats PlusTM offers the latest design in
particulate respirators. QuickLatch(R) half mask respirators offer an
innovative, patented on-and-off latching system that can be accomplished with
just one hand.
Other Protection Products: The Company also offers first aid kits predominantly
through the Consumer/Do-It-Yourself (DIY) market. First aid kits are either for
general use or for industrial or commercial uses. Additional products in this
group include safety vests, flagging tape, and safety cones.
Products - Safety Prescription Eyewear Segment
The Com pany's Safety Prescription Eyewear ("SRx") products are designed to
protect the eyes from the typical hazards encountered in the industrial work
environment. The Company purchases component parts (lenses and the majority of
its frames) from various suppliers, grinds and shapes the lenses to the end
user's prescription, and then assembles the glasses using the end user's choice
of frame. The Company views its ability to provide individual attention to each
patient through Company-employed, as well as independently contracted eyecare
professionals as an essential part of its SRx business.
Products - Specialty Composites Segment
The Company's Specialty Composites segment manufactures a wide array of
energy-absorbing materials that are incorporated into other manufacturers'
products to control noise, vibration and shock. Specialty Composites' products
fall into three broad categories: (i) barriers and absorbers for airborne noise
control, (ii) damping and isolation products for vibration and shock control,
and (iii) energy control products for vibration, shock control and comfort
management. Specific product applications for such materials include noise- and
vibration-damping matting used in under-hood cab treatments for transportation
equipment such as Class 8 heavy trucks, as well as shock protection parts for
electronic devices such as computer disk drives, servers and highly damped
materials for the interior cabins of business and regional jet aircraft. The
Company's products include Tufcote(R) polyurethane foams for acoustical
applications, Confor(R) heavily damped viscoelastic foams for ergonomic
cushioning applications and shock protection and Isodamp(R) foams for the
reduction of mechanical vibration, noise and shock. Specialty Composites also
produces the specially formulated foam used in the manufacture of Safety
Products' PVC earplugs. The principal strengths of Specialty Composites are its
specialized polyurethane formulations, its thin-sheet casting capability, its
composite technologies and its applications and materials engineering. These
strengths allow the Company to manufacture in a single process, high value-added
composites using casting, extrusion and molding processes.
Sales and Marketing
The Company divides its sales and marketing force into its three business
segments, as follows:
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Sales and Marketing - Safety Products Segment
Within Safety Products, sales are managed through four channels: North American
Industrial Distribution; Consumer/Do-It-Yourself ("DIY"); Europe; and
International. Each of these channels has its own sales force and its own
distinct yet synergistic sales strategies. In addition, through the acquisitions
of Peltor(R) and Norhammer, the Company significantly expanded its sales
coverage, including a dedicated effort to serve the specialty communications
earmuff market. The Company also produces versions of the PVC plug for many
international airlines for inclusion in their amenity kits.
North American Industrial Distribution (NAI). This is the largest sales
channel for Safety Products and includes approximately 200 Dialog(TM)
industrial distributors and approximately 160 industrial dealers in the
U.S., Canada and Mexico. Participation in the Dialog(TM) program requires
minimum annual purchase levels while encouraging support across the full
product line. Dialog distributors qualify for annual volume and growth
rebates, and cooperative advertising. The Company also offers Dialog(TM)
distributors financial incentives for establishing electronic order
entry/invoicing interfaces with the Company, and for developing marketing
programs, which promote the Company's products.
Consumer. Under the AOSafety(R) brand name, the Company is America's
leading supplier of personal safety products. The AOSafety(R) brand offers
a wide variety of quality products to meet existing and emerging consumer
personal safety needs in many marketplaces. Within the
Hardware/Do-it-Yourself marketplace, AOSafety(R) is the primary brand
carried by The Home Depot, Ace Hardware, TruServ Corporation, Lowe's Home
Improvement Warehouse and other retailers. AOSafety(R) also has a position
in the sporting goods safety marketplace and AOSafety(R) products are
marketed in the drug and mass merchandise channels.
Europe. The Company has a significant presence in Europe with manufacturing
facilities in England, Sweden, and France, and sales offices in the U.K.,
Sweden, Norway, Germany, France, Italy and Spain. The Company's historical
strength in this market has been in passive hearing protection products
(E-A-R(R)) sold through over 1000 industrial distributors, and Peltor
Communications products sold to the military, sport shooting, and rally
sports market segments. Through a recent acquisition of Lunette de
Protection Essilor (Leader Industries), AOSafety is now the number one
prescription eyewear brand in France.
International. The Company exports its products around the world, and this
channel is managed through independent sales representatives located in
Singapore, Miami (covering the Caribbean and Central America), Brazil,
Australia, New Zealand and South Africa (covering the Middle East).
Sales and Marketing - Safety Prescription Eyewear Segment (SRx)
The SRx segment employs its own sales force to sell its products throughout
North America. Approximately 85% of the Company's safety prescription eyewear
are sold directly to more than 15,000 industrial locations, including a majority
of the industrial companies in the Fortune 500. The remainder of the Company's
SRx products are sold through the industrial distribution channel and directly
to eyecare professionals.
Sales and Marketing - Specialty Composites Segment
The Company utilizes an inside sales and marketing team, independent
manufacturers representatives and select distributors to identify global sales
opportunities in target markets for Specialty Composites' products and
technologies. Once such applications have been identified, the Company's
marketing, sales and technical staffs work closely with customer product
development teams to provide the customer with cost-effective, integrated
solutions for noise, vibration, shock, cushioning and/or comfort management
problems. Currently, Specialty Composites' marketing efforts are aimed at four
key, strategic segments worldwide: aircraft, precision electronic equipment,
heavy-duty trucks and original equipment manufacturing (OEM).
Aircraft Market. Specialty Composites provides integrated thermal acoustic
systems for aircraft manufacturers and refurbishers worldwide. Designed
primarily for business and regional jets, the systems include high
performance, weight-efficient, multi-function composites that the Company
has developed specifically to meet the requirements of aircraft
applications.
Precision Equipment Market. This global market has increasingly focused on
compact designs and highly portable devices. Specialty Composites'
engineering expertise and advanced energy-control materials and technology
are critical to customers' product development, helping in the design of
quieter, more rugged, more
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accurate and faster devices. Key applications include portable and desk top
computers, hand held devices, disk drives, data servers and data storage
units.
Heavy-duty Truck Market. Focusing mainly on Class 5 through Class 8
vehicles, Specialty Composites' strategy in the truck market has been to
assist manufacturers in meeting regulatory pass-by noise standards and in
differentiating vehicles on the basis of interior noise levels.
Incorporating acoustical foams, barriers and multi-function composite
products, thermal and acoustic treatment packages are designed for maximum
performance and minimum installation labor.
Industrial and OEM Market. Specialty Composites' energy-control technology
base, broad product line and depth of engineering experience enable the
Company to provide highly effective, targeted solutions to manufacturers in
a wide range of industries, ranging from noise control treatments for
pumps, generators and compressors, to vibration damping and shock isolation
in garage door openers, laboratory centrifuges and high-speed printers.
Research and Development
The Company has a strong emphasis on new product development, innovation and
protection of intellectual property in each of its three business segments.
Research and Development - Safety Products Segment
The Company believes that its Research and Development facilities, personnel and
programs are among the best in the PPE industry. Since its inception in 1972,
the Company's ultimate predecessor, the former E-A-R(R) (Energy Absorbing
Resins) Division of Cabot Corporation ("Cabot"), has been a leader in the
development of technology for understanding noise, measuring noise and hearing
loss, and in developing products and programs to encourage hearing protection
and conservation. In order to test the efficacy of its hearing protection
products, the Company owns and operates a National Voluntary Laboratory
Accreditation Program ("NVLAP") laboratory in the United States. The Company
also operates sound chambers and testing facilities in the United States and
Sweden that measure the performance of its materials and designs. With these and
other capabilities, the Company believes it is a leader in the development of
both passive and active hearing protection products. Similarly, the Company
believes that it has been a pioneer and leader in the development and testing of
safety eyewear as extensive facilities are operated for the design and testing
of these products. The Company also has facilities for the design and testing of
respiratory safety equipment. Many of the Research and Development personnel of
the Company are recognized experts in the safety products industry.
Research and Development - Safety Prescription Eyewear Segment
This segment shares resources with the Safety Products Segment in the areas of
coating technology, automation and manufacturing process improvements. This
segment works extensively with outside suppliers for development of frames,
lenses and coatings.
Research and Development - Specialty Composites Segment
Specialty Composites' research and development efforts focus on developing
proprietary materials and enhancing existing products in order to meet market
and customer needs identified by the Company's marketing, sales and technical
staffs. Products such as VersaDamp(TM) thermoplastic elastomers and Confor(R)
environmentally friendly, energy-absorbing foams are being introduced in a
growing number of applications across all markets served by Specialty
Composites.
Raw Materials and Suppliers
The Company buys and consumes a wide variety of raw materials, component parts,
office supplies, and maintenance and repair parts. Significant categories
purchased include corrugated paper products, poly packaging films, chemicals,
eyewear frames and optical lenses. The chemical category includes plastic resins
such as polycarbonates, propionates, polyols, plasticizers, substrates,
pre-polymers, isocyanates and adhesives. The eyewear frames are for both the
non-prescription and SRx products.
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The Company has a diverse base of material suppliers and is subject to market
risks with respect to industry pricing in paper and crude oil as it relates to
various commodity items. Items with potential risk of price volatility include
paperboard, packaging films, nylons, resins, propylene, ethylene, plasticizer
and freight. With reference to supplier agreements that allow for price changes
based upon an index, the Company builds anticipated commodity price movements
into each year's planning cycle. The Company manages pricing pressure exposure
on large volume commodities such as polycarbonate, polyols and polyvinyl
chloride via price negotiations utilizing alternative supplier competitive
pricing. However, where appropriate, the Company will use a single source for
supply of certain items. In addition, based on the material, availability of
supply, level of quality and the technical difficulty to produce, the Company
will use a major and minor source to insure continued best pricing and a ready
back up supply. The Company does not enter into derivative instruments to manage
commodity risk.
The Company's commodity pricing and negotiating strategy is to consolidate
suppliers where applicable, leverage competitive pricing, identify alternate
lower cost materials and work with existing suppliers to reduce costs through
engineering and innovation.
Although the Company outsources the production of less than 10% of its products
to various manufacturers, the Company has found resource availability, abundant
supplier competition and infrastructure stability in the Far East to provide
favorable supply opportunities.
Manufacturing and Distribution Operations
The Company maintains a high degree of vertical integration, allowing it to
manufacture over 90% of the products that it sells. The Company's strengths
include the manufacture of foams (casting, molding and fabricating) for
Specialty Composites' products (including the foam used in the manufacture of
PVC earplugs); high speed assembly and packaging of earplugs; plastic injection
molding, coating and assembly of non-prescription eyewear; and assembly,
grinding, polishing and coating of prescription eyewear. The Company also
utilizes a limited number of contract manufacturers in the United States of
America, Mexico, and Europe to supplement internal operations and to assemble
and/or manufacture products where the Company does not have world class
processing capabilities. The Company uses selected Asian suppliers for some
product lines to complement Company manufactured products and fill in product
families, where it is advantageous to minimize capital expenditures and
accelerate new product introductions. The Company will continue to use contract
manufacturers where appropriate to remain competitive and maximize profit
margins. Consistent across all of the Company's manufacturing operations is an
emphasis on producing high quality products. Currently, all of the Company's
manufacturing facilities have been awarded ISO 9002 or ISO 9001 certification,
indicating that the Company has achieved and sustained a high degree of quality
and consistency with respect to its products. The Company has also attained QS
9000 certification for the Specialty Composites operations in Indianapolis and
Newark. The Company believes that ISO certification is an increasingly important
selling feature both domestically and internationally, and certain customers
require ISO certification from all their vendors.
The Company's products are generally shipped within several days from the
receipt of a purchase order. As a result, backlog is not material to the
Company's business.
Manufacturing and Distribution Operations - Safety Products Segment
The Company's Indianapolis, Indiana plant is the largest earplug manufacturing
facility in the world. It fabricates, molds and packages hundreds of millions of
pairs of earplugs annually, utilizing automated, high-speed assembly and
packaging equipment. The economies of scale present in this operation are unique
in the hearing protection products industry and management believes that they
offer the Company a competitive advantage in lowering costs. The plant's
high-speed robotic fabrication, assembly and packaging of earplugs facilitate
cost-savings, high-volume production and improved cycle times and inventory
management. The Southbridge, Massachusetts facility is the Company's largest
manufacturing site and manufactures a wide variety of Personal Protection
Equipment. These manufactured safety products include respiratory, plug and muff
type hearing, head and face, and a broad offering of safety eyewear protection.
All Company manufacturing sites have implemented a number of initiatives
resulting in significant improvements in the areas of safety, quality, cost, and
customer service.
The Company's principal international manufacturing operations are located in
Poynton, England and Varnamo, Sweden. The Poynton facility serves customers in
Western Europe, producing and packaging earplugs and other
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hearing and eyewear products. The Varnamo, Sweden plant is the principal Peltor
manufacturing location supplying finished goods and components to customers and
other subsidiaries from this location.
The Company fills virtually all of its domestic and certain of its international
orders through its distribution center located in Indianapolis, Indiana which
has bar-code scanning capabilities to assure rapid turn-around time and service
levels for customer orders. Recent freight studies, having taken into
consideration Aearo Company manufacturing locations in conjunction with domestic
customer locations, have shown Indianapolis to be the ideal single warehouse and
distribution location for our safety business. Over the road carriers are
readily available in Indianapolis, which contributes to competitive pricing for
both our inbound and outbound business. European orders are filled from
distribution facilities near Manchester, U.K. and in Varnamo, Sweden. The UK
facility services all of Europe with the exception of the Nordic countries. The
French eyewear market is serviced from the recently acquired Joinville facility
near Paris.
Manufacturing and Distribution Operations - Safety Prescription Eyewear Segment
The SRx production operations are comprised of two facilities located in the
U.S., one in Canada and two in Europe. The U.S. locations are in Indiana and
Oklahoma. In Canada, the Mississauga, Ontario plant fabricates prescription
eyewear and, together with a small customer service operation in Montreal,
produces SRx products for the Canadian market. In both Poynton, England and
Joinville, France, the Company has small SRx laboratories that serve primarily
the U.K. and French market, respectively. These facilities possess lens
surfacing, edging, grinding and coating machinery capable of handling glass,
plastic and polycarbonate lenses. The lenses are then fitted into frames and the
finished product is shipped to customers. These facilities currently manufacture
and distribute approximately 500,000 pairs of safety prescription glasses
annually. Prescription eyewear fulfillment is predominantly by US Postal
Service.
Manufacturing and Distribution Operations - Specialty Composites Segment
Specialty Composites' products are manufactured in Indianapolis, Indiana, and
Newark, Delaware. The Indianapolis plant, which supplies specially formulated
foam for the Company's PVC earplugs, manufactures and fabricates sheet and roll
PVC and polyurethane materials and molds polyurethanes. This facility also
houses technical support functions, including research and development,
applications engineering, sales and marketing administration, quality assurance
and customer service support. The Newark, Delaware, facility manufactures
polyurethane foams and houses the Company's proprietary, thin sheet foam casting
line, which permits the casting of both sheet and composite materials, including
facings and substrates, in a single pass through the line. Product development
for this facility is onsite.
Competition and the Personal Protection Equipment Market
The PPE market is fragmented and highly competitive as a large number of
relatively small, independent manufacturers with limited product lines serve the
PPE market. The Company estimates that there are more than 500 manufacturers of
PPE (other than safety clothing, gloves and shoes) in the United States of
America, Europe and Southeast Asia. Participants in the industry range in size
from small, independent, single-product companies with annual sales of less than
$15 million, to a small number of multinational corporations with annual sales
in excess of $100 million. The Company believes that participants in the PPE
market compete primarily on the basis of product characteristics (such as
design, style and functional performance), product quality, service, brand name
recognition and, to a lesser extent, price. From a positive competitive
standpoint, the Company believes it is currently well situated, primarily
because of its large size and its broad product offerings, to compete in this
fragmented industry. The Company enjoys certain economies of scale that are not
available to smaller competitors. However, the industry has recently undergone
some degree of consolidation that could potentially increase long-term
competitive pressures on the Company. Many of the Company's customers,
particularly in the growing consumer/DIY channel, prefer the type of "one stop
shopping" that the Company can provide. The Company's advanced distribution
center further facilitates timely and accurate deliveries.
Several manufacturers compete in noise and vibration control, but few if any
competitors offer the complete range of technology and energy-control materials
as Specialty Composites. Thus the Company is able to differentiate itself by
bundling its technology, engineering and wide ranges of products into energy
control solutions or systems that add value to customers' products and supply
chain management. In markets where technology is of particular value,
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Specialty Composites is able to command better margins, but price is a
significant factor in other highly competitive markets sectors in which the
Company participates.
Employees
As of September 30, 2002, the Company had 1,510 employees, of whom 915 were
primarily engaged in manufacturing, 406 in sales, marketing and distribution, 52
in research and development and 137 in general and administrative. The Company
believes its employee relations are good. The Company has one domestic U.S.
facility that employs union members. This facility, located in Plymouth,
Indiana, employs 72 members of the International Union of Electronic,
Electrical, Salaried, Maritime and Furniture Workers (out of a total of 85
employees), and the Company's relations with these union members are fully
satisfactory. The union contract expires on June 26, 2004.
Patents and Trademarks
The Company owns and has obtained licenses to various domestic and foreign
patents, patent applications and trademarks related to its products, processes
and business. The Company values particularly highly its trademark for the color
yellow for earplugs in the United States and Canada and places significant value
on its overall patent portfolio. However, no single patent or patent application
is material to the Company. The Company's patents expire at various times in the
future not exceeding 20 years.
Government Regulation
As a manufacturer of safety products, the Company is subject to regulation by
numerous governmental bodies. Principal among the federal regulatory agencies in
the United States of America are: the Occupational Safety and Health
Administration ("OSHA"), which regulates the occupational usage of all PPE, the
Environmental Protection Agency ("EPA"), which regulates labeling of hearing
protection devices; the Mine Safety and Health Administration ("MSHA") and the
National Institute of Occupational Safety and Health ("NIOSH"), both of which
certify respirators. These agencies generally mandate that the Company's
products meet standards established by private groups, such as American National
Standards Institute ("ANSI"). The Company's products are also subject to foreign
laws and regulations. In particular, they must comply with the Canadian
Standards Association, European Committee for Normalization and Standards
Australia. The Company believes it is in compliance in all material respects
with the regulations and standards of these governmental bodies.
Environmental Matters
The Company is subject to various evolving federal, state and local
environmental laws and regulations governing, among other things, emissions to
air, discharge to waters and the generation, handling, storage, transportation,
treatment and disposal of hazardous substances and wastes. The Company believes
that it is in substantial compliance with all such laws and regulations. The
Company has an active program to ensure environmental compliance and achievement
of environmental goals and objectives. In addition, all sites are implementing
Environmental Management Systems as part of a phased approach to ISO 14001
registration and certification within the next 18 to 24 months.
- 10 -
Item 2. Properties
The Company owns and/or leases facilities in the United States of America,
Canada, and Europe. The following table sets forth the location of each, its
square footage and the principal function of each.
Approximate
Location Square Feet Function
SAFETY PRODUCTS
Southbridge, Massachusetts 295,000 Manufacturing/Administration
Indianapolis, Indiana (1) 220,564 Distribution/Customer Service
Indianapolis, Indiana 81,540 Manufacturing/Corporate Headquarters
Poynton, England (2) 56,530 Manufacturing/Distribution/Customer Service
Varnamo, Sweden 125,595 Manufacturing/Distribution/Customer Service
Ettlingen, Germany 45,000 Manufacturing/Distribution/Customer Service
Paris, France 1,894 Sales Office
Barcelona, Spain (*) Sales Office
Milan, Italy (*) Sales Office
Barrie, Ontario, Canada 4,768 Manufacturing/Distribution/Customer Service
Oslo, Norway 6,300 Sales/Distribution/Customer Service
Joinville-le-Pont, France 13,000 Sales/Distribution/Customer Service
SAFETY PRESCRIPTION EYEWEAR
Chickasha, Oklahoma 35,000 Manufacturing/Customer Service
Plymouth, Indiana 10,224 Manufacturing/Customer Service
Athens, Tennessee 28,000 Customer Service
Mississauga, Ontario, Canada 28,850 Manufacturing/Customer Service
Montreal, Quebec, Canada 1,800 Customer Service
Anne Arundel County, Maryland 7,698 Customer Service
Anne Arundel County, Maryland 5,000 Customer Service
Birmingham, Alabama 1,500 Customer Service
Brooklyn Park, Maryland 1,200 Customer Service
Dundalk, Maryland 1,050 Customer Service
Newport News, Virginia 1,400 Customer Service
Richmond, Virginia (*) Customer Service
York, Pennsylvania (*) Customer Service
Sparrows Point, Maryland (*) Customer Service
Cherry Hill, New Jersey (*) Customer Service
SPECIALTY COMPOSITES
Indianapolis, Indiana 156,000 Manufacturing/Distribution/Customer Service
Newark, Delaware 79,650 Manufacturing/Distribution
Newark, Delaware 75,200 Warehouse/Distribution
- ---------------------
(1) This facility also serves as an international distribution center.
(2) This facility's primary function is manufacturing safety products.
(*) Less than 1,000 square feet.
- 11 -
The Company believes that its facilities are suitable for its operations and
provide sufficient capacity to meet the Company's requirements for the
foreseeable future. All of the Company's facilities are leased except for the
following facilities owned by the Company: (i) the Safety Products manufacturing
facility in Indianapolis, (ii) the Specialty Composites
manufacturing/distribution facility in Indianapolis, (iii) the Specialty
Composites manufacturing facility in Newark, and (iv) the Safety Products
manufacturing facility in Ettlingen, Germany. The Company believes that it will
be able to renew each of its leases upon their respective expiration dates on
commercially reasonable terms. In addition, the Company believes that it would
be able to lease suitable additional or replacement space on commercially
reasonable terms.
- 12 -
Item 3. Legal Proceedings
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 on July 11, 1995, as amended in 2002. This
agreement provides that, 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 silica-related legal claims asserted after July
11, 1995 and alleged to have arisen out of the use of respirators while exposed
to asbestos or silica prior to January 1, 1997. 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 have arisen from the use of
respirators while exposed to asbestos or silica on or after January 1, 1997. The
Company also may be responsible for certain claims relating to acquired
companies other than the AOSafety(R) Division that are not covered by, and are
unrelated to, the agreement with Cabot. The Company retains responsibility and
liability for all other product liability claims and accordingly maintains
insurance protection for claims other than asbestosis and silicosis.
At September 30, 2002, the Company has recorded liabilities of approximately
$4.8 million, which represents reasonable estimates of its probable liabilities,
for product liabilities substantially related to asbestos and silica-related
claims as determined by the Company in consultation with an independent
consultant. The accrual does not include estimates for insurance recoveries.
This reserve is re-evaluated periodically and additional charges or credits to
operations may result as additional information becomes available. Consistent
with the current environment being experienced by companies involved in asbestos
and silica-related litigation, there has been an increase in the number of
asserted claims that could potentially involve the Company. 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
and silica-related litigation could increase the Company's cost over time. In
light of these and other uncertainties inherent in making long-term projections,
the Company has determined that the five-year period through fiscal 2007 is the
most reasonable time period for projecting asbestos and silica-related claims
and defense costs. It is possible that the Company may incur liabilities in an
amount in excess of amounts currently reserved. However, taking into account
currently available information, historical experience, and the Cabot agreement,
but recognizing the inherent uncertainties in the projection of any future
events, it is management's opinion that these suits or claims should not result
in final judgments or settlements in excess of the Company's reserve that, in
the aggregate, would have a material effect on the Company's financial
condition, liquidity or results of operations.
- 13 -
Item 4. Submission of Matters to a Vote of Security Holders
On September 7, 2002, the Company held a special meeting of stockholders. The
stockholders approved the selection of Deloitte & Touche LLP as the Company's
independent public accountants for the year ending September 30, 2003 with a
total of 101,562.5 votes in favor, no votes in opposition and 350 abstention
votes. The stockholders voted to elect the following directors for the ensuing
year with a total of 101,562.5.5 votes in favor of each director and 350
abstention votes for each director: Norman W. Alpert, Bryan P. Marsal, John D.
Curtin, Jr., William E. Kassling, Michael A. McLain, Arthur J. Nagle, Daniel S.
O'Connell, John A. Shaw and William J. Brady.
- 14 -
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
As of December 1, 2002 there were outstanding 101,912.5 shares of common stock,
par value $0.01 per share, of Aearo ("Aearo Common Stock"). All of the Aearo
Common Stock is held, collectively, by Vestar Equity Partners, L.P. (together
with certain related persons, "Vestar"), Cabot Corporation and management. As of
December 1, 2002 there were 33 shareholders of record of Aearo Common Stock. In
July 1995, Vestar, Cabot and management effected through the Company the
acquisition of substantially all of the assets and certain liabilities of Cabot
CSC Corporation ("Old Cabot Safety Corporation"), a wholly-owned subsidiary of
Cabot, and certain of its affiliates (the "Formation Acquisition") for $206.1
million. To effectuate the Formation Acquisition, the Company sold $100 million
of 12 1/2% senior subordinated notes due 2005 (the "Senior Subordinated Notes"),
issued to Vestar and Cabot an aggregate of $45 million of 12 1/2% redeemable
preferred stock (the "Aearo Preferred Stock"), and issued to Vestar, Cabot and
certain members of management and key employees of the Company an aggregate of
100,000 shares of Aearo Common Stock. See Item 12, "Security Ownership of
Certain Beneficial Owners and Management." All of the common stock of the
Subsidiary is owned by Aearo, and thus no trading market exists for such stock.
Accordingly, no trading market exists for any capital stock of the Company.
The Company has never paid cash dividends on the Aearo Common Stock. Payment of
dividends on the Aearo Common Stock is limited by the terms of the Company's
credit agreement and Senior Subordinated Notes and is subordinated to payment of
dividends on the Aearo Preferred Stock. See Note 7 to the Consolidated Financial
Statements.
- 15 -
Item 6. Selected Financial Data
The selected historical financial data as of and for the periods ended September
30, 1998, 1999, 2000, 2001, and 2002 are derived from the consolidated financial
statements of Aearo Corporation and subsidiaries. The data should be read in
conjunction with the consolidated financial statements and related notes,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and other financial information included herein.
AEARO CORPORATION
SELECTED FINANCIAL DATA
(Dollars in Millions, Except per Share Amounts and Ratios)
Years Ended September 30,
1998 1999 2000 2001 2002
----------- ---------- ---------- ---------- ----------
Income Statement Data:
Net Sales--
Safety Products $ 217.1 $ 212.7 $ 219.7 $ 206.3 $ 208.5
Safety Prescription Eyewear 36.4 35.5 39.9 39.1 40.8
Specialty Composites 39.7 42.9 45.9 38.5 37.6
----------- ---------- ---------- ---------- ----------
Total net sales 293.2 291.1 305.5 283.9 286.9
Cost of Sales 163.1 156.7 160.8 155.2 (4) 150.4 (5)
----------- ---------- ---------- ---------- ----------
Gross profit 130.1 134.4 144.7 128.7 136.5
Operating Expenses--
Selling and administrative 90.4 87.5 95.6 87.3 91.9
Research and technical service 4.7 4.7 5.5 5.2 5.7
Amortization expense 6.8 6.8 6.9 6.5 6.3
Other charges (income), net (0.3) 0.8 (0.3) 0.7 1.5
Restructuring charge 11.6 (3) - - 9.1 (4) (0.1) (5)
----------- ---------- ---------- ---------- ----------
Operating income 16.9 34.6 37.0 19.9 31.2
Interest expense, net 26.1 24.3 24.4 23.7 20.1
----------- ---------- ---------- ---------- ----------
Income (loss) before
income taxes (9.2) 10.3 12.6 (3.8) 11.1
Provision for (benefit from)
income taxes 2.2 3.2 3.6 (1.9) 1.8
----------- ---------- ---------- ---------- ----------
Net income (loss) $ (11.4) $ 7.1 $ 9.0 $ (1.9) $ 9.3
=========== ========== ========== ========== ==========
Other Data:
EBITDA (1) $ 47.1 $ 51.0 $ 54.6 $ 48.1 $ 48.5
Depreciation and amortization 20.3 18.3 18.7 18.7 17.3
Capital expenditures 5.8 8.4 9.6 7.8 9.7
Ratio of earnings to fixed
charges (2) - 1.4 1.5 - 1.5
Balance Sheet Data (at period-end):
Total assets $ 293.0 $ 282.3 $ 266.8 $ 261.3 $ 270.2
Debt 233.2 214.8 199.8 202.2 195.6
Stockholders' equity 11.1 16.5 15.8 9.9 21.5
- 16 -
Notes to Selected Financial Data:
1. EBITDA is defined 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 generally accepted accounting
principles 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. EBITDA
presented for the years ended September 30, 1998 and 2001 exclude unusual
charges of $11.6 million, and $11.4 million, respectively, and excludes
unusual credits of $0.6 million for the year ended September 30, 2002.
2. Ratio of earnings to fixed charges is defined as pretax income from
continuing operations plus fixed charges divided by fixed charges. Fixed
charges include interest expense (including amortization of debt issuance
costs). Earnings for the period ended September 30, 1998 and 2001 were
inadequate to cover fixed charges by $9.2 million and $3.8 million,
respectively.
3. During fiscal 1998, the Company recorded a restructuring charge of $11.6
million related to the restructuring plans announced by the Company during
the fiscal year. On February 3, 1998, the Company announced the appointment
of Michael A. McLain as President and Chief Executive Officer and on March
25, 1998, the Company announced plans to close the Boston headquarters and
relocate it to Indianapolis, Indiana, where the Company has substantial
operations. In addition, on September 30, 1998 the Company announced plans
to improve profitability through complexity reduction and restructuring.
4. On September 30, 2001, the Company recorded a restructuring charge of $11.4
million related 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 (See Note 17 of Notes to
Consolidated Financial Statements).
5. During fiscal 2002, the Company reversed $0.6 million of reserves related
to the September 30, 2001 restructuring provision. The adjustment
represents a change in estimate of the plan for the disposal of certain
items of inventory and the closure of its Ettlingen, Germany plant. The
inventory provision of $0.5 million was classified as cost of sales with
the remaining $0.1 million classified as operating expenses.
- 17 -
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with "Selected Financial
Data," and the consolidated financial statements of the Company, including notes
thereto, appearing elsewhere in this Report. 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.
General
The following discussion provides a summary of major developments affecting the
Company over the past few years.
The Company benefited from new product launches including the Lexa(R) product
line first introduced in 1998, which continued with very positive growth during
1999. In addition, new hearing products introduced during 1999 included
E-A-Rsoft(TM), Yellow Neons(R), SuperFit(R), and several new Peltor(R)
communication products. New eyewear products introduced during 1999 included
Nassau Rave(R) and new safety prescription eyewear frames.
During fiscal year 2000, the Company achieved record sales and EBITDA levels
with sales increasing 4.9%, despite a stronger US dollar, which had the affect
of depressing reported sales by approximately $6.4 million. On a currency
adjusted basis sales were 7.7% higher than the previous year. Although sales
were higher in all three of the Company's segments, the Specialty Composites
trucking market began to soften during the fourth quarter. The continued
productivity improvements in purchasing and manufacturing, especially in the
manufacture of non-prescription eyewear product lines, drove a strong
improvement in gross profit performance, resulting in a .8 point improvement in
the gross profit percentage of sales. The gross profit would have been
approximately an additional .6 points higher had it not been for the weakness of
the Euro, which depressed revenue while having a more limited impact on
manufacturing costs.
During fiscal year 2001, continued softening of the trucking market that began
in the fourth quarter of the previous year was followed by overall softness in
the North American economy. Order softness began with the consumer marketplace
and then the industrial marketplace as consumer confidence and manufacturing
employment in North America declined during the year. In addition, the US dollar
continued to strengthen against most global currencies, which had the affect of
depressing reported sales by approximately $8.0 million. Continued productivity
improvements in purchasing and manufacturing enabled the Company to offset much
of the negative currency impact as well as the impact on manufacturing overhead
absorption due to reduced volume. Selling and administrative expenses decreased
$8.3 million primarily due to the Company's proactive measures to reduce
expenses in line with the slowdown in the economy. In May 2001 the Company
completed an upgrade of its SAP management information system to version 3.1I
and it intends to continue to apply information system version upgrades, as it
deems appropriate. In July 2001, the Company successfully completed the
refinancing of its indebtedness under its prior $165.0 million credit agreement
with a new $135.0 million credit agreement and ended the year with undrawn
revolver commitments of approximately $30.0 million, an available U.K. overdraft
facility of $5.0 million and cash of $18.2 million. On September 30, 2001 the
Company recorded a restructuring charge of $11.4 million related to a
restructuring plan announced by the Company to improve its competitive position
and long-term profitability.
The terrorist events of September 11, 2001, coupled with the previously weak
economy, made for a challenging start for fiscal year 2002. Sales for the first
quarter were off 9.8% versus the prior year due to the resulting significant
slowdown in the manufacturing sectors of the economy in which the Company
markets its products. The following three quarters showed comparable
improvements with sales down only 4.5% in the second quarter and then up 6.0%
and 12.7% in quarters three and four.
Despite the difficult economy in fiscal 2002, the Company was able to improve
performance through continued reliance on its strategy of ongoing productivity
improvements, global new product development and value-creating acquisitions.
Productivity improvements in purchasing and manufacturing as well as the
benefits of the restructuring
- 18 -
program implemented toward the end of fiscal 2001 allowed the Company to improve
gross profits to 47.4% of net sales (up 130 basis points). The initiatives on
global new product development resulted in the Company launching 36 new or
improved product lines including the Quick-Latch(R) respiratory line, the
X-Factor(TM) eyewear line for the Consumer channel, and PU shaped earplugs under
the EARsoft(R) name. In addition, the Company also released new and improved
Peltor passive muffs as well as the new and improved Comtac(TM) and PowerCom
Plus(TM) communication muffs. In addition, the difficult economy did provide
acquisition opportunities and the Company was able to complete four value
creating acquisitions during the fiscal year. All four acquisitions were
"tuck-in" acquisitions that were made with cash and are, in the opinion of
management, highly accretive. These acquisitions are in the Company's core
product offerings and enhance the Company's global eyewear positions. In
prescription eyewear the Company added to SRx's number one global market share
position under its single AOSafety(R) brand name, and in non-prescription
eyewear the Company acquired an eyewear line that was restaged under the
X-Series(TM) line which is being expanded through the International, Consumer,
European and North American channels. The overall result was that the Company
ended its fiscal year with improved EBITDA of $48.5 million, as compared to
$48.1 million in the previous fiscal year, with undrawn revolver commitments of
approximately $30.0 million, an available U.K. overdraft facility of $5.0
million and cash of $14.5 million.
Critical Accounting Policies
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's 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 the
accompanying Notes to the Consolidated Financial Statements) the following
policies involve a higher degree of judgment and/or complexity.
Income Taxes - The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards ("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 in the United States prior to the expiration of
the tax loss and credit carryforwards, which expire over various periods ranging
from 2010 to 2021. In its evaluation of the adequacy of the valuation allowance,
the Company assesses prudent and feasible tax planning strategies. Due to the
uncertainties of realizing these tax benefits, the Company has recorded a full
valuation allowance against these losses and credit carryforwards. 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.
Product Liabilities -The Company has established reserves for potential product
liabilities that arise out of the use of the Company's products. A significant
amount of judgment is required to quantify the Company's ultimate exposure in
these matters and the valuation of reserves is estimated based on currently
available information, historical experience and from time to time the Company
may seek the assistance of an independent consultant. 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. A reduction of
$0.6 million was made during fiscal 2002 to account for new information made
available during the year.
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.
Revenue Recognition - The Company recognizes revenue when title and risk
transfer to the customer, which is generally when the product is shipped to
customers. At the time revenue is recognized, certain provisions may also
- 19 -
be recorded including an allowance for doubtful accounts. Allowance for doubtful
accounts is generally based on a percentage of aged receivables. However,
management judgment is involved with the final determination of the allowance
based on several factors including specific analysis of a customers credit
worthiness, historical bad debt experience, changes in payment history and
general economic and market trends.
Results of Operations
The following table sets forth the major components of the Company's
consolidated statements of operations expressed as a percentage of net sales.
Years Ended September 30,
----------------------------------
2000 2001 2002
-------- --------- ----------
Net sales:
Safety Products 71.9 % 72.7 % 72.7 %
Safety Prescription Eyewear 13.1 13.8 14.2
Specialty Composites 15.0 13.5 13.1
--------- --------- ----------
Total net sales 100.0 100.0 100.0
Cost of sales 52.6 54.7 52.4
--------- --------- ----------
Gross profit 47.4 45.3 47.6
Selling and administrative 31.3 30.8 32.0
Research and technical services 1.8 1.8 2.0
Amortization expense 2.2 2.3 2.2
Other charges (income), net 0.0 0.0 0.5
Restructuring charge 0.0 3.2 0.0
--------- --------- ----------
Operating income 12.1 % 7.2 % 10.9 %
========= ========= ==========
Fiscal 2002 Compared to Fiscal 2001
Net Sales. Net sales in the year ended September 30, 2002 increased 1.1% to
$286.9 million from $283.9 million in the year ended September 30, 2001. The
increase in sales was primarily driven by new product launches and acquisitions.
The Safety Products segment net sales in the year ended September 30, 2002
increased 1.1% to $208.5 million from $206.3 million in the year ended September
30, 2001. The Safety Products segment included approximately $5.3 million of
sales from the acquisition of Leader Industries in January 2002. The Safety
Prescription Eyewear segment net sales in the year ended September 30, 2002
increased 4.3% to $40.8 million from $39.1 million in the year ended September
30, 2001. The Safety Prescription Eyewear segment included approximately $2.5
million of sales from the acquisition of Iron Age Vision in December 2001 and
Chesapeake Optical in May 2002. The Specialty Composites segment net sales in
the year ended September 30, 2002 decreased 2.3% to $37.6 million from $38.5
million in the year ended September 30, 2001. The decrease was primarily driven
by volume declines in the industrial equipment market segment.
Gross Profit. Gross profit in the year ended September 30, 2002 increased 6.1%
to $136.5 million from $128.7 million in the year ended September 30, 2001.
Gross profit as a percentage of net sales in the year ended September 30, 2002
improved by 2.3% basis points to 47.6% as compared to 45.3% in the year ended
September 30, 2001. The increase in gross margin was primarily due to
productivity improvements and the impact of the restructuring plan that was
charged during the year ended September 30, 2001.
Selling and Administrative Expenses. Selling and administrative expenses in the
year ended September 30, 2002 increased 5.3% to $91.9 million from $87.3 million
in the year ended September 30, 2001. The increase is primarily due to the
impact of the acquisitions in addition to increased spending in sales and
marketing to support new product launches and build brand recognition. Selling
and administrative expenses as a percentage of net sales in the year ended
September 30, 2002 were 32.0%, compared to 30.8% in the year ended September 30,
2001.
Research and Technical Services. Research and technical services expense in the
year ended September 30, 2002 increased 9.6% to $5.7 million from $5.2 million
in the year ended September 30, 2001. The increase is primarily due to increased
spending for new product development. Research and technical services expenses
as a percentage of net sales in the year ended September 30, 2002 were 2.0%
compared to 1.8% in the year ended September 30, 2001.
- 20 -
Other Charges (Income), Net. Other charges (income), net was expense of $1.5
million for the year ended September 30, 2002 as compared to expense of $0.7
million for the year ended September 30, 2001. The $1.5 million expense for the
year ended September 30, 2002 was primarily attributed to foreign currency
transaction and hedge losses of approximately $0.8 million and $0.5 million of
asset write-offs. The $0.7 million expense for the year ended September 30, 2001
was primarily attributed to foreign currency transaction and hedge losses of
approximately $0.8 million. The foreign currency transaction and hedge losses
were largely due to a weakening U.S. dollar, mainly in the second half of the
fiscal year, as compared to European currencies. This currency shift, although
unfavorable to other charges (income), net, was favorable to overall operating
income.
Restructuring Charge. On September 30, 2001 the Company recorded a restructuring
charge of $11.4 million related to a restructuring plan announced by the Company
to improve its competitive position and long-term profitability. The plan
included 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. On September 30, 2002, the
Company revised its estimate relating to the disposal of certain items of
inventory and to the closure of its Ettlingen, Germany operation and adjusted
the restructuring provision by $0.6 million, of which $0.5 million was
classified as cost of sales relating to inventory. As of September 30, 2002,
there is approximately $4.2 million accrued relating to the restructuring.
Operating Income. Primarily as a result of the factors discussed above,
operating income increased $11.3 million or 56.8% in the year ended September
30, 2002 from $19.9 million in the year ended September 30, 2001. Operating
income as a percentage of net sales in the year ended September 30, 2002 was
10.9% as compared to 7.0% in the year ended September 30, 2001.
Interest Expense, Net. Interest expense, net in the year ended September 30,
2002 decreased 15.3% to $20.1 million from $23.7 million in the year ended
September 30, 2001. The decrease is attributed to lower weighted average
borrowings and lower interest rates during the year ended September 30, 2002 as
compared to the year ended September 30, 2001.
Income (Loss) Before Provision for (Benefit From) Income Taxes. Income before
provision for income taxes increased $14.9 million to $11.1 million in the year
ended September 30, 2002 compared to a loss of $3.8 million in the year ended
September 2001. Income before provision for income taxes excluding restructuring
charges increased $2.8 million to $10.5 million in the year ended September 30,
2002 compared to $7.6 million in the year ended September 30, 2001.
Provision for (Benefit From) Income Taxes. The provision for income taxes in the
year ended September 30, 2002 was $1.8 million compared to a benefit of $1.9
million in the year ended September 30, 2001. The Company's effective tax rate
was lower than the statutory rate due to a decrease in the valuation allowance.
The valuation allowance at September 30, 2002 and 2001 relates to the
uncertainty of realizing the tax benefits of reversing temporary differences and
net operating loss carryforwards.
Net Income (Loss). For the year ended September 30, 2002, the Company recorded
net income of $9.3 million as compared to a net loss of $1.9 million for the
year ended September 30, 2001.
- 21 -
EBITDA. EBITDA is defined as earnings before interest, taxes, depreciation,
amortization, and non-operating income or expense. Non-operating income or
expense is further defined by the Company as extraordinary gains or losses, or
gains or losses from disposition 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 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 below 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.
EBITDA Calculation
(Dollars in Thousands)
Change
Years Ended September 30, Favorable/(Unfavorable)
2001 2002 Amount Percent
------- ------------ ------------ ------------
Operating Income
Add Backs: 19,914 31,159 11,245 56.5 %
Depreciation 10,123 10,958 835 8.2
Amortization of Intangibles 6,530 6,293 (237) (3.6)
Non-operating costs (income), net 44 690 646 --
Unusual Charges 11,441 (600) (12,041) (105.2)
------- ------------ ----------- ------------
EBITDA 48,052 48,500 448 0.9 %
======= ============ =========== ============
By Segment
Safety Products 39,844 42,326 2,482 6.2 %
Safety Prescription Eyewear 2,237 1,621 (616) (27.5)
Specialty Composites 1,409 3,433 2,024 143.5
Reconciling Items 4,562 1,120 (3,442) (75.4)
------- ------------ ----------- ------------
48,052 48,500 448 0.9 %
======= ============ =========== ============
EBITDA for the year ended September 30, 2002 was $48.5 million, which was $0.4
million higher than the year ended September 30, 2001. This increase was the
result of the Company's continued strategy of ongoing productivity, new product
development and value creating acquisitions despite a weak economy and
increasing costs for items such as insurance and employee benefits. The Safety
Products segment EBITDA for the year ended September 30, 2002 increased 6.2% to
$42.3 million from $39.8 million in the year ended September 30, 2001. The
increase was primarily due to acquisitions, new product launches and increased
productivity. The Safety Prescription Eyewear segments EBITDA in the year ended
September 30, 2002 decreased 27.5% to $1.6 million from $2.2 million in the year
ended September 30, 2001. This decrease was primarily due to higher operating
expenses and integration costs for acquisitions. The Specialty Composites
segment EBITDA for the year ended September 30, 2002 increased 143.5% to $3.4
million from $1.4 million in the year ended September 30, 2001. The increase was
primarily driven by productivity improvements, improved product mix, the
positive impacts of the 2001 restructuring plan and lower operating expenses
partially offset by lower sales volume. 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.
Fiscal 2001 Compared to Fiscal 2000
Net Sales. Net sales in the year ended September 30, 2001 decreased 7.1% to
$283.9 million from $305.5 million in the year ended September 30, 2000. The
change in sales was primarily driven by the significant slowdown in the
manufacturing sector of the economy as well as weakness in global currencies
relative to the U.S. dollar. The strength of the U.S. dollar relative to foreign
currencies had the impact of reducing sales by approximately $8.0 million. The
Safety Products segment net sales in the year ended September 30, 2001 decreased
6.1% to $206.3
- 22 -
million from $219.7 million in the year ended September 30, 2000. The strength
of the U.S. dollar relative to foreign currencies had the impact of reducing
Safety Products sales by approximately $7.9 million. The Safety Prescription
Eyewear segment net sales in the year ended September 30, 2001 decreased 2.0% to
$39.1 million from $39.9 million in the year ended September 30, 2000. The
Specialty Composites segment net sales in the year ended September 30, 2001
decreased 16.1% to $38.5 million from $45.9 million in the year ended September
30, 2000. The decrease was primarily driven by continued weakness in the North
American economy and resulted in volume declines in the truck market and the
electronics segment of the precision equipment market, which includes computers
and personal communication system (PCS) applications.
Gross Profit. Gross profit in the year ended September 30, 2001 decreased 11.1%
to $128.7 million from $144.7 million in the year ended September 30, 2000.
Gross profit as a percentage of net sales in the year ended September 30, 2001
was 45.3% as compared to 47.4% in the year ended September 30, 2000. The
decrease in gross margin was primarily due to the restructuring charges of $2.4
million related to the provision for inventory as discussed below. The gross
profit percentage in the year ended September 30, 2001 excluding restructuring
charges was 46.2%. The additional decrease in gross margin was due to lower
capacity utilization, higher utility costs and the adverse impact of foreign
currencies partially offset by productivity improvements and cost reductions to
offset the decline in volume. The average exchange rate used for the Euro in the
consolidated financial statements for the year ended September 30, 2001 and 2000
was 0.888 and 0.970, respectively.
Selling and Administrative Expenses. Selling and administrative expenses in the
year ended September 30, 2001 decreased 8.7% to $87.3 million from $95.6 million
in the year ended September 30, 2000. The decrease is primarily due to the
Company's proactive measures to reduce expenses in line with the slowdown in the
economy. Additionally, expenses in 2000 included higher legal expenses related
to the Moldex-Metric, Inc. trademark dispute as well as costs related to the
development of our e-commerce infrastructure. Selling and administrative
expenses as a percentage of net sales in the year ended September 30, 2001 were
30.8% of net sales, compared to 31.3% in the year ended September 30, 2000.
Other Charges (Income), Net. Other charges (income), net was an expense of $0.7
million for the year ended September 30, 2001 as compared to income of $0.2
million for the year ended September 30, 2000. The $0.7 million expense for the
year ended September 30, 2001 was primarily attributed to foreign currency
transaction losses of approximately $0.6 million. The $0.2 million income for
the year ended September 30, 2000 was primarily attributed to foreign currency
transaction gains of approximately $0.9 million somewhat offset by the $0.5
million write off of an abandoned information technology system that was under
development for the Safety Prescription Eyewear segment.
Restructuring Charge. On September 30, 2001 the Company recorded a restructuring
charge of $11.4 million related 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 restructuring charge includes cash charges that total $2.3 million and
includes $1.8 million for severance and related costs to cover the reduction of
5% of the Company's current work force and $0.5 million other costs associated
with this plan. The restructuring also includes non-cash charges that total $9.1
million and includes $3.2 million for non-cancelable long term lease
obligations, asset impairment charges of $2.9 million, $2.4 million for the
write-off of inventory and $0.6 million related to the sale of the Company's
Ettlingen, Germany location.
It is anticipated that the restructuring will be completed during fiscal 2003
and the annualized savings are expected to be $4.8 million, with $2.4 million
occurring in fiscal year 2002. The inventory provision of $2.4 million was
classified as cost of sales in the consolidated statement of operations with the
remaining $9.1 million classified as operating expenses.
Operating Income. Primarily as a result of the factors discussed above,
operating income excluding unusual charges, decreased $5.7 million or 15.3% in
the year ended September 30, 2001 from $37.0 million in the year ended September
30, 2000. Operating income as a percentage of net sales in the year ended
September 30, 2001 was 11.1% before unusual charges as compared to 12.1% in the
year ended September 30, 2000.
- 23 -
Interest Expense, Net. Interest expense, net in the year ended September 30,
2001 decreased 2.9% to $23.7 million from $24.4 million in the year ended
September 30, 2000. The decrease is attributed to a lower weighted average
interest rate in the year ended September 30, 2001 as compared to the year ended
September 30, 2000.
Income (Loss) Before Provision for (Benefit From) Income Taxes. Income (loss)
before provision for (benefit from) income taxes decreased $16.4 million to a
loss of $3.8 million in the year ended September 30, 2001 compared to income of
$12.6 million in the year ended September 2000. Income before provision for
benefits from income taxes excluding unusual charges decreased $4.9 million to
$7.7 million compared to $12.6 million in the prior year.
Provision for (Benefit From) Income Taxes. The provision for (benefit from)
income taxes in the year ended September 30, 2001 was $(1.9) million compared to
$3.6 million in the year ended September 30, 2000. The Company's effective tax
rate was lower than the statutory rate due to a decrease in the valuation
allowance. The valuation allowance at September 30, 2001 and 2000 relates to the
uncertainty of realizing the tax benefits of reversing temporary differences and
net operating loss carryforwards.
Net Income (Loss). For the year ended September 30, 2001, the Company recorded a
net loss of $(1.9) million as compared to net income of $9.0 million for the
year ended September 30, 2000.
EBITDA. EBITDA is defined as earnings before interest, taxes, depreciation,
amortization, and non-operating income or expense. Non-operating income or
expense is further defined by the Company as extraordinary gains or losses, or
gains or losses from disposition 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 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 below 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.
EBITDA Calculation
(Dollars in Thousands)
Change
Years Ended September 30, Favorable/(Unfavorable)
2000 2001 Amount Percent
------------ ------------ ----------- -----------
Operating Income 37,011 19,914 (17,097) (46.2) %
Add Backs:
Depreciation 10,056 10,123 67 0.7
Amortization of Intangibles 6,859 6,530 (329) (4.8)
Non-operating costs (income), net 692 44 (648) (93.6)
Unusual Charges - 11,441 11,441 ---
------------ ------------ ---------- ----------
EBITDA 54,618 48,052 (6,566) (12.0) %
============ ============ ========== ==========
By Segment
Safety Products 48,775 39,844 (8,931) (18.3) %
Safety Prescription Eyewear 4,008 2,237 (1,771) (44.2)
Specialty Composites 3,531 1,409 (2,122) (60.1)
Reconciling Items (1,696) 4,562 6,258 (369.0)
------------ ------------ --------- ----------
54,618 48,052 (6,566) (12.0) %
============ ============ ========= ==========
EBITDA for the year ended September 30, 2001, excluding unusual charges, was
$48.1 million, which was $6.6 million lower than the year ended September 30,
2000. This decrease was due primarily to the significant slowdown in the
economy. EBITDA as a percentage of net sales in the year ended September 30,
2001, excluding unusual
- 24 -
charges, was 16.9% as compared to 17.9% in the year ended September 30, 2000.
The Safety Products segment EBITDA for the year ended September 30, 2001
decreased 18.3% to $39.8 million from $48.9 million in the year ended September
30, 2000. The decrease was primarily due to the significant slowdown in the
manufacturing sector of the economy and the negative impact of foreign exchange
on operating results. The Safety Prescription Eyewear segments EBITDA in the
year ended September 30, 2001 decreased 44.2% to $2.2 million from $4.0 million
in the year ended September 30, 2000. This decrease was primarily due to
unfavorable product mix and reduced sales volume due to the weak economy. The
Specialty Composites segment EBITDA for the year ended September 30, 2001
decreased 60.1% to $1.4 million from $3.5 million in the year ended September
30, 2000. The decrease was primarily due to reduced sales volume due to the weak
economy. 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.
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 many of the Company's selling and
distribution costs are also denominated in these currencies, a large portion of
product costs is 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(R), the
Company's operations are also affected by changes in exchange rates relative to
the Swedish Krona. 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 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 Company's revenues or results of operations.
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
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 (collectively the Senior Bank
Facilities). The amount outstanding on the Term Loans at September 30, 2002, was
approximately $93.9 million. No amounts were outstanding under the Revolving
Credit Facility or the U.K. overdraft facility. At September 30, 2002, the
Company's committed lines of credit totaled approximately $34.0 million.
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 September 30, 2002.
During the first quarter of fiscal 2002, the Company's Board of Directors
authorized management to repurchase, from time to time, a portion of the
Company's 12.5% Notes, subject to market conditions and other factors. No
assurances can be given as to whether or when or at what price such repurchases
will occur. Subsequently, pursuant to a first amendment to the Senior Bank
Facilities, the Company purchased and retired $2.0 million of the Notes.
- 25 -
Maturities under the Company's Term Loans are: $12.5 million in fiscal 2003,
$16.7 million in fiscal 2004 and $64.7 million in fiscal 2005. 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 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 year ended
September 30, 2002 totaled $26.6 million as compared to $21.5 million for the
year ended September 30, 2001. The increase of $5.1 million was primarily due to
a $3.3 million increase in net income adjusted for cash and non cash charges
(depreciation, amortization, deferred taxes and other) and a $1.7 million net
change in assets and liabilities. The Company's net changes in assets and
liabilities was primarily driven by a $3.2 million increase in accounts payable
and accrued liabilities, a $1.5 million increase in other, net, partially offset
by a $3.0 million reduction of cash from accounts receivables and inventory.
The Company typically makes capital expenditures related primarily to the
maintenance and improvement of manufacturing facilities. The Company spent $8.2
million for capital expenditures for the year ended September 30, 2002 as
compared to $7.8 million for capital expenditures for the year ended September
30, 2001 and $9.6 million for the year ended September 30, 2000. The Company's
capital spending is of a relatively short duration, with the complete commitment
process typically involving less than one year.
Net cash used by investing activities was $17.7 million for the year ended
September 30, 2002 as compared to $7.8 million for the year ended September 30,
2001. The increase of $9.9 million in net cash used by investing activities is
primarily attributed to the acquisitions of Iron Age Vision for $0.8 million in
December 2001, the acquisition of Leader Industries for $5.1 million in January
2002 and the acquisition of Chesapeake Optical for $3.6 million in May 2002.
These amounts are inclusive of acquisition fees and restructuring costs.
Net cash used by financing activities for the year ended September 30, 2002 was
$10.7 million compared with net cash provided by financing activities for the
year ended September 30, 2001 of $1.6 million. The change of $12.3 million is
primarily due to the repayment of Term Loans in the year ended September 30,
2002 compared to the prior year when the Company refinanced its prior credit
agreement. 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 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.
- 26 -
Item 7A. 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. 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.
To mitigate the effects of changes in foreign currency rates on profitability
the Company executes two hedging programs, one for transaction exposures, and
the other for cash flow exposures in European operations. The Company utilizes
forward foreign currency contracts for transaction as well as cash flow
exposures. For the year ended September 30, 2002, net transaction losses were
$0.2 million and cash flow hedge losses were $0.6 million. In addition, the
Company limits the 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 it
relates to cash flow exposures in European operations, the Company had no
forward foreign currency contracts as of September 30, 2002.
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.
The Company has approximately $25.0 million of variable rate debt protected
under an interest rate collar arrangement through September 30, 2003. The floor
is set at 2% and the cap at 6.25%. The fair value of the collar at September 30,
2002 was $0.1 million. The Company has not elected to take hedge accounting
treatment for the interest rate collar as defined under SFAS No. 133 and, as a
result, any fair value adjustment is charge directly to other income/(expense).
Approximately $141,000 was expensed during the fiscal year ended September 30,
2002.
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.
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 risk of price volatility 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,
- 27 -
competition, and infrastructure stability has provided a favorable purchasing
environment. The Company does not enter into derivative instruments to manage
commodity risks.
- 28 -
Item 8. Financial Statements and Supplementary Data
Index to Financial Statements
Independent Auditor's Report..................................................30
Report of Independent Public Accountants......................................31
Consolidated Balance Sheets...................................................32
Consolidated Statements of Operations.........................................33
Consolidated Statements of Stockholders' Equity...............................34
Consolidated Statements of Cash Flows.........................................35
Notes to Consolidated Financial Statements....................................36
- 29 -
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders of Aearo Corporation:
We have audited the accompanying consolidated balance sheets of Aearo
Corporation and subsidiaries as of September 30, 2002 and 2001, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
the years ended September 30, 2002 and 2001. Our audits also included the
financial statement schedule listed in the Index at Item 15. These financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits. The
financial statements and financial statement schedule of Aearo Corporation for
the year ended September 30, 2000, were audited by other auditors who have
ceased operations. Those auditors expressed an unqualified opinion on those
financial statements and financial statement schedule in their report dated
December 15, 2000.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Aearo Corporation and subsidiaries
as of September 30, 2002 and 2001, and the results of their operations and their
cash flows for the years then ended, in conformity with accounting principles
generally accepted in the United States of America. Also, in our opinion, such
financial statement schedule, when considered in relation to the basic 2002 and
2001 consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Indianapolis, Indiana
December 4, 2002
- 30 -
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of Aearo Corporation:
We have audited the accompanying consolidated balance sheet of Aearo Corporation
and subsidiaries (a Delaware corporation) as of September 30, 2000, and the
related consolidated statements of operations, stockholders' equity and cash
flows for the years ended September 30, 1999 and 2000. These financial
statements and the schedule referred to below are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and the schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Aearo Corporation and
subsidiaries as of September 30, 2000, and the results of their operations and
their cash flows for the years ended September 30, 1999 and 2000, in conformity
with accounting principles generally accepted in the United States.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the index to the
accompanying financial statements is presented for purposes of complying with
the Securities and Exchange Commission's rules and is not part of the basic
financial statements. For the years ended September 30 1999 and 2000, the
schedule has been subjected to the auditing procedures applied in our audits of
the basic financial statements and, in our opinion, fairly states, in all
material respects, the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Indianapolis, Indiana,
December 15, 2000
The report of Arthur Andersen LLP ("Andersen") is a copy of a report previously
issued report covering fiscal years 2001 and 2000. The predecessor auditor has
not reissued its report.
- 31 -
AEARO CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, Except Share Amounts)
September 30, September 30,
2001 2002
--------------- ---------------
ASSETS
Current Assets:
Cash and cash equivalents $ 18,233 $ 14,480
Accounts receivable (net of reserve for doubtful accounts
of $831 and $1,524, respectively) 42,428 46,478
Inventories 29,564 33,161
Deferred and prepaid expenses 2,325 3,449
--------------- ---------------
Total current assets 92,550 97,568
--------------- ---------------
Long Term Assets:
Property, plant and equipment, net 47,003 48,096
Intangible assets, net 118,200 121,979
Other assets 3,549 2,526
--------------- ---------------
Total Assets $ 261,302 $ 270,169
=============== ===============
LIABILITIES
Current Liabilities:
Current portion of long-term debt $ 8,393 $ 12,847
Accounts payable and accrued liabilities 34,812 36,410
Accrued interest 2,691 2,568
U.S. and foreign income taxes 2,265 1,156
--------------- ---------------
Total current liabilities 48,161 52,981
--------------- ---------------
Long-term debt 193,836 182,715
Deferred income taxes 383 800
Other liabilities 9,066 12,129
--------------- ---------------
Total Liabilities 251,446 248,625
--------------- ---------------
COMMITMENTS AND CONTINGENCIES
Preferred stock, $.01 par value-
(Redemption value of $96,801 and $109,480, respectively)
Authorized - 200,000 shares
Issued and outstanding - 45,000 shares - -
Stockholders' Equity:
Common stock $.01 par value-
Authorized -- 200,000 shares
Issued and outstanding -- 102,088 and 101,913 1 1
Additional paid-in-capital 32,374 32,254
Retained earnings (deficit) (2,494) 6,825
Accumulated other comprehensive loss (20,025) (17,536)
--------------- ---------------
Total Stockholders' Equity 9,856 21,544
--------------- ---------------
Total Liabilities and Stockholders' Equity $ 261,302 $ 270,169
=============== ===============
The accompanying notes are an integral part of these consolidated financial
statements.
- 32 -
AEARO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands)
Years Ended September 30,
2000 2001 2002
----------------- -------------- -------------
Net sales $ 305,475 $ 283,862 $ 286,867
Cost of sales 160,759 152,849 150,897
Unusual charges (income) - 2,364 (500)
-------------- -------------- -------------
Gross profit 144,716 128,649 136,470
Selling and administrative 95,560 87,286 91,903
Research and technical services 5,528 5,162 5,740
Amortization expense 6,859 6,530 6,293
Other charges (income), net (242) 680 1,475
Unusual charges (income) - 9,077 (100)
-------------- -------------- -------------
Operating income 37,011 19,914 31,159
Interest expense, net 24,387 23,666 20,055
-------------- -------------- -------------
Income (loss) before provision for (benefit
from) income taxes 12,624 (3,752) 11,104
Provision for (benefit from) income taxes 3,576 (1,872) 1,785
-------------- -------------- -------------
Net income (loss) $ 9,048 $ (1,880) $ 9,319
============== ============== =============
The accompanying notes are an integral part of these consolidated financial
statements.
- 33 -
AEARO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in Thousands)
Accumulated
Preferred Additional Accumulated Other Comprehensive
Stock Common Stock Paid-in Earnings Comprehensive Income
Shares Amount Shares Amount Capital (Deficit) Loss Total (Loss)
------ ------- ------- ------- ---------- ----------- ------------- ------- -------------
Balance, October 1, 1999 45,000 102,538 $ 1 $ 32,566 $ (9,662) $ (6,431) $ 16,474
Issuance of shareholder notes - - - - (67) - - (67)
Repurchase of common stock, net - - (450) - (286) - - (286)
Foreign currency translation
adjustment - - - - - - (9,320) (9,320) $ (9,320)
Net income - - - - - 9,048 - 9,048 9,048
-----------
Comprehensive loss - - - - - - - - $ (272)
------ ------- ------- ------- ---------- ----------- ------------- --------- ===========
Balance, September 30, 2000 45,000 - 102,088 1 32,213 (614) (15,751) 15,849
Repayment of shareholder notes - - - - 161 - - 161
Foreign currency translation
adjustment - - - - - - (4,252) (4,252) $ (4,252)
Unrealized loss on derivative
instruments - - - - - - (22) (22) (22)
Net loss - - - - - (1,880) - (1,880) (1,880)
------------
Comprehensive loss $ (6,154)
------ ------- ------- ------- ---------- ----------- ------------- ------- ============
Balance, September 30, 2001 45,000 - 102,088 1 32,374 (2,494) (20,025) 9,856
Issuance of shareholder notes (25) (25)
Repurchase of common stock, net (175) - (95) (95)
Foreign currency translation
adjustment - - - - - - 199 199 $ 199
Net minimum pension liability
adjustment 2,290 2,290 2,290
Net income - - - - - 9,319 - 9,319 9,319
------------
Comprehensive income 11,808
============
------ -------- ------- ------- ---------- ----------- ------------- -------
Balance, September 30, 2002 45,000 - 101,913 $ 1 $ 32,254 $ 6,825 $ (17,536) $21,544
====== ======== ======= ======= ========== =========== ============= =======
The accompanying notes are an integral part of these consolidated financial
statements.
- 34 -
AEARO CORPORATION AND SUBSIDIRARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
Years Ended September 30,
2000 2001 2002
----------- ------------ -----------
Cash Flows from Operating Activities:
Net income (loss) $ 9,048 $ (1,880) $ 9,319
Adjustments to reconcile net income (loss) to cash provided by operating
activities --
Depreciation 10,056 10,123 10,958
Amortization 8,616 8,543 7,848
Deferred income taxes (196) (101) 401
Provision for restructuring charges - 11,441 (600)
Other non-cash items, net 859 (2,993) 551
Changes in assets and liabilities, net of effects of acquisitions--
Accounts receivable, net (2,812) 1,210 (25)
Inventories (275) 1,758 (5)
Accounts payable and accrued liabilities 633 (5,222) (1,983)
Other 1,631 (1,341) 112
----------- ------------ -----------
Net cash provided by operating activities 27,560 21,538 26,576
----------- ------------ -----------
Cash Flows from Investing Activities:
Cash paid for acquisitions (4,465) - (9,515)
Additions to property, plant and equipment (9,552) (7,799) (8,232)
Proceeds provided by disposals of property, plant and equipment 34 38 13
----------- ------------ -----------
Net cash used by investing activities (13,983) (7,761) (17,734)
----------- ------------ -----------
Cash Flows from Financing Activities:
Repurchases of common stock, net (286) - (95)
Repayment (issuance) of shareholder notes (67) 161 (25)
Repayment of senior subordinated notes - - (2,000)
(Repayment of) proceeds from revolving credit facility, net 4,150 (10,000) -
(Repayment of) proceeds from of term loans (15,146) 11,700 (8,178)
Repayment on Capital Lease Obligations - - (143)
Repayment of other long-term debt (269) (222) (215)
----------- ------------ -----------
Net cash (used in) provided by financing activities (11,618) 1,639 (10,656)
----------- ------------ -----------
Effect of Exchange Rate Changes on Cash (2,514) (678) (1,939)
----------- ------------ -----------
Net increase (decrease) in cash and cash equivalents (555) 14,738 (3,753)
Cash and cash equivalents, beginning of year 4,050 3,495 18,233
----------- ------------ -----------
Cash and cash equivalents, end of year $ 3,495 $ 18,233 $ 14,480
=========== ============ ===========
Non Cash Investing and Financing Activities:
Capital Lease Obligations $ - $ - $ 1,421
=========== ============ ===========
Cash Paid for:
Interest $ 22,637 $ 22,023 $ 18,697
Income Taxes $ 2,233 $ 1,983 $ 2,649
=========== ============ ===========
- 35 -
AEARO CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
Aearo Corporation, a Delaware corporation ("Aearo"), and its direct wholly
owned subsidiary, Aearo Company I, doing business as Aearo Company, a
Delaware corporation (the "Subsidiary") (collectively referred to herein as
the Company) manufactures and sells products through three reportable
segments. The Company's segments 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
under the brand names: AOSafety(R), E-A-R(R), and Peltor(R). 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 and shapes the
lenses to the customer's prescription, and then assembles the glasses using
the customer's choice of frame. The Specialty Composites segment
manufactures and sells a wide array of energy-absorbing materials that are
incorporated into other manufacturers' products to control noise, vibration
and shock.
Aearo Corporation was formed by Vestar Equity Partners, L.P. ("Vestar") in
June 1995 to effect the acquisition of substantially all of the assets and
liabilities of Cabot Safety Corporation and certain affiliates (the
"Predecessor"), all of which were wholly owned by Cabot Corporation
("Cabot"), (the "Formation Acquisition"). Separate financial statements of
Aearo Company are not presented because they do not provide any additional
information from what is presented in the consolidated financial statements
of Aearo Corporation that would be meaningful to the holders of the senior
subordinated notes (the Senior Subordinated Notes) (see Note 7).
2. Significant Accounting Policies
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United
States of America. All significant intercompany balances and transactions
have been eliminated in consolidation. The significant accounting policies
of the Company are described below.
Use of Estimates
The preparation of the 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 consolidated financial statements
and the reported amounts of revenues and expenses during the reporting
periods. Actual results could differ from those estimates.
Reclassifications
Certain amounts included in the prior year's consolidated financial
statements have been reclassified to conform to the current year
presentation. The reclassifications have no impact on net income (loss)
previously reported.
Revenue Recognition
The Company recognizes revenue when title and risk transfer to the
customer, which is generally when the product is shipped to customers. At
the time revenue is recognized, certain provisions may also be recorded
including an allowance for doubtful accounts. Allowance for doubtful
accounts is generally based on a percentage of aged receivables. However,
management judgment is involved with the final determination of the
allowance based on several factors including specific analysis of a
customers credit worthiness, historical bad debt experience, changes in
payment history and general economic and market trends.
Advertising
The Company expenses the costs of advertising as incurred. These expenses
were approximately $7.9 million, $5.9 million, and $6.1 million for the
years ended September 30, 2000, 2001 and 2002, respectively.
- 36 -
Cash Equivalents
The Company considers all time deposits and short-term investments with an
original maturity of three months or less to be cash equivalents.
Foreign Currency Translation and Transactions
Foreign Currency Translation:
Assets and liabilities of non-U.S. subsidiaries are translated at the
exchange rate as of the end of the year. Income and expenses are translated
at the approximate average exchange rates during the year. Foreign currency
translation adjustments are recorded as a separate component of
stockholders' equity.
Foreign Currency Transactions:
Foreign currency gains and losses arising from transactions by any of the
Company's subsidiaries are reflected in net income (loss). For the years
ended September 30, 2000, 2001 and 2002 the accompanying consolidated
statements of operations include approximately $0.4 million, $0.4 million,
and $0.2 million, respectively, of transaction losses included in other
(income) charges, net.
To mitigate the effects of changes in foreign currency rates on
profitability related to trade accounts receivable and trade accounts
payable denominated in foreign currencies, the Company enters into forward
foreign currency contracts. Gains and losses related to contracts
designated as hedges of trade accounts receivable and trade accounts
payable denominated in foreign currencies are accrued as exchange rates
change and are recognized in the accompanying consolidated statements of
operations as transaction (gains) and losses and included in other (income)
charges, net. As of September 30, 2002, relative to these exposures, the
Company had forward foreign currency contracts open in the following
amounts:
Currency Amount (000s) Contract Position
-------- ------------- -----------------
British Pound 1,228 Buy
Canadian Dollar 1,285 Sell
Norwegian Krona 7,840 Sell
Swedish Krona 103,834 Buy
Swiss Franc 980 Buy
Euro 1,712 Sell
Danish Krona 1,918 Sell
As of September 30, 2002, the Company has recorded an unrealized gain of
$0.1 million associated with the above forward foreign currency contract
commitments.
In addition, the Company enters into forward foreign currency contracts to
hedge a portion of anticipated sales denominated in Great Britain Pound
Sterling and Euro to mitigate the impact of the effects of changes in
foreign currency rates on profitability related to cash flows from European
operations. Gains and losses on these hedge contracts are deferred and
recognized as an adjustment to the other charges (income), net. For the
year ended September 30, 2001 and 2002, the consolidated statement of
operations include approximately $0.2 million and $0.6 million of losses
related to these instruments.
As of September 30, 2002, relative to these exposures, the Company has no
outstanding forward foreign contracts. The Company does not enter into
forward foreign contracts for trading purposes.
Inventories
Inventories are stated at the lower of cost or market, cost being
determined using the first-in, first-out (FIFO) method.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost. Depreciation of
property, plant and equipment is calculated
- 37 -
using the straight-line method based on estimated economic useful lives.
Expenditures for maintenance and repairs and minor renewals are charged to
expense. Expenses for maintenance and repairs totaled approximately $2.9
million, $2.4 million and $2.6 million for the years ended September 30,
2000, 2001 and 2002, respectively.
Property, plant, equipment, and the related estimated useful lives are as
follows:
Asset Classification Estimated Useful Life
Buildings 25-40 years
Leasehold improvements Life of the lease or useful life,
whichever is shorter
Machinery and equipment 3-10 years
Furniture and fixtures 3-10 years
Upon the sale or retirement of assets, the cost and related accumulated
depreciation are removed from the consolidated financial statements, and
any resultant gain or loss is recognized.
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 currently enacted tax rates.
Intangible Assets
Intangible assets consist primarily of goodwill, patents and trademarks
purchased in business acquisitions. Intangible assets are amortized over
their estimated useful lives.
Estimated lives by major category of intangible assets at September 30,
2002 are as follows:
Goodwill 25 years
Patents Life of patents (up to 17 years)
Non-compete agreements Life of agreements (up to 5 years)
Trademarks, trade names and other Varies from 15 to 25 years
Impairment
The Company accounts for long-lived and certain intangible assets in
accordance with Statement of Financial Accounting Standards ("SFAS") No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of". The Company continually reviews its long-lived
and intangible assets for events or changes in circumstances that might
indicate the carrying amount of the assets may not be recoverable. The
Company assesses the recoverability of the assets by determining whether
the amortization of such assets over their remaining lives can be recovered
through projected undiscounted future cash flows. The amount of impairment,
if any, is measured based on projected discounted future cash flows using a
discount rate reflecting the Company's average cost of funds. During the
year ended September 30, 2000, the Company determined that an information
technology system that was under development was impaired. As a result, the
Company wrote off approximately $0.5 million related to this system. During
the year ended September 30, 2001, the Company identified certain
manufacturing assets in the Newark, Delaware facility that were determined
by the Company to be impaired. As a result, the Company wrote off
approximately $2.9 million related to those assets (see Note 17) as part of
its restructuring plan. During the year ended September 30, 2002, as a
result of normal product/equipment obsolescence, and productivity or
capacity enhancement projects, the Company wrote off approximately $0.5
million of manufacturing assets that were charged to other (income)
charges, net. All impairment charges are recorded to other (income)
charges, net in the consolidated statement of operations.
Deferred Financing Costs
Deferred financing costs are stated at cost as a component of other assets
and amortized over the life of the related debt. Amortization of deferred
financing costs is included in interest expense and aggregated $1.8
million, $2.0 million and $1.3 million for the years ended September 30,
2000, 2001 and 2002, respectively.
- 38 -
Fair Value of Financial Instruments
In accordance with the requirements of SFAS No. 107, "Disclosures about
Fair Value of Financial Instruments", the Company has determined the
estimated fair value of its financial instruments using appropriate market
information and valuation methodologies. Considerable judgment is required
to develop the estimates of fair value; thus, the estimates are not
necessarily indicative of the amounts that could be realized in a current
market exchange. The Company's financial instruments consist of cash and
cash equivalents, accounts receivable, accounts payable, Senior
Subordinated Notes, bank debt (including Term Loans, the Revolving Credit
Facility and other debt) and interest rate instruments. The carrying value
of these assets and liabilities is a reasonable estimate of their fair
market value at September 30, 2002, except for the Senior Subordinated
Notes, for which the Company estimates the fair market value to be
approximately $99.0 million at September 30, 2002.
The Company has approximately $25.0 million of variable rate debt protected
under an interest rate collar arrangement through September 30, 2003. The
floor is set at 2% and the cap at 6.25%. The fair value of the collar at
September 30, 2002 was $0.1 million. The Company has not elected to take
hedge accounting treatment for the interest rate collar as defined under
SFAS No. 133 and, as a result, any fair value adjustment is charge directly
to other income/(expense). Approximately $0.1 million was expensed during
the fiscal year ended September 30, 2002.
The Company also uses off-balance sheet financial instruments in the form
of forward foreign currency contracts. Current market prices were used to
estimate the fair value of the forward foreign currency contracts.
The future value of the forward foreign currency contracts and the related
currency positions are subject to offsetting market risk resulting from
foreign currency exchange rate volatility. The counter-parties to these
contracts are substantial and creditworthy financial institutions. Neither
the risks of counter-party non-performance nor the economic consequences of
counter-party non-performance associated with these contracts are
considered by the Company to be material.
Accounting for Stock-based Compensation
SFAS No. 123 "Accounting for Stock-Based Compensation" addresses accounting
and reporting requirements for stock options and other equity instruments
issued or granted based on their fair market values. The Company intends to
continue accounting for its stock-based compensation plans for employees in
accordance with Accounting Principals Board ("APB") No. 25, "Accounting for
Stock Issued to Employees". Under SFAS No. 123, companies choosing to
continue to use APB No. 25 to account for stock-based compensation plans
for employees must make footnote disclosure of the pro forma effects on
earnings per share, had the principles contained within SFAS No. 123 been
applied (see Note 12).
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 consolidated statement of
operations and totaled $16.8 million, $17.1 million and $17.2 million in
fiscal 2000, 2001 and 2002, respectively. The Company recovers a portion of
its shipping and handling costs from its customers and records this
recovery in net sales.
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
adoption of SFAS No. 133 on October 1, 2000 resulted in a $0.4 million
transition adjustment charge to accumulated other comprehensive income to
recognize the fair value of all derivatives that are designated as cash
flow hedges.
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
exchange contracts and interest rate swap agreements, which are derivatives
as defined by SFAS No. 133. The Company enters into forward
- 39 -
foreign currency contracts to mitigate the effects of changes in foreign
currency rates on profitability and enters into interest rate swap
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 (loss). Amounts accumulated in other comprehensive
income (loss) will be reclassified as earnings when the related product
sales affect earnings for forward foreign currency contracts or when
related interest payments affect earnings for interest rate swaps. There
were no forward foreign currency contracts or interest rate derivatives at
September 30, 2002 as defined under SFAS No. 133. For the year ended
September 30, 2002 the Company reclassified into earnings a net loss of
$0.6 million resulting from the exercise of forward foreign currency
contracts. All forward foreign currency contracts were determined to be
highly effective whereby no ineffectiveness was recorded in earnings.
The Company has approximately $25.0 million of variable rate debt protected
under an interest rate collar arrangement through September 30, 2003. The
floor is set at 2% and the cap at 6.25%. The fair value of the collar at
September 30, 2002 was $0.1 million. The Company has not elected to take
hedge accounting treatment for the interest rate collar as defined under
SFAS No. 133 and, as a result, any fair value adjustment is charge directly
to other income/(expense). Approximately $0.1 million was expensed during
the fiscal year ended September 30, 2002.
The Company also executes forward foreign currency 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 $0.4 million
for the year ended September 30, 2002.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 142, "Goodwill and Other Intangibles". 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 at least 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 adopting this standard and has not yet determined the
effect of adoption on its financial position or results of operations.
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 required to adopt the provisions of this statement
in October 2002. The Company does not expect the adoption of SFAS No. 143
to have a material effect on its financial position or results of
operations.
In August 2001, the 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 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 does not
expect the adoption of SFAS No. 144 to have a material effect on its
financial position or results of operations.
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,
- 40 -
"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 has not yet determined the effect of adoption on its
financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated
with Exit or Disposal Activities". This statement addresses financial
accounting and reporting for costs associated with exit of disposal
activities and nullifies EITF No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring). This statement is
effective for exit or disposal activities that are initiated after December
31, 2002, with early adoption encouraged. 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 or results of operations.
3. Inventories
Inventories consisted of the following at September 30 (dollars in
thousands):
2001 2002
--------------- -----------------
Raw materials $ 7,259 $ 7,514
Work in process 8,364 10,196
Finished goods 13,941 15,451
---------------- -----------------
$ 29,564 $ 33,161
================ =================
4. Property, Plant and Equipment
Property, plant and equipment consisted of the following at September 30
(dollars in thousands):
2001 2002
----------------- ------------------
Land $ 2,540 $ 2,589
Building and improvements 19,650 20,774
Machinery and equipment 49,912 59,687
Furniture and fixtures 19,715 23,486
Construction in progress 7,015 4,670
---------------- ------------------
98,832 111,206
Less - accumulated depreciation 51,829 63,110
---------------- ------------------
$ 47,003 $ 48,096
================ ==================
5. Intangible Assets
Intangible assets consisted of the following at September 30 (dollars in
thousands):
2001 2002
----------------- ------------------
Goodwill $ 80,395 $ 93,804
Trademarks and trade names 74,122 74,122
Patents 1,638 1,916
Non-compete agreement 585 701
Other 215 215
----------------- ------------------
$ 156,955 $ 170,758
Less - accumulated amortization 38,755 48,779
----------------- ------------------
$ 118,200 $ 121,979
----------------- ------------------
- 41 -
6. Accounts Payable and Accrued Liabilities
Accounts payable and accrued liabilities consisted of the following at
September 30 (dollars in thousands):
2001 2002
----------- -----------
Accounts payable - trade $ 14,614 $ 17,137
Accrued liabilities --
Employee compensation and benefits (Note 9) 8,743 9,189
Restructuring reserve 6,343 3,829
Other 5,112 6,255
----------- -----------
$ 34,812 $ 36,410
=========== ===========
7. Debt
The long-term debt consisted of the following at September 30 (dollars in
thousands):
2001 2002
------------ -----------
Term loans, due 2002 $ 8,131 $ --
Term loans, due 2003 12,196 12,529
Term loans, due 2004 16,262 16,706
Term loans, due 2005 63,047 64,641
Senior subordinated notes, due 2005, 12.5% 100,000 98,000
Mortgage note, due 1998 - 2006, 10.1% 2,236 2,165
Other 357 1,521
------------ ----------
202,229 195,562
Less--Current portion of long-term debt 8,393 12,847
------------- ----------
Total $ 193,836 $ 182,715
============= ==========
Senior Bank Facilities
The Company's debt structure includes up to an aggregate of $135.0 million
under a credit agreement with various banks 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 (collectively the Senior Bank Facilities).
The amount outstanding on the Term Loans at September 30, 2002, was
approximately $93.9 million. No amounts were outstanding under the
Revolving Credit Facility or the U.K. overdraft facility. The Revolving
Credit Facility provides for the issuance of letters of credit in an
aggregate face amount of up to $10.0 million. The Term Loans amortize
quarterly over a four-year period. Amounts repaid or prepaid in respect of
the Term Loans may not be re-borrowed. Loans and letters of credit under
the Revolving Credit Facility will be available until the Revolving Loan
Maturity Date, which is March 31, 2005.
At the Company's option, the interest rates per annum applicable to the
Senior Bank Facilities are either (a) an adjusted rate based on the London
Interbank Offered Rate (LIBOR) plus a margin of 3.25% in the case of Term
Loans and 2.75% for revolving loans or (b) the Base Rate, as defined, plus
a margin of 2.25% in the case of Term Loans and 1.75% for revolving loans.
The Base Rate is the higher of Bankers Trust Company's announced prime
lending rate or the Overnight Federal Funds rate plus 0.50%. The Company
must pay certain fees in connection with the Senior Bank Facilities,
including a commitment fee ranging from 0.375% to 0.50% on the undrawn
portion of the commitments in respect of the Revolving Credit Facility
based upon the Company's leverage ratio, and a 0.25% facing fee relating to
the issuance of letters of credit.
- 42 -
The Company is entitled to an Interest Reduction Discount of .25% when the
Company achieves a leverage ratio of less then 3.50. The discount would
apply to all Term Loans and the revolving loans.
Under the terms of the Senior Bank Facilities, the Company is required to
comply with a number of affirmative and negative covenants. Among other
restrictions, Aearo Company must satisfy certain financial covenants and
ratios, including interest coverage ratios, leverage ratios, fixed charge
coverage ratios and limits on the amount of permitted capital acquisitions.
The Senior Bank Facilities also impose limitations on certain business
activities of the Company. The Senior Bank Facilities restrict, among other
things, the incurrence of additional indebtedness, creation of certain
liens, the payment of dividends on the Company's Common Stock, sales of
certain assets and limitations on transactions with affiliates. As of
September 30, 2002, Aearo Company was in compliance with the covenants of
the Senior Bank Facilities. The Senior Bank Facilities are unconditionally
guaranteed by Aearo Corporation and secured by first priority security
interests in substantially all the capital stock and tangible and
intangible assets of the Company.
During the first quarter of fiscal 2002, the Company's Board of Directors
authorized management to repurchase, from time to time, a portion of the
Company's 12.5% Senior Subordinated Notes (Notes), subject to market
conditions and other factors. No assurances can be given as to whether or
when or at what price such repurchases will occur. Subsequently, pursuant
to a first amendment to the Senior Bank Facilities, the Company purchased
and retired $2.0 million of the Notes.
Term Loans
At September 30, 2002, the total balance outstanding on the Term Loans was
$93.9 million and interest rates were 5.0% for the U.S. Dollar Term Loan
($53.8 million US dollars outstanding at September 30, 2002), 7.2% for the
British Pound Term Loan (15.8 million British Pounds outstanding at
September 30, 2002), 6.5% for the Euro Term Loan (11.5 million Euro
outstanding at September 30, 2002), and 6.2% for the Canadian Term Loan
(6.2 million Canadian dollars outstanding at September 30, 2002). For the
year ended September 30, 2002, the weighted average interest rates paid
were 5.4%, 7.6% 6.7% and 5.9% for the U.S. Dollar Term Loan, the British
Pounds Term Loan, the Euro Term Loan and the Canadian Term Loan,
respectively.
At September 30, 2001, the total balance outstanding on the Term Loans was
$99.6 million and interest rates were 5.8% for the U.S. Dollar Term Loan
($58.8 million US dollars outstanding at September 30, 2001), 7.8% for the
British Pound Term Loan (17.3 million British Pounds outstanding at
September 30, 2001), 6.9% for the Euro Term Loan (12.6 million Euro
outstanding at September 30, 2001), and 6.5% for the Canadian Term Loan
(6.2 million Canadian dollars outstanding at September 30, 2001). For the
year ended September 30, 2001, the weighted average interest rates paid
were 7.0%, 8.6% 7.8% and 7.6% for the U.S. Dollar Term Loan, the British
Pounds Term Loan, the Euro Term Loan and the Canadian Term Loan,
respectively.
Revolving Credit Facility
At September 30, 2002, no amounts were outstanding on the Revolving Credit
Facility. For the year ended September 30, 2002, the maximum amount
outstanding was $1.5 million, the average was approximately zero and the
weighted average interest rate paid was 6.5%. At September 30, 2002,
approximately $29.0 million was available for additional borrowings and
$22.9 million to finance additional permitted acquisitions.
At September 30, 2001, no amounts were outstanding on the Revolving Credit
Facility. For the year ended September 30, 2001, the maximum amount
outstanding was $23.4 million, the average was $13.5 million and the
weighted average interest rate paid was 8.8%. At September 30, 2001,
approximately $29.3 million was available for additional borrowings and
$30.0 million to finance additional permitted acquisitions.
Senior Subordinated Notes
In connection with the Formation Acquisition, Aearo Company issued $100.0
million of Notes due 2005, which are unsecured obligations of the Company.
The Notes bear interest at a rate of 12.5% per annum and interest is
payable semiannually on each January 15 and July 15.
The Notes are redeemable at the option of the Company, on or after July 15,
2000. From and after July 15, 2000, the Notes will be subject to redemption
at the option of the Company, in whole or in part, at various
- 43 -
redemption prices, declining from 106.3% of the principal amount to par on
and after July 15, 2004. The Company repurchased $2.0 million of Notes in
October 2001.
The Notes indenture contains affirmative and negative covenants and
restrictions similar to those required under the terms of the Senior Bank
Facilities discussed above. As of September 30, 2002, the Company was in
compliance with the various covenants of the Notes agreement. The Notes are
unconditionally guaranteed on an unsecured, senior subordinated basis by
Aearo Corporation.
Maturities
As of September 30, 2002, the scheduled maturity of indebtedness for each
of the next five years and thereafter is as follows (dollars in thousands):
Amount
-----------
2003 $ 12,847
2004 17,003
2005 162,963
2006 2,149
2007 262
Thereafter 338
-----------
$ 195,562
===========
8. Interest Expense, Net
Interest expense, net comprises the following items (dollars in thousands):
Years Ended September 30,
2000 2001 2002
--------------- ------------- --------------
Expense $ 24,546 $ 23,869 $ 20,266
Income (159) (203) (211)
--------------- ------------- --------------
Interest expense, net $ 24,387 $ 23,666 $ 20,055
=============== ============= ==============
- 44 -
9. Employee Benefit Plans
The Company maintains a noncontributory defined benefit cash balance
pension plan. Benefits provided under the plan are primarily based on years
of service and the employee's compensation.
The following represents information summarizing the Company's defined
benefit cash balance pension plan (dollars in thousands):
Years Ended September 30,
Change in benefit obligation 2000 2001 2002
---------------- ---------------- -------------
Benefit obligation at beginning of year $ 9,500 $ 9,887 $ 11,343
Service cost 1,299 1,336 1,286
Interest cost 668 721 790
Plan amendments - - 30
Benefits paid (1,299) (993) (1,581)
Actuarial gain (loss) (281) 392 1,127
---------------- ---------------- --------------
Benefit obligation at end of year $ 9,887 $ 11,343 $ 12,995
---------------- ---------------- --------------
Change in plan assets
Fair value of plan assets at beginning of year $ 9,103 $ 10,535 $ 9,259
Actual return of plan assets 960 (1,491) (945)
Employer contributions 1,771 1,208 1,223
Benefits paid (1,299) (993) (1,581)
---------------- ---------------- --------------
Fair value of plan assets at end of year $ 10,535 $ 9,259 $ 7,956
---------------- ---------------- --------------
Reconciliation of funded status
Funded status $ 648 $ (2,084) $ (5,039)
Unrecognized prior service cost 103 96 117
Unrecognized actuarial (gain) loss (3,442) (572) 2,285
---------------- ---------------- --------------
Net pension liability included in accrued liabilities $ (2,691) $ (2,560) $ (2,637)
================ ================ ==============
Amounts recognized in statement of financial position
Prepaid benefit cost $ -- $ -- $ --
Accrued benefit liability (2,691) (2,560) (4,860)
Intangible asset -- -- 116
Accumulated other comprehensive income -- -- 2,107
---------------- ---------------- --------------
Net amount recognized $ (2,691) $ (2,560) $ (2,637)
---------------- ---------------- --------------
Components of net periodic benefit cost
Service cost $ 1,299 $ 1,336 $ 1,286
Interest cost 668 721 790
Expected return on plan assets (700) (842) (785)
Unrecognized prior service cost 7 7 9
Recognized actuarial gain (130) (145) --
---------------- ---------------- --------------
Net periodic benefit cost $ 1,144 $ 1,077 $ 1,300
================ ================ ==============
- 45 -
The weighted average assumptions used in determining net periodic benefit
cost and the projected benefit obligation were as follows:
Years Ended September 30,
2000 2001 2002
------- ------- --------
Discount rate 7.75% 7.50% 6.75%
Expected long-term rate of return of plan assets 8.00% 8.00% 8.50%
Rate of compensation increase 4.00% 4.00% 4.00%
======= ======= ========
In addition, the Company has an unfunded, noncontributory defined benefit
pension plan, the Aearo Company Supplemental Executive Retirement Plan (the
SERP Plan), which is also a cash balance plan. The SERP Plan, effective
January 1, 1994, covers certain employees in the United States. The costs
to the Company for the SERP Plan were $127,000, $148,000 and $111,000 for
the years ended September 30, 2000, 2001 and 2002, respectively. The
aggregate liability for the SERP Plan was $462,000, $524,000 and $486,000
for the years ended September 30, 2000, 2001 and 2002, respectively.
A 401(k) plan, the Aearo Company Employees' 401(k) Savings Plan, was
established as of May 1, 1990. Employees normally scheduled to work a
minimum of 1,000 hours per year can join the plan immediately and may
contribute up to 60% of their compensation. The Company contributes amounts
equal to 50% of the employee's contribution to a maximum of 3% of the
employee's pay. The costs to the Company for this Plan were $857,000,
$903,000 and $866,000 for the years ended September 30, 2000, 2001 and
2002, respectively.
The Company has a defined contribution savings plan for U.K. employees,
under which eligible employees are allowed to contribute up to 15% of their
compensation. The Company contributes 5% of pay for all eligible employees
and additional amounts equal to 40% of the employee's contribution to a
maximum of 2% of the employee's pay. For the years ended September 30,
2000, 2001 and 2002, the Company contributed approximately $198,000,
$212,000, and $197,000, respectively.
Postretirement Benefits
The Company does not provide defined benefit postretirement plans for
retirees after age 65, except that all employees who elect early retirement
at age 62 or older are eligible to receive life insurance coverage that
terminates on their 65th birthday. In addition, employees who were age 55
or older with 10 years of service as of April 1, 1990 are eligible to
receive limited health care and life insurance coverage for themselves and
their eligible dependents upon early retirement at age 62 or older. These
coverages terminate on the 65th birthday of the retiree or his or her
spouse. The health care benefit is a fixed dollar contribution and the life
insurance benefit is a fixed coverage amount.
10. Related Party Transactions
An annual management fee, which is to be shared by Cabot and Vestar, is
paid in aggregate amounts with respect to each fiscal year equal to the
greater of (i) $400,000 or (ii) 1.25% of the consolidated net income of the
Company and its subsidiaries before cash interest, taxes, depreciation and
amortization for such fiscal year. This annual management fee is shared by
Cabot and Vestar based on their relative equity ownership of the Company
and payments totaled approximately $686,000, $728,000 and $519,000 during
the years ended September 30, 2000, 2001 and 2002, respectively.
The Company and Cabot have entered into an arrangement relating to certain
respirator claims asserted after the Formation Acquisition as long as the
Company pays to Cabot an annual fee of $400,000, as discussed in Note 13.
The Company paid Cabot $400,000 for each of the years ended September 30,
2000, 2001 and 2002.
The Company has made available to certain members of management (Management
Investors) loans in order to provide such Management Investors with funds
to be applied to a portion of the purchase price of the Common Stock
purchased by such Management Investors under the Stock Purchase Plan. Each
such loans (i) is secured by Common Stock purchased with the proceeds
thereof, (ii) bears interest at an annual rate determined pursuant to
Section 7872(f)(2) of the Internal Revenue Code, and (iii) is subject to
mandatory prepayment in the event the employment of the Management Investor
terminates or of maturity. The aggregate amount of these loans was
approximately $1,335,000 and $1,363,000 at September 30, 2001 and 2002,
respectively, and is reflected as a reduction of the additional paid-in
capital account in the consolidated statements of stockholders' equity.
- 46 -
11. Income Taxes
Income (loss) before provision for income taxes was as follows (dollars in
thousands):
Years Ended September 30,
2000 2001 2002
------------------- ----------------- --------------
Domestic $ 6,157 $ (10,865) $ 4,762
Foreign 6,467 7,113 6,342
------------------- ----------------- --------------
Total $ 12,624 $ (3,752) $ 11,104
=================== ================= ==============
A summary of provision (benefit) for income taxes was as follows (dollars
in thousands):
Years Ended September 30,
2000 2001 2002
------------------- ---------------- ---------------
U.S. Federal and State:
Current $ 163 $ (3,525) $ 125
Deferred 1,940 - 203
------------------- ---------------- ---------------
$ 2,103 $ (3,525) $ 328
=================== ================ ===============
Foreign:
Current 1,581 1,957 1,226
Deferred (108) (304) 231
------------------- ---------------- ---------------
1,473 1,653 1,457
------------------- ---------------- ---------------
Total $ 3,576 $ (1,872) $ 1,785
=================== ================ ===============
The provision (benefit) for income taxes at the Company's effective tax rate
differed from the provision (benefit) for income taxes at the statutory rate
as follows (dollars in thousands):
Years Ended September 30,
2000 2001 2002
------------------- ----------------- ---------------
Computed tax expense (benefit) at the $ 4,293 $ (1,277) $ 3,740
expected statutory rate
State taxes, net of federal effect 37 (51) 82
Foreign income taxed at different rates (192) (1,172) (166)
Foreign dividends - - 324
Non-deductible goodwill amortization 320 308 309
Non-deductible expenses 200 267 99
Increase (decrease) in valuation
allowance (493) 110 (2,302)
Other, net (589) (57) (301)
------------------- ---------------- ---------------
Provision (benefit) for income taxes $ 3,576 $ (1,872) $ 1,785
=================== ================ ===============
Significant components of deferred income taxes are as follows at September
30 (dollars in thousands):
As of September 30,
2001 2002
Deferred tax assets ---------------- ----------------
Pension and other benefits $ 2,086 $ 1,862
Property, plant and equipment (3,441) (3,158)
Intangible assets 1,716 459
Restructuring charges 2,079 1,349
Inventory 1,202 1,147
Net operating loss carryforwards - Foreign 2,538 --
Net operating loss carryforwards - 10,474 11,298
Domestic
Accrued expenses and other 1,233 345
---------------- ----------------
Subtotal 17,887 13,302
Valuation allowances (18,270) (14,102)
================ ================
Total deferred tax liability $ (383) $ (800)
================ ================
- 47 -
The valuation allowance at September 30, 2001 and 2002 relates to the
uncertainty of realizing the tax benefits of reversing temporary
differences and net operating loss carryforwards. The gross amount of
domestic net operating loss carryforwards, before the tax effect, is
approximately $30.8 million as of September 30, 2002. The net operating
loss carryforwards expire at various periods ranging from 2010 to 2021. Of
the valuation allowance recorded as of September 30, 2002, approximately
$6.7 million will be used to reduce goodwill if the benefits are realized.
During the year ended September 30, 2000, approximately $1.9 million of
valuation allowances originally established through purchase accounting
were reversed through goodwill.
12. Stockholders' Equity
Stock Ownership and Stockholders' Agreement
As of September 30, 2002, Cabot owns 41.7% of common stock (42,500 shares)
and 50% of redeemable preferred stock (22,500 shares), Vestar owns 41.7% of
common stock (42,500 shares) and 50% of redeemable preferred stock (22,500
shares) and the Management Investors and certain other employees of the
Company own 16.6% of common stock (16,912.5 shares). Vestar, Cabot and the
Management Investors are parties to a stockholders' agreement (the
"Stockholders' Agreement"). The Stockholders' Agreement contains stock
transfer restrictions, as well as provisions granting certain tag-along
rights, drag-along rights, registration rights and participation rights.
The preferred stock is cumulative redeemable $.01 par value stock.
Dividends accrue whether or not dividends are declared or funds are
available at an annual rate of 12.5%, compounded quarterly. To date, no
dividends have been declared. Accrued dividends may be paid in cash or in
additional shares of preferred stock. Shares are redeemable for cash at any
time, subject to certain exceptions, at the option of the Company at a
redemption price equal to the actual or implied purchase price ($45.0
million) plus a redemption payment based on the dividend rate. As of
September 30, 2002, the redemption value of the preferred stock is $109.5
million.
Aearo Company is permitted to pay cash dividends to Aearo Corporation for
taxes and expenses in the ordinary course of business. The maximum amount
of cash dividends paid to Aearo Corporation for ordinary business expenses
may not exceed $1,000,000 in any fiscal year. As long as no event of
default would result, Aearo Corporation and Aearo Company are permitted to
pay dividends consisting of shares of qualified capital stock, as defined
in the Senior Bank Facilities, and Aearo Corporation may redeem or purchase
shares of its capital stock held by former employees of Aearo Corporation
or any of its subsidiaries following the termination of their employment,
provided that the aggregate amount paid by Aearo Corporation with respect
to such purchases or redemptions does not exceed $5.0 million in any fiscal
year and $7.5 million in the aggregate. Aearo Company may pay cash
dividends to Aearo Corporation for the latter purpose. Additionally, Aearo
Corporation may pay dividends on its preferred stock in additional shares
of preferred stock. To date, Aearo Corporation has not paid dividends on
either common or preferred stock.
Stock Option Plans
On June 27, 1996, the Company adopted the Executive Stock Option Plan (the
"Executive Plan") whereby the Company, subject to approval of the Board of
Directors, may grant up to 5,000 non-qualified options to certain members
of management. In July 1997, the Company's Board of Directors adopted and
the stockholders subsequently approved the 1997 Stock Option Plan (the
"1997 Option Plan") under which 10,000 shares of Aearo Common Stock were
reserved for issuance. During the year ended September 30, 2002, an
additional 1,800 shares were reserved for issuance. Under the 1997 Option
Plan, non-qualified and qualified options may be granted to employees of
the Company. Options granted under the Executive Plan and the 1997 Option
Plan will vest and become exercisable upon the earlier of the date on which
a stipulated return (as defined) is achieved by Vestar and Cabot on their
investment in the Company or the tenth anniversary of the date of grant.
The option term will be 10 years, except that options shall expire in
certain instances of termination of employment and upon the sale of the
Company. As of September 30, 2002, a total of 15,920 options were
outstanding under the Executive Plan and 1997 Option Plan and a total of
880 options were available for grant.
Pro Forma Stock-Based Compensation Expense
SFAS No. 123, "Accounting for Stock-Based Compensation", sets forth a
fair-value-based method of recognizing stock-based compensation expense. As
permitted by SFAS No. 123, the Company has elected to continue to
- 48 -
apply APB No. 25 to account for its stock-based compensation plans. Had
compensation cost for these plans been determined consistent with SFAS No.
123, the Company's net income (loss) would have been reduced by $0.1
million and $0.2 million in the year ended September 30, 2001 and 2002,
respectively.
The fair value of each option grant was estimated on the grant date using
the Black-Scholes pricing model with the following weighted average
assumptions:
2000 2001 2002
---------- --------- ---------
Risk-free interest rate 6.01% 5.22% 4.52%
Expected life of options granted 10 years 10 years 10 years
Expected volatility of underlying stock 0% 0% 0%
Dividend yield 0% 0% 0%
Stock Option Activity
Stock option data for the Executive Plan and the 1997 Option Plan for the
years ended September 30, 2000, 2001 and 2002 were as follows:
Number Weighted Average
of Shares Exercise Price
------------ -----------------
Outstanding, October 1, 1999 7,729 $ 600
Granted 750 600
Granted 1,466 800
Forfeited (62) 600
Outstanding, September 30, 2000 9,883 $ 630
Granted 2,500 800
Forfeited (218) 600
Forfeited (94) 800
Outstanding, September 30, 2001 12,071 $ 664
Granted 4,274 600
Granted 31 800
Forfeited (456) 600
-------------- -----------------
Outstanding, September 30, 2002 15,920 $ 649
============== =================
The following table sets forth information regarding options outstanding at
September 30, 2002:
Weighted Average
Weighted Average Exercise Price for
Number Number Currently Weighted Average Remaining Currently
of Options Exercise Price Exercisable Exercise Price Contractual Life Exercisable
----------------- --------------------- -------------------- -------------------- -------------------- --------------------
12,017 $ 600.00 - $ 600.00 6.74 years N/A
3,903 $ 800.00 - $ 800.00 7.78 years N/A
- 49 -
13. Commitments and Contingencies
Lease Commitments
The Company leases certain transportation vehicles, warehouse facilities,
office space, and machinery and equipment under cancelable and
noncancelable operating leases. Rent expense under such arrangements
totaled $6.4 million, $7.5 million and $7.9 million for the years ended
September 30, 2000, 2001 and 2002, respectively. Future minimum rental
commitments under noncancelable leases in effect at September 30, 2002 are
as follows (dollars in thousands):
2003 $ 4,386
2004 3,845
2005 2,399
2006 3,050
2007 824
Thereafter 1,341
--------------
Total $ 15,845
==============
Contingencies
Various lawsuits and claims arise against the Company in the ordinary
course of its business. Most of these lawsuits and claims are products
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 that 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 on July
11, 1995, as amended in 2002. This agreement provides that, 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 silica-related legal claims asserted after July 11, 1995 and
alleged to have arisen out of the use of respirators while exposed to
asbestos or silica prior to January 1, 1997. 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 have arisen from the
use of respirators while exposed to asbestos or silica on or after January
1, 1997. The Company also may be responsible for certain claims relating to
acquired companies other than the AOSafety(R) Division that are not covered
by, and are unrelated to, the agreement with Cabot.
At September 30, 2002, the Company has recorded liabilities of
approximately $4.8 million, which represents reasonable estimates of its
probable liabilities, for product liabilities substantially related to
asbestos and silica-related claims as determined by the Company in
consultation with an independent consultant. This reserve is re-evaluated
periodically and additional charges or credits to operations may result as
additional information becomes available. Consistent with the current
environment being experienced by companies involved in asbestos and
silica-related litigation, there has been an increase in the number of
asserted claims that could potentially involve the Company. 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 and silica-related litigation could increase the
Company's cost over time. In light of these and other uncertainties
inherent in making long-term projections, the Company has determined that
the five-year period through fiscal 2007 is the most reasonable time period
for projecting asbestos and silica-related
- 50 -
claims and defense costs. It is possible that the Company may incur
liabilities in an amount in excess of amounts currently reserved. However,
taking into account currently available information, historical experience,
and the Cabot agreement, but recognizing the inherent uncertainties in the
projection of any future events, it is management's opinion that these
suits or claims should not result in final judgments or settlements in
excess of the Company's reserve that, in the aggregate, would have a
material effect on the Company's financial condition, liquidity or results
of operations.
14. Acquisitions
On December 14, 2001, the Company acquired Iron Age Vision from Iron Age
Corporation of Pittsburgh, Pennsylvania. The acquisition has been accounted
for as a purchase transaction in accordance with SFAS No. 141, and,
accordingly, the consolidated financial statements for the periods
subsequent to December 14, 2001 reflect the purchase price, including
transaction costs, allocated to tangible and intangible assets acquired and
liabilities assumed, based on their estimated fair values as of December
14, 2001. The purchase price of $0.9 million was, inclusive of acquisition
fees and costs to restructure operations, allocated based on the fair value
of assets acquired, which consisted primarily of receivables and fixed
assets. The excess of purchase price over the fair market value of assets
acquired of $0.5 million was allocated to goodwill.
On January 21, 2002, the Company acquired the industrial safety business of
Montreal, Canada based Leader Industries, Inc. The acquisition has been
accounted for as a purchase transaction in accordance with SFAS No. 141,
and, accordingly, the consolidated financial statements for the periods
subsequent to January 21, 2002 reflect the purchase price, including
transaction costs, allocated to tangible and intangible assets acquired and
liabilities assumed, based on their estimated fair values as of January 21,
2002. The purchase price of $5.1 million , inclusive of acquisition fees
and costs to restructure operations, was allocated based on the fair value
of assets acquired, which consisted primarily of inventory, receivables,
fixed assets and accrued liabilities. The excess of purchase price over the
fair market value of assets acquired of $2.2 million was allocated to
goodwill.
On May 7, 2002, the Company acquired Chesapeake Optical Company of
Baltimore, Maryland. The acquisition has been accounted for as a purchase
transaction in accordance with SFAS No. 141, and, accordingly, the
consolidated financial statements for the periods subsequent to May 7, 2002
reflect the purchase price, including transaction costs, allocated to
tangible and intangible assets acquired and liabilities assumed, based on
their estimated fair values as of May 7, 2002. The purchase price of $3.6
million, inclusive of acquisition fees and costs to restructure operations,
was allocated based on the fair value of assets acquired, which consisted
primarily of inventory, receivables, fixed assets and accrued liabilities.
The excess of purchase price over the fair market value of assets acquired
of $2.9 million was allocated to goodwill.
These operations have been included in consolidated results from the dates
of acquisition. Had the acquisitions been consolidated at the beginning of
the year prior to the acquisitions, they would not have materially affected
results.
15. Segment Data
As defined by SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information", the Company's three reportable segments are
Safety Products, Safety Prescription Eyewear and Specialty Composites. The
Safety Products segment manufactures and sells hearing protection devices,
communication headsets, 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 Safety
Prescription Eyewear segment purchases component parts (lenses and the
majority of its frames) from various suppliers, grinds and shapes the
lenses to 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.
- 51 -
Net sales to external customers by business segment (dollars in thousands):
2000 2001 2002
----------- ----------- -----------
Safety Products $ 219,710 $ 206,311 $ 208,538
Safety Prescription Eyewear 39,913 39,076 40,834
Specialty Composites 45,852 38,475 37,495
----------- ----------- -----------
Total $ 305,475 $ 283,862 $ 286,867
=========== =========== ===========
EBITDA by business segment and reconciliation to income before provision
for (benefit from) income taxes (dollars in thousands):
2000 2001 2002
----------- ----------- ----------
Safety Products $ 48,775 $ 39,844 $ 42,326
Safety Prescription Eyewear 4,008 2,237 1,621
Specialty Composites 3,531 1,409 3,433
Reconciling items (1,696) 4,562 1,120
----------- ----------- ----------
Total EBITDA $ 54,618 $ 48,052 $ 48,500
=========== =========== ==========
Depreciation 10,056 10,123 10,958
Amortization of intangibles 6,859 6,530 6,293
Non-operating costs (income) 692 44 690
Unusual charges 11,441 (600)
Interest, net 24,387 23,666 20,055
------------ ----------- -----------
Income before provision for/(benefit from)
income taxes $ 12,624 $ (3,752) $ 11,104
============ =========== ===========
The Company evaluates 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 by the Company for
EBITDA purposes 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 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.
Intersegment sales of the Specialty Composites segment to the Safety
Products segment totaled $3.5 million and $3.9 million for the years ended
September 30, 2001 and 2002, respectively. The intersegment sales value is
generally determined at fully absorbed inventory cost at standard rates
plus 25%.
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.
Depreciation by business segment (dollars in thousands):
2000 2001 2002
----------- ----------- -----------
Safety Products $ 7,384 $ 7,966 $ 8,657
Safety Prescription Eyewear 765 378 717
Specialty Composites 1,907 1,779 1,584
----------- ----------- -----------
Total $ 10,056 $ 10,123 $ 10,958
=========== =========== ===========
- 52 -
Identifiable assets by business segment (dollars in thousands):
2000 2001 2002
---------- ----------- ----------
Safety Products $ 217,072 $ 201,183 $ 216,262
Safety Prescription Eyewear 13,986 15,095 14,695
Specialty Composites 23,730 18,918 18,891
Reconciling items 12,078 26,106 20,321
---------- ----------- -----------
Total $ 266,866 $ 261,302 $ 270,169
========== =========== ===========
Reconciling items include corporate assets such as cash, information
technology and other shared systems.
Capital expenditures by business segment (dollars in thousands):
2000 2001 2002
---------- ----------- -----------
Safety Products $ 7,628 $ 5,788 $ 7,921
Safety Prescription Eyewear 37 425 499
Specialty Composites 1,347 1,075 791
Reconciling items 540 511 442
---------- ----------- -----------
Total $ 9,552 $ 7,799 $ 9,653
========== =========== ===========
Reconciling items include corporate expenditures such as information
technology and other shared systems.
Net sales by principal geographic areas (dollars in thousands):
2000 2001 2002
----------- ----------- -----------
United States of America $ 194,452 $ 179,398 $ 175,358
Canada 22,103 20,370 20,997
United Kingdom 16,635 13,501 13,115
Germany 11,449 11,447 10,984
Sweden 12,405 10,981 10,710
France 7,568 6,975 10,097
Italy 5,387 5,156 4,933
All others 35,476 36,034 40,673
----------- ----------- ------------
Total $ 305,475 $ 283,862 $ 286,867
=========== =========== ============
The sales as shown above represent the value of shipments into the
customer's country of residence. For the years ended September 30, 2000,
2001 and 2002, no single customer accounted for more than 10% of sales.
Net identifiable assets by principal geographic areas (dollars in
thousands):
2000 2001 2002
----------- ----------- ------------
United States of America $ 176,822 $ 173,076 $ 173,068
Canada 9,333 9,584 10,252
United Kingdom 17,708 19,304 18,426
Germany 1,451 2,138 144
Sweden 60,834 56,673 61,860
All others 718 527 6,419
----------- ----------- ------------
Total $ 266,866 $ 261,302 $ 270,169
=========== =========== ============
- 53 -
16. Quarterly Financial Data (Unaudited)
The following table contains selected unaudited quarterly financial data
for fiscal years 2001 and 2002.
QUARTERLY FINANCIAL DATA
(In Thousands, Except Per Share Amounts)
--------------------------------------------------------------------------------
Fiscal Year Fiscal Year
2001 2002
--------------------------------------- ----------------------------------------
First Second Third Fourth First Second Third Fourth
------- --------- -------- -------- --------- -------- --------- -------
Net Sales $68,365 $ 74,039 $72,138 $ 69,320 $ 61,644 $70,683 $76,435 $78,105
Cost of Sales 37,553 39,116 39,007 39,537 32,928 37,360 40,024 40,085
------- --------- ------- -------- --------- -------- -------- -------
Gross Profit 30,812 34,923 33,131 29,783 28,716 33,323 36,411 38,020
Unusual Charge - - - 9,077 - - - (100)
Income (Loss) before provision
for (benefit from) income taxes (2,320) 3,619 5,466 (10,517) (188) 2,580 3,132 5,580
Net Income (Loss) (2,387) 3,035 5,012 (7,540) (711) 2,017 2,282 5,731
17. Restructuring
On September 30, 2001 the Company recorded an unusual charge of $11.4
million related 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 restructuring charge included cash charges totaling $2.3 million
consisting of $1.8 million for severance and related 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 restructuring also included non-cash
charges totaling $9.1 million consisting of $3.2 million for non-cancelable
long term lease obligations, asset impairment charges of $2.9 million, $2.4
million for the write-off of inventory and $0.6 million related to the sale
of the Company's Ettlingen, Germany location.
During 2002, the Company reversed $0.6 million of reserves related to the
September 30, 2001 restructuring provision. The adjustment represents a
change in estimate of the plan for the disposal of certain items of
inventory and the closure of its Ettlingen, Germany plant. The portion
related to inventory of $0.5 million was classified as reduction in cost of
sales with the remaining $0.1 million classified as operating expenses.
The following table displays the activity and balances of the restructuring
reserve account as of and for the year ended September 30, 2002 (in
thousands):
September 30, September 30,
2001 Charges Adjustments 2002
------------- ----------- ----------- ------------
Employee termination costs $ 1,849 $ (1,119) $ -- $ 730
Lease agreements 3,249 (897) 2,352
Loss on disposal of assets 800 (100) 700
Other 445 (398) 47
------------- ----------- ----------- ------------
Total $ 6,343 $ (2,414) $ (100) $ 3,829
------------- ----------- ----------- ------------
- 54 -
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
On May 18, 2001, the Company filed a Current Report on Form 8-K regarding
the dismissal of Arthur Anderson and the appointment of Deloitte and Touche
as its independent accountants.
- 55 -
PART III
Item 10. Directors and Executive Officers
The following table sets forth certain information with respect to the directors
and executive officers of the Company as of December 1, 2002.
Name Age Position
- ----------------------------------- ---- -----------------------------------------------------------------------
Michael A. McLain (1) 52 Chief Executive Officer, President, and Chairman of the Board of
Directors
Jeffrey S. Kulka 45 Vice President and Chief Financial Officer, Treasurer and Secretary
James H. Bernhardt 58 Vice President and Chief Marketing Officer
James H. Floyd 47 Senior Vice President, Logistics and Information Technology, Managing
Director, International and Business Director, Consumer
Joseph C. Marlette 59 Senior Vice President, Manufacturing and Research and Development
M. Rand Mallitz 60 Vice President and Senior Vice President Specialty Composites
D. Garrad (Gary) Warren, III 50 Senior Vice President, North American Industrial Safety Sales and
Managing Director - Europe
James M. Phillips 50 Vice President, Human Resources
Rahul Kapur 51 Vice President, Corporate Development and Business Director, SRx
Norman W. Alpert (1,2) 43 Director
Daniel S. O'Connell 47 Director
Arthur J. Nagle 66 Director
Bryan P. Marsal (2) 51 Director
William E. Kassling (2) 57 Director
William J. Brady (1,2) 41 Director
John D. Curtin, Jr. 68 Director
John A. Shaw 54 Director
1. Member of Compensation Committee
2. Member of Audit Committee
- 56 -
Michael A. McLain has been President, Chief Executive Officer and Director of
the Company since February 1998. Effective May 30, 2001, he was named Chairman
of the Board of Directors. Prior to joining the Company, he was President and
Chief Executive Officer of DowBrands, Inc., a large manufacturer of household
consumer products. Mr. McLain is a Director of Park Tudor School, Cluett
American Corporation, and Little Rapids Corporation.
Jeffrey S. Kulka, Vice President and Chief Financial Officer, Treasurer and
Secretary joined the Company in March 1997 as Corporate Controller. Prior to
joining Aearo, he spent ten years with Augat Inc. in a variety of assignments
including Divisional Controllerships and Business Development in domestic and
international settings.
James H. Bernhardt joined the Company in February 2001 as Vice President and
Chief Marketing Officer. Prior to joining Aearo, he was Senior Vice
President/General Manager of the Miracle-Gro Division of the Scotts Company.
Altogether, he has 30 years of experience in packaged goods marketing.
James H. Floyd, Senior Vice President, Logistics and Information Technology,
Managing Director, International and Business Director, Consumer, joined Aearo
in April 1998. Prior to 1998, he was responsible for global logistics and
packaging functions at DowBrands. He began his career at Procter and Gamble
where he worked for seven years.
Joseph C. Marlette, Senior Vice President, Manufacturing and Research and
Development joined the Company in April 1998. Prior to joining Aearo, he spent
33 years in various manufacturing positions with the Dow Chemical Company.
M. Rand Mallitz joined the Company in January 1992 as Vice President and General
Manager, E-A-R(R) Specialty Composites. In December 1999, he was promoted to
Vice President Aearo, Senior Vice President Specialty Composites. Prior to
joining the Company, Mr. Mallitz was CEO/President of Roth Office Products until
1992.
D. Garrad (Gary) Warren, III joined the Company in November 1999 and currently
serves as Senior Vice President - NAI Sales and Managing Director, Europe. Prior
to that, Mr. Warren was Senior Vice President, Sales and Customer Development
for International Home Foods in Parsippany, New Jersey.
James M. Phillips, Vice President, Human Resources joined the Company in May
1998. He worked for Dow Chemical Company for more than 20 years and has worked
in recruiting, training and compensation for many diverse divisions of Dow.
Rahul Kapur joined the Company in April 1998 as Vice President of Corporate
Development. He currently is Vice President of Corporate Development and
Business Director, SRx. Mr. Kapur joined DowBrands in 1985 in New Product
Development and held various positions in Marketing and Strategic Development,
including Director of Marketing for Europe. He began his career with Richardson
Vicks and Unilever.
Norman W. Alpert is a Managing Director of Vestar Capital Partners and was a
founding partner of Vestar at its inception in 1988. Mr. Alpert is a director of
Aearo Corporation, MCG Capital Corporation, Cluett American Group, Siegelgale
Holdings, Inc. and Remington Products Company, L.L.C. all companies in which
Vestar or its affiliates have a significant equity interest. He became a
director of the Company in July 1995.
Daniel S. O'Connell is the Chief Executive Officer and founder of Vestar Capital
Partners. Mr. O'Connell is a director of Cluett American Corporation, Insight
Communications Company, Inc., Remington Products Company L.L.C., Siegelgale
Holdings Inc., Sunrise Medical, Inc., St. John Knits Co., Inc., Agrilink Foods,
Inc. and Michael Foods, Inc. All are companies in which Vestar or its affiliates
have a significant equity interest. He became a director of the Company in July
1995.
Arthur J. Nagle is a Managing Director of Vestar Capital Partners and was a
founding partner of Vestar at its inception in 1988. Mr. Nagle is a director of
Advanced Organics, Inc., Gleason Corporation, Remington Products Company,
L.L.C., and Sheridan Healthcare, Inc., all companies in which Vestar or its
affiliates have a significant equity interest. He became a director of the
Company in July 1995.
Bryan P. Marsal, is co-founder of Alvarez & Marsal, Inc. ("A&M"), a global
professional services firm specializing in providing corporate advisory and
management services to distressed and underperforming companies. Previously, he
has served as Chairman and CEO of Cluett American Corporation, Republic Health
Corporation, Anthony
- 57 -
Manufacturing, and Gitano. He was also Chief Operating Officer of Alexander's
Department Stores. Mr. Marsal holds both a B.B.A. and a M.B.A from the
University of Michigan. He also serves on the boards of Timex Corporation, and
Cluett American Corporation (Gold Toe Socks). He became a director of the
Company in October 1998.
William E. Kassling was named Chairman of the Board of Wabtec Corporation in
February 2001, after having served as Chairman and Chief Executive Officer since
1990. Between 1984 and 1990, Mr. Kassling served as Vice President, Group
Executive for the Railway Products Group of American Standard Incorporated.
Prior to 1984, he held various operating and strategic planning assignments with
American Standard, Clark Equipment Company and Boston Consulting Group. Mr.
Kassling earned an MBA from the University of Chicago and a BS in industrial
management from Purdue University. In addition to Aearo, Mr. Kassling is a board
member of the Pittsburgh Penguins and Scientific Atlanta. He became a director
of the Company in July 1998.
William J. Brady is Vice President and General Manager of Cabot's Fumed Metal
Oxides business. He also oversees Cabot's Ink Jet Colorants business unit,
Corporate New Business Development, and Logistics function. Bill joined Cabot in
1986 and has held various positions in the United States of America and Japan.
Prior to Cabot, he was a research chemist with Sterling Drug Company.
John D. Curtin, Jr. retired as Chairman and Chief Executive Officer of the
Company in February 1998. Mr. Curtin was named Chief Executive Officer of the
Company in April 1994 and became a director of the Company in July 1995. Mr.
Curtin joined Cabot in 1989 as Chief Financial Officer and Executive Vice
President. Prior to joining Cabot he was President, Chief Executive Officer and
Director of Curtin & Co., Inc., a private investment-banking firm. Mr. Curtin is
also a director of Harbor Global Company, LTD, Hamilton Thorne Biosciences,
Inc., and Nano-C, LLC.
John A. Shaw is Executive Vice President and Chief Financial Officer of Cabot
Corporation in Boston, Massachusetts. Previously, he was with Dominion Resources
in Richmond, Virginia in charge of finance for their energy company. Prior to
that he spent 20 years with Atlantic Richfield. Mr. Shaw has a B.Sc. with honors
in Mechanical Engineering from Bristol University in the UK and is a Chartered
Accountant.
The number of directors of the Company is fixed at nine. Under a stockholders'
agreement among Aearo, Vestar, Cabot, and the Management Investors dated July
11, 1995 (the "Stockholders' Agreement"), Vestar has the right to designate five
directors, Cabot has the right to designate two directors, and the Management
Investors have the right to designate two directors. Messrs. Alpert, O'Connell,
Nagle, Kassling and Marsal are the directors designated by Vestar. Mr. Brady and
Mr. Shaw are the directors designated by Cabot. Mr. McLain and Mr. Curtin are
currently the directors designated by the Management Investors. See Item 13,
"Certain Relationships and Related Transactions -- Stock Ownership and
Stockholders' Agreement -- Election and Removal of Directors." The term of
office for each director ends when his or her successor elected at the annual
meeting of stockholders or upon his or her removal or resignation.
The Board of Directors has established an audit committee consisting of Norman
W. Alpert, William E. Kassling and Bryan P. Marsal (the "Audit Committee"). The
Audit Committee recommends the firm to be appointed as independent accountants
to audit financial statements and to perform services related to the audit,
reviews the scope and results of the audit with the independent accountants,
reviews with management and the independent accountants the Company's annual
operating results, considers the adequacy of the internal accounting procedures,
considers the effect of such procedures on the accountants' independence and
establishes policies for business values, ethics and employee relations.
Officers and directors of Aearo and the Subsidiary are not subject to Section 16
of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
- 58 -
Item 11. Executive Compensation
The compensation of executive officers of the Company is determined by the Board
of Directors. The following table sets forth certain information concerning
compensation received by the Chief Executive Officer and the other four most
highly-compensated executive officers of the Company serving at the end of
fiscal 2002 (the "Named Executive Officers") for services rendered to the
Company in all capacities (including service as an officer or director) in
fiscal 2002.
Summary Compensation Table
Annual Compensation
Fiscal All Other Annual
Year Salary Bonus Compensation
Michael A. McLain 2002 $ 500,004 $ 225,069 $ 86,797(1)
Chief Executive Officer, President, and Chairman of the Board 2001 $ 496,667 $ 56,250 $ 84,977
of Directors 2000 $ 473,784 $ 286,738 $ 64,989
D. Garrad Warren, III 2002 $ 243,000 $ 87,507 $ 64,250(2)
Senior Vice President, North American Industrial Safety Sales 2001 $ 240,833 $ 21,870 $ 43,316
and Managing Director, Europe 2000 $ 192,500 $ 106,764 $ 195,386
James H. Floyd 2002 $ 207,934 $ 75,623 $ 52,721(3)
Senior Vice President, Logistics and Information Technology, 2001 $ 195,066 $ 17,784 $ 42,122
Managing Director, International and Business Director, 2000 $ 187,624 $ 77,976 $ 26,791
Consumer
M. Rand Mallitz 2002 $ 206,604 $ 74,399 $ 22,907(4)
Vice President and Senior Vice President, Specialty Composites 2001 $ 205,267 $ 18,594 $ 25,180
2000 $ 197,000 $ 99,975 $ 24,906
Rahul Kapur 2002 $ 192,108 $ 69,177 $ 40,495(5)
Vice President, Corporate Development and Business Director, 2001 $ 190,873 $ 17,289 $ 34,336
SRx 2000 $ 183,204 $ 92,978 $ 25,215
1. Includes contributions made on behalf of Mr. McLain to the Company's 401(k)
Savings Plan ($5,250) and to the Company's Cash Balance Plan ($12,049).
Also includes expenses recognized by the Company for unfunded accruals made
on Mr. McLain's behalf to the Company's Supplemental Executive Retirement
Plan ($32,168) as well as Company match and interest credits to the
Company's Deferred Compensation Plan ($37,330).
2. Includes contributions made on behalf of Mr. Warren to the Company's 401(k)
Savings Plan ($5,250) and to the Company's Cash Balance Plan ($12,049).
Also includes expenses recognized by the Company for unfunded accruals made
on Mr. Warren's behalf to the Company's Supplemental Executive Retirement
Plan ($7,280) as well as Company match and interest credits to the
Company's Deferred Compensation Plan ($39,671).
3. Includes contributions made on behalf of Mr. Floyd to the Company's 401(k)
Savings Plan ($5,200); to the Company's Cash Balance Plan ($12,049). Also
includes expenses recognized by the Company for unfunded accruals made on
Mr. Floyd's behalf to the Company's Supplemental Executive Retirement Plan
($3,418) as well as Company match and interest credits to the Company's
Deferred Compensation Plan ($32,054).
4. Includes contributions made on behalf of Mr. Mallitz to the Company's
401(k) Savings Plan ($5,767) and to the Company's Cash Balance Plan
($12,049). Also includes expenses recognized by the Company for unfunded
accruals made on Mr. Mallitz's behalf to the Company's Supplemental
Executive Retirement Plan ($3,883) as well as Company match and interest
credits to the Company's Deferred Compensation Plan ($1,208).
5. Includes contributions made on behalf of Mr. Kapur to the Company's 401(k)
Savings Plan ($4,835) and to the Company's Cash Balance Plan ($11,575).
Also includes expenses recognized by the Company for unfunded
- 59 -
accruals made of Mr. Kapur's behalf to the Company's Supplemental Executive
Retirement Plan ($3,004) as well as Company match and interest credits to
the Company's Deferred Compensation Plan ($21,081).
The following table sets forth information concerning the number and value of
unexercised options to purchase Aearo Common Stock held by the Named Executive
Officers at the end of fiscal 2002. None of the Named Executive Officers
exercised any stock options during fiscal 2002.
Value of Outstanding
Number of Beneficial In-the-money Options
Shares Options at Fiscal Year-end At Fiscal Year-end (1)
Acquired Value
Name On Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
- ------------------------- ------------- ----------- -------------- ---------------- -------------- -----------------
Michael A. McLain -- -- -- 1,100 $ -- $ --
D. Garrad Warren, III -- -- -- 1,750 -- --
M. Rand Mallitz -- -- -- 356 --
Rahul Kapur -- -- -- 275 -- --
James H. Floyd -- -- -- 400 -- --
1. There was no public market for the Aearo Common Stock as of September 30,
2002. Accordingly, these values have been calculated on the basis of an
assumed fair market value of $600 per share as established by the Company's
Board of Directors.
Director Compensation
Directors (other than two Directors unaffiliated with Cabot or Vestar (the
"Outside Directors")) serve without compensation (other than reimbursement of
expenses) in connection with rendering services as such. The Outside Directors
receive $10,000 annually for their service as Directors and an additional $2,500
per meeting, plus reimbursement of expenses. In connection with their
appointment, Outside Directors appointed in prior fiscal years have been given
the opportunity to purchase a limited number of shares of Aearo Common Stock. No
Outside Directors were appointed to the Board during fiscal 2002. Outside
Directors may also elect to participate in the Deferred Compensation Plan.
Employee Stock and Other Benefit Plans
Stock Purchase Plan. In connection with the Formation Acquisition, the Company
adopted the Cabot Safety Holdings Corporation 1995 Stock Purchase Plan, as
amended and restated (the "Stock Purchase Plan"), in order to encourage
ownership of Aearo Common Stock by selected officers and employees and
independent directors of the Company. Under the Stock Purchase Plan, 15,000
shares of Aearo Common Stock have been reserved for purchase by the Company's
executive officers and other senior members of management as determined by the
Board of Directors. As of December 1, 2002, 13,200 of such shares were issued
and outstanding.
Aearo Common Stock acquired under the Stock Purchase Plan is subject to
forfeiture through various puts and calls. In the event of death, permanent
disability or retirement, which retirement occurs at age 65 or older with at
least 3 years of service, such stock may be put to the Company by the holder at
fair market value and the Company has a call on such stock at the same price. In
the event of termination for cause, the Company has a call at the lesser of
initial cost and fair market value. In the event of termination by the Company
other than for cause and in the case of voluntary resignation, the Company has a
call (i) with respect to a percentage of such stock equal to the number of years
elapsed since the Formation Acquisition multiplied by 20% at fair market value,
and (ii) with respect to the remainder of such stock at the lesser of initial
cost and fair market value. Shares repurchased by the Company are held in
reserve, and may be issued to existing and future employees or non-employee
directors. These puts and calls expire (i) on the date on which certain
financial performance benchmarks (which, following an initial public offering of
the Aearo Common Stock, depend in part on the future market value of the Aearo
Common Stock) are achieved by the Company or (ii) on various dates, none
exceeding five years from the date of purchase. Each Management Investor is also
required to be a party to the Stockholders' Agreement. See Item 13, "Certain
Relationships and Related Transactions -- Stockholders' Agreement."
Stock Option Plans. In June 1996, the Company's Board of Directors adopted and
the stockholders subsequently approved the Executive Stock Option Plan (the
"Executive Plan") under which 5,000 shares of Aearo Common
- 60 -
Stock have been reserved for issuance. In July 1997, the Company's Board of
Directors adopted and the stockholders subsequently approved the 1997 Stock
Option Plan (the "1997 Option Plan") under which 11,800 shares of Aearo Common
Stock have been reserved for issuance. Under the 1997 Option Plan non-qualified
and qualified options may be granted to employees of the Company.
Each of the Executive Plan and the 1997 Option Plan is administered by a
committee of the Board of Directors consisting of all non-employee directors. As
of September 30, 2002, non-qualified options to acquire 12,017 shares at a price
of $600 per share, and 3,903 shares at a price of $800 per share have been
granted to officers and key employees of the Company under the Company's stock
option plans and 880 options remain available for issuance.. Of outstanding
options, 3,881.25 in the aggregate have been granted to Named Executive
Officers, including Mr. McLain (1,100 options), Mr. Warren (1,750 options), Mr.
Floyd (400 options), Mr. Kapur (275 options) and Mr. Mallitz (356.25 options).
The options will vest and become exercisable upon the earlier of: (i) the date
on which certain financial performance benchmarks (which depend in part on the
future market value of the Aearo Common Stock) are achieved by the Company and
(ii) the tenth anniversary of the date of grant. The option term is 10 years;
provided, however, that unexercised options expire earlier in certain instances
of termination of employment of the option holder and may expire in the event of
a merger or liquidation of the Company or a sale of substantially all the assets
of the Company. Aearo Common Stock acquired upon exercise of options granted
under the Executive Plan or 1997 Option Plan is subject to the same
restrictions, including puts and calls and drag-along rights as Aearo Common
Stock acquired under the Stock Purchase Plan. See "Stock Purchase Plan."
The following table sets forth certain information relating to option grants for
Named Executive Officers pursuant to the Executive Plan and the 1997 Option Plan
during the year ended September 30, 2002.
Potential Realizable Value at
% of Total Assumed Annual Rates of Stock
Options Price Appreciation for Option
Number of Granted in Exercise Term (1)
Underlying the Fiscal Price Expiration
Name Options Year ($/Shr) Date 5% ($) 10% ($)
---- ------- ---- ------- ---- ------ -------
D. Garrad Warren, III 500 11.6 600 05/30/12 188,668 478,123
J. Floyd 100 2.3 600 05/30/12 37,734 95,625
R. Mallitz 100 2.3 600 05/30/12 37,734 95,625
R. Kapur 75 1.7 600 05/30/12 28,300 71,718
(1) Potential Realizable Value is based on assumed growth rates for the
10-year option term (5% annual growth results in a stock price of
$930.80 and 10% annual growth rate results in a stock price of
$1,414.77).
Management Incentive Plan. The Company provides performance-based compensation
awards to executive officers and key employees for achievement during each year
as part of a management incentive plan. Such compensation awards are a function
of individual performance and consolidated corporate results. Business unit
performance also is a factor in determining compensation awards with respect to
key employees who are not executive officers. The specified qualitative and
quantitative criteria employed by the Board of Directors of the Company in
determining bonus awards varies for each individual and from year to year.
Supplemental Severance Pay Policy. The Company has adopted a severance pay
policy providing executive officers and key employees with salary continuation
in the event of a termination. Termination resulting from cause, retirement,
death and disability are not eligible. Subject to the Company's discretion, the
policy generally provides for one month's base pay for each full year of service
with a minimum amount payable of three month and a maximum amount payable of
twelve months.
Deferred Compensation Plan. The Company has adopted a Deferred Compensation Plan
which is a non-qualified savings plan under the IRS code and which provides
executive officers and paid directors the opportunity to defer the receipt of
base salary and/or bonus. The plan is effective for fiscal years beginning with
fiscal year 2000 and provides unfunded deferred compensation payments upon a
participant's retirement or termination from the Company. Participant deferrals
are credited annually with amounts based upon long-term
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bond rates and with amounts replicating the Company match in the 401(k) for
savings from income above the qualified plan limits.
401(k) Plan. The Company has adopted a savings plan (the "Savings Plan"), which
is qualified under Section 401(a) and 401(k) of the Code. All regular employees
of the Company in the United States of America normally scheduled to work a
minimum of 1,000 hours per year are eligible to participate in the Savings Plan
immediately. For each employee who elects to participate in the Savings Plan and
makes a contribution thereto, the Company will make a matching contribution. The
Company matches 50.0% of the first 6.0% of compensation contributed. The maximum
contribution for any participant for any year is 60.0% of such participant's
eligible compensation, not to exceed the 401(k) plan elective deferral limit set
forth by the IRS. Contributions to the Savings Plan will be invested, as the
employee directs, in any combination of investment options.
Employment Contracts and Termination of Employment and Change-In-Control
Arrangements. Effective January 23, 1998, the Company entered into an agreement
with Michael A. McLain which covers the terms and conditions of his employment.
It contains a provision for separation benefits in the event of a change of
control or other termination not related to performance.
Pension Plans. The Company has adopted a Cash Balance Pension Plan. Under such
plan, the Company will provide participants with annual credits of 4.0% of
eligible compensation up to the Social Security Wage Base as set forth annually
by the Social Security Administration and Department of Health and Human
Services. An additional annual credit of 4.0% of eligible compensation from the
Social Security Wage Base up to the Qualified Plan Compensation Limit set forth
by the Internal Revenue Service (IRS) is provided. All balances in the accounts
of participants will be credited with interest based on the prior year's U.S.
Treasury bill rate. At retirement, participants eligible for benefits may
receive the balance standing in their account in a lump sum or as a monthly
pension having equivalent actuarial value.
Additionally, the Company has adopted a Supplemental Executive Retirement Plan,
which is a non-qualified plan under the Internal Revenue Code, and which
provides unfunded deferred compensation benefits to certain individuals whose
salary exceeds the Qualified Plan Compensation Limit set forth by the IRS.
Pursuant to the plan, participants are credited annually with amounts
representing 8% of compensation in excess of the Qualified Plan Compensation
Limit.
The following table sets forth, for the Named Executive Officers, the estimated
annual benefits payable upon retirement at normal retirement age, from both the
qualified and non-qualified pension plans assuming in each case that such
officer elects payment over time rather that in a lump sum:
Name and Principal Position Annual Benefits
Payable
---------------------------------------------------------------------------------- ---------------
Michael A. McLain $ 97,558
Chief Executive Officer, President, and Chairman of the Board of Directors
D. Garrad Warren, III $ 40,963
Senior Vice President, North American Industrial Safety Sales and Managing
Director, Europe
M. Rand Mallitz $ 28,067
Vice President Aearo and Senior Vice President Specialty Composites
Rahul Kapur $ 33,785
Senior Vice President, Corporate Development and Business Director, SRx
James H. Floyd $ 51,658
Senior Vice President, Logistics and Information Technology, Managing
Director, International and Business Director, Consumer
Compensation Committee Interlocks and Insider Participation
The Company has a Compensation Committee of the Board of Directors. As of
December 1, 2002, the committee consists of Messrs. Alpert, McLain and Brady,
three directors of the Company. Mr. McLain is also the Chief
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Executive Officer and President of the Company as well as Chairman of the Board
of Directors. This committee makes all executive officer compensation decisions,
with Mr. McLain abstaining with respect to decisions affecting his own
compensation, and reviews them with the full Board of Directors of the Company.
- 63 -
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information with respect to the
beneficial ownership of Aearo Common Stock, including beneficial ownership by
each person or entity known by the Company to own beneficially 5% or more of the
Company's voting capital stock, by the Directors, the Named Executive Officers
and all of the Company's Directors and executive officers as a group as of
December 1, 2002. All of the Subsidiary's issued and outstanding capital stock
is owned by Aearo.
Number of Shares of Percentage of
Name and Address of Beneficial Owner Aearo Common Stock Outstanding Shares
Vestar Equity Partners, L.P. (1)
245 Park Avenue 42,500 41.7%
New York, New York 10167
Cabot CSC Corporation (2) 42,500 41.7%
Two Seaport Lane, Suite 1300
Boston, Massachusetts 02210
Norman W. Alpert (3) 42,500 41.7%
Daniel S. O'Connell (3) 42,500 41.7%
Arthur J. Nagle (3) 42,500 41.7%
William J. Brady (4) 42,500 41.7%
John A. Shaw (4) 42,500 41.7%
Michael A. McLain 4,050 3.97%
John D. Curtin, Jr. 3,713 3.64%
Rahul Kapur 1,000 *
James H. Floyd 1,000 *
M. Rand Mallitz 950 *
D. Garrad Warren, III 600 *
Bryan P. Marsal 250 *
William E. Kassling 250 *
Directors and executive officers as a group (17 persons)(5) 98,363 96.5%
- -------------------------------------
* Less than 1%.
- 64 -
1. The general partner of Vestar is Vestar Associates L.P., a limited
partnership whose general partner is Vestar Associates Corporation
("V.A.C."). In such capacity, V.A.C. exercises sole voting and investment
power with respect to all of the shares held of record by Vestar. Messrs.
Alpert, O'Connell and Nagle, who are directors of the Company, are
affiliated with Vestar in the capacities described under "Management --
Directors and Executive Officers" and are stockholders of V.A.C.
2. The board of directors of Cabot CSC Corporation controls the voting and
investment of the shares of Aearo Common Stock held by Cabot CSC
Corporation. Cabot CSC Corporation is a wholly-owned subsidiary of Cabot.
Cabot appoints the directors of Cabot CSC Corporation and exercises
ultimate voting and investment power with respect to all shares held of
record by Cabot CSC Corporation. Cabot is a publicly held Company and,
accordingly, no single stockholder, director or officer of Cabot is deemed
to have or share such voting or investment power within the meaning of Rule
13d-3 under the Exchange Act. Accordingly, no part of the shares of Aearo
Common Stock owned of record by Cabot CSC Corporation is beneficially owned
by any stockholder, director or officer of Cabot.
3. Messrs. Alpert, O'Connell and Nagle are affiliated with Vestar in the
capacities described under "Directors and Executive Officers." Ownership of
Aearo Common Stock for these individuals includes 42,500 shares of Aearo
Common Stock included in the above table beneficially owned by Vestar,
although such persons believe that they do not have such beneficial
ownership. Each such person's business address is c/o Vestar Equity
Partners, L.P. at the address set forth above.
4. Messrs. Brady and Shaw are affiliated with Cabot, the parent of Cabot CSC
Corporation, in the capacity described under "Directors and Executive
Officers." Ownership of Aearo Common Stock for these individuals includes
42,500 shares of Aearo Common Stock included in the above table
beneficially owned by Cabot CSC Corporation, of which such persons disclaim
beneficial ownership. Each such person's business address is c/o Cabot CSC
Corporation Two Seaport Lane, Suite 1300, Boston, MA 02210.
5. Cabot, Vestar and the Management Investors have entered into a
Stockholders' Agreement, the terms of which are described more fully under
Item 13, "Certain Relationships and Related Transactions -- Stock Ownership
and Stockholders' Agreement." Does not include 3,550 shares of Aearo Common
Stock held by Management Investors who are not executive officers.
- 65 -
Item 13. Certain Relationships and Related Transactions
The Asset Transfer Agreement
The Company is a party to an asset transfer agreement dated as of June 13, 1995
with Cabot and certain of its subsidiaries (including Old Cabot Safety
Corporation) (the "Asset Transfer Agreement") entered into in connection with
the Formation Acquisition. The Asset Transfer Agreement contains customary
representations, warranties and covenants. Cabot and certain of its
subsidiaries, on the one hand, and Aearo and the Subsidiary on the other, have
also agreed to indemnify and hold each other and their affiliates harmless
against certain breaches of representations or covenants and certain other
liabilities.
The Company has the right to pay an annual fee of $400,000 to Old Cabot Safety
Corporation, and has elected to make this payment, with the result that Old
Cabot Safety Corporation will retain responsibility and liability for, and
indemnify the Company against, certain legal claims alleged to arise out of the
use of respirators sold prior to June 1995. See Item 3, Legal Proceedings, for a
more detailed discussion of the respective rights and obligations of the parties
under this arrangement.
Stock Ownership and Stockholders' Agreement
As of September 30, 2002, Cabot owns 41.7% of common stock (42,500 shares) and
50% of redeemable preferred stock (22,500 shares), Vestar owns 41.7% of common
stock (42,500 shares) and 50% of redeemable preferred stock (22,500 shares) and
the Management Investors and certain other employees of the Company own 16.6% of
common stock (16,912.5 shares). Vestar, Cabot and the Management Investors are
parties to a stockholders' agreement (the Stockholders' Agreement). The
Stockholders' Agreement contains stock transfer restrictions, as well as
provisions granting certain tag-along rights, drag-along rights, registration
rights and participation rights.
The preferred stock is cumulative redeemable $.01 par value stock. Dividends
accrue whether or not dividends are declared or funds are available at an annual
rate of 12.5%, compounded quarterly. To date, no dividends have been declared.
Accrued dividends may be paid in cash or in additional shares of preferred
stock. Shares are redeemable for cash at any time, subject to certain
exceptions, at the option of the Company at a redemption price equal to the
actual or implied purchase price ($45 million) plus a redemption payment based
on the dividend rate. As of September 30, 2002, the redemption value of the
preferred stock is $109.5 million.
Aearo Company is permitted to pay cash dividends to Aearo Corporation for taxes
and expenses in the ordinary course of business. The maximum amount of cash
dividends paid to Aearo Corporation for ordinary business expenses may not
exceed $1,000,000 in any fiscal year. As long as no event of default would
result, Aearo Corporation and Aearo Company are permitted to pay dividends
consisting of shares of qualified capital stock, as defined in the Senior Bank
Facilities, and Aearo Corporation may redeem or purchase shares of its capital
stock held by former employees of Aearo Corporation or any of its subsidiaries
following the termination of their employment, provided that the aggregate
amount paid by Aearo Corporation with respect to such purchases or redemptions
does not exceed $5.0 million in any fiscal year and $7.5 million in the
aggregate. Aearo Company may pay cash dividends to Aearo Corporation for the
latter purpose. Additionally, Aearo Corporation may pay dividends on its
preferred stock in additional shares of preferred stock.
Election and Removal of Directors. The Stockholders' Agreement provides that the
Board of Directors of the Company shall consist of nine members. Currently there
are nine directors serving. The parties agreed to vote all shares of Aearo
Common Stock owned or controlled by them so as to elect as members of the Board
of Directors persons designated as follows: (i) Vestar designates three
directors so long as the Vestar Relative Percentage (as defined below) is at
least 75% or Vestar and its affiliates beneficially own on a fully diluted basis
at least 21,250 shares of Aearo Common Stock (50% of the shares of Aearo Common
Stock acquired by them in the Formation Acquisition), (ii) Cabot may designate
two directors so long as the Cabot Relative Percentage (as defined below) is at
least 75% or Cabot and its affiliates own beneficially on a fully diluted basis
at least 21,250 shares of Aearo Common Stock (50% of the shares of Aearo Common
Stock acquired by them in the Formation Acquisition), (iii) Vestar may designate
two additional directors who are not partners, officers or employees of any of
Vestar or its affiliates so long as the Vestar Relative Percentage is as least
75% or Vestar and its affiliates beneficially own at least 31,875 shares of
Aearo Common Stock (75% of the shares of Aearo Common Stock acquired by them in
the Formation Acquisition), provided that Vestar must notify Cabot in writing in
advance of the identities of these
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director nominees and obtain Cabot's approval thereof, which may not be
unreasonably withheld, and (iv) the Management Investors may designate two
directors so long as the Management Investors together own beneficially on a
fully diluted basis at least 3,750 shares of Aearo Common Stock (25% of the
shares of Aearo Common Stock acquired by all Management Investors in the
Formation Acquisition), provided that the two designees of the Management
Investors must be initial designees as of the closing date, and in the case of
subsequent designees other than the initial designees, shall be officers serving
in similar capacities. The foregoing provisions relating to the election of
directors terminate in the event that both Cabot and its affiliates, on the one
hand, and Vestar and its affiliates, on the other hand, own on a fully diluted
basis fewer than 4,250 shares of Aearo Common Stock (10% of the shares of Aearo
Common Stock acquired by them in the Formation Acquisition). The term "Vestar
Relative Percentage" means a percentage reflecting (a)(i) $31 million plus (ii)
the amount paid for capital stock of Aearo by Vestar and its Affiliates after
the Formation Acquisition less (iii) the value (based on price per share) of all
shares of Aearo Common Stock and Aearo Preferred Stock acquired by Vestar and
its affiliates in the Formation Acquisition and no longer held by them, less
(iv) the value of all shares of the Aearo Common Stock and Aearo Preferred Stock
acquired by Vestar and its affiliates after the Formation Acquisition and no
longer held by them, as a percentage of (b) the amount calculated pursuant to
clause (a) for Cabot and its affiliates for such date. The term "Cabot Relative
Percentage" has a correlative meaning focused on Cabot's remaining investment in
Aearo capital stock relative to Vestar's. Messrs. Alpert, O'Connell and Nagle
were designated by Vestar as described in clause (i) above, Mr. Brady and Mr.
Shaw were designated by Cabot as described in clause (ii) above, Messrs.
Kassling and Marsal were designated by Vestar as described in clause (iii) above
and Mr. McLain and Mr. Curtin were designated by the Management Investors as
described in clause (iv) above. All directors can be removed, with or without
cause, and replaced by the stockholders who have the right to designate them.
Tag-along Rights. So long as a public offering of Aearo Common Stock shall not
have occurred and subject to certain exceptions, with respect to any proposed
transfer of Aearo Common Stock or Aearo Preferred Stock by Vestar, other than
transfers to affiliates, each other stockholder will have the right to require
that the proposed transferee purchase a certain percentage of the shares owned
by such stockholder at the same price and upon the same terms and conditions.
Drag-along Rights. The Stockholders' Agreement provides that, so long as Vestar
and its affiliates beneficially own at least 21,250 shares of Aearo Common Stock
(50% of the shares of Aearo Common Stock acquired by them in the Formation
Acquisition) or the Vestar Relative Percentage is at least 75%, if Vestar
receives an offer from a third party to purchase all but not less than all
outstanding shares of Aearo Common Stock and Aearo Preferred Stock and such
offer is accepted by Vestar, then each party to the Stockholders' Agreement will
transfer all shares of Aearo Common Stock and Aearo Preferred Stock owned or
controlled by such party on the terms of the offer so accepted by Vestar,
provided that all such transfers occur on substantially identical terms and the
number of shares to be acquired by the third party after giving effect to all
such transfers would be sufficient under the certificate of incorporation and
by-laws of the Company, any applicable agreements and applicable law to permit
such third party to eliminate all remaining minority interests through a merger
opposed by such minority interests. These so-called "drag-along" rights do not
apply to sales in a public offering or to stock that has been sold by a party to
the Stockholders' Agreement in a public offering or pursuant to Rule 144.
If Vestar intends to transfer Aearo Common Stock to a third party in any
transaction in which these drag-along rights are invoked, Vestar must give Cabot
30 days' advance written notice and, at the request of Cabot must discuss the
possibility of Cabot, in lieu of the third party, acquiring such Aearo Common
Stock, provided that this provision does not obligate Cabot to purchase such
Aearo Common Stock or Vestar to sell such Aearo Common Stock either to Cabot or
to the third party.
Other Voting Matters. So long as the drag-along rights are in effect, the
parties to the Stockholders' Agreement are obligated to vote all shares of Aearo
Common Stock owned or controlled by them to ratify, approve and adopt the
following actions to the extent that they are adopted and approved by the Board
of Directors: (i) any merger or consolidation involving the Company that is, in
substance, an acquisition of another Company by the Company or a sale of the
Company and in either case does not affect in any way the relative rights of
Cabot and Vestar or result in any benefit to Vestar other than the benefits to
it as a stockholder of the Company equal to the benefits received by other
stockholders, share for share, and (ii) any amendment to the certificate of
incorporation of the Company whereby such amendment does not adversely affect
such stockholder in a manner different from that in which any other stockholder
is affected. In addition, so long as the voting agreements providing for the
election of directors remain in effect, the parties to the Stockholders'
Agreement agreed not to vote to approve, ratify or adopt any
- 67 -
amendment to the by-laws of the Company unless such amendment is expressly
authorized by the Stockholders' Agreement or recommended by the Board of
Directors.
Transfers of Common Stock. Subject to certain limitations, transfers of Aearo
Common Stock and Aearo Preferred Stock by parties to the Stockholders' Agreement
are restricted unless the transferee agrees to become a party to, and be bound
by, the Stockholders' Agreement, provided that such restrictions do not apply to
sales in a public offering or pursuant to Rule 144. In addition, subject to
certain limitations, Cabot and the Management investors agreed not to transfer
their shares of Aearo Common Stock or Aearo Preferred Stock without the prior
written consent of Vestar. Under certain circumstances, the transfer of Aearo
Common Stock or Aearo Preferred Stock by Vestar, Cabot and their affiliates is
permitted.
Participation Rights. Under certain circumstances, if Aearo proposes to issue
any capital stock to Vestar, Cabot or any of their respective affiliates, each
other stockholder shall have the opportunity to purchase such capital stock on a
pro rata basis.
Approval of Affiliate Transactions. The Stockholders' Agreement provides that
the Company shall not, and shall cause its subsidiaries not to, enter into any
transaction with any affiliate of the Company unless such transaction (i) is on
fair and reasonable terms no less favorable to the Company or such subsidiary
than it could obtain in a comparable arm's length transaction, (ii) is
contemplated by the Stockholders' Agreement, the Asset Transfer Agreement or the
management advisory agreement among the Company and Vestar and Cabot or (iii) is
for the payment of reasonable and customary regular fees to outside directors.
In no event will the Company issue Aearo Common Stock or other equity securities
to Vestar or Cabot or any affiliate of the Company, subject to certain
limitations, below the fair market value of such shares of Aearo Common Stock or
equity securities.
Registration Rights. The Stockholders' Agreement provides that, subject to
certain limitations, upon a written request by Vestar or a written request by
Cabot (but only in the event that a period of one year or more has elapsed since
a public offering of Aearo Common Stock without Cabot having an opportunity to
participate), the Company will use its best efforts to effect the registration
of all or part of the Aearo Common Stock owned by such requesting stockholder,
provided that (i) the Company will not be required to effect more than one
registration within any 360 day period and (ii) neither Vestar nor Cabot will be
entitled to request more than two registrations. Under certain circumstances, if
the Company proposes to register shares of Aearo Common Stock, it will, upon the
written request of any stockholder, use all reasonable efforts to effect the
registration of such stockholders' Aearo Common Stock.
Termination. The Stockholders' Agreement will terminate as to any Aearo Common
Stock or Aearo Preferred Stock, subject to certain limitations, on the date,
such Aearo Common Stock is sold in a public offering or pursuant to Rule 144.
The rights of Vestar will terminate under the Stockholders' Agreement when
Vestar and its affiliates own no Aearo Common Stock, common stock equivalents or
Aearo Preferred Stock. The rights of Cabot under the Stockholders' Agreement
will terminate on the earliest date when Cabot or its affiliates own no Aearo
Common Stock, common stock equivalents or Aearo Preferred Stock.
Management Advisory Agreement. In connection with the Formation Acquisition, the
Company became a party to a management advisory agreement with Vestar and Cabot
(the "Management Advisory Agreement"), pursuant to which the Company is
obligated to pay an annual management fee in an aggregate amount with respect to
each fiscal year equal to the greater of (i) $400,000 and (ii) 1.25% of the
consolidated net income of the Company before cash interest, taxes, depreciation
and amortization for such fiscal year to be shared by Cabot and Vestar based on
their relative equity ownership of the Company. These payments totaled
approximately $686,000, $728,000 and $519,000 during the years ended September
30, 2000, 2001 and 2002, respectively. Messrs. Alpert, O'Connell and Nagle,
three of the directors of the Company, are affiliated with Vestar in the
capacities described under Item 10, "Directors and Executive Officers" and,
accordingly, benefit from any payments received by Vestar. Mr. Brady and Mr.
Shaw, two of the directors for the Company, are affiliated with Cabot in the
capacities described under Item 10, "Directors and Executive Officers" and,
accordingly, benefit indirectly from any payments received by Cabot.
Management and Director Loans. The Company has made available to certain
Management Investors loans in order to provide such Management Investors with
funds to be applied to a portion of the purchase price of the Common Stock
purchased by such Management Investors under the Stock Purchase Plan. Such loans
(i) are secured by the Aearo Common Stock purchased with the proceeds thereof,
(ii) bear interest at an annual rate determined pursuant to Section 7872(f)(2)
of the Internal Revenue Code, and (iii) are subject to mandatory prepayment in
the event the
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employment of such Management Investor terminates or event of maturity. At
December 1, 2002, amounts outstanding in thousands of dollars were:
Amount Outstanding Aggregate Amount Outstanding at
Management Investors December 1, 2002 September 30, 2002 Interest Rate
- ------------------------------------ --------------------------- ------------------------------------ ------------------
Michael A. McLain $ 647 $ 644 2.73 %
D. Garrad (Gary) Warren, III 240 239 2.73 %
Rahul Kapur 70 70 2.73%
Joseph C. Marlette 70 70 2.73%
James H. Floyd 70 70 2.73%
M. Rand Mallitz 79 79 2.73%
- 69 -
Item 14. Controls and Procedures
Disclosure controls and procedures are defined by the Securities and Exchange
Commission as those controls and other procedures that are designed to ensure
that information required to be disclosed in the Company's filings under the
Securities Act of 1934 is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commission's rules and
forms. The Company's Chief Executive Officer and Chief Financial Officer have
evaluated the Company's disclosure controls and procedures within 90 days prior
to the filing of this Annual Report on Form 10-K405 and have determined that
such disclosure controls and procedures are effective.
Subsequent to the Company's evaluation, there were no significant changes in
internal controls or other factors that could significantly affect internal
controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
- 70 -
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
The following documents are filed as part of this Annual Report on Form 10-K405:
a) 1. Financial Statements:
See Index to financial statements under Item 8 on page 29 of this report.
2. Financial Statement Schedules:
See Schedule II on page 72 of this report.
3. Exhibits:
See Index of Exhibits on pages 76 to 80 hereof.
b) Current Reports on Form 8-K
On October 1, 2001, the Company filed a Current Report on Form 8-K
regarding the announcement of its restructuring.
On October 19, 2001, the Company filed a Current Report on Form 8-K
regarding a slowdown in the market for its products and other matters.
c) Exhibits
See Index of Exhibits on pages 76 to 80 hereof.
d) Financial Statement Schedule See Schedule II on page 72 of this report.
- 71 -
SCHEDULE II
AEARO CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
For the years ended September 30, 2000,
2001, and 2002
(Dollars in thousands)
Additions
Balance at Provisions Charged to
beginning of Charged to Other Net Deductions Balance at
Period Operations Accounts From Allowances end of Period
--------------- ------------------ -------------- ------------------ --------------
Year ended September 30, 2000
Bad Debt Reserve 1,296 366 - (308) 1,354
Year ended September 30, 2001
Bad Debt Reserve 1,354 450 - (973) 831
Year ended September 30, 2002
Bad Debt Reserve 831 999 - (306) 1,524
- 72 -
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.
Aearo Corporation
Date: December 15, 2002 By: /s/ Michael A. McLain
---------------------
Michael A. McLain
Chief Executive Officer, President, and Chairman
of the Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Date: December 15, 2002 /s/ Michael A. McLain
---------------------
Michael A. McLain
President, Chief Executive Officer and Chairman
(Principal Executive Officer)
Date: December 15, 2002 /s/ Jeffrey S. Kulka
--------------------
Jeffrey S. Kulka
Vice President, Chief Financial Officer, Treasurer
and Secretary
/s/ John D. Curtin, Jr.*
------------------------
John D. Curtin, Jr., Director
/s/ Norman W. Alpert*
---------------------
Norman W. Alpert, Director
/s/ William J. Brady*
---------------------
William J. Brady, Director
/s/ John Shaw*
--------------
John Shaw, Director
/s/ Arthur J. Nagle*
--------------------
Arthur J. Nagle, Director
/s/ Daniel S. O'Connell*
------------------------
Daniel S. O'Connell, Director
/s/ William Kassling*
---------------------
William Kassling, Director
/s/ Bryan Marsal*
-----------------
Bryan Marsal, Director
*By Michael A. McLain, as attorney-in-fact under a Power of Attorney executed by
the Directors listed above, which Power of Attorney is being filed with the
Securities and Exchange Commission as an exhibit hereto.
Date: December 15, 2002 /s/ Michael A. McLain
---------------------------------------------------
Michael A. McLain
Attorney-In-Fact
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CERTIFICATION
I, Michael A. McLain, Principal Executive Officer of Aearo Corporation, certify
that:
1. I have reviewed this annual report on Form 10-K405 of Aearo Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or person performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: December 15, 2002
Michael A. McLain
Chief Executive Officer,
President and Chairman of the Board
(Principal Executive Officer)
- 74 -
CERTIFICATION
I, Jeffrey S. Kulka, Principal Financial Officer of Aearo Corporation, certify
that:
1. I have reviewed this annual report on Form 10-K405 of Aearo Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior the filing date of
this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or person performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: December 15, 2002
Jeffrey S. Kulka
Vice President, Chief Financial Officer,
Treasurer and Secretary
(Principal Financial Officer)
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INDEX OF EXHIBITS
Exhibit
Number Description
2.1 Asset Transfer Agreement, dated as of June 13, 1995, among Aearo
Company (formerly, Cabot Safety Corporation), Cabot Canada Ltd., Cabot
Safety Limited, Cabot Corporation, Aearo Corporation (formerly, Cabot
Safety Holdings Corporation), and Cabot Safety Acquisition
Corporation. (Incorporated by reference to Exhibit No. 2.1 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company and
Aearo Corporation.)
2.2 Trademark Coexistence Agreement, dated July 11, 1995, between Cabot
Corporation and Cabot Safety Intermediate Corporation. (Incorporated
by reference to Exhibit No. 2.2 to the Registration Statement on Form
S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety
Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings
Corporation).)
2.3 Subscription Agreement, dated July 11, 1995, between Aearo Corporation
(formerly, Cabot Safety Holdings Corporation) and Vestar Equity
Partners, L.P. (Incorporated by reference to Exhibit No. 2.3 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company
(formerly, Cabot Safety Corporation) and Aearo Corporation.)
2.4 Stockholders' Agreement, dated as of July 11, 1995, among Vestar
Equity Partners, L.P., Cabot CSC Corporation, Aearo Corporation
(formerly, Cabot Safety Holdings Corporation), Cabot Corporation, and
the Management Investors. (Incorporated by reference to Exhibit No.
2.4 to the Registration Statement on Form S-4, No. 33-96190, of Aearo
Company (formerly, Cabot Safety Corporation) and Aearo Corporation.)
2.5 Form of Executive Security Purchase Agreement, dated as of July 11,
1995, between Aearo Corporation (formerly, Cabot Safety Holdings
Corporation) and the Management Investors (Senior Management).
(Incorporated by reference to Exhibit No. 2.5 to the Registration
Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot
Safety Corporation) and Aearo Corporation.)
2.6 Form of Executive Security Purchase Agreement, dated as of July 11,
1995, between Aearo Corporation (formerly, Cabot Safety Holdings
Corporation) and the Management Investors (Middle Management).
(Incorporated by reference to Exhibit No. 2.6 to the Registration
Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot
Safety Corporation) and Aearo Corporation.)
2.7 Assignment and Assumption Agreement, dated as of July 11, 1995, by and
between Aearo Corporation (formerly, Cabot Safety Holdings
Corporation), Cabot Safety Acquisition Corporation and Cabot Safety
Intermediate Corporation. (Incorporated by reference to Exhibit No.
2.7 to the Registration Statement on Form S-4, No. 33-96190, of Aearo
Company (formerly, Cabot Safety Corporation) and Aearo Corporation.)
2.8 Assignment and Assumption Agreement, dated as of July 11, 1995, by and
between Aearo Corporation (formerly, Cabot Safety Holdings
Corporation), Cabot Safety Acquisition Corporation and Cabot Safety
Acquisition Limited (UK). (Incorporated by reference to Exhibit No.
2.8 to the Registration Statement on Form S-4, No. 33-96190, of Aearo
Company (formerly, Cabot Safety Corporation) and Aearo Corporation.)
2.9 Assignment and Assumption Agreement, dated as of July 11, 1995, by and
between Aearo Corporation (formerly, Cabot Safety Holdings
Corporation), Cabot Safety Acquisition Corporation and Cabot Safety
Canada Acquisition Ltd. (Canada). (Incorporated by reference to
Exhibit No. 2.9 to the Registration Statement on Form S-4, No.
33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and
Aearo Corporation.)
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2.10 Bill of Sale and Assignment, dated as of July 11, 1995, made by Aearo
Company (formerly, Cabot Safety Corporation), Cabot Canada Ltd., and
Cabot Safety Limited in favor of Aearo Corporation (formerly, Cabot
Safety Holdings Corporation), Cabot Safety Acquisition Corporation,
Cabot Safety Intermediate Corporation, Cabot Safety Acquisition
Limited and Cabot Safety Canada Acquisition Ltd. (Incorporated by
reference to Exhibit No. 2.10 to the Registration Statement on Form
S-4, No. 33-96190, of Aearo Company and Aearo Corporation.)
2.11 Assumption Agreement dated as of July 11, 1995, by Aearo Corporation
(formerly, Cabot Safety Holdings Corporation), Cabot Safety
Acquisition Corporation, Cabot Intermediate Corporation, Cabot Safety
Acquisition Limited and Cabot Safety Canada Acquisition Ltd. in favor
of Cabot Corporation, Aearo Company (formerly, Cabot Safety
Corporation), Cabot Canada Ltd. and Cabot Safety Limited.
(Incorporated by reference to Exhibit No. 2.11 to the Registration
Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo
Corporation.)
2.12 Worldwide Trademark Assignment dated July 11, 1995, by Aearo Company
(formerly, Cabot Safety Corporation) to Cabot Safety Intermediate
Corporation. (Incorporated by reference to Exhibit No. 2.12 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company and
Aearo Corporation (formerly, Cabot Safety Holdings Corporation).)
2.13 Worldwide Copyright Assignment dated July 11, 1995, by Aearo Company
(formerly, Cabot Safety Corporation) to Cabot Safety Intermediate
Corporation. (Incorporated by reference to Exhibit No. 2.13 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company and
Aearo Corporation (formerly, Cabot Safety Holdings Corporation).)
2.14 Worldwide Patent Assignment dated July 11, 1995, by Aearo Company
(formerly, Cabot Safety Corporation) to Cabot Safety Intermediate
Corporation. (Incorporated by reference to Exhibit No. 2.14 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company and
Aearo Corporation (formerly, Cabot Safety Holdings Corporation).)
2.15 Management Advisory Agreement made as of July 11, 1995, among Aearo
Company (formerly, Cabot Safety Corporation), Aearo Corporation
(formerly, Cabot Safety Holdings Corporation), Certain Subsidiaries of
Aearo Corporation, Vestar Capital Partners and Cabot Corporation.
(Incorporated by reference to Exhibit No. 2.15 to the Registration
Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo
Corporation.)
2.17 Assignment and Assumption Agreement dated July 11, 1995, by and
between Aearo Company (formerly, Cabot Safety Corporation) and Cabot
Safety Acquisition Corporation with Respect to the Installment Sale
Agreement dated September 1, 1978 by and between the Department of
Community Affairs and Economic Development of the State of Delaware
and Specialty Composites Corporation (Predecessor to Cabot Safety
Corporation) Pertaining to Real Property Located in New Castle County,
Delaware, Tax Parcel Number 11- 010.00-003 (Delaware IRB).
(Incorporated by reference to Exhibit No. 2.17 to the Registration
Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo
Corporation (formerly, Cabot Safety Holdings Corporation).)
2.18 Assignment and Assumption Agreement dated July 11, 1995, by and
between Cabot Corporation and Cabot Safety Acquisition Corporation
with Respect to that Certain Loan Agreement dated as of June 1, 1982
by and between the City of Indianapolis, Indiana and Cabot Corporation
(Indianapolis IRB). (Incorporated by reference to Exhibit No. 2.18 to
the Registration Statement on Form S-4, No. 33-96190, of Aearo Company
(formerly, Cabot Safety Corporation) and Aearo Corporation (formerly,
Cabot Safety Holdings Corporation).)
2.19 Stock Purchase Agreement by and among Aearo Company (formerly, Cabot
Safety Corporation), Peltor Holding AB, Leif Palmaer Invest AB, Leif
Anderzon Invest AB and Active i Malmo All, dated April 25, 1996.
(Incorporated by reference to Exhibit 2.1 to the Current Report on
Form 8-K of Aearo Corporation (formerly, Cabot Safety Holdings
Corporation) dated May 30, 1996.)
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2.20* Stock Purchase Agreement by and among Aearo Company (formerly, Cabot
Safety Corporation), Eastern Safety Equipment Co., Inc., Alfred H.
Jacobson and William Klein and Jack P. Hecht as Trustees of a certain
Trust, dated September 19, 1995.
2.21* Amendment to Stockholder's Agreement dated as of July 3, 1996, by and
among Vestar Equity Partners, L.P., Cabot CSC Corporation, Aearo
Corporation (formerly, Cabot Safety Holdings Corporation) Cabot
Corporation, and certain other stockholders of Aearo Corporation.
2.22* Amendment to Stock Purchase Agreement by and among Aearo Company
(formerly, Cabot Safety Corporation), Peltor Holding AB, Leif Palmaer
Invest AB, Leif Anderzon Invest AB and Active i Malmo AB, dated May
15, 1996.
3.3** Certificate of Amendment of Amended and Restated Certificate of
Incorporation of Cabot Safety Holdings Corporation dated May 29, 1996
3.4** Certificate of Incorporation of Aearo Corporation as Amended through
May 29, 1996
3.5** Aearo Corporation By-Laws as Amended through May 29, 1996
4.1 Indenture dated as of July 11, 1995 between Aearo Company (formerly,
Cabot Safety Corporation), Aearo Corporation (formerly, Cabot Safety
Holdings Corporation), and Fleet National Bank of Connecticut
(formerly, Shawmut Bank Connecticut, National Association), as
Trustee. (Incorporated by reference to Exhibit No. 4.1 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company and
Aearo Corporation.)
4.2 Form of Note. (Incorporated by reference to Exhibit No. 4.2 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company
(formerly, Cabot Safety Corporation) and Aearo Corporation (formerly,
Cabot Safety Holdings Corporation).)
4.3 Form of Exchange Note. (Incorporated by reference to Exhibit No. 4.3
to the Registration Statement on Form S-4, No. 33-96190, of Aearo
Company (formerly, Cabot Safety Corporation) and Aearo Corporation
(formerly, Cabot Safety Holdings Corporation).)
4.4 Registration Rights Agreement, dated as of July 11, 1995, among Cabot
Safety Acquisition Corporation, Aearo Corporation (formerly, Cabot
Safety Holdings Corporation), BT Securities Corporation and Chemical
Securities Inc. (Incorporated by reference to Exhibit No. 4.4 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company
(formerly, Cabot Safety Corporation) and Aearo Corporation.)
4.5 First Supplemental Indenture dated December 6, 1995. (Incorporated by
reference to Exhibit No. 4.5 to the Annual Report on Form 10-K of
Aearo Corporation (formerly, Cabot Safety Holdings Corporation) for
the fiscal year ended September 30, 1995.)
10.1* Credit Agreement dated as of July 11, 1995, and amended and restated
as of May 30, 1996, among Aearo Corporation (formerly, Cabot Safety
Holdings Corporation), Aearo Company (formerly, Cabot Safety
Corporation), Certain of its Subsidiaries, Various Banks, and Bankers
Trust Company as Co- Arranger and Administrative Agent.
10.2* Amended and Restated US Pledge Agreement dated as of July 11, 1995, as
made by Cabot Safety Acquisition Corporation, Aearo Corporation
(formerly, Cabot Safety Holdings Corporation), Cabot Safety
Intermediate Corporation and CSC FSC, Inc., in favor of Bankers Trust
Company as Collateral Agent for the Benefit of the Secured Creditors.
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10.3* Amended and Restated Foreign Pledge Agreement as of July 11, 1995,
amended and restated as of May 30, 1996, made by Cabot Safety Canada
Acquisition Limited and Cabot Safety Acquisition Limited in favor of
Bankers Trust Company as Collateral Agent for the Benefit of the
Secured Creditors.
10.4 Charge Over United Kingdom Patents and Trademarks made the 11th Day of
July 1995, by Cabot Safety Intermediate Corporation and the Bankers
Trust Company as Collateral Agent for Itself and for the Secured
Creditors. (Incorporated by reference to Exhibit No. 10.4 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company
(formerly, Cabot Safety Corporation) and Aearo Corporation (formerly,
Cabot Safety Holdings Corporation).)
10.5* Amended and Restated US Security Agreement dated as of July 11, 1995,
as amended and restated as of May 30, 1996, among Aearo Corporation
(formerly, Cabot Safety Holdings Corporation), Cabot Safety
Acquisition Corporation, Cabot Safety Intermediate Corporation, CSC
FSC, Inc., and Bankers Trust Company as Collateral Agent for the
Benefit of the Secured Creditors.
10.6* Amended and Restated Canadian Security Agreement dated as of July 11,
1995, as amended and restated as of May 30, 1996, granted by Cabot
Safety Canada Acquisition Limited in favor of Bankers Trust Company as
Collateral Agent for the Benefit of the Secured Creditors.
10.7 English Security Agreement (The Debenture) made on the 11th Day of
July, 1995 between the Cabot Safety Acquisition Limited and Bankers
Trust Company as Collateral Agent for Itself and for the Secured
Creditors. (Incorporated by reference to Exhibit No. 10.7 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company
(formerly, Cabot Safety Corporation) and Aearo Corporation (formerly,
Cabot Safety Holdings Corporation).)
10.8 Mortgage and Security Agreement, Assignment of Leases, Rents and
Profits, Financing Statement, and Fixture Filing made by Cabot Safety
Acquisition Corporation, as Mortgagor, to Bankers Trust Company, as
Collateral Agent, as Mortgagee (recorded in Marion County, Indiana)
pertaining to Real Property located at 7911 Zionsville Road,
Indianapolis, Indiana. (Incorporated by reference to Exhibit No. 10.8
to the Registration Statement on Form S-4, No. 33-96190, of Aearo
Company (formerly, Cabot Safety Corporation) and Aearo Corporation
(formerly, Cabot Safety Holdings Corporation).)
10.9 Mortgage and Security Agreement, Assignment of Leases, Rents and
Profits, Financing Statement, and Fixture Filing made by Cabot Safety
Acquisition Corporation, as Mortgagor, to Bankers Trust Company, as
Collateral Agent, as Mortgagee (recorded in New Castle County,
Delaware) pertaining to l0 Acre Site of Unimproved Land adjacent to
5457 West 79th Street, Indianapolis, Indiana. (Incorporated by
reference to Exhibit No. 10.9 to the Registration Statement on Form
S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety
Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings
Corporation).)
10.10 Mortgage and Security Agreement, Assignment of Leases, Rents and
Profits, Financing Statement, and Fixture Filing made by Cabot Safety
Acquisition Corporation, as Mortgagor, to Bankers Trust Company, as
Collateral Agent, as Mortgagee (recorded in New Castle County,
Delaware) pertaining to Real Property located at 650 Dawson Drive,
Newark, Delaware. (Incorporated by reference to Exhibit No. 10.10 to
the Registration Statement on Form S-4, No. 33-96190, of Aearo Company
(formerly, Cabot Safety Corporation) and Aearo Corporation (formerly,
Cabot Safety Holdings Corporation).)
10.16* Aearo Corporation (formerly, Cabot Safety Holdings Corporation)
Amended and Restated 1995 Employee and Non-Employee Director Stock
Purchase Plan. (M)
10.17* Form of Executive Security Purchase Agreement. (M)
10.18* Aearo Corporation (formerly, Cabot Safety Holdings Corporation)
Executive Stock Option Plan, adopted June 26, 1996. (M)
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10.19* Amended and Restated US Subsidiary Guaranty dated July 11, 1995
delivered by Cabot Safety Intermediate Corporation, CSC FSC, Inc. and
Eastern Safety Equipment Co., Inc. in favor of Bankers Trust Company.
10.25* Amended and Restated US Subsidiary Guaranty dated July 11, 1995 as
amended and restated as of May 30, 1996, delivered by Cabot Safety
Intermediate Corporation, CSC FSC, Inc. and Eastern Safety Equipment
Co., Inc. in favor of Bankers Trust Company.
10.27 Aearo Corporation 1997 Stock Option Plan (incorporated by reference to
the same numbered exhibit of the Company's Annual Report on 1998 10-K
for the year ended September 30, 1998), adopted June 3, 1997. (M)
10.29 Credit Agreement dated July 11, 1995, and Amended and Restated as of
July 13, 2001 (incorporated by reference to the same numbered exhibit
of the Company's Quarterly Report on Form 10-Q for the quarterly
period ending June 30, 2001).
10.30 First Amendment to the Amended and Restated Credit Agreement as of
July 13, 2001, dated October 17, 2001 (incorporated by reference to
the same numbered exhibit of the Company's Quarterly Report on Form
10-Q for the quarterly period ending December 31, 2001).
10.31 Employment Agreement between the Company and Michael A. McLain
(incorporated by reference to Exhibit 10.1 of the Company's Quarterly
Report on Form 10-Q for the Quarterly period ending March 31, 1998).
(M)
10.32** Form of Executive Security Purchase Agreement Investor Note. (M)
10.33** Form of Pledge and Security Agreement related to Executive Security
Purchase Agreement Investor Note. (M)
10.34** Form of Amendment No. 1 to Executive Security Purchase Agreement
Investor Note, effective 2002. (M)
10.35** Summary of Management Incentive Plan for Executives other than the
CEO. (M)
10.36** Summary of Management Incentive Plan for the CEO. (M)
10.37** Nonqualified Deferred Compensation Plan, effective August 5, 1999. (M)
10.38** Summary of Executive Supplemental Severance Pay Policy, as in effect
December 1, 2002. (M)
10.39** Supplemental Executive Retirement Plan, revised January 1, 1999. (M)
12.1** Statements re: Computation of Ratios.
21.1** List of Subsidiaries.
24.1** Powers of Attorney (see page 73 of this report).
* Incorporated by reference to the same numbered exhibit to the registration
statement on Form S-l, No. 333-05047, of Aearo Corporation (formerly, Cabot
Safety Holdings Corporation).
** Filed herewith.
(M) Identifies management contract or compensatory plan.
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