SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2003
Commission file number 0-26942
AEARO CORPORATION
(Exact name of registrant as specified in its charter)
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Delaware 13-3840450
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
5457 West 79th Street 46268
Indianapolis, Indiana (Zip Code)
(Address of principal executive offices)
(317) 692-6666
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No __
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes__ No X
The number of shares of the registrant's common stock, par value $.01 per
share, outstanding as of February 13, 2004 was 59,412.5.
Aearo Corporation
TABLE OF CONTENTS
Form 10-Q for the Quarterly Period Ended December 31, 2003
PART I-FINANCIAL INFORMATION..................................................3
Item 1. Financial Statements.................................................3
Condensed Consolidated Balance Sheets - Assets.............................3
Condensed Consolidated Balance Sheets - Liabilities and
Stockholders' Equity....................................................4
Condensed Consolidated Statements of Operations............................5
Condensed Consolidated Statements of Cash Flows............................6
Notes To Condensed Consolidated Financial Statements.......................7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................................16
Item 3. Quantitative and Qualitative Disclosures About Market Risk..........24
Item 4. Controls and Procedures.............................................26
PART II - OTHER INFORMATION..................................................27
Item 1. Legal Proceedings...................................................27
Item 2. Changes in Securities and Use of Proceeds...........................29
Item 3. Defaults Upon Senior Securities.....................................29
Item 4. Submission of Matters to a Vote of Security Holders.................29
Item 5. Other Information...................................................29
Item 6. Exhibits and Reports on Form 8-K....................................29
SIGNATURES...................................................................30
EXHIBIT INDEX................................................................31
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PART I-FINANCIAL INFORMATION
Item 1...Financial Statements
AEARO CORPORATION
Condensed Consolidated Balance Sheets - Assets
(Dollars in Thousands)
December 31, September 30,
2003 2003
-------------- --------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 4,670 $ 7,301
Accounts receivable (net of allowance for
doubtful accounts of
$1,475 and $1,358, respectively) 45,362 49,146
Inventories 42,561 37,269
Deferred and prepaid expenses 5,615 7,321
-------------- --------------
Total current assets 98,208 101,037
-------------- --------------
LONG TERM ASSETS:
Property, plant and equipment, net 49,092 48,869
Goodwill, net 86,089 81,770
Other intangible assets, net 57,819 57,887
Other assets 3,267 3,953
-------------- --------------
Total assets $ 294,475 $ 293,516
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AEARO CORPORATION
Condensed Consolidated Balance Sheets - Liabilities and Stockholders' Equity
(Dollars in Thousands, Except for Per Share and Share Amounts)
December 31, September 30,
2003 2003
-------------- --------------
(Unaudited)
CURRENT LIABILITIES:
Current portion of long-term debt $ 18,763 $ 17,767
Accounts payable and accrued liabilities 39,177 44,043
Accrued interest 5,692 2,736
U.S. and foreign income taxes 1,883 1,885
-------------- --------------
Total current liabilities 65,515 66,431
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LONG TERM LIABILITIES:
Long-term debt 191,904 195,786
Deferred income taxes 1,707 1,609
Other liabilities 12,073 11,334
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Total liabilities 271,199 275,160
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COMMITMENTS AND CONTINGENCIES
Preferred stock, $.01 par value-
(Redemption value of $63,845 and $61,910, respectively)
Authorized--200,000 shares
Issued and outstanding--22,500 shares - -
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value-
Authorized--200,000 shares
Issued and outstanding--59,413 shares 1 1
Stock subscription receivables (1,409) (1,399)
Retained earnings 29,224 26,541
Accumulated other comprehensive loss (4,540) (6,787)
-------------- --------------
Total stockholders' equity 23,276 18,356
-------------- --------------
Total liabilities and stockholders'
equity $ 294,475 $ 293,516
============== ==============
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Aearo Corporation
Condensed Consolidated Statements of Operations
(Dollars in Thousands)
(Unaudited)
For the Three Months Ended
December 31,
---------------------------------
2003 2002
--------------- ---------------
NET SALES $ 79,201 $ 68,717
COST OF SALES 41,776 35,645
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Gross profit 37,425 33,072
SELLING AND ADMINISTRATIVE 27,471 24,321
RESEARCH AND TECHNICAL SERVICES 1,741 1,583
AMORTIZATION OF INTANGIBLES 108 116
OTHER (CREDITS) CHARGES, NET (1,042) 458
--------------- ---------------
Operating income 9,147 6,594
INTEREST EXPENSE, NET 5,812 4,942
--------------- ---------------
Income before provision for income taxes 3,335 1,652
PROVISION FOR INCOME TAXES 652 610
--------------- ---------------
Net income $ 2,683 $ 1,042
=============== ===============
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Aearo Corporation
Condensed Consolidated Statements of Cash Flows
(Dollars in Thousands)
(Unaudited)
For the Three Months Ended
December 31,
------------------------------
2003 2002
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,683 $ 1,042
Adjustments to reconcile net income
to cash provided by operating activities-
Depreciation 2,929 2,659
Amortization of intangible assets and
deferred financing costs 1,263 516
Deferred income taxes (7) --
Other, net 107 217
Changes in assets and liabilities-
(net of effects of acquisitions)
Accounts receivable 5,067 8,145
Inventories (4,304) (3,793)
Income taxes payable 28 (603)
Accounts payable and accrued liabilities (2,794) (264)
Other, net 2,003 265
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Net cash provided by operating activities 6,975 8,184
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CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (2,353) (2,187)
Cash paid for acquisitions (1,250)
Proceeds provided by disposals of property,
plant and equipment 12 5
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Net cash used by investing activities (2,341) (3,432)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of revolving credit facility, net (1,100) --
Repayment of term loans (4,466) (3,164)
Repayment of capital lease obligations (61) (49)
Repayment of long-term debt (82) (23)
Other (11) (12)
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Net cash used by financing activities (5,720) (3,248)
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EFFECT OF EXCHANGE RATE CHANGES ON CASH (1,545) 115
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INCREASE IN (DECREASE) IN CASH AND
CASH EQUIVALENTS (2,631) 1,619
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 7,301 14,480
------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 4,670 $ 16,099
============= =============
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Capital lease obligations $ -- $ 430
============= =============
CASH PAID FOR:
Interest $ 1,325 $ 1,541
============== =============
Income taxes $ 953 $ 5
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AEARO CORPORATION
Notes To Condensed Consolidated Financial Statements
DECEMBER 31, 2003
(Unaudited)
1) CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments necessary to
present fairly, in accordance with accounting principles generally accepted
in the United States of America, the Company's financial position, results
of operations and cash flows for the interim periods presented. The results
of operations for the interim periods shown in this report are not
necessarily indicative of results for any future interim period or for the
entire year. These condensed consolidated financial statements do not
include all disclosures associated with annual financial statements and
accordingly should be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's Annual Report on
Form 10-K405.
2) COMPANY BACKGROUND
Aearo Corporation, a Delaware corporation, and its direct wholly owned
subsidiary, Aearo Company, a Delaware corporation (collectively referred to
herein as the "Company") manufactures and sells products under the brand
names: AOSafety(R), E-A-R(R), Peltor(R) and SafeWaze(TM). These products
are sold through three reportable segments, which are Safety Products,
Safety Prescription Eyewear and Specialty Composites.
3) SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates. The preparation of the condensed consolidated financial
statements in conformity with accounting principles generally accepted in
the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting periods. Actual results could differ from those
estimates.
Reclassifications. Certain amounts included in the prior period financial
statements may have been reclassified to conform to the current period
presentation. The reclassifications have no impact on net income 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 pricing discounts and incentives. In addition, an
allowance for doubtful accounts is generally recorded 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 customer's credit worthiness, historical bad debt
experience, changes in payment history and general economic and market
trends.
Foreign Currency Translation. Assets and liabilities of the Company's
foreign subsidiaries are translated at period-end exchange rates. Income
and expenses are translated at the approximate average exchange rate during
the period. 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.
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Income Taxes. Deferred tax assets and liabilities are determined based on
the difference between the financial statement and tax bases of assets and
liabilities using currently enacted tax rates. The effective tax rate in
the three months ended December 31, 2003 and 2002 was different from the
statutory rate due to the mix of income between the Company's foreign and
domestic subsidiaries. The Company's foreign subsidiaries had taxable
income in their foreign jurisdictions while the Company's domestic
subsidiaries have net operating loss carry-forwards for income tax
purposes. Due to the uncertainty of realizing these tax benefits, the tax
benefits generated by the net operating losses have been fully offset by a
valuation allowance.
Goodwill and Other Intangibles. Effective October 1, 2002, the Company
adopted Statement of Financial Accounting Standards ("SFAS") No 142,
"Goodwill and Other Intangibles". Under the provisions of SFAS No. 142,
goodwill and intangible assets that have indefinite useful lives are no
longer amortized but are tested at least annually for impairment.
Intangible assets that have finite useful lives will continue to be
amortized over their useful lives and reviewed for impairment at each
reporting date. The following presents a summary of intangibles assets as
of December 31, 2003:
Gross Accumulated Carrying
Amount Amortization Amount
------------- ------------- -------------
Trademarks $ 75,722 $ (21,409) $ 54,313
Customer Relationship List 1,850 (46) 1,804
Patents 2,118 (837) 1,281
Other 1,549 (1,128) 421
------------- ------------- -------------
Total Intangibles $ 81,239 $ (23,420) $ 57,819
============= ============= =============
Aggregate Estimate of Amortization Expense:
For the year ended 9/30/2004 $ 431
For the year ended 9/30/2005 $ 401
For the year ended 9/30/2006 $ 405
For the year ended 9/30/2007 $ 417
For the year ended 9/30/2008 $ 328
For the year ended 9/30/2009 $ 340
The following presents the changes in the carrying amount of goodwill for
the period ended December 31, 2003:
Balance October 1, 2003 $ 81,770
Additions --
Impairments --
Translation adjustment 4,319
----------------
Balance December 31, 2003 $ 86,089
================
Employers' Disclosure about Pension and Other Post Retirement Benefit. In
December 2003, the FASB revised SFAS No. 132, "Employers' Disclosure about
Pension and Other Post Retirement Benefits". The revision of SFAS No. 132
requires additional disclosures about assets, obligations, cash flows and
net periodic benefit costs of defined benefit pension plans and other post
retirement plans. The provisions of this statement regarding interim
disclosures will be effective for the Company in the period ending March
31, 2004.
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Stock-based Compensation. The Company currently accounts for stock-based
compensation under the intrinsic method of Accounting Principles Board
("APB") Opinion No. 25. The following table illustrates the effect on net
income as if the fair value based method had been applied to all
outstanding awards: (Dollars in thousands)
Three Months Ended
December 31,
-----------------------------
2003 2002
------------- -------------
(Unaudited) (Unaudited)
Net income as reported $ 2,683 $ 1,042
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of tax (37) (34)
------------- -------------
Proforma net income $ 2,646 $ 1,008
============= =============
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" requires
that every derivative instrument be recorded in the balance sheet as either
an asset or a liability measured at its fair value.
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 forward foreign
currency contracts and interest rate swap, cap and collar agreements, which
are derivatives as defined by SFAS No. 133. The Company enters into forward
foreign currency contracts to mitigate the effects of changes in foreign
currency rates on profitability and enters into interest rate swap and
collar agreements to hedge its variable interest rate risk. These
derivatives are cash flow hedges. For all qualifying and highly effective
cash flow hedges, the changes in the fair value of the derivatives are
recorded in other comprehensive income. Amounts accumulated in other
comprehensive income will be reclassified as earnings when the related
product sales affect earnings for forward foreign currency contracts. As a
result of the forward foreign currency contracts, the Company has recorded
a derivative payable of $0.8 million and $0.4 million at December 31, 2003
and September 30, 2003, respectively. All forward foreign currency
contracts will expire over the next nine months.
During the periods ending December 31, 2003 and 2002, the Company
reclassified into earnings a net loss of approximately $0.2 million and
$0.1 million, respectively, resulting from the exercise of forward foreign
currency contracts. All forward foreign currency contracts were determined
to be highly effective; therefore no ineffectiveness was recorded in
earnings.
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 $ 0.1 million
for each of the periods ended December 31, 2003 and 2002.
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The Company has approximately $30.5 million of variable rate debt protected
under an interest rate cap arrangement through December 31, 2004. The fair
value of the cap at December 31, 2003 and September 30, 2003 was $0.1
million, respectively. The Company has not elected to take hedge accounting
treatment for the interest rate cap as defined under SFAS No, 133 and, as a
result, any fair value adjustment is charged directly to other
income/(expense). During the quarter ended December 31, 2003 there was no
change in the value of the interest rate cap.
4) COMPREHENSIVE INCOME
Comprehensive income consisted of the following (Dollars in thousands):
Three months ended
December 31,
-----------------------------
2003 2002
------------- -------------
(Unaudited) (Unaudited)
Net income $ 2,683 $ 1,042
Foreign currency translation adjustment,
net of income taxes 2,636 2,868
Unrealized loss on derivative instruments,
net of Income taxes (389) (597)
------------- --------------
Comprehensive income $ 4,930 $ 3,313
============= ==============
5) INVENTORIES
Inventories consisted of the following (Dollars in thousands):
December 31, September 30,
2003 2003
------------- -------------
(Unaudited)
Raw materials $ 9,952 $ 8,301
Work in process 10,599 11,976
Finished goods 22,010 16,992
------------- -------------
$ 42,561 $ 37,269
============= =============
Inventories, which include materials, labor and manufacturing overhead, are
stated at the lower of cost or market, cost being determined using the
first-in, first-out method.
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6) DEBT
The Company's debt structure includes: (a) $98.0 million of 12.5% Senior
Subordinated Notes ("Notes") due 2005, which are publicly held and
redeemable at the option of the Company, in whole or in part, at various
redemption prices, (b) $15.0 million of Holding Company Notes due 2005, and
(c) up to an aggregate of $130.0 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 and (ii) the Revolving Credit Facility providing for up to $30.0
million of revolving loans for general corporate purposes (collectively the
"Senior Bank Facilities"). In addition the Company has the capacity to
borrow $5.0 million under a U.K. overdraft facility (the "Overdraft
Facility"). The amount outstanding on the Term Loans and Revolving Credit
Facility at December 31, 2003, were approximately $83.4 and $10.6 million,
respectively. The U.K overdraft facility has not been formalized or
executed; therefore no amounts were outstanding at December 31, 2003. Under
the terms of the Senior Bank Facilities, the Note Indenture and the Note
Purchase Agreement for the Holding Company Notes, Aearo Company is required
to comply with certain financial covenants and restrictions. Aearo Company
was in compliance with all financial covenants and restrictions at December
31, 2003.
To finance part of the redemption of Aearo's common and preferred stock
owned by Cabot Corporation in August 2003, the Company authorized the
issuance and sale of $15.0 million aggregate principal of Holding Company
Notes due July 15, 2005.
The Company's Board of Directors has 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 such repurchases will occur.
7) COMMITMENTS AND CONTINGENCIES
Lease Commitments. The Company leases certain transportation vehicles,
warehouse facilities, office space, and machinery and equipment under
cancelable and non-cancelable leases, most of which expire within 10 years
and may be renewed by the Company.
Contingencies. Various lawsuits and claims arise against the Company in the
ordinary course of its business. Most of these lawsuits and claims are
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 is a defendant in lawsuits by plaintiffs alleging
that they suffer from respiratory medical conditions, such as asbestosis or
silicosis, relating to exposure to asbestos and silica, and that such
conditions result, in part, from the use of respirators that, allegedly,
were negligently designed or manufactured. The defendants in these lawsuits
are often numerous, and include, in addition to manufacturers and
distributors of respirators, manufacturers, distributors and installers of
sand (used in sand blasting), asbestos and asbestos-containing products.
Most of these claims are covered by the Asset Transfer Agreement entered
into on June 13, 1995 by the Company and Aearo Company, on the one hand,
and Cabot and certain of its subsidiaries (the "Sellers"), on the other
hand (the "1995 Asset Transfer Agreement"). In the 1995 Asset Transfer
Agreement, so long as the Company makes an annual payment of $400,000 to
Cabot, the Sellers agreed to retain, and Cabot and the Sellers agreed to
defend and indemnify the Company against, any liability or obligation
relating to or otherwise arising under any proceeding or other claim
against the Company or Cabot or their respective affiliates or other
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parties with whom any Seller directly or indirectly has a contractual
liability sharing arrangement which sounds in product liability or related
causes of action arising out of actual or alleged respiratory medical
conditions caused or allegedly caused by the use of respirators or similar
devices sold by Sellers or their predecessors (including American Optical
Corporation and its predecessors) prior to July 11, 1995. To date, the
Company has elected to pay the annual fee and intends to continue to do so.
The Company could potentially be liable for claims currently retained by
Sellers if the Company elects to cease paying the annual fee or if Cabot
and the Sellers no longer are able to perform their obligations under the
1995 Asset Transfer Agreement. Cabot acknowledged in the Stock Purchase
Agreement that it and the Company entered into on June 27, 2003 (providing
for the sale by Cabot to the Company of all of the common and preferred
stock of the Company owned by Cabot) that the foregoing provisions of the
1995 Asset Transfer Agreement remain in effect. The 1995 Asset Transfer
Agreement does not apply to claims relating to the business of Eastern
Safety Equipment, the stock of which the Company acquired in 1996.
At December 31, 2003 and September 30, 2003, the Company has recorded
liabilities of approximately $4.5 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 2008 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 1995 Asset Transfer
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.
8) SEGMENT REPORTING
The Company manufactures and sells products under the brand names:
AOSafety(R), E-A-R(R), Peltor(R) and SafeWaze(TM). These products are sold
through three reportable segments, which are Safety Products, Safety
Prescription Eyewear and Specialty Composites. The Safety Products segment
manufactures and sells hearing protection devices, communication headsets,
non-prescription safety eyewear, face shields, reusable and disposable
respirators, hard hats, fall protection and first aid kits. The Safety
Prescription Eyewear segment manufactures and sells prescription eyewear
products that are designed to protect the eyes from the typical hazards
encountered in the industrial work environment. The Company's Safety
Prescription Eyewear segment purchases component parts (lenses and the
majority of its frames) from various suppliers, grinds, shapes and applies
coatings to the lenses in accordance with the customer's prescription, and
then assembles the glasses using the customer's choice of frame. The
Specialty Composites segment manufactures a wide array of energy-absorbing
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materials that are incorporated into other manufacturers' products to
control noise, vibration and shock.
Net Sales by Business Segment (Dollars in thousands):
Three Months Ended
December 31,
-----------------------------
2003 2002
------------- -------------
(Unaudited) (Unaudited)
Safety Products $ 59,780 $ 50,486
Safety Prescription Eyewear 9,464 9,804
Specialty Composites 9,957 8,427
------------- -------------
Total $ 79,201 $ 68,717
============= =============
Inter-segment sales from the Specialty Composites segment to the Safety
Products segment totaled $0.7 million and $0.8 million for the three months
ended December 31, 2003 and 2002, respectively. The inter-segment sales
value is determined at fully absorbed inventory cost at standard rates plus
25%.
Profit (loss) by Business Segment and reconciliation to income before provision
for income taxes (Dollars in thousands):
Three Months Ended
December 31,
-----------------------------
2003 2002
------------- -------------
(Unaudited) (Unaudited)
Safety Products $ 11,230 $ 8,957
Safety Prescription Eyewear (214) (68)
Specialty Composites 1,168 480
------------- -------------
Segment profit 12,184 9,369
Depreciation 2,929 2,659
Amortization of intangibles 108 116
Interest 5,812 4,942
------------- -------------
Income before provision for income taxes $ 3,335 $ 1,652
============= =============
Segment profit is defined as operating income before depreciation,
amortization, interest expense and income taxes and represents the measure
used by the chief operating decision maker to assess segment performance
and make decisions about the allocation of resources to business segments.
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9) RESTRUCTURING CHARGE
During fiscal 2001, the Company recorded a restructuring charge of $11.4
million relating to a restructuring plan announced by the Company to
improve its competitive position and long-term profitability. The plan
includes the closure of its Ettlingen, Germany plant, significantly
reorganizing operations at the Company's Varnamo, Sweden plant,
rationalizing the manufacturing assets and product mix of its Specialty
Composites business unit and a reduction of products and product lines.
During the 4th quarter of fiscal 2003, the Company reversed $0.3 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 was classified as a reduction in cost of
sales.
The following table displays the activity and balances of the restructuring
reserve account for the three months ended December 31, 2003 (Dollars in
thousands):
September 30, December 31,
2003 Charges 2003
------------- ------------- -------------
Employee termination costs $ 224 $ (46) $ 178
Lease agreements 1,456 (189) 1,267
Loss on disposal of assets 691 (322) 369
Other 17 17
------------- ------------- -------------
Total $ 2,388 $ (557) $ 1,831
============= ============= =============
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10) ACQUISITIONS
On March 14, 2003 the Company acquired VH Industries, Inc. ("VH") of
Concord, North Carolina for approximately $11.6 million. VH Industries is a
manufacturer of fall protection products sold under the SafeWaze trade name
in the United States. The transaction was accounted for using the purchase
method of accounting in accordance with SFAS No. 141, "Business
Combinations", and accordingly, the operating results of VH have been
included with those of the Company subsequent to March 14, 2003. The
following unaudited pro forma information presents results as if the
acquisition had occurred at the beginning of the respective periods
(Dollars in thousands):
Three Months Ended
December 31,
-----------------------------
2003 2002
------------- -------------
Net sales as reported $ 79,201 $ 68,717
Pro forma sales 79,201 71,058
Net income as reported $ 2,683 $ 1,042
Pro forma net income 2,683 1,369
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the Consolidated
Financial Statements of the Company, including notes thereto. This Report
contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
The Company's actual results could differ materially from those set forth in
such forward-looking statements. The factors that might cause such a difference
include, among others, the following: risks associated with indebtedness; risks
related to acquisitions; risks associated with the conversion to a new
management information system; high level of competition in the Company's
markets; importance and costs of product innovation; risks associated with
international operations; product liability exposure; unpredictability of patent
protection and other intellectual property issues; dependence on key personnel;
the risk of adverse effect of economic and regulatory conditions on sales; and
risks associated with environmental matters
Critical Accounting Policies
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's condensed consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America ("GAAP"). GAAP requires the
use of estimates, judgments, assumptions and subjective interpretations of
accounting principles that affect the reported amounts of assets, liabilities,
revenues and expenses. The Company believes its use of estimates and underlying
accounting assumptions adhere to GAAP and are consistently applied. The Company
revises its estimates and assumptions as new information becomes available.
The Company believes that of its significant accounting policies (see Notes to
the Consolidated Financial Statements in the Company's Annual Report on Form
10-K405) the following policies involve a higher degree of judgment and/or
complexity.
Income Taxes - The Company accounts for income taxes in accordance with
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
-16-
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 a restructuring charge in fiscal 2001 based
on a 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 $0.3 million was made
during the 4th quarter of fiscal 2003 to account for new information made
available during the year.
Pension Plan - The valuation of the Company's pension plan requires the use of
assumptions and estimates that are used to develop actuarial valuations of
expenses and assets/liabilities. These assumptions include discount rates,
investment returns, projected salary increases and mortality rates. The
actuarial assumptions used in the Company's pension reporting are reviewed
annually and compared with external benchmarks to assure that they accurately
account for future pension obligations. Changes in assumptions and future
investment returns could potentially have a material impact on the Company's
pension expense and funding requirements.
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 be
recorded including pricing discounts and incentives. In addition, an allowance
for doubtful accounts is generally recorded 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 customer's credit worthiness, historical bad debt experience,
changes in payment history and general economic and market trends.
Goodwill - The Company adopted SFAS No. 142, "Goodwill and Other Intangible
Assets" on October 1, 2002. This standard requires that goodwill no longer be
amortized, and instead, be tested for impairment on a periodic basis. In testing
for a potential impairment of goodwill, SFAS No. 142 requires the Company to
individually allocate and assign the carrying value of assets and liabilities
(including goodwill) to specific reporting units or business segments, estimate
the fair value of the reporting units or business segments, and determine
goodwill impairment by comparing the estimated fair value to the assigned
carrying value. The process of evaluating the potential impairment is highly
subjective and requires significant judgment at many points during the analysis.
As of January 1, 2004, the Company is in the process of performing its annual
impairment evaluation. The Company may incur charges for impairment of goodwill
in the future if the carrying value of assets exceeds the estimated fair value.
Any future impairment charge could adversely affect the Company's results of
operation and financial position.
-17-
Results of Operations
(Dollars in Thousands)
(Unaudited)
Three months ended December 31,
-----------------------------------------------
2003 % 2002 %
------------ -------- ------------ --------
Net Sales
Safety Products $ 59,780 75.5 $ 50,486 73.5
Safety Prescription Eyewear 9,464 11.9 9,804 14.3
Specialty Composites 9,957 12.6 8,427 12.2
------------ -------- ------------ --------
Total net sales 79,201 100.0 68,717 100.0
Cost of Sales 41,776 52.7 35,645 51.9
------------ -------- ------------ --------
Gross profit 37,425 47.3 33,072 48.1
Operating Expenses
Selling and administration 27,471 34.7 24,321 35.4
Research and technical services 1,741 2.2 1,583 2.3
Amortization 108 0.1 116 0.1
Other charges (income), net (1,042) (1.3) 458 0.7
------------ -------- ------------ --------
Total operating expenses 28,278 35.7 26,478 38.5
Operating income 9,147 11.6 6,594 9.6
Interest expense, net 5,812 7.3 4,942 7.2
------------ -------- ------------ --------
Income before provision
for income taxes 3,335 4.3 1,652 2.4
Provision for income taxes 652 0.8 610 0.9
------------ -------- ------------ --------
Net income $ 2,683 3.5 $ 1,042 1.5
============ ======== ============ ========
Results of Operations -- Three Months Ended December 31, 2003 Compared to Three
Months Ended December 31, 2002
Net Sales. Net sales in the three months ended December 31, 2003 increased 15.3%
to $79.2 million from $68.7 million in the three months ended December 31, 2002.
The increase in net sales was primarily driven by organic growth in the Safety
Products and Specialty Composites segments, the impact of the SafeWaze
acquisition and foreign currency translation, partially offset by a decline in
the Safety Prescription Eyewear segment. The weakness of the U.S. dollar and the
SafeWaze acquisition favorably impacted net sales by $3.5 million and $2.2
million, respectively. The Safety Products segment net sales in the three months
ended December 31, 2003 increased 18.4% to $59.8 million from $50.5 million in
the three months ended December 31, 2002. The increase in net sales resulted
from 7.4% increase due to organic growth, a 6.6% increase due to foreign
currency translation and a 4.4% increase due to the acquisition of SafeWaze.
Organic sales growth for the Safety Products segment, defined as net sales less
the impact of foreign currency translation and acquisitions, has increased for
six consecutive quarters. The Company attributes this growth to its ability to
successfully introduce new products into the markets it serves. The Safety
Prescription Eyewear segment net sales in the three months ended December 31,
2003 decreased 3.5% to $9.5 million from $9.8 million in the three months ended
December 31, 2002. The decrease in net sales was primarily due to the reduction
in manufacturing employment in North America. Specialty Composites' net sales in
-18-
the three months ended December 31, 2003 increased 18.2% to $10.0 million from
$8.4 million in the three months ended December 31, 2002. The increase was
primarily driven by volume increases in the precision electronics and truck
markets. The Company tracks measures such as computer and electronic production
data and truck build rates to gauge the momentum in the Specialty Composites
segment which has been experiencing positive sales trends in the last two
quarters.
Gross Profit. Gross profit in the three months ended December 31, 2003 increased
13.2% to $37.4 million from $33.1 million in the three months ended December 31,
2002. The increase in gross profit is primarily due to improved sales volumes,
continued productivity improvements in manufacturing operations, the impact of
acquisitions and the effects of foreign currency translation. Gross profit as a
percentage of net sales in the three months ended December 31, 2003 was 47.3% as
compared to 48.1% in the three months ended December 31, 2002. The decline in
the gross profit percentage of net sales is primarily due to product and channel
mix.
Operating Expenses. Operating expenses in the three months ended December 31,
2003 increased 6.8% to $28.3 million from $26.5 million in the three months
ended December 31, 2002. The increase in operating expenses was primarily driven
by an increase in selling and administrative and research and technical services
expenses, partially offset by a decrease in other charges (income), net. Selling
and administrative expenses included approximately $0.6 million of expenses due
to acquisitions and $1.0 million due to foreign exchange as well as increased
spending to support new product launches and build brand support. Selling and
administrative expenses as a percentage of net sales decreased to 34.7% in the
three months ended December 31, 2003 as compared to 35.4% in the three months
ended December 31, 2002. Other charges (income), net was income of $1.0 million
for the three months ended December 31, 2003 as compared to expense of $0.5
million in the three months ended December 31, 2002. The improvement of $1.5
million was primarily driven by foreign currency transaction gains in the period
ended December 31, 2003 and assets write-offs of $0.3 million in the period
ended December 31, 2002 that did not reoccur in the period ended December 31,
2003.
Operating Income. Primarily as a result of the factors mentioned above,
operating income increased 38.7% to $9.1 million in the three months ended
December 31, 2003 from $6.6 million in the three months ended December 31, 2002.
Operating income as a percentage of net sales in the three months ended December
31, 2003 increased to 11.6% as compared to 9.6% in the three months ended
December 31, 2002.
Interest Expense, Net. Interest expense, net, in the three months ended December
31, 2003 increased 17.6% to $5.8 million from $4.9 million in the three months
ended December 31, 2002. The increase is attributed to higher weighted average
borrowings for the three months ended December 31, 2003 as compared to the three
months ended December 31, 2002. The increase in borrowings can be mainly
attributed to the issuance of $15.0 million of Holding Company Notes to finance
part of the redemption of Aearo's common and preferred stock owned by Cabot
Corporation.
Provision For Income Taxes. The provision for income taxes in the three months
ended December 31, 2003 was $0.7 million as compared to $0.6 million in the
three months ended December 31, 2002. The effective tax rate in the three months
ended December 31, 2003 and 2002 was different from the statutory rate due to
the mix of income between the Company's foreign and domestic subsidiaries. The
Company's foreign subsidiaries had taxable income in their foreign jurisdictions
while the Company's domestic subsidiaries have net operating loss carry-forwards
for income tax purposes. Due to the uncertainty of realizing these tax benefits,
the tax benefits generated by the net operating losses have been fully offset by
a valuation allowance.
-19-
Net Income. For the three months ended December 31, 2003 the Company had net
income of $2.7 million as compared to $1.0 million for the three months ended
December 31, 2002 mainly for the reasons described above.
-20-
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 currency. While many of the Company's selling and
distribution costs are also denominated in these currencies, a large portion of
product costs are U.S. Dollar denominated. As a result, a decline in the value
of the U.S. Dollar relative to other currencies can have a favorable impact on
the profitability of the Company, and an increase in the value of the U.S.
Dollar relative to these other currencies can have a negative effect on the
profitability of the Company. The Company's Swedish operations are also affected
by changes in exchange rates relative to the Swedish Krona. In contrast to the
above, a decline in the value of the Krona relative to other currencies can have
a favorable impact on the profitability of the Company and an increase in the
value of the Krona relative to other currencies can have a negative impact on
the profitability of the Company. The Company utilizes forward foreign currency
contracts, and other hedging instruments, to mitigate the effects of changes in
foreign currency rates on profitability.
Effects of Inflation
In recent years, inflation has been modest and has not had a material impact
upon the results of the Company's operations.
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.
To finance part of the redemption of Aearo's common and preferred stock owned by
Cabot Corporation in August 2003, the Company authorized the issuance and sale
of $15.0 million aggregate principal of Holding Company Notes due July 15, 2005.
The Company's debt structure includes: (a) $98.0 million of 12.5% 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, (b) $15.0 million of Holding Company Notes due 2005, and (c)
up to an aggregate of $130.0 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 and (ii) the
Revolving Credit Facility providing for up to $30.0 million of revolving loans
for general corporate purposes (collectively the "Senior Bank Facilities"). In
addition the Company has the capacity to borrow $5.0 million under a U.K.
overdraft facility (the "Overdraft Facility"). The amount outstanding on the
Term Loans and Revolving Credit Facility at December 31, 2003, were
approximately $83.4 and $10.6 million, respectively. The U.K overdraft facility
has not been formalized or executed; therefore no amounts were outstanding at
December 31, 2003. Under the terms of the Senior Bank Facilities, the Note
Indenture and the Note Purchase Agreement for the Holding Company Notes, Aearo
Company is required to comply with certain financial covenants and restrictions.
Aearo Company was in compliance with all financial covenants and restrictions at
December 31, 2003.
The Company's Board of Directors has 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
such repurchases will occur.
-21-
Maturities under the Company's Term Loans are: $13.4 million for the remainder
of fiscal 2004 and $70.0 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 the current 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 the Senior Bank Facilities, the Notes and the Holding Company Notes.
The Company's Revolving Credit Facility and Term Loans mature in March 2005.
The Company typically makes capital expenditures related primarily to the
maintenance and improvement of manufacturing facilities. The Company's principal
source of cash to fund these capital requirements is cash from operations. The
Company spent $2.4 million and $2.2 million, respectively for capital
expenditures for the three months ended December 31, 2003 and 2002,
respectively.
The Company's net cash provided by operating activities for the three months
ended December 31, 2003 totaled $7.0 million as compared to $8.2 million for the
three months ended December 31, 2002. The decrease of $1.2 million was due
primarily to a $3.9 million decrease related to the net changes in assets and
liabilities, partially offset by an improvement in net income adjusted for cash
and non-cash charges (depreciation, amortization, deferred taxes and other). The
Company's net changes in assets and liabilities was primarily driven by a
decrease in cash from receivables, inventory and accounts payable and accrued
liabilities, partially offset by an increase in cash from income taxes and
other, net.
Net cash used by investing activities was $2.3 million for the three months
ended December 31, 2003 as compared to $3.4 million for the three months ended
December 31, 2002. The decrease in net cash used by investing activities is
primarily attributed to acquisitions made in the three months ended December 31,
2002.
Net cash used by financing activities for the three months ended December 31,
2003 was $5.7 million compared with net cash used by financing activities for
the three months ended December 31, 2002 of $3.2 million. The change of $2.5
million is primarily due to the increased repayment of the revolving credit
facility and term loans in the three months ended December 31, 2003 as compared
to the three months ended December 31, 2002.
The Company maintains a non-contributory defined benefit cash balance pension
plan. The Company utilizes an outside actuarial firm to estimate pension expense
and funding based on various assumptions including the discount rate and the
expected long-term rate of return on plan assets. In developing the expected
long-term rate of return assumption, the Company's management evaluates input
from outside investment advisors and actuaries as of the measurement date.
Actual asset returns for the Company's pension plan improved in fiscal 2003
after two years of negative returns. Although recent trends have been positive,
the Company lowered the long-term rate of return on plan assets from 8.5% to
8.0% for the year ended September 30, 2003. The Company's management believes
that this rate is reasonable based on historical trends over a 20-30 year
period. The estimated effect of a 1% change in the expected long-term rate of
return on plan assets results in a $0.1 million impact on pension expense. The
discount rate had also been lowered from 6.75% to 6.00% for the fiscal year
ended September 30, 2003. The Company bases the discount rate on the AA
Corporate bond yields. The estimated impact of a 1% change in the discount rate
results in a $0.2 million impact on pension expense.
The variability of asset returns and discount rates may have either a favorable
or unfavorable impact on the Company's pension expense and the funded status of
the pension plan. Under minimum funding rules, no additional pension
-22-
contributions were required to be made in fiscal 2003. However, contributions
may increase in future years. Due to the uncertainty of the future returns of
the equity and corporate bond markets, it is difficult to estimate the impact of
pension contributions in the future.
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.
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.
Off-Balance Sheet Arrangements
The Company has no financing arrangements involving variable interest entities.
-23-
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risks related to changes in foreign currencies,
interest rates and commodity pricing. The Company uses derivatives to mitigate
the impact of changes in foreign currencies and interest rates. All derivatives
are for purposes other than trading. The Company adopted the provisions of SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" on
October 1, 2000. The Company has formally documented its hedging relationships,
including identification of hedging instruments and the hedge items, as well as
its risk management objectives.
Foreign Currency Risk
The Company's results of operations are subject to risks associated with
operating in foreign countries, including fluctuations in currency exchange
rates. While many of the Company's selling and distribution costs are
denominated in Canadian and European currencies, a large portion of product
costs are U.S. Dollar denominated. As a result, a decline in the value of the
U.S. Dollar relative to other currencies can have a favorable impact on the
profitability of the Company and an increase in the value of the U.S. Dollar
relative to these other currencies can have a negative effect on the
profitability of the Company. The Company's Swedish 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 foreign operations. The Company utilizes
forward foreign currency contracts for transaction as well as cash flow
exposures. For the three months ended December 31, 2003 and 2002, net
transaction exposures were a loss of $0.1 million, respectively. Cash flow
exposures for the same period were a loss of $0.2 million and $0.1 million,
respectively. 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 a
result of the forward foreign currency contracts, the Company has recorded a
derivative payable of $0.8 million and $0.4 million at December 31, 2003 and
September 30, 2003, respectively. All forward foreign currency contracts will
expire over the next nine months.
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 $ 0.1 million for each of the periods ended December 31, 2003
and 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.
-24-
The Company has approximately $30.5 million of variable rate debt protected
under an interest rate cap arrangement through December 31, 2004. The fair value
of the cap at December 31, 2003 and September 30, 2003 was $0.1 million,
respectively. The Company has not elected to take hedge accounting treatment for
the interest rate cap as defined under SFAS No, 133 and, as a result, any fair
value adjustment is charge directly to other income/(expense). During the
quarter ending December 31, 2003 there was no change in the value of the
interest rate cap.
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, competition, and
infrastructure stability has provided a favorable purchasing environment. The
Company does not enter into derivative instruments to manage commodity risks.
-25-
Item 4. 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 as of December 31,
2003, and have determined that such disclosure controls and procedures are
effective.
There has been no change in the Company's internal control over financial
reporting during the quarter ended December 31, 2003, that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
-26-
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
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 is a defendant in lawsuits by plaintiffs alleging that
they suffer from respiratory medical conditions, such as asbestosis or
silicosis, relating to exposure to asbestos and silica, and that such conditions
result, in part, from the use of respirators that, allegedly, were negligently
designed or manufactured. The defendants in these lawsuits are often numerous,
and include, in addition to manufacturers and distributors of respirators,
manufacturers, distributors and installers of sand (used in sand blasting),
asbestos and asbestos-containing products. Most of these claims are covered by
the Asset Transfer Agreement entered into on June 13, 1995 by the Company and
Aearo Company, on the one hand, and Cabot and certain of its subsidiaries (the
"Sellers"), on the other hand (the "1995 Asset Transfer Agreement"). In the 1995
Asset Transfer Agreement, so long as the Company makes an annual payment of
$400,000 to Cabot, the Sellers agreed to retain, and Cabot and the Sellers
agreed to defend and indemnify the Company against, any liability or obligation
relating to or otherwise arising under any proceeding or other claim against the
Company or Cabot or their respective affiliates or other parties with whom any
Seller directly or indirectly has a contractual liability sharing arrangement
which sounds in product liability or related causes of action arising out of
actual or alleged respiratory medical conditions caused or allegedly caused by
the use of respirators or similar devices sold by Sellers or their predecessors
(including American Optical Corporation and its predecessors) prior to July 11,
1995. To date, the Company has elected to pay the annual fee and intends to
continue to do so. The Company could potentially be liable for claims currently
retained by Sellers if the Company elects to cease paying the annual fee or if
Cabot and the Sellers no longer are able to perform their obligations under the
1995 Asset Transfer Agreement. Cabot acknowledged in the Stock Purchase
Agreement that it and the Company entered into on June 27, 2003 (providing for
the sale by Cabot to the Company of all of the common and preferred stock of the
Company owned by Cabot) that the foregoing provisions of the 1995 Asset Transfer
Agreement remain in effect. The 1995 Asset Transfer Agreement does not apply to
claims relating to the business of Eastern Safety Equipment, the stock of which
the Company acquired in 1996.
At December 31, 2003 and September 30, 2003, the Company has recorded
liabilities of approximately $4.5 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 2008 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 1995 Asset Transfer Agreement, but recognizing
-27-
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.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits See Index of Exhibits on page 29 hereof.
(b) Reports on Form 8-K
On October 9, 2003, the Company filed a Current Report on Form 8-K to
announce its revenues for the fiscal year ended September 30, 2003.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: February 13, 2004 AEARO CORPORATION
/s/ Jeffrey S. Kulka
--------------------------------
Jeffrey S. Kulka
Senior Vice President,
Chief Financial Officer,
Treasurer, and Secretary
(Principal Financial and
Accounting Officer)
EXHIBIT INDEX
EXHIBITS DESCRIPTION
31.1 Certification of Principal Executive Officer
31.2 Certification of Principal Financial Officer