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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 333-116676
AEARO COMPANY I
(Exact name of registrant as specified in its charter)
Delaware 13-3840356
(State or other jurisdiction of incorporation (IRS Employer Identification No.)
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)
_______________________
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 14, 2005 was 100.
AEARO COMPANY I
TABLE OF CONTENTS
Form 10-Q for the Quarterly Period Ended December 31, 2004
PART I-FINANCIAL INFORMATION..................................................3
Item 1.Financial Statements...................................................3
Consolidated Balance Sheets - Assets..........................................3
Consolidated Balance Sheets - Liabilities and Stockholder's Equity............4
Consolidated Statements of Operations.........................................5
Consolidated Statement of Stockholder's Equity................................6
Consolidated Statements of Cash Flows.........................................7
Notes to Consolidated Financial Statements....................................8
Item 2.Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................22
Item 3.Quantitative and Qualitative Disclosures About Market Risk ...........28
Item 4.Controls and Procedures...............................................30
PART II - OTHER INFORMATION..................................................31
Item 6.Exhibits and Reports on Form 8-K......................................31
SIGNATURES...................................................................32
EXHIBIT INDEX................................................................33
7
PART I-FINANCIAL INFORMATION
Item 1. Financial Statements
AEARO COMPANY I AND SUBSIDIARIES
Consolidated Balance Sheets - Assets
(In Thousands)
December 31, September 30,
2004 2004
--------------- --------------
Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 27,445 $ 27,724
Accounts receivable (net of allowance
for doubtful accounts of
$1,464 and $1,358, respectively) 52,375 54,159
Inventories 42,818 40,849
Deferred and prepaid expenses 7,437 4,146
-------------- ----------
Total current assets 130,075 126,878
--------------- ----------
LONG TERM ASSETS:
Property, plant and equipment, net 54,599 54,750
Goodwill, net 122,802 133,745
Other intangible assets, net 184,578 185,855
Other assets 16,202 15,144
-------------- ----------
Total assets $ 508,256 $ 516,372
--------------- -----------
The accompanying notes are an integral part of these consolidated financial
statements
AEARO COMPANY I AND SUBSIDIARIES
Consolidated Balance Sheets - Liabilities and Stockholder's Equity
(In Thousands, Except for Per Share and Share Amounts)
--------------- ------------
December 31, September 30,
2004 2004
--------------- -------------
(Unaudited)
CURRENT LIABILITIES:
Current portion of long-term debt $ 1,673 $ 1,639
Accounts payable and accrued liabilities 46,132 46,730
Accrued interest 3,066 6,996
U.S. and foreign income taxes 2,174 1,648
------------ ----------
------------- ----------
Total current liabilities 53,045 57,013
------------- ----------
LONG TERM LIABILITIES:
Long-term debt 306,815 302,842
Deferred income taxes 44,369 59,699
Other liabilities 14,565 14,726
-------------- ----------
Total liabilities 418,794 434,280
-------------- ----------
STOCKHOLDER'S EQUITY:
Common stock, $.01 par value-
Authorized--100 shares
Issued and outstanding--100 shares - -
Paid in capital 101,620 101,610
Accumulated deficit (14,397) (19,415)
Accumulated other comprehensive income (loss) 2,239 (103)
--------------- ----------
Total stockholder's equity 89,462 82,092
--------------- ----------
Total liabilities and stockholder's equity $ 508,256 $ 516,372
=============== ============
The accompanying notes are an integral part of these consolidated financial
statements
Consolidated Statements of Operations
(In Thousands)
(Unaudited)
Three Months Ended
December 31,
2004 2003
Successor Predecessor
Net sales $ 95,761 | $ 79,201
|
Cost of sales 48,705 | 41,776
-------- |---------
Gross profit 47,056 | 37,425
|
Selling and administrative 31,731 | 27,471
|
Research and technical services 2,220 | 1,741
|
Amortization 1,318 | 108
|
Other income, net (68) | (1,042)
---------- ---------
Operating income 11,855 | 9,147
|
Interest expense, net 5,241 | 5,466
|
Income before provision for income taxes 6,614 | 3,681
|
Provision for income taxes 1,596 | 791
------------ |---------
|
Net income $ 5,018 | $ 2,890
------------ ---------
The accompanying notes are an integral part of these consolidated financial
statements
AEARO COMPANY I AND SUBSIDIARIES
Consolidated Statement of Stockholder's Equity
(In Thousands, Except Share Amounts)
Additional Accumulated
Paid Retained Other Comprehensive
Common In Earnings Comprehensive Income
Income
Predecessor Shares Amount Capital (Deficit) (Loss) Total (Loss)
------- -------- ---------- ----------- ------------- --------- -------------
Balance, October 1, 2003 100 $ $32,531 $ 7,713 $ (6,786) $ 33,458
Net income - - - 8,564 - 8,564 $ 8,564
Foreign currency translation
adjustment 1,688 1,688 1,688
Net minimum pension liability
adjustment 4 4 4
-------------
Comprehensive income $ 10,256
=============
------- -------- ---------- ----------- ------------- ---------
Balance, March 31, 2004 100 $ - $ 32,531 $ 16,277 $ (5,094) $ 43,714
======= ======== ========== =========== ============= =========
- -----------------------------------------------------------------------------------------------------------------------
Successor
$
Capital contribution 100 - $ 101,610 $ - $ $101,610
Net loss - - - (5,110) - (5,110) (5,110)
Foreign currency translation
adjustment - - - - (103) (130) $ (390)
Dividend to parent for
repayment of debt (14,305) - (14,305) -
-------------
Comprehensive loss - - - - - $ (5,213)
------- -------- -- ---------- ----------- ------------- --------- =============
Balance, September 30, 2004 100 101,610 (19,415) (103) 82,092
------- -------- -- ---------- ----------- ------------- ---------
Net income - - - 5,018 - 5,018 $ 5,018
Foreign currency translation
adjustment - - - - 2,342 2,342 2,342
Vesting of restricted stock - - 10 - 10 -
-------------
Comprehensive income - - - - - - $ 7,360
=============
------- -------- ---------- ----------- ------------- ---------
Balance, December 31, 2004 100 $ - $ 101,620 $(14,397) $ 2,239 $ 89,462
======= ======== ========== =========== ============= =========
AEARO COMPANY I AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)
For the Three Months Ended
December 31,
--------------------------------
2004 | 2003
-----------------|---------------
CASH FLOWS FROM OPERATING ACTIVITIES: Successor | Predecessor
Net income $ 5,018 | $ 2,890
Adjustments to reconcile net income to cash provided by operating |
activities- |
Depreciation 2,577 | 2,929
Amortization of intangible assets and deferred financing costs 1,660 | 1,263
Deferred income taxes 240 | (7)
Other, net 67 | 107
Changes in assets and liabilities- |
Accounts receivable 3,027 | 5,067
Inventories (1,060) | (4,304)
Income taxes payable 843 | 28
Interest payable (3,930) | 2,956
Accounts payable and accrued liabilities (4,144) | (5,957)
Other, net (2,935) | 2,003
Net cash provided by operating activities 1,363 | 6,975
|
CASH FLOWS FROM FINANCING ACTIVITIES: |
Additions to property, plant and equipment (1,494) | (2,353)
Proceeds provided by disposals of property, plant and equipment 1 | 12
Net cash used by investing activities (1,493) | (2,341)
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
Repayment of revolving credit facility, net -- | (1,100)
Repayment of term loans (325) | (4,466)
Repayment of capital lease obligations (65) | (61)
Repayment of long term debt (224) | (82)
Other -- | (11)
|
Net cash used for financing activities (614) | (5,720)
|
EFFECT OF EXCHANGE RATE ON CASH 465 | (1,545)
|
DECREASE IN CASH AND CASH EQUIVALENTS (279) | (2,631)
|
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 27,724 | 7,301
|
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 27,445 |$ 4,670
|
|
|
|
CASH PAID FOR: |
Interest $ 9,265 |$ 1,325
Income taxes $ 1,026 |$ 953
AEARO COMPANY I AND SUBSIDIARIES
Notes to Consolidated Financial Statements
DECEMBER 31, 2004
(Unaudited)
Consolidated Financial Statements
In the opinion of management, the accompanying unaudited consolidated financial
statements of Aearo Company I (the "Company") contain all normal, recurring
adjustments necessary to present fairly, in accordance with accounting
principles generally accepted in the United States of America, the 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 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-K.
2) Company Background, Merger and Basis of Presentation
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. On March 10, 2004, Aearo Corporation ("Parent"), the
Company's parent, entered into a merger agreement ("Merger Agreement") with AC
Safety Holding Corp. and its subsidiary, AC Safety Acquisition Corp. that closed
on April 7, 2004 (the "Merger"). Pursuant to the terms of the Merger Agreement,
on April 7, 2004 ("Acquisition Date"), AC Safety Acquisition Corp. merged with
and into Aearo Corporation with Aearo Corporation surviving the Merger as a
wholly-owned subsidiary of AC Safety Holding Corp. The aggregate purchase price
was approximately $409.2 million, including fees and expenses. The Merger was
financed with approximately $303.7 million of debt as discussed in Note 6, $3.7
million of which was assumed, $4.2 million of cash and $101.3 million of equity.
The Company continues to be wholly-owned by Aearo Corporation after the Merger.
The purpose of the Merger was to effect a change of control from Aearo
Corporation to the Company's ultimate parent AC Safety Holding Corp.
Approximately $87.0 million of proceeds from the Merger was distributed to our
Parent and used to pay the shareholders of the Parent to effect the merger
transaction. An additional $14.3 million distributed to our Parent was used to
pay the outstanding debt of the Parent as of April 7, 2004. The Merger was a
business combination under SFAS No. 141, "Business Combinations," and the
purchase price paid for our Parent reflects the push down of 100% of the
purchase price resulting from the Merger. Accordingly, the results of operations
subsequent to the Acquisition Date are presented on a different basis of
accounting than the results of operations prior to the Acquisition Date, and,
therefore are not directly comparable. The sale was accounted for as if it had
occurred on March 31, 2004, as management determined that results of operations
were not significant and no material transactions occurred during the period
from April 1, 2004 to April 7, 2004. The periods prior to April 7, 2004, are
referred to as predecessor financial statements and the periods after April 7,
2004, are referred to as successor financial statements. The purchase price is
allocated to the Company's tangible and intangible assets and liabilities based
upon estimated fair values as of the date of the Merger. The purchase price has
been preliminarily allocated as follows (dollars in thousands):
Working capital $ 77,357
Fixed assets 55,139
Other assets and liabilities 16,073
Deferred tax liabilities (45,258)
Finite lived intangible asset 74,104
Indefinite lived intangible assets 114,300
Goodwill 117,444
---------
Purchase price $ 409,159
---------
3) Significant Accounting Policies
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 financial statements and the reported amounts
of revenues and expenses during the reporting periods. Actual results could
differ from those estimates. Revenue Recognition and Allowance for Doubtful
Accounts. 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. 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 stockholder's equity. Foreign Currency
Transactions. Foreign currency gains and losses arising from transactions by any
of the Company's subsidiaries are reflected in net income. 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 for the three months ended
December 31, 2004 and 2003 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 had operating losses for income tax purposes.
Due to the uncertainty of realizing the tax benefits of the net operating
losses, the tax benefits have been partially offset by a valuation allowance.
The Company is included in the consolidated tax return filed by Aearo
Corporation. All taxes are recorded as if separate, stand alone returns were
filed. Deferred taxes are based on preliminary purchase price allocations and
may be subsequently adjusted. Goodwill and Other Intangibles. Under the
provisions of SFAS No. 142, "Goodwill and Other Intangibles", goodwill and
intangible assets that have indefinite useful lives are not amortized but are
tested at least annually for impairment. Intangible assets that have finite
useful lives are amortized over their useful lives and reviewed for impairment
at each reporting date. The following presents a summary of intangibles assets
as of September 30, 2004 and December 31, 2004, before final allocations
resulting from the Merger:
Gross Accumulated
September 30, 2004 Amount Amortization Additions Carrying Amount
Trademarks $ 114,300 $ -- $ -- $ 114,300
Customer Relationship List 73,000 (2,433) -- 70,567
Patents 719 (122) 82 679
Other 385 (76) -- 309
------------ --------------- ----------- ------------
Total Intangibles $ 188,404 $ (2,631) $ 82 $ 185,855
------------ --------------- ----------- ------------
Gross Accumulated
December 31, 2004 (Unaudited) Amount Amortization Additions Carrying Amount
Trademarks $ 114,300 $ -- $ -- $ 114,300
Customer Relationship List 73,000 (3,650) -- 69,350
Patents 801 (185) 41 657
Other 385 (114) -- 271
------------ --------------- ----------- ------------
Total Intangibles $ 188,486 $ (3,949) $ 41 $ 184,578
------------ --------------- ----------- ------------
Estimate of Aggregate Amortization Expense:
Year ending September 30, 2005 $ 5,230
Year ending September 30, 2006 5,225
Year ending September 30, 2007 5,114
Year ending September 30, 2008 4,904
Year ending September 30, 2009 4,913
The following presents the preliminary allocation of goodwill resulting from the
Merger and the changes in the carrying amount of goodwill for the three months
ended December 31, 2004 (dollars in thousands):
Three Months Ended
December 31, 2004
Beginning balance $ 133,745
Allocation adjustment (15,696)
Translation adjustment 4,753
-----------------
Ending balance $ 122,802
Stock-based Compensation. The Company accounts for stock-based compensation
under the recognition and measurement principles of Accounting Principals Board
("APB") No. 25, "Accounting for Stock Issued to Employees". Accordingly, no
compensation expense for stock options has been recognized as all options
granted had an exercise price equal to or above the price of the underlying
common stock on the grant date. The Company recognizes compensation expense
related to restricted stock awards and amortizes the expense over the vesting
period based on the estimated fair value of the stock at the date of grant. The
following table illustrates the effect on net income if the Company had applied
the fair value recognition provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation" as amended by SFAS No. 148 "Accounting for Stock-Based
Compensation - Transition and Disclosure," to stock-based employee compensation
(dollars in thousands):
Three Months Ended
December 31,
2004 | 2003
------- | -------
Successor | Predecessor
Net Income as reported $ 5,018 | $ 2,890
Stock based compensation expense recorded under APB |
No. 25, net of tax -- | --
Stock-based compensation expense determined under |
the fair value method, net of tax (31) | (37)
------- | -------
Proforma net income $ 4,987 | $ 2,853
------- | -------
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 foreign currency exchange contracts and interest rate swap 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 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 or when related interest payments affect earnings for
interest rate swaps. At December 31, 2004, the Company had no forward foreign
currency contracts or interest rate derivatives as defined under SFAS No. 133.
For the three month periods ended December 31, 2003, the Company reclassified
into earnings net losses of $0.2 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 had approximately $30.5 million of variable rate debt
protected under an interest rate cap arrangement, which expired December 31,
2004. The Company did not elect hedge accounting treatment for the interest rate
cap as defined under SFAS No. 133, and, as a result, any fair value adjustment
was charged directly to other charges (income), net. There was no impact on
earnings for each of the periods ended December 31, 2003 and 2004. 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. For the three months ended December
31, 2003 and 2004, the impact on earnings for trade activities was a net loss of
$0.1 million and $0.1 million, respectively. The Company's Senior Subordinated
Notes contain an embedded call option that requires bifurcation because it was
determined to not be clearly and closely related to the debt host contract. As a
result of the valuation of the embedded call option, the Company has recorded a
derivative asset of approximately $2.0 million and a corresponding liability as
of September 30, 2004 and December 31, 2004, respectively. The derivative asset
will be marked to market each quarter with a corresponding (gain) or loss to the
statement of operations. The corresponding liability is amortized using the
effective interest method over the term of the senior subordinated notes. For
the three month period ended December 31, 2004, the mark to market revaluation
of the embedded call option was immaterial. The resulting amortization of the
corresponding liability resulted in a reduction in interest expense of less than
$0.1 million for the three months ended December 31, 2004.
4) Comprehensive Income
Comprehensive income consisted of the following (dollars in thousands):
Three Months Ended
December 31,
----------------------------
2004 | 2003
---------------|-------------
Successor | Predecessor
Unaudited) | (Unaudited)
Net Income $ 5,018 | $ 2,890
|
Foreign currency translation adjustment 2,342 | 2,636
Unrealized loss on derivative instruments - | (389)
--------- | ---------
Comprehensive income $ 7,360 | $ 5,137
--------- ---------
5) Inventories
Inventories consisted of the following (dollars in thousands):
December 31, September 30,
2004 2004
-------------- -------------
(Unaudited)
Raw materials $ 10,578 $ 9,302
Work in process 9,706 12,087
Finished goods 22,534 19,460
----------- ------------
$ 42,818 $ 40,849
=========== =============
Inventories, which include materials, labor and manufacturing overhead, are
stated at the lower of cost or market, cost being determined using the first-in,
first-out method.
6) Debt
The Company's debt structure includes: (a) $175.0 million of 8.25% Senior
Subordinated Notes ("8.25% Notes") due 2012, which are publicly held and
redeemable at the option of the Company, in whole or in part at various
redemption prices, (b) up to an aggregate of $175.0 million under its Credit
Agreement with various banks comprised of (i) a secured term loan facility
consisting of loans providing for up to $125.0 million of term loans
(collectively the "Term Loans") with a portion of the Term Loans denominated in
Euros, (ii) a secured revolving credit facility ("Revolving Credit Facility")
providing for up to $50.0 million of revolving loans for general corporate
purposes, and (iii) an uncommitted incremental term loan facility of up to $60
million for acquisitions (collectively, the "Senior Bank Facilities"). The
amounts outstanding on the Term Loans and Revolving Credit Facility at September
30, 2004, were approximately $126.0 and $0 million, respectively. Since the
Acquisition Date, the Company's debt has been negatively impacted by $6.3
million related to the fluctuation of the euro relative to the U.S dollar as of
December 31, 2004. The amounts outstanding on the Term Loans and Revolving
Credit Facility at December 31, 2004, were approximately $130.3 and $0 million,
respectively. The Revolving Credit Facility provides for the issuance of letters
of credit in an aggregate face amount of up to $15.0 million. The Company had
approximately $1.4 million and $1.6 million of letters of credit outstanding at
September 30, 2004 and December 31, 2004, respectively. The Term Loans amortize
quarterly over a seven 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 April 7, 2010. The Term Loans mature on April 7, 2011. Effective
December 31, 2004, the Company received a 0.25% reduction in the interest rate
paid on its Term Loans for meeting certain financial covenants. The Company was
in compliance with all financial covenants and restrictions as of December 31,
2004.
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. 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 Corporation, on the one hand, and Cabot
Corporation 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 Aearo Corporation makes an annual payment of $400,000 to Cabot, the
Sellers agreed to retain, and Cabot and the Sellers agreed to defend and
indemnify Aearo Corporation and its subsidiaries against, any liability or
obligation relating to or otherwise arising under any proceeding or other claim
against Aearo Corporation and its subsidiaries 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, Aearo
Corporation has elected to pay the annual fee and intends to continue to do so.
In addition, under the terms of the Merger Agreement with AC Safety Acquisition
Corp., Aearo Corporation agreed to make the annual payment to Cabot for a
minimum of seven years from the Acquisition Date. Aearo Corporation and its
subsidiaries could potentially be liable for claims currently retained by
Sellers if Aearo Corporation 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 a stock purchase agreement that
it and Aearo Corporation entered into on June 27, 2003 (providing for the sale
by Cabot to Aearo Corporation of all of the common and preferred stock of Aearo
Corporation 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, 2004 and September 30,
2004, the Company has recorded liabilities of approximately $4.0 million and
$5.4 million, respectively, 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 results of 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 Aearo
Corporation and its subsidiaries, including 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 2010 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
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,
-------------------------------
2004 2003
-------------------------------
Successor | Predecessor
(Unaudited) | (Unaudited)
Safety Products $ 71,153 | $ 59,780
Safety Prescription Eyewear 8,974 | 9,464
Specialty Composites 15,634 | 9,957
------------ | -----------
Total $ 95,761 | $ 79,201
------------ | -----------
Inter-segment sales from the Specialty Composites segment to the Safety Products
segment totaled $1.2 million and $0.7 million for the three months ended
December 31, 2004 and 2003, 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,
-------------------------------
2004 2003
--------------------------------
Successor | Predecessor
(Unaudited) | (Unaudited)
Safety Products $ 12,214 | $ 11,230
Safety Prescription Eyewear (325)| (214)
Specialty Composites 3,861 | 1,168
------------- | ------------
Segment profit 15,750 | 12,184
------------- | ------------
|
Depreciation 2,577 | 2,929
Amortization of intangibles 1,318 | 108
Interest 5,241 | 5,466
------------- | ------------
Income before provision for income taxes $ 6,614| $ 3,681
------------- | ------------
Segment profit is defined as operating income (loss) 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.
9) Pension
The following table presents the components of net periodic pension cost for the
three month periods ended December 31, 2004 and 2003, respectively (dollars in
thousands):
Three Months Ended
December 31,
-----------------------------
Successor Predecessor
-----------------------------
2004 | 2003
Service cost $ 364 | $ 335
Interest cost 206 | 186
Expected return on plan assets (184) | (167)
Amortization of prior service cost -- | 2
------------- | -----------
Total $ 386 | $ 356
------------- | ------------
The Company previously disclosed in its Annual Report on Form 10-K for the year
ended September 30, 2004, that it expected to contribute $1.2 million to its
pension plan in 2005. As of December 31, 2004, the Company has not made any
contributions to its pension plan and plans to contribute the entire $1.2
million in the fourth quarter of fiscal 2005.
10) Summarized Financial Information
The Company's 8.25% Senior Subordinated Notes due 2012 are fully and
unconditionally guaranteed, on a joint and several basis, by substantially all
of the Company's wholly-owned domestic subsidiaries ("Subsidiary Guarantors").
The non-guarantor subsidiaries are the Company's foreign subsidiaries. The
following financial information illustrates the composition of the combined
Subsidiary Guarantors based on the preliminary allocation of purchase price. The
Company believes that the separate, complete financial statements of the
respective guarantors would not provide additional material information which
would be useful in assessing the financial composition of the Subsidiary
Guarantors (dollars in thousands).
Consolidated Statement of Operations(Unaudited)
Three Months Ended December 31, 2004
Successor
-------------------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I SubsidiariesSubsidiariesEliminationsConsolidated
Net Sales................................. $ 71,699 $ -- $ 35,044 $ (10,982) $ 95,761
Cost of sales............................. 40,434 -- 19,245 (10,974) 48,705
-------- -------- -------- ---------- ----------
Gross profit............................ 31,265 -- 15,799 (8) 47,056
Selling and administrative................ 21,778 2,400 7,553 -- 31,731
Research and technical services........... 1,343 -- 877 -- 2,220
Amortization.............................. 934 64 320 -- 1,318
Other charges (income), net............... 3,979 (6,459) 2,412 -- (68)
-------- -------- -------- ---------- ----------
Operating income (loss)................ 3,231 3,995 4,637 (8) 11,855
Interest expense (income)................. 5,118 (347) 470 -- 5,241
-------- -------- -------- ---------- ----------
Income (loss) before taxes................ (1,887) 4,342 4,167 (8) 6,614
Income tax provision (benefit)............ (1,778) 2,043 1,331 -- 1,596
Equity in subsidiaries.................... 5,135 2,836 (7,971) --
-------- -------- -------- ---------- ----------
Net income............................. $ 5,026 $ 5,135 $ 2,836 $ (7,979) $ 5,018
-------- -------- -------- ---------- ----------
Consolidated Statement of Operations (Unaudited)
Three Months Ended December 31, 2003
Predecessor
-------------------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I SubsidiariesSubsidiariesEliminationsConsolidated
Net Sales................................. $ 58,187 $ -- $ 30,642 $ (9,628) $ 79,201
Cost of Sales............................. 33,515 -- 17,841 (9,580) 41,776
-------- -------- -------- ---------- ----------
Gross profit........................... 24,672 -- 12,801 (48) 37,425
Selling and administrative................ 20,537 229 6,705 -- 27,471
Research and technical services........... 1,157 -- 584 -- 1,741
Amortization.............................. 84 24 -- -- 108
Other charges (income), net............... 3,086 (6,565) 2,437 -- (1,042)
-------- -------- -------- ---------- ----------
Operating income....................... (192) 6,312 3,075 (48) 9,147
Interest expense (income)................. 5,129 (535) 872 -- 5,466
-------- -------- -------- ---------- ----------
Income (loss) before taxes................ (5,321) 6,847 2,203 (48) 3,681
Income tax provision (benefit)............ (2,749) 2,944 596 -- 791
Equity in subsidiaries.................... 5,510 1,607 (7,117) --
-------- -------- -------- ---------- ----------
Net income............................. $ 2,938 $ 5,510 $ 1,607 $ (7,165) $ 2,890
-------- -------- -------- ---------- ----------
Consolidated Balance Sheet (Unaudited)
December 31, 2004
Non-
Aearo Guarantor Guarantor
Company I SubsidiariesSubsidiariesEliminationsConsolidated
Current Assets:
Cash and cash equivalents.............. $ 21,640 $ 351 $ 5,454 $ -- $ 27,445
Receivables, net....................... 31,978 1,672 18,725 -- 52,375
Inventories............................ 30,431 -- 12,703 (316) 42,818
Deferred and prepaid expenses.......... 6,232 -- 1,205 -- 7,437
-------- -------- -------- ---------- ----------
Total current assets...................... 90,281 2,023 38,087 (316) 130,075
-------- -------- -------- ---------- ----------
Long Term Assets:
Property plan and equipment............ 38,924 -- 15,675 -- 54,599
Goodwill and other intangibles, net.... 91,860 122,294 93,226 -- 307,380
Inter-company receivables (payables) (52,651) 98,155 (45,504) -- --
Investment in subsidiaries ............ 251,506 67,292 (778) (318,020) --
Other assets........................... 16,191 -- 11 -- 16,202
-------- -------- -------- ---------- ----------
Total assets.............................. $436,111 $289,764 $100,717 $(318,336) $ 508,256
-------- -------- -------- ---------- ----------
Current Liabilities:
Current portion of long term debt...... $ 1,673 $ -- $ -- $ -- $ 1,673
Accounts payable and accrued
liabilities............................ 28,431 3,959 13,742 -- 46,132
Accrued interest....................... 3,066 -- -- -- 3,066
Income tax payables (receivables)...... 2,523 (2,564) 2,215 2,174
-------- -------- -------- ---------- ----------
Total current liabilities................. 35,693 1,395 15,957 -- 53,045
-------- -------- -------- ---------- ----------
Long Term Liabilities:
Long term debt......................... 306,815 -- -- -- 306,815
Deferred income taxes.................. 7,863 23,860 12,646 -- 44,369
Other liabilities...................... 14,565 -- -- -- 14,565
-------- -------- -------- ---------- ----------
Total liabilities......................... 364,936 25,255 28,603 -- 418,794
-------- -------- -------- ---------- ----------
Stockholder's Equity:
Common................................. -- -- 4,222 (4,222) --
Paid in capital........................ 101,620 267,796 41,765 (309,561) 101,620
Accumulated deficit.................... (24,934) (9,484) 29,004 (8,983) (14,397)
Accumulated other comprehensive income
(loss)................................. (5,511) 6,197 (2,877) 4,430 2,239
-------- -------- -------- ---------- ----------
Total stockholder's equity................ 71,175 264,509 72,114 (318,336) 89,462
-------- -------- -------- ---------- ----------
Total liabilities and stockholder's equity $436,111 $289,764 $100,717 $(318,336) $ 508,256
-------- -------- -------- ---------- ----------
Consolidated Balance Sheet
September 30, 2004
Non-
Aearo Guarantor Guarantor
Company I SubsidiariesSubsidiariesEliminationsConsolidated
Current Assets:
Cash and cash equivalents.............. $ 18,309 $ 140 $ 9,275 $ -- $ 27,724
Receivables, net....................... 34,823 -- 19,336 -- 54,159
Inventories............................ 29,956 -- 11,202 (309) 40,849
Deferred and prepaid expenses.......... 3,014 -- 1,132 -- 4,146
-------- -------- -------- ---------- ----------
Total current assets...................... 86,102 140 40,945 (309) 126,878
-------- -------- -------- ---------- ----------
Long Term Assets:
Property plan and equipment............ 40,040 -- 14,710 -- 54,750
Goodwill and other intangibles, net.... 134,567 131,786 53,247 -- 319,600
Inter-company receivables (payables) 64,478 (12,147) (52,331) -- --
Investment in subsidiaries ............ 154,350 40,981 (713) (194,618) --
Other assets........................... 15,133 -- 11 -- 15,144
-------- -------- -------- ---------- ----------
Total Assets.............................. $494,670 $160,760 $ 55,869 $(194,927) $ 516,372
-------- -------- -------- ---------- ----------
Current Liabilities:
Current portion of long term debt...... $ 1,618 $ -- $ 21 $ -- $ 1,639
Accounts payable and accrued
liabilities............................ 32,623 577 13,530 -- 46,730
Accrued interest....................... 6,996 -- -- -- 6,996
Income tax payables (receivables)...... 2,324 (2,317) 1,641 -- 1,648
-------- -------- -------- ---------- ----------
Total current liabilities................. 43,561 (1,740) 15,192 -- 57,013
-------- -------- -------- ---------- ----------
Long Term Liabilities:
Long term debt......................... 302,662 -- 180 -- 302,842
Deferred income taxes.................. 58,073 -- 1,626 -- 59,699
Other liabilities...................... 14,726 -- -- -- 14,726
-------- -------- -------- ---------- ----------
Total liabilities......................... 419,022 (1,740) 16,998 -- 434,280
-------- -------- -------- ---------- ----------
Stockholder's Equity:
Common................................. -- -- 7,396 (7,396) --
Paid in capital........................ 101,610 167,519 12,280 (179,799) 101,610
Accumulated deficit.................... (24,824) (8,664) 26,168 (12,095) (19,415)
Accumulated other comprehensive income
(loss)................................. (1,138) 3,645 (6,973) 4,363 (103)
-------- -------- -------- ---------- ----------
Total stockholder's equity................ 75,648 162,500 38,871 (194,927) 82,092
-------- -------- -------- ---------- ----------
Total liabilities and stockholder's equity $494,670 $160,760 $ 55,869 $(194,927) $ 516,372
-------- -------- -------- ---------- ----------
Consolidating Statement of Cash Flows (Unaudited)
Three Months Ended December 31, 2004
Successor
-------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I SubsidiariesSubsidiariesConsolidated
Net cash provided by (used for) operating
activities............................. $ 1,262 $ 780 $ (679) $ 1,363
Net cash used for investing activities.... (886) -- (607) (1,493)
Net cash provided by (used for) financing
activities............................. 2,706 (3,120) (200) (614)
Effect of exchange rate on cash........... 249 2,551 (2,335) 465
-------- -------- -------- ----------
Increase (decrease) in cash and cash
equivalents............................ 3,331 211 (3,821) (279)
Cash and cash equivalents at the
beginning of the period................ 18,309 140 9,275 27,724
-------- -------- -------- ----------
Cash and cash equivalents at the end of
the period............................. $ 21,640 $ 351 $ 5,454 $ 27,445
-------- -------- -------- ----------
Consolidating Statement of Cash Flows (Unaudited)
Three Months Ended December 31, 2003
Predecessor
-------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I SubsidiariesSubsidiariesConsolidated
Net cash provided by operating activities. $ 2,765 $ 2,379 $ 1,831 $ 6,975
Net cash used for investing activities.... (1,199) -- (1,142) (2,341)
Net cash used for financing activities.... (1,264) (3,600) (856) (5,720)
Effect of exchange rate on cash........... (388) 1,453 (2,610) (1,545)
-------- -------- -------- ----------
Increase (decrease) in cash and cash
equivalents............................ (86) 232 (2,777) (2,631)
Cash and cash equivalents at the
beginning of the period................ 1,544 206 5,551 7,301
-------- -------- -------- ----------
Cash and cash equivalents at the end of
the period............................. $ 1,458 $ 438 $ 2,774 $ 4,670
-------- -------- -------- ----------
22 Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
This report contains forward-looking statements within the meaning of the
federal securities laws. Statements that are not historical facts, including
statements about the Company's beliefs and expectations, are forward-looking
statements. Forward-looking statements included statements preceded by, followed
by or that include the words "may," "could," "would," "should," "believe,"
"expect," "anticipate," "plan," "estimate," "target," "project," "intend," or
similar expressions. These statements include, among others, statements
regarding the Company's expected business outlook, anticipated financial and
operating results, the Company's business strategy and means to implement the
strategy, the Company's objectives, the amount and timing of future capital
expenditures, future acquisitions, the likelihood of the Company's success in
developing and introducing new products and expanding its business, the timing
of the introduction of new and modified products or services, financing plans,
working capital needs and sources of liquidity. Forward-looking statements are
only predictions and are not guarantees of performance. These statements are
based on management's beliefs and assumptions, which in turn are based on
currently available information. Important assumptions relating to the
forward-looking statements include, among others, assumptions regarding demand
for our products, the cost, timing and success of product upgrades and new
product introductions, expected pricing levels, the timing and cost of planned
capital expenditures and expected synergies relating to acquisitions. These
assumptions could prove inaccurate. Forward-looking statements also involve
risks and uncertainties, which could cause actual results to differ materially
from those contained in any forward-looking statements. Many of these factors
are beyond the Company's ability to control or predict. You should read this
report in conjunction with the more detailed risks included in the Company's
Annual Report on Form 10-K for the fiscal year ended September 30,2004.. The
Company believes these forward-looking statements are reasonable; however, undue
reliance should not be placed on any forward-looking statements, which are based
on current expectations. Further, forward-looking statements speak only as of
the date they are made, and except as otherwise required by the federal
securities laws, the Company undertakes no obligation to update any of them
publicly in light of new information or future events.
Merger Agreement
On March 10, 2004, Aearo Corporation ("Parent"), the Company's parent, entered
into a Merger Agreement with AC Safety Holding Corp. and its subsidiary, AC
Safety Acquisition Corp. that closed on April 7, 2004 (the "Merger"). Pursuant
to the terms of the Merger Agreement, AC Safety Acquisition Corp. merged with
and into Aearo Corporation with Aearo Corporation surviving the Merger as a
wholly-owned subsidiary of AC Safety Holding Corp. The aggregate purchase price
was approximately $409.2 million, including estimated fees and expenses. The
Merger was financed with approximately $303.7 million of debt, of which $3.7
million was assumed, $4.2 million of cash and $101.3 million of equity. The
merger was a business combination under SFAS No. 141, "Business Combinations,"
and the purchase price paid for our Parent was pushed down to the Company.
Accordingly, the results of operations (unaudited) subsequent to the Acquisition
Date are presented on a different basis of accounting than the results of
operations (unaudited) prior to the Acquisition Date, and therefore, are not
directly comparable. The sale was accounted for as if it had occurred on March
31, 2004, as management determined that results of operations were not
significant and no material transactions occurred during the period from April
1. 2004 to April 7, 2004.
Results of Operations -- Three Months Ended December 31, 2004 Compared to Three
Months Ended December 31, 2003.
The following discussion provides a comparison of the results of operations for
the successor company and that of the predecessor company for the three months
ended December 31, 2004 and 2003, respectively. The discussion is provided for
comparative purposes only, but the value of such comparison may be limited.
Material variances that are caused by the different basis of accounting have
been disclosed where applicable. The following table sets forth the major
components of the Company's consolidated statements of operations expressed as a
percentage of net sales.
Results of Operations
(Dollars in Thousands)
(Unaudited)
Three Months Ended December 31,
2004 (1) % 2003 %
Net sales: Successor Predecessor
Safety Products $ 71,153 74.3 | $ 59,780 75.5
Safety Prescription Eyewear 8,974 9.4 | 9,464 11.9
Specialty Composites 15,634 16.3 | 9,957 12.6
---------- ---- | -------- ----
Total net sales 95,761 100.0 | 79,201 100.0
Cost of sales 48,705 50.9 | 41,776 52.7
---------- ---- | -------- ----
Gross profit 47,056 49.1 | 37,425 47.3
---------- ---- | -------- ----
|
Operating expenses: |
Selling and administrative 31,731 33.1 | 27,471 34.7
Research and technical services 2,220 2.3 | 1,741 2.2
Amortization 1,318 1.4 | 108 0.1
Other income, net (68) (0.1)| (1,042) (1.3)
---------- ---- | -------- ----
Total operating expense 35,201 36.7 | 28,278 35.7
Operating income 11,855 12.4 | 9,147 11.6
Interest expense, net 5,241 5.5 | 5,466 6.9
---------- ---- | -------- ----
Income before taxes 6,614 6.9 | 3,681 4.6
Provision for income taxes 1,596 1.7 | 791 1.0
---------- ---- | -------- ----
Net income $ 5,018 5.2 | $ 2,890 3.6
---------- ---- | -------- ----
(1) Reflects a new basis of accounting subsequent to April 7, 2004 due to the
Merger.
Net sales for the three months ended December 31, 2004 increased 20.9% to $95.8
million from $79.2 million in the three months ended December 31, 2003. The
increase in net sales was primarily driven by organic growth in the Safety
Products and Specialty Composites segments and foreign currency translation. The
weakness of the U.S. dollar favorably impacted net sales by $2.8 million. The
Safety Products segment net sales for the three months ended December 31, 2004
increased 19.0% to $71.2 million from $59.8 million in the three months ended
December 31, 2003. The increase in net sales resulted from a 14.6% increase in
organic growth and a 4.4% increase due to foreign currency translation. Organic
sales growth for the Safety Products segment, defined as net sales less the
impact of foreign currency translation and acquisitions, has increased for ten
consecutive quarters. The Company attributes this growth to an improved economy
and its ability to successfully introduce new products into the markets it
serves. The Safety Prescription Eyewear segment net sales for the three months
ended December 31, 2004 decreased 5.2% to $9.0 million from $9.5 million for the
three months ended December 31, 2003. The decrease in net sales resulted from a
6.1% reduction in volume partially offset by 0.9% increase from foreign currency
translation. Specialty Composites' net sales for the three months ended December
31, 2004 increased 57.0% to $15.6 million from $10.0 million in three months
ended December 31, 2003. The increase was primarily driven by market share gains
and an improving economy driving volume increases in the precision electronics,
truck, aircraft and industrial 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 six quarters. Gross profit for the three
months ended December 31, 2004 increased 25.7% to $47.1 million from $37.4
million for the three months ended December 31, 2003. Gross profit as a
percentage of net sales for the three months ended December 31, 2004 was 49.1%
as compared to 47.3% for the three months ended December 31, 2003. The
improvement in the gross profit percentage is primarily due to favorable product
mix, productivity improvements and the impact of foreign currency translation.
The Safety Products segment gross profit in the three months ended December 31,
2004 increased 22.3% to $36.0 million from $29.4 million in the three months
ended December 31, 2003. The increase in gross profit is primarily due to an
improvement in sales volume due to an improved economy and the Company's ability
to successfully introduce new products into the markets it serves, productivity
improvements and the favorable impact of foreign currency translation. Volume
and productivity improvements contributed approximately 17% of the increase in
gross profit with foreign currency translation contributing the remaining 5% of
the increase. The Safety Prescription Eyewear segment gross profit in the three
months ended December 31, 2004 decreased 7.4% to $4.1 million from $4.4 million
in the three months ended December 31, 2003. The decrease was primarily the
result of a 6.1% reduction due to a decrease in sales volume and a 1.3%
reduction due to sales mix. Specialty Composites' gross profit in the three
months ended December 31, 2004 increased 93.0% to $7.0 million from $3.6 million
in the three months ended December 31, 2003. The increase was primarily driven
by market share gains and an improving economy driving volume increases in the
precision electronics, truck, aircraft and industrial markets, aided by
productivity and improved manufacturing absorption. Approximately 74.0% of the
increase in the Specialty Composites gross profit was due to volume increases
and favorable product mix with the remaining 19% of the increase due to
productivity improvements. Operating expenses for the three months ended
December 31, 2004 increased 24.5% to $35.2 million from $28.3 million for the
three months ended December 31, 2003. The increase in operating expenses was
primarily driven by an increase in selling and administrative amortization
expense and other charges, net. Selling and administrative expenses included
approximately $0.7 million due to foreign currency translation, $1.3 million due
to performance based incentives related to the increase in sales volume, $0.4
million related to freight and distribution with the remaining increase
consistent with the increase in sales volume. Selling and administrative
expenses as a percentage of net sales improved to 33.1% for the three months
ended December 31, 2004 as compared to 34.7% for the three months ended December
31, 2003. Amortization expense increased approximately $1.2 million due to the
preliminary allocation of purchase price to finite lived intangible assets
required by SFAS No. 141 due to the Merger Agreement. The increase in other
charges, net was attributed to the less favorable impact of foreign currency
transaction expenses in the three months ended December 31, 2004 as compared to
December 31, 2003. Interest expense, net, for the three months ended December
31, 2004 decreased to $5.2 million from $5.5 million for the three months ended
December 31, 2003. The decrease is due to lower weighted average interest rates
under the Company's new credit facility and the 8.25% senior subordinated notes,
partially offset by the increase in the level of the Company's debt. The
provision for income taxes for the three months ended December 31, 2004 was $1.6
million compared to $0.8 million for the three months ended December 31, 2003.
The effective tax rate for the three months ended December 31, 2004 and 2003 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 losses for income tax purposes. Due to the uncertainty of
realizing these tax benefits, the tax benefits for net operating losses have
been partially offset by a valuation allowance.
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, from time to time, will utilize
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.
The Company's debt structure includes: (a) $175.0 million of 8.25% Senior
Subordinated Notes ("8.25% Notes") due 2012, (b) up to an aggregate of $175.0
million under its Credit Agreement with various banks comprised of (i) a secured
term loan facility consisting of loans providing for up to $125.0 million of
term loans (collectively the "Term Loans") with a portion of the Term Loans
denominated in Euros, (ii) a secured revolving credit facility ("Revolving
Credit Facility") providing for up to $50.0 million of revolving loans for
general corporate purposes, and (iii) an uncommitted incremental term loan
facility of up to $60 million for acquisitions (collectively, the "Senior Bank
Facilities"). The amounts outstanding on the Term Loans and Revolving Credit
Facility at September 30, 2004, were approximately $126.0 and $0 million,
respectively. The Company's debt has been negatively impacted by $6.3 million
related to the fluctuation of the euro relative to the U.S dollar as of December
31, 2004. The amounts outstanding on the Term Loans and Revolving Credit
Facility at December 31, 2004, were approximately $130.3 and $0 million,
respectively. The Revolving Credit Facility provides for the issuance of letters
of credit in an aggregate face amount of up to $15.0 million. The Company had
approximately $1.4 million and $1.6 million of letters of credit outstanding at
September 30, 2004 and December 31, 2004, respectively. The Term Loans amortize
quarterly over a seven-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 April 7, 2010. The Term Loans mature on April 7, 2011. Effective
December 31, 2004, the Company received a 0.25% reduction in the interest rate
paid on its Term Loans for meeting certain financial covenants. The Company was
in compliance with all financial covenants and restrictions as of December 31,
2004.
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 $1.5 million and $2.4 million, respectively for capital
expenditures for the three months ended December 31, 2004 and 2003,
respectively. The Company anticipates it will spend approximately $11.0 million
for capital expenditures in its fiscal year ending September 30, 2005.
The Company's net cash provided by operating activities for the three months
ended December 31, 2004 totaled $1.4 million as compared to $7.0 million for the
three months ended December 31, 2003. The decrease of $5.6 million was primarily
due to an $8.6 million decrease related to the net changes in assets and
liabilities, partially offset by a $2.9 million 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 interest payable of $6.9 million due
to the change in timing of the payment for the senior subordinated notes as a
result of the merger. The remaining change was due to a decrease from
receivables, accounts payable and accrued liabilities and other, net, partially
offset by an increase in cash from inventories and income taxes payable.
Net cash used for investing activities was $1.5 million for the three months
ended December 31, 2004 as compared to $2.3 million for the three months ended
December 31, 2003. The decrease in net cash used by investing activities is
primarily attributed to reduced spending for property, plant and equipment.
Net cash used for financing activities for the three months ended December 31,
2004 was $0.6 million compared with $5.7 million for the three months ended
December 31, 2003. The change is primarily due to the lower debt servicing
requirement under the Company's new credit facility as compared to the debt
servicing requirements under the old credit facility.
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. To develop the expected
long-term rate of return on assets assumption, the Company considered historical
returns and future expectations for returns for each asset class, as well as the
target asset allocation of the pension portfolio. Over the 11 year period ended
September 30, 2004, the returns on the portfolio, assuming it was invested at
the current target asset allocation in prior periods, would have been a compound
annual average return of 9.3%. Considering this information and the potential
for lower future returns due to the generally lower interest rate environment,
the Company selected an 8.0% rate of return on plan asset assumption. Actual
asset returns for the Company's pension plan improved in the last two fiscal
years after two years of negative returns. 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 annual pension expense. The discount rate was also unchanged
at 6.0% for the fiscal year ended September 30, 2004. 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 $0.1 million impact on annual 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
contributions were required to be made in fiscal 2004. The following benefit
payments, which reflect expected future service, as appropriate, are expected to
be paid (in thousands of dollars):
Fiscal year 2005 $ 1,121
Fiscal year 2006 466
Fiscal year 2007 618
Fiscal year 2008 830
Fiscal year 2009 1,214
Fiscal year 2010 - 2014 6,784
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, capital expenditures and debt service
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.
Contractual Obligations
The Company has the following minimum commitments under contractual obligations
including purchase obligations by fiscal year, as defined by the U.S. Securities
and Exchange Commission as of December 31, 2004:
2010 and
2005 2006-2007 2008-2009 after Total
Capital lease obligations $ 264 $ 705 $ 368 $ 32 $ 1,369
Operating lease obligations 2,650 5,815 5,064 5,546 19,075
Mortgage obligations 269 2,048 -- -- 2,317
Purchase obligations 2,746 3,479 3,201 -- 9,426
Respiratory commitment 300 800 800 800 2,700
Long term debt 16,346 43,403 43,173 320,028 422,950
-------- -------- -------- ---------- -----------
Total $ 22,575 $ 56,250 $ 52,606 $ 326,406 $ 457,837
-------- -------- -------- ---------- -----------
The amounts for long term debt above include both interest and principal
payments. The Company paid approximately $4.7 million for taxes worldwide in
fiscal 2004 and does not anticipate significant changes to its tax obligations
in the future. The Company has approximately $1.4 million of letters of credit
outstanding as of December 31, 2004 and does not anticipate significant changes
to its outstanding letters of credit in the future.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements or financing arrangements
involving variable interest entities.
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
from time to time are for purposes other than trading. The Company accounts for
derivatives pursuant to SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities", as amended. 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, 2004 and 2003, net
transaction exposures were a loss of $0.1 million for each period. For the three
months ended December 31, 2004 and 2003, cash flow exposures were $0.0 million
and a loss of $0.2 million, respectively. In addition, the Company limits the
foreign exchange impact on the balance sheet with foreign denominated debt in
euros.
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. Since
the Company had no open forward foreign currency contracts as of December 31,
2004, the Company had recorded no derivative asset or liability at December 31,
2004. As a result of open forward foreign currency contracts, the Company had a
derivative payable of $0.4 million as of September 30, 2004.
The Company may 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 results of operations. The impact on
results of operations was a loss of approximately $0.1 million, for the three
months ended December 31, 2004 and 2003, respectively.
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 had approximately $30.5 million of variable rate debt protected
under an interest rate cap arrangement, which expired December 31, 2004. The
Company had not elected hedge accounting treatment for the interest rate cap as
defined under SFAS No, 133 and, as a result, any fair value adjustment was
charged directly to other charges (income), net. During the three months ended
December 31, 2004, 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.
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,
2004, 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, 2004, that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
See Index of Exhibits on page 33 hereof.
(b) Reports on Form 8-KOn November 17, 2004, the Company filed a Current Report
on Form 8-K to announce the appointment of a new Director.
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 14, 2005 AEARO COMPANY I
/s/ Michael A. McLain
_______________________________________
Michael A. McLain
Chairman and Chief Executive Officer
(Principal Executive Officer)
/s/ Jeffrey S. Kulka
_______________________________________
Jeffrey S. Kulka
Senior Vice President, Chief Financial
Officer and Secretary
(Principal Financial and Accounting Officer)
EXHIBIT INDEX
EXHIBITS DESCRIPTION
31.1 Certification of Chief Executive Officer pursuant to Rule 15d-14(a) of the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Rule 15d-14(a) of the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.