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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 March 31, 2005
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 IRS Employer Identification No.)
of 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)
_______________________
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 May 9, 2005 was 100.
AEARO COMPANY I
TABLE OF CONTENTS
Form 10-Q for the Quarterly Period Ended March 31, 2005
PART I-FINANCIAL INFORMATION...................................................3
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 .........................................................25
Item 3.Quantitative and Qualitative Disclosures About Market Risk.............36
Item 4.Controls and Procedures ...............................................38
PART II - OTHER INFORMATION...................................................39
Item 6.Exhibits and Reports on Form 8-K.......................................39
SIGNATURES....................................................................40
EXHIBIT INDEX.................................................................41
PART I-FINANCIAL INFORMATION
Item 1. Financial Statements
AEARO COMPANY I AND SUBSIDIARIES
Consolidated Balance Sheets - Assets
(In Thousands)
March 31, September 30,
2005 2004
------------ -------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 40,947 $ 27,724
Accounts receivable (net of allowance for
doubtful accounts of$1,439 and $1,358, respectively) 56,497 54,159
Inventories 40,913 40,849
Deferred and prepaid expenses 6,603 4,146
-------------- ------------
Total current assets 144,960 126,878
-------------- ------------
LONG TERM ASSETS:
Property, plant and equipment, net 53,213 54,750
Goodwill, net 120,691 133,745
Other intangible assets, net 183,321 185,855
Other assets 15,235 15,144
-------------- ------------
Total assets $ 517,420 $ 516,372
=============== ==============
The accompanying notes are an integral part of these consolidated financial
statements
3
AEARO COMPANY I AND SUBSIDIARIES
Consolidated Balance Sheets - Liabilities and Stockholder's Equity
(In Thousands, Except for Per Share and Share Amounts)
March 31, September 30,
2005 2004
--------------- -------------
(Unaudited)
CURRENT LIABILITIES:
Current portion of long-term debt $ 1,656 $ 1,639
Accounts payable and accrued liabilities 47,612 46,730
Accrued interest 6,679 6,996
Accrued income taxes 2,179 1,648
--------------- ----------
Total current liabilities 58,126 57,013
--------------- ----------
LONG TERM LIABILITIES:
Long-term debt 304,044 302,842
Deferred income taxes 40,053 59,699
Other liabilities 14,794 14,726
--------------- ----------
Total liabilities 417,017 434,280
--------------- ----------
STOCKHOLDER'S EQUITY:
Common stock, $.01 par value-
Authorized--100 shares
Issued and outstanding--100 shares - -
Paid in capital 101,630 101,610
Accumulated deficit (2,296) (19,415)
Accumulated other comprehensive income (loss) 1,069 (103)
--------------- -----------------
Total stockholder's equity 100,403 82,092
--------------- -----------------
Total liabilities and stockholder's equity $ 517,420 $ 516,372
=============== =================
The accompanying notes are an integral part of these consolidated financial
statements
4
AEARO COMPANY I AND SUBSIDIARIES
Consolidated Statements of Operations
(In Thousands)
(Unaudited)
Three Months Ended Six Months Ended
March 31, March 31,
2005 2004 2005 2004
Successor Predecessor Successor Predecessor
Net sales $ 104,478 $ 90,378 $ 200,239 $ 169,579
Cost of sales 52,928 47,280 101,633 89,056
----------- ------------ ----------- -----------
Gross profit 51,550 43,098 98,606 80,523
Selling and administrative 32,680 29,364 64,411 56,835
Research and technical services 2,211 1,883 4,431 3,623
Amortization 1,297 134 2,615 242
Other (income) charges, net 380 535 312 (506)
Restructuring -- (1,091) -- (1,091)
------------ ---------- --------- ------------
Operating income 14,982 12,273 26,837 21,420
Interest expense, net 5,688 5,370 10,929 10,836
------------ ---------- --------- ------------
Income before provision for
income taxes 9,294 6,903 15,908 10,584
Provision (benefit) for income taxes (2,807) 1,229 (1,211) 2,020
----------- --------- --------- ------------
Net income $ 12,101 $ 5,674 $ 17,119 $ 8,564
----------- --------- ---------- ------------
The accompanying notes are an integral part of these consolidated financial
statements
5
AEARO COMPANY I AND SUBSIDIARIES
Consolidated Statement of Stockholder's Equity
(In Thousands, Except Share Amounts)
Additional Retained Accumulated
Paid Earnings/ Other Comprehensive
Common In (Accumulated 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) (103) $ (103)
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 - - - 17,119 - 17,119 $ 17,119
Foreign currency translation
adjustment - - - - 1,172 1,172 1,172
Vesting of restricted stock - - 20 - 20 -
-------------
Comprehensive income - - - - - - $ 18,291
=============
------- -------- ---------- ----------- ------------- ---------
Balance, March 31, 2005 100 $ - $ 101,630 $ (2,296) $ 1,069 $100,403
======= ======== ========== =========== ============= =========
The accompanying notes are an integral part of these consolidated financial
statements
6
AEARO COMPANY I AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)
For the Six Months Ended
March 31,
----------------------------
2005 | 2004
---------------|------------
CASH FLOWS FROM OPERATING ACTIVITIES: Successor | Predecessor
Net income $ 17,119 | $ 8,564
Adjustments to reconcile net income to cash |
provided by operating activities- |
Depreciation 5,006 | 5,931
Amortization of intangible assets 2,615 | 2,283
Amortization of deferred financing costs 721 | (15)
Deferred income taxes (4,066) | --
Stock based compensation 20 |
Restructuring -- | (1,091)
Loss on disposal of assets 61 | 682
Changes in assets and liabilities- |
Accounts receivable (1,556) | (1,113)
Inventories 326 | (3,464)
Income taxes payable 430 | (1,453)
Interest payable (317) | 270
Accounts payable and accrued liabilities (2,118) | (3,491)
Prepaid expenses and other assets (764) | 633
Other liabilities (91) | 1,299
--------- | ---------
Net cash provided by operating activities 17,386 | 9,035
--------- | ---------
CASH FLOWS FROM INVESTING ACTIVITIES: |
Additions to property, plant and equipment (3,189) | (5,006)
Proceeds provided by disposals of property, 23 | 12
plant and equipment --------- | ---------
Net cash used by investing activities (3,166) | (4,994)
|
CASH FLOWS FROM FINANCING ACTIVITIES: |
Proceeds from revolving credit facility, net -- | 3,950
Repayment of term loans (647) | (8,949)
Repayment of capital lease obligations (132) | (122)
Repayment of long term debt (248) | (119)
--------- | ---------
Net cash used for financing activities (1,027) | (5,240)
--------- | ---------
EFFECT OF EXCHANGE RATE ON CASH 30 | (789)
|
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 13,223 | (1,988)
|
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 27,724 | 7,301
--------- | ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 40,947 |$ 5,313
--------- | ---------
CASH PAID FOR: |
Interest $ 10,969 |$ 8,862
======= | =======
Income taxes $ 2,718 |$ 3,254
======= | =======
The accompanying notes are an integral part of these consolidated financial
statements
7
AEARO COMPANY I AND SUBSIDIARIES
Notes to Consolidated Financial Statements
MARCH 31, 2005
(Unaudited)
1) 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 $409.3 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, $4.3 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 adjustment made to deferred tax liabilities and
goodwill during the six months ended March 31, 2005, reflect the adjustment
8
of the purchase price allocation to identifiable intangible assets and the
related deferred tax liabilities for differences between book and tax basis
of those assets as a result of finalizing the tax basis of certain assets.
The purchase price has been 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 117,629
-------
Purchase price $ 409,344
=======
Goodwill as a result of the Merger is not deductible for tax purposes.
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. The Company offers its customers three types of
incentive programs: a sales rebate/volume discount program, a marketing
incentive program and a co-operative advertising program. The sales
rebate/volume discount program is based on achieved volume levels along
with growth incentives over the prior year's sales dollars. Rebate
obligations are estimated based on current sales levels and are recorded as
a reduction of revenue when sales to the customer make progress towards the
required sales level. The marketing incentive program provides qualifying
customers with funds to assist the customers with marketing the Company's
products. The funds provided to the qualifying customers are recorded as a
reduction of revenue when sales to the customer make progress towards the
required sales level. The co-operative advertising program provides funds
to specific customers to advertise the Company's products. The qualifying
customers provide specific documentation of the advertising to the Company
to assure that the benefit received is comparable to other arms length
advertising expenditures undertaken by the Company. The amount of
co-operative advertising charged to selling and administrative expenses for
the three months ended March 31, 2005 and 2004 were $0.6 million and $0.5
million, respectively. The amount of co-operative advertising charged to
selling and administrative expenses for the six months ended March 31, 2005
and 2004 were $1.1 million and $0.9 million, respectively.
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
9
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.
Cost of Goods Sold. Cost of goods sold includes all costs to
manufacture the Company's products including raw materials, which include
inbound freight and import duties, direct labor, plant supervision,
maintenance labor and parts, quality control, receiving, purchasing,
production planning, manufacturing supplies, scrap, rework, utilities,
depreciation, property taxes, sales and use taxes and insurance.
Selling and Administrative Expenses. Selling and administrative
expenses include salaries and benefits for selling, marketing, customer
service, finance and human resources personnel, direct marketing expenses,
trade show expenses, commissions, selling expenses, bad debts, advertising,
travel and entertainment, office supplies, recruiting, relocation, legal
expenses, accounting fees, consulting and warehousing and logistics
expenses incurred after the point of manufacture.
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. At September 30, 2004, the
Company's deferred tax asset from the benefit of net operating losses were
partially offset by a valuation allowance of $7.5 million. During the three
month period ended March 31, 2005, management determined that based on
current domestic operating results, it is more likely than not that
domestic net operating losses will be realized and consequently reversed
the $7.5 million valuation allowance.
The Company is included in the consolidated tax return filed by AC
Safety Holding Corp. All taxes are recorded as if separate, stand alone
returns were filed.
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 March 31, 2005, resulting from the Merger:
Gross Accumulated Carrying
September 30, 2004 Amount Amortization Additions 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
======= ======= === =======
10
Gross Accumulated Carrying
March 31, 2005 (Unaudited) Amount Amortization Additions Amount
-------------------------- ------- ------------- --------- --------
Trademarks $ 114,300 $ -- $ -- $ 114,300
Customer Relationship List 73,000 (4,867) -- 68,133
Patents 842 (245) 41 638
Other 385 (135) -- 250
------- ------- ----- ----------
Total Intangibles $ 188,527 $ (5,247) $ 41 $ 183,321
======= ======= ===== ==========
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 allocation of goodwill resulting from the
Merger and the changes in the carrying amount of goodwill for the six
months ended March 31, 2005 (dollars in thousands):
Six Months
Ended
March 31,
2005
-----
Beginning balance $ 133,745
Allocation adjustment (15,518)
Translation adjustment 2,464
---------
Ending balance $ 120,691
=========
The allocation adjustment in the six months ended March 31, 2005,
reflects the adjustment of the purchase price allocation to identifiable
intangible assets and the related deferred tax liabilities for differences
between book and tax basis of those assets as a result of finalizing the
tax basis of certain assets.
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.
11
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 Six Months Ended
March 31, March 31,
2005 | 2004 2005 | 2004
---- | ---- ---- | ----
Successor | Predecessor Successor | Predecessor
Net income as reported $ 12,101 | $ 5,674 $ 17,119 | $ 8,564
Stock based compensation expense | |
recorded under APB No. 25, net of tax -- | -- -- | --
Stock-based compensation expense | |
determined under the fair value | |
mthod, net of tax (20) | (34) (51) | (67)
--------- --------- ------- | -------
Proforma net income $ 12,081 | $ 5,640 $ 17,068 | $ 8,497
========= ========= ======= =======
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 March 31, 2005, the
Company had no forward foreign currency contracts or interest rate
derivatives as defined under SFAS No. 133. For the three and six month
periods ended March 31, 2004, the Company reclassified into earnings net
losses of $0.4 million and $0.5 million, respectively 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 a $0.1 million impact on earnings for the six month period ended March
31, 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. The impact on earnings was a loss of approximately $0.1 million
12
and $0.2 million for the three and six months period ending March 31, 2005,
respectively, compared to net loss of $0.2 million and $0.4 million,
respectively for the three and six months ended, March 31, 2004,
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. 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 and six month
period ended March 31, 2005, the mark to market revaluation of the embedded
call option was a loss of approximately $0.1 million in other (income)
charges, net. The resulting amortization of the corresponding liability
resulted in a reduction in interest expense of approximately $0.2 million
for the six months ended March 31, 2005.
4) Other Comprehensive Income
The following table presents the reclassification amounts related to
unrealized holding gains and losses presented in the statement of
stockholder's equity for the three and six month periods ended March 31,
2005 and 2004, respectively (dollars in thousands):
Three Months Ended Six Months Ended
March 31, March 31,
2005 | 2004 2005 | 2004
---- | ---- ---- | ----
Successor | Predecessor Successor | Predecessor
Unrealized holding losses on derivatives | |
during the period $ -- | $ (390) $ -- | $ (522)
Less: reclassification adjustment for | |
gains (losses) included in the statement | |
of operations -- | (390) | (522)
------- | ------- ------- | ------
Proforma net income $ -- | $ -- $ -- | $ --
======= | ======= ======= | ======
5) Inventories
Inventories consisted of the following (dollars in thousands):
March 31, September 30,
2005 2004
------------------- --------------
(Unaudited)
Raw materials $ 10,105 $ 9,302
Work in process 9,130 12,087
Finished goods 21,678 19,460
------------------- --------------
$ 40,913 $ 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.
13
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 $60.0 million for acquisitions (collectively, the "Senior
Bank Facilities"). Since the Acquisition Date, the Company's debt has been
negatively impacted by $3.9 million related to the fluctuation of the Euro
relative to the U.S dollar as of March 31, 2005. The Company does not plan
to take any measure to minimize the foreign exchange impact of its Euro
denominated debt. The amounts outstanding on the Term Loans and Revolving
Credit Facility at March 31, 2005, were approximately $127.6 and $0
million, respectively compared to $126.0 million and $0 million,
respectively at September 30, 2004. 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 March 31, 2005,
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 March 31,
2005.
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.
Many 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
14
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.
In fiscal 2003 and 2004, Aearo settled 259 claims in which it was
named as a defendant for an average settlement amount of $24.36 in silica
claims and $83.24 in asbestos claims, while an additional 200 claims were
dismissed without any payment (43.6% of cases closed), because Aearo was
not a proper defendant or did not make the product in question. As of
September 30, 2004, the number of open claims where Aearo was named as a
defendant in silica and asbestos related matters was 11,002 and 4,261,
respectively. For the six months ended March 31, 2005, the increases in
number of claims where Aearo was named as a defendant in silica and
asbestos related matters was 106 and 1,200 respectively. The 1,200 new
asbestos claims include 1,148 claims that allege exposure from clothing,
which the Company never manufactured. No claims were settled where Aearo
was named as a defendant in silica and asbestos related matters during the
six months ended March 31, 2005. As of March 31, 2005, the number of open
claims where Aearo was named as a defendant in silica and asbestos related
matters was 11,108 and 5,461, respectively.
In addition to the above claims, Aearo may agree to pay a share of the
settlement and defense costs in particular cases even though the company is
not named as a defendant because of agreements with prior owners of the
brand and/or because of allegations that Aearo has some risk of legal
liability as a successor ("additional claims"). During the six months ended
March 31, 2005, Aearo paid a total of $1.67 million for settlement,
administrative and defense costs resulting in the settlement of 4,325
silica and asbestos claims that were settled between October 1, 2002 and
September 30, 2004 involving both claims in which Aearo was named as a
defendant and additional claims. During the period October 1, 2004 to March
31, 2005 Aearo paid a total of one hundred dollars for one additional claim
that was settled during that time period. In addition, Aearo may receive
the benefit of releases in some additional cases settled by the AO Defense
Group regardless of whether or not any claim was made against Aearo.
All data was provided by an outside law firm which tracks numbers of
cases and settlements on behalf of the "AO Defense Group" and is believed
to be materially accurate. The AO Defense Group is a voluntary association
of current and former manufacturers of the "AO Safety" brand of respirators
and certain of their insurers in which Aearo participates and through which
all of its settlements have been handled in the relevant years. Also,
between October 1, 2004 and March 31, 2005, there may have been claims
settled by and fully funded by the insurers of Eastern Safety Equipment
Co., Inc., a dissolved former subsidiary of Aearo.
15
At March 31, 2005 and September 30, 2004, the Company has recorded
liabilities of approximately $4.3 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. The $0.7 million reduction in the reserve, net of new accruals
which added to the reserve, since September 30, 2004 is primarily
attributed to the payment of $1.67 million, as referenced above, to pay
costs attributed to settlement, administrative and defense costs that had
been reached over a two year time period. This reserve is re-evaluated
periodically and additional charges or credits to results of operations may
result as additional information becomes available. 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 2009 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. The factors used for determining the
Company's reportable segments were predominantly based on the nature and
type of product sold.
16
Net Sales by Business Segment (dollars in thousands):
Three Months Ended Six Months Ended
March 31, March 31,
2005 2004 2005 2004
Successor | Predecessor Successor | Predecessor
(Unaudited) | (Unaudited) (Unaudited) | (Unaudited)
Safety Products $ 78,612 | $ 68,184 $ 149,765 | $ 127,964
Safety Prescription Eyewear 10,239 | 10,873 19,213 | 20,337
Specialty Composites 15,627 | 11,321 31,261 | 21,278
----------| ---------- ---------- | ----------
Total $ 104,478 | $ 90,378 $ 200,239 | $ 169,579
======= | ========== ========== | ==========
Inter-segment sales from the Specialty Composites segment to the
Safety Products segment totaled $1.0 million and $0.8 million for the three
months ended March 31, 2005 and 2004, respectively. Inter-segment sales
from the Specialty Composites segment to the Safety Products segment
totaled $2.1 million and $1.5 million for the six months ended March 31,
2005 and 2004, respectively. The inter-segment sales value is determined at
fully absorbed inventory cost at standard rates plus 25%. The Company does
not have a single customer in any of its three reportable segments that
accounts for more than 10% of segment revenues in any of the periods
presented.
Profit (loss) by business segment and reconciliation to income before
income taxes (dollars in thousands):
Three Months Ended Six Months Ended
March 31, March 31,
2005 2004 2005 2004
Successor | Predecessor Successor | Predecessor
(Unaudited) | (Unaudited) (Unaudited) | (Unaudited)
Safety Products $ 15,634 | $ 12,474 $ 27,848 | $ 23,704
Safety Prescription Eyewear (16) | 157 (341) | (57)
Specialty Composites 3,090 | 1,687 6,951 | 2,855
--------- | --------- -------- | --------
Segment profit 18,708 | 14,318 34,458 | 26,502
| |
Depreciation 2,429 | 3,002 5,006 | 5,931
Amortization of intangibles 1,297 | 134 2,615 | 242
Restructuring -- | (1,091) -- | (1,091)
Interest 5,688 | 5,370 10,929 | 10,836
--------- | --------- -------- | ---------
Income before income taxes $ 9,294 | $ 6,903 $ 15,908 | $ 10,584
========= ========= ========= =========
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.
17
9) Pension
The following table presents the components of net periodic pension
cost for the three and six month periods ended March 31, 2005 and 2004
(dollars in thousands):
Three Months Ended Six Months Ended
March 31, March 31,
2005 2004 2005 2004
Successor | Predecessor Successor | Predecessor
(Unaudited)| (Unaudited) (Unaudited) | (Unaudited)
Service cost $ 364 | $ 335 $ 725 | $ 670
Interest cost 206 | 186 412 | 371
Expected return on plan assets (184) | (166) (368) | (332)
Amortization of prior service cost -- | 2 -- | 5
--------- | --------- -------- | --------
Total $ 386 | $ 357 $ 769 | $ 714
========= | ========= ======== | ========
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 March 31, 2005, 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) Subsequent Events
On April 28, 2005, the Company amended its credit agreement to allow
the Company to make, prior to September 30, 2005, up to $35 million of cash
distributions to Aearo Corporation, its parent corporation for the purpose
of paying cash dividends to AC Safety Holding Corp., its parent, to be used
by AC Safety Holding Corp. primarily to redeem, pro rata, its outstanding
preferred shares and to pay accrued dividends on the preferred shares.
On May 4, 2005, the Company's Board of Directors declared a cash dividend
to be paid to the Company's parent, Aearo Corporation, the sole holder of
common stock, par value $.01 per share, of approximately $35 million. Aearo
Corporation will in turn pay a cash dividend to AC Safety Holding Corp.,
the Company's ultimate parent, who will use the proceeds to make a partial
redemption of its preferred stock, par value $.01 per share. The Company
will use available cash to fund the dividend.
18
11) 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. 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)
Six Months Ended March 31, 2005
Successor
-------------------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I SubsidiariesSubsidiariesEliminationsConsolidated
Net sales.......................... $148,332 $ -- $ 73,602 $ (21,695) $ 200,239
Cost of sales...................... 83,479 -- 39,797 (21,643) 101,633
------- ------- -------- -------- --------
Gross profit..................... 64,853 -- 33,805 (52) 98,606
Selling and administrative......... 46,215 2,527 15,669 -- 64,411
Research and technical services.... 2,785 -- 1,646 -- 4,431
Amortization....................... 1,851 124 640 -- 2,615
Other charges (income), net........ 8,552 (13,364) 5,124 -- 312
------- ------- -------- -------- --------
Operating income (loss)......... 5,450 10,713 10,726 (52) 26,837
Interest expense (income).......... 10,687 (1,641) 1,883 -- 10,929
------- ------- -------- -------- --------
Income (loss) before taxes......... (5,237) 12,354 8,843 (52) 15,908
Income tax provision (benefit)..... (9,671) 5,092 3,368 -- (1,211)
Equity in subsidiaries' earnings... 12,737 5,475 (18,212) --
------- ------- -------- -------- --------
Net income...................... $17,171 $ 12,737 $ 5,475 $ (18,264) $ 17,119
======== ======== ======== ======== ========
19
Consolidated Statement of Operations (Unaudited)
Six Months Ended March 31, 2004
Predecessor
-------------------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I Subsidiaries Subsidiaries Eliminations Consolidated
Net sales............................. $122,913 $ -- $ 65,030 $ (18,364) $ 169,579
Cost of sales......................... 71,142 -- 36,348 (18,434) 89,056
--------- ------ -------- -------- --------
Gross profit........................ 51,771 -- 28,682 70 80,523
Selling and administrative............ 42,612 674 13,549 -- 56,835
Research and technical services....... 2,351 -- 1,272 -- 3,623
Amortization.......................... 168 74 -- -- 242
Other charges (income), net........... 6,815 (12,283) 4,962 -- (506)
Restructuring charges (income)........ (1,091) -- -- -- (1,091)
--------- ------ -------- -------- --------
Operating income................... 916 11,535 8,899 70 21,420
Interest expense (income), net........ 10,117 (983) 1,702 -- 10,836
--------- ------ -------- -------- --------
Income (loss) before taxes............ (9,201) 12,518 7,197 70 10,584
Income tax provision (benefit)........ (4,642) 5,022 1,640 -- 2,020
Equity in subsidiaries' earnings...... 13,053 5,557 (18,610) --
--------- ------ -------- -------- --------
Net income......................... $ 8,494 $ 13,053 $ 5,557 $ (18,540) $ 8,564
======== ======== ======== ========= ========
Consolidated Statement of Operations (Unaudited)
Three Months Ended March 31, 2005
Successor
------------------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I Subsidiaries Subsidiaries Eliminations Consolidated
---------- ------------ ------------ ------------ ------------
Net sales............................. $ 76,633 $ -- $ 38,558 $ (10,713) $ 104,478
Cost of Sales......................... 43,045 -- 20,552 (10,669) 52,928
--------- ------ -------- -------- --------
Gross profit....................... 33,588 -- 18,006 (44) 51,550
Selling and administrative............ 24,437 127 8,116 -- 32,680
Research and technical services....... 1,442 -- 769 -- 2,211
Amortization.......................... 917 60 320 -- 1,297
Other charges (income), net........... 4,573 (6,905) 2,712 -- 380
--------- ------ -------- -------- --------
Operating income................... 2,219 6,718 6,089 (44) 14,982
Interest expense (income)............. 5,569 (1,294) 1,413 -- 5,688
--------- ------ -------- -------- --------
Income (loss) before taxes............ (3,350) 8,012 4,676 (44) 9,294
Income tax provision (benefit)........ (7,893) 3,049 2,037 -- (2,807)
Equity in subsidiaries' earnings...... 7,602 2,639 (10,241) --
--------- ------ -------- -------- --------
Net income......................... $ 12,145 $ 7,602 $ 2,639 $ (10,285) $ 12,101
========== ======== ======== ========= =========
20
Consolidated Statement of Operations (Unaudited)
Three Months Ended March 31, 2004
Predecessor
-------------------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I SubsidiariesSubsidiariesEliminationsConsolidated
Net sales................................. $ 64,726 $ -- $ 34,388 $ (8,736) $ 90,378
Cost of sales............................. 37,627 -- 18,507 (8,854) 47,280
--------- ------ -------- -------- --------
Gross profit............................ 27,099 -- 15,881 118 43,098
Selling and administrative................ 22,075 445 6,844 -- 29,364
Research and technical services........... 1,195 -- 688 -- 1,883
Amortization.............................. 84 50 -- -- 134
Other charges (income), net............... 3,728 (5,718) 2,525 -- 535
Restructuring charges (income)............ (1,091) -- -- -- (1,091)
--------- ------ -------- -------- --------
Operating income....................... 1,108 5,223 5,824 118 12,273
Interest expense (income), net............ 4,988 (448) 830 -- 5,370
--------- ------ -------- -------- --------
Income (loss) before taxes................ (3,880) 5,671 4,994 118 6,903
Income tax provision (benefit)............ (1,893) 2,078 1,044 -- 1,229
Equity in subsidiaries' earnings.......... 7,543 3,950 (11,493) --
--------- ------ -------- -------- --------
Net income............................. $ 5,556 $ 7,543 $ 3,950 $ (11,375) $ 5,674
========== ======== ======== ========= =========
21
Consolidated Balance Sheet (Unaudited)
March 31, 2005
Non-
Aearo Guarantor Guarantor
Company I Subsidiaries Subsidiaries Eliminations Consolidated
--------- ------------ ------------ ------------ ------------
Current Assets:
Cash and cash equivalents.............. $ 32,803 $ 191 $ 7,953 $ -- $ 40,947
Receivables, net....................... 36,942 -- 19,555 -- 56,497
Inventories............................ 29,778 -- 11,496 (361) 40,913
Deferred and prepaid expenses.......... 5,330 -- 1,273 -- 6,603
--------- ------ -------- -------- --------
Total current assets...................... 104,853 191 40,277 (361) 144,960
--------- ------ -------- -------- --------
Long Term Assets:
Property plan and equipment............ 38,214 -- 14,999 -- 53,213
Goodwill and other intangibles, net.... 91,122 122,273 90,617 -- 304,012
Inter-company receivables (payables)... (52,476) 95,877 (43,401) -- --
Investment in subsidiaries ............ 247,066 67,292 (734) (313,624) --
Other assets........................... 15,224 -- 11 -- 15,235
--------- ------ -------- -------- --------
Total assets.............................. $444,003 $285,633 $101,769 $(313,985) $ 517,420
========== ======== ======== ========= =========
Current Liabilities:
Current portion of long term debt...... $ 1,656 $ -- $ -- $ -- $ 1,656
Accounts payable and accrued
liabilities............................ 33,347 333 13,932 -- 47,612
Accrued interest....................... 6,679 -- -- -- 6,679
Income tax payables (receivables)...... 2,451 (2,482) 2,210 2,179
--------- ------ -------- -------- --------
Total current liabilities................. 44,133 (2,149) 16,142 -- 58,126
--------- ------ -------- -------- --------
Long Term Liabilities:
Long term debt......................... 304,044 -- -- -- 304,044
Deferred income taxes.................. 2,955 23,860 13,238 -- 40,053
Other liabilities...................... 14,794 -- -- -- 14,794
--------- ------ -------- -------- --------
Total liabilities......................... 365,926 21,711 29,380 -- 417,017
--------- ------ -------- -------- --------
Stockholder's Equity:
Common................................. -- -- 4,222 (4,222) --
Paid in capital........................ 101,630 267,796 41,765 (309,561) 101,630
Accumulated deficit.................... (20,392) (8,961) 31,643 (4,586) (2,296)
Accumulated other comprehensive income
(loss)................................. (3,161) 5,087 (5,241) 4,384 1,069
--------- ------ -------- -------- --------
Total stockholder's equity................ 78,077 263,922 72,389 (313,985) 100,403
--------- ------ -------- -------- --------
Total liabilities and stockholder's equity $444,003 $285,633 $101,769 $(313,985) $ 517,420
========== ======== ======== ========= =========
22
Consolidated Balance Sheet
September 30, 2004
Non-
Aearo Guarantor Guarantor
Company I Subsidiaries Subsidiaries Eliminations Consolidated
--------- ---------- ------------ ------------ ------------
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
========== ======== ======== ========= =========
23
Consolidating Statement of Cash Flows (Unaudited)
Six Months Ended March 31, 2005
Successor
-------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I Subsidiaries Subsidiaries Consolidated
--------- ------------ ------------ ------------
Net cash provided by operating activities. $ 9,516 $ 6,169 $ 1,701 $ 17,386
Net cash used for investing activities.... (1,978) -- (1,188) (3,166)
Net cash provided by (used for) financing
activities............................. 6,734 (7,560) (201) (1,027)
Effect of exchange rate on cash........... 222 1,442 (1,634) 30
------ -------- -------- --------
Increase (decrease) in cash and cash
equivalents............................ 14,494 51 (1,322) 13,223
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............................. $ 32,803 $ 191 $ 7,953 $ 40,947
========== ======== ======== =========
A
Consolidating Statement of Cash Flows (Unaudited)
Six Months Ended March 31, 2004
Predecessor
-------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I Subsidiaries Subsidiaries Consolidated
--------- ------------ ------------ ------------
Net cash provided by (used for) operating
activities............................. $ (1,359) $ 6,407 $ 3,987 $ 9,035
Net cash used for investing activities.... (3,326) -- (1,668) (4,994)
Net cash provided by (used for) financing
activities............................. 3,255 (6,840) (1,655) (5,240)
Effect of exchange rate on cash........... 779 978 (2,546) (789)
------ -------- -------- --------
Increase (decrease) in cash and cash
equivalents............................ (651) 545 (1,882) (1,988)
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............................. $ 893 $ 751 $ 3,669 $ 5,313
========== ======== ======== =========
24
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 $409.3 million, including estimated fees and
expenses. The Merger was financed with approximately $303.7 million of debt, of
which $3.7 million was assumed, $4.3 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.
25
Results of Operations -- Three Months Ended March 31, 2005 Compared to
Three Months Ended March 31, 2004.
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 March 31, 2005 and 2004, 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 March 31,
2005 (1) % 2004 %
Net sales: Successor | Predecessor
Safety Products $ 78,612 75.2 | $ 68,184 75.5
Safety Prescription Eyewear 10,239 9.8 | 10,873 12.0
Specialty Composites 15,627 15.0 | 11,321 12.5
--------- ------ | -------- --------
Total net sales 104,478 100.0 | 90,378 100.0
Cost of sales 52,928 50.7 | 47,280 52.3
--------- ------ | -------- --------
Gross profit 51,550 49.3 | 43,098 47.7
--------- ------ | -------- --------
Operating expenses: |
Selling and administrative 32,680 31.3 | 29,364 32.5
Research and technical services 2,211 2.1 | 1,883 2.1
Amortization 1,297 1.2 | 134 0.1
Other charges, net 380 0.4 | 535 0.6
Restructuring -- -- | (1,091) (1.2)
--------- ------ | -------- --------
Total operating expense 36,568 35.0 | 30,825 34.1
Operating income 14,982 14.3 | 12,273 13.6
Interest expense, net 5,688 5.4 | 5,370 5.9
--------- ------ | -------- --------
Income before income taxes 9,294 8.9 | 6,903 7.6
Provision (benefit) for income taxes (2,807) (2.7) | 1,229 1.3
--------- ------ | -------- --------
Net income $ 12,101 11.6 | $ 5,674 6.3
========== ======== | ========= =========
(1) Reflects a new basis of accounting subsequent to April 7, 2004 due to the
Merger.
Net sales for the three months ended March 31, 2005 increased 15.6% to $104.5
million from $90.4 million in the three months ended March 31, 2004. 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 $2.5 million. The
Safety Products segment net sales for the three months ended March 31, 2005
increased 15.3% to $78.6 million from $68.2 million in the three months ended
March 31, 2004. The increase in net sales resulted from an 11.8% increase in
organic growth and a 3.5% increase due to foreign currency translation. Organic
sales growth for the Safety Products segment, defined as net sales less the
26
impact of foreign currency translation and acquisitions, has increased for
eleven 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 March 31, 2005 decreased 5.8% to $10.2 million from $10.9 million
for the three months ended March 31, 2004. The decrease in net sales resulted
from a 6.6% reduction in volume partially offset by 0.8% increase from foreign
currency translation. Specialty Composites' net sales for the three months ended
March 31, 2005 increased 38.0% to $15.6 million from $11.3 million in three
months ended March 31, 2004. 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 seven quarters.
Gross profit for the three months ended March 31, 2005 increased 19.6% to $51.6
million from $43.1 million for the three months ended March 31, 2004. Gross
profit as a percentage of net sales for the three months ended March 31, 2005
was 49.3% as compared to 47.7% for the three months ended March 31, 2004. The
improvement in the gross profit percentage is primarily due to a 1.4 %
improvement due to product mix and a 0.3% improvement due to the impact of
foreign currency translation. The Company's gross profit may not be comparable
to the gross profit of other entities who record shipping and handling expenses
as a component of cost of sales. The Safety Products segment gross profit in the
three months ended March 31, 2005 increased 20.6% to $40.3 million from $33.4
million in the three months ended March 31, 2004. 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 18.9% of the increase in gross profit with foreign currency
translation contributing the remaining 1.7% of the increase. The Safety
Prescription Eyewear segment gross profit in the three months ended March 31,
2005 decreased 10.4% to $4.7 million from $5.2 million in the three months ended
March 31, 2004. The decrease was primarily the result of a 5.8% reduction due to
a decrease in sales volume and a 4.6% reduction due to product mix. Specialty
Composites' gross profit in the three months ended March 31, 2005 increased
46.5% to $6.6 million from $4.5 million in the three months ended March 31,
2004. 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 38.0% of the increase in the Specialty Composites
gross profit was due to volume increases with the remaining 8.5% of the increase
due to product mix.
Operating expenses for the three months ended March 31, 2005 increased 18.6% to
$36.6 million from $30.8 million for the three months ended March 31, 2004. The
increase in operating expenses was primarily driven by an increase in selling
and administrative, amortization expense, restructuring and research and
technical partially offset by other charges, net. Selling and administrative
expenses included approximately $0.6 million due to performance based incentives
related to the increase in sales volume, $0.5 million due to foreign currency
translation and $0.3 million related to freight and distribution with the
27
remaining increase consistent with the increase in sales volume. Selling and
administrative expenses as a percentage of net sales improved to 31.3% for the
three months ended March 31, 2005 as compared to 32.5% for the three months
ended March 31, 2004. Amortization expense increased approximately $1.2 million
due to the allocation of purchase price to finite lived intangible assets
required by SFAS No. 141 due to the Merger Agreement. The slight decrease in
other charges, net was attributed to a $0.2 million favorable impact of foreign
currency transaction expenses in the three months ended March 31, 2005 as
compared to March 31, 2004.
Interest expense, net, for the three months ended March 31, 2005 increased
to $5.7 million from $5.4 million for the three months ended March 31, 2004. The
increase is due to the increase in the level of the Company's debt partially
offset by lower weighted average interest rates under the Company's new credit
facility and the 8.25% senior subordinated notes.
The provision for income taxes for the three months ended March 31, 2005 was a
benefit of $2.8 million compared to expense of $1.2 million for the three months
ended March 31, 2004. At September 30, 2004, the Company's deferred tax asset
from the benefit of net operating losses were partially offset by a valuation
allowance of $7.5 million. During the three month period ended March 31, 2005,
management determined that based on current domestic operating results, it is
more likely than not that domestic net operating losses will be realized and
consequently reversed the $7.5 million valuation allowance.
Results of Operations
(Dollars in Thousands)
(Unaudited)
Six Months Ended March 31,
2005 (1) % 2004 %
Net sales: Successor | Predecessor
Safety Products $ 149,765 74.8 | $ 127,964 75.5
Safety Prescription Eyewear 19,213 9.6 | 20,337 12.0
Specialty Composites 31,261 15.6 | 21,278 12.5
--------- ------ | -------- --------
Total net sales 200,239 100.0 | 169,579 100.0
Cost of sales 101,633 50.8 | 89,056 52.5
--------- ------ | -------- --------
Gross profit 98,606 49.2 | 80,523 47.5
--------- ------ | -------- --------
Operating expenses: |
Selling and administrative 64,411 32.2 | 56,835 33.5
Research and technical services 4,431 2.2 | 3,623 2.1
Amortization 2,615 1.3 | 242 0.1
Other charges (income), net 312 0.2 | (506) (0.2)
Restructuring -- -- | (1,091) (0.6)
--------- ------ | -------- --------
Total operating expense 71,769 35.8 | 59,103 34.9
Operating income 26,837 13.4 | 21,420 12.6
Interest expense, net 10,929 5.5 | 10,836 6.4
--------- ------ | -------- --------
Income before income taxes 15,908 7.9 | 10,584 6.2
Provision (benefit) for income taxes (1,211) (0.6) | 2,020 1.1
--------- ------ | -------- --------
Net income $ 17,119 8.5 | $ 8,564 5.1
========== ======== | ========= =========
(1) Reflects a new basis of accounting subsequent to April 7, 2004 due to
the Merger.
Net sales for the six months ended March 31, 2005 increased 18.1% to $200.2
million from $169.6 million in the six months ended March 31, 2004. The increase
in net sales was primarily driven by organic growth in the Safety Products and
28
Specialty Composites segments and foreign currency translation. The weakness of
the U.S. dollar favorably impacted net sales by $5.2 million. The Safety
Products segment net sales for the six months ended March 31, 2005 increased
17.0% to $149.8 million from $128.0 million in the six months ended March 31,
2004. The increase in net sales resulted from a 13.1% increase in organic growth
and a 3.9% 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 eleven 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 six months ended March 31,
2005 decreased 5.5% to $19.2 million from $20.3 million for the six months ended
March 31, 2004. The decrease in net sales resulted from a 6.4% reduction in
volume partially offset by 0.9% increase from foreign currency translation.
Specialty Composites' net sales for the six months ended March 31, 2005
increased 46.9% to $31.3 million from $21.3 million in six months ended March
31, 2004. 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 seven quarters.
Gross profit for the six months ended March 31, 2005 increased 22.5% to
$98.6 million from $80.5 million for the six months ended March 31, 2004. Gross
profit as a percentage of net sales for the six months ended March 31, 2005 was
49.2% as compared to 47.5% for the six months ended March 31, 2004. The
improvement in the gross profit percentage is primarily due to a 1.5 %
improvement due to product mix and a 0.3% improvement due to the impact of
foreign currency translation. The Company's gross profit may not be comparable
to the gross profit of other entities who record shipping and handling expenses
as a component of cost of sales. The Safety Products segment gross profit in the
six months ended March 31, 2005 increased 21.4% to $76.2 million from $62.8
million in the six months ended March 31, 2004. 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
16.3% of the increase in gross profit with foreign currency translation
contributing the remaining 5.1% of the increase. The Safety Prescription Eyewear
segment gross profit in the six months ended March 31, 2005 decreased 8.9% to
$8.7 million from $9.6 million in the six months ended March 31, 2004. The
decrease was primarily the result of a 6.4% reduction due to a decrease in sales
volume and a 2.5% reduction due to product mix. Specialty Composites' gross
profit in the six months ended March 31, 2005 increased 67.2% to $13.6 million
from $8.2 million in the six months ended March 31, 2004. 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 46.9%
of the increase in the Specialty Composites gross profit was due to volume
increases with the remaining 20.3% of the increase due to product mix.
Operating expenses for the six months ended March 31, 2005 increased 21.4%
to $71.8 million from $59.1 million for the six months ended March 31, 2004. The
increase in operating expenses was primarily driven by an increase in selling
and administrative, amortization expense, restructuring and research and
technical partially offset by other charges, net. Selling and administrative
29
expenses included approximately $1.9 million due to performance based incentives
related to the increase in sales volume, $1.2 million due to foreign currency
translation and $0.7 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 32.2% for the
six months ended March 31, 2005 as compared to 33.5% for the six months ended
March 31, 2004. Amortization expense increased approximately $2.4 million due to
the 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 foreign currency transaction expenses in addition to $0.3 million
of gain from the sale of assets in the six months ended March 31, 2004.
Interest expense, net, for the six months ended March 31, 2005 increased to
$10.9 million from $10.8 million for the six months ended March 31, 2004. The
increase is due to the increase in the level of the Company's debt partially
offset by lower weighted average interest rates under the Company's new credit
facility and the 8.25% senior subordinated notes.
The provision for income taxes for the six months ended March 31, 2005 was
a benefit of $1.2 million compared to expense of $2.0 million for the six months
ended March 31, 2004. At September 30, 2004, the Company's net operating losses
were partially offset by a valuation allowance of $7.5 million. During the six
month period ended March 31, 2005, management determined that based on current
domestic operating results, it is more likely than not that domestic net
operating losses will be realized and consequently reversed the $7.5 million
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, dividends and acquisitions.
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
30
purposes, and (iii) an uncommitted incremental term loan facility of up to $60.0
million for acquisitions (collectively, the "Senior Bank Facilities"). Since the
Acquisition Date, the Company's debt has been negatively impacted by $3.9
million related to the fluctuation of the Euro relative to the U.S dollar as of
March 31, 2005. The Company does not plan to take any measure to minimize the
foreign exchange impact of its Euro denominated debt. The amounts outstanding on
the Term Loans and Revolving Credit Facility at March 31, 2005, were
approximately $127.6 and $0 million, respectively compared to $126.0 million and
$0 million, respectively at September 30, 2004. 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 March 31, 2005,
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 March 31, 2005.
On April 28, 2005, the Company amended its credit agreement to allow the
Company to make, prior to September 30, 2005, up to $35 million of cash
distributions to Aearo Corporation, its parent corporation for the purpose of
paying cash dividends to AC Safety Holding Corp., its parent, to be used by AC
Safety Holding Corp. primarily to redeem, pro rata, its outstanding preferred
shares and to pay accrued dividends on the preferred shares.
On May 4, 2005, the Company's Board of Directors declared a cash dividend to be
paid to the Company's parent, Aearo Corporation, the sole holder of common
stock, par value $.01 per share, of approximately $35 million. Aearo Corporation
will in turn pay a cash dividend to AC Safety Holding Corp., the Company's
ultimate parent, who will use the proceeds to make a partial redemption of its
preferred stock, par value $.01 per share. The Company will use available cash
to fund the dividend.
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 $3.2 million and $5.0 million, respectively for capital
expenditures for the six months ended March 31, 2005 and 2004, respectively. The
Company anticipates it will spend approximately $10.0 million for capital
expenditures in its fiscal year ending September 30, 2005.
The Company's net cash provided by operating activities for the six months
ended March 31, 2005 totaled $17.4 million as compared to $9.0 million for the
six months ended March 31, 2004. The increase of $8.3 million was primarily due
to a $5.1 million improvement in net income adjusted for cash and non-cash
charges (depreciation, amortization, deferred taxes and other), and a $3.2
million improvement in the net changes in assets and liabilities.
Net cash used for investing activities was $3.2 million for the six months
ended March 31, 2005 as compared to $5.0 million for the six months ended March
31, 2004. 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 six months ended March 31,
2005 was $1.0 million compared with $5.2 million for the six months ended March
31, 2004. 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.
31
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, 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's business is affected by macroeconomic activity, mainly
manufacturing output in developed nations. In addition, significant changes in
product mix and volume can impact the Company's liquidity and capital resources
in both the short and long term. As such, the Company's liquidity and capital
resources are more likely to be impacted by macroeconomic factors. The Company
believes that its disciplined approach to cost control, its diversification into
consumer and other channels and the available capacity on its revolving credit
facility will enable the Company to maintain adequate liquidity and capital
resources in an economic downturn. The introduction of new products is likely to
continue to favorably impact liquidity and capital resources in periods of
economic growth although there are no assurances that these trends will continue
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, 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.
Product Liability Claims
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
32
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. Many 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.
In fiscal 2003 and 2004, Aearo settled 259 claims in which it was named as
a defendant for an average settlement amount of $24.36 in silica claims and
$83.24 in asbestos claims, while an additional 200 claims were dismissed without
any payment (43.6% of cases closed), because Aearo was not a proper defendant or
did not make the product in question. As of September 30, 2004, the number of
open claims where Aearo was named as a defendant in silica and asbestos related
matters was 11,002 and 4,261, respectively. For the six months ended March 31,
2005, the increases in number of claims where Aearo was named as a defendant in
silica and asbestos related matters was 106 and 1,200 respectively. The 1,200
new asbestos claims include 1,148 claims that allege exposure from clothing,
which the Company never manufactured. No claims were settled where Aearo was
named as a defendant in silica and asbestos related matters during the six
months ended March 31, 2005. As of March 31, 2005, the number of open claims
where Aearo was named as a defendant in silica and asbestos related matters was
11,108 and 5,461, respectively.
In addition to the above claims, Aearo may agree to pay a share of the
settlement and defense costs in particular cases even though the company is not
named as a defendant because of agreements with prior owners of the brand and/or
because of allegations that Aearo has some risk of legal liability as a
successor ("additional claims"). During the six months ended March 31, 2005,
Aearo paid a total of $1.67 million for settlement, administrative and defense
costs resulting in the settlement of 4,325 silica and asbestos claims that were
settled between October 1, 2002 and September 30, 2004 involving both claims in
which Aearo was named as a defendant and additional claims. During the period
October 1, 2004 to March 31, 2005 Aearo paid a total of one hundred dollars for
one additional claim that was settled during that time period. In addition,
Aearo may receive the benefit of releases in some additional cases settled by
the AO Defense Group regardless of whether or not any claim was made against
Aearo.
33
All data was provided by an outside law firm which tracks numbers of cases
and settlements on behalf of the "AO Defense Group" and is believed to be
materially accurate. The AO Defense Group is a voluntary association of current
and former manufacturers of the "AO Safety" brand of respirators and certain of
their insurers in which Aearo participates and through which all of its
settlements have been handled in the relevant years. Also, between October 1,
2004 and March 31, 2005, there may have been claims settled by and fully funded
by the insurers of Eastern Safety Equipment Co., Inc., a dissolved former
subsidiary of Aearo.
At March 31, 2005 and September 30, 2004, the Company has recorded
liabilities of approximately $4.3 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. The
$0.7 million reduction in the reserve, net of new accruals which added to the
reserve, since September 30, 2004, is primarily attributed to the payment of
$1.67 million, as referenced above, to pay costs attributed to settlement,
administrative and defense costs that had been reached over a two year time
period. This reserve is re-evaluated periodically and additional charges or
credits to results of operations may result as additional information becomes
available. 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 2009 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.
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 March 31, 2005:
(1) 2010 and
2005 2006-2007 2008-2009 after Total
---- --------- --------- -------- ------
Capital lease obligations $ 176 $ 705 $ 368 $ 32 $ 1,281
Operating lease obligations 1,702 5,794 5,043 5,573 18,113
Mortgage obligations 179 2,048 -- -- 2,227
Purchase obligations 720 6,680 6,402 -- 13,802
Respiratory commitment 200 800 800 800 2,600
Long term debt 10,786 43,403 43,173 320,028 417,390
--------- ------ -------- -------- --------
Total $ 13,764 $ 59,430 $ 55,786 $ 326,433 $ 455,414
========== ======= ======== ========= =========
(1) Amounts presented in the current fiscal year represent remaining payments
for the fiscal year.
34
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 March 31, 2005 and does not anticipate significant changes to
its outstanding letters of credit in the future.
The Company plans to fund approximately $1.5-$2.2 million per year for
pension obligations over the next 5 years. The above contribution level was
determined after consideration of many factors such as the funded status of the
plan, the long term rate of return on plan assets of 8%, the duration of plan
liabilities, workforce characteristics and changes to plan features. The goal of
the funding strategy is to achieve full funding while minimizing the year to
year volatility of contribution payments.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements or financing arrangements
involving variable interest entities.
35
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 Results of
Operations and cash flows, the Company executes two hedging programs, one for
transaction exposures, and the other for cash flow exposures in foreign
operations. In order to implement the transaction hedging program, the Company
utilizes 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 and $0.2 million for the three and six months
period ending March 31, 2005, respectively, compared to net loss of $0.2 million
and $0.4 million, respectively for the three and six months ended March 31,
2004. In regard to its cash flow hedging program, the Company complies with SFAS
No. 133 which requires that derivative instruments be recorded in the balance
sheet as either an asset or liability measured at its fair value. As of March
31, 2005, the company did not have any hedges in place for the cash flow hedging
program and therefore the Company had recorded no derivative asset or liability
at March 31, 2005. As a result of open forward foreign currency contracts
entered into in the implementation of the Company's cash flow hedging program,
the Company had a derivative payable of $0.4 million as of March 31, 2004. In
addition, the Company limits the foreign exchange impact on the balance sheet
with debt denominated in Euros.
Interest Rates
The Company is exposed to market risk from changes in interest rates. The
Company, from time to time, will utilize interest rate instruments to reduce the
impact of either increases or decreases in interest rates on its floating rate
debt.
36
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, fair value adjustments were charged
directly to other charges (income), net. There was a $0.1 million impact on
earnings for the six month period ending March 31, 2004.
The Company is of the opinion that it is well positioned to manage interest
rate 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.
37
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
March 31, 2005, 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 March 31, 2005, that has materially affected,
or is reasonably likely to materially affect, the Company's internal control
over financial reporting.
38
PART II - OTHER INFORMATION
Item 6. Exhibits
(a) Exhibits
See Index of Exhibits on page 41 hereof.
39
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: May 9, 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)
40
EXHIBIT INDEX
EXHIBITS DESCRIPTION
3.2 Bylaws of Aearo Company I
10.12 First Amendment, dated as of April 28, 2005, with respect to
the Credit Agreement, dated as of April 7, 2004, among AC Safety
Holding Corp. andAearo Corporation, as guarantors, the other
guarantors party thereto, the various lenders party thereto,
Bear Stearns Corporate Lending, as Syndication Agent, National
City Bank of Indiana and Wells Fargo Bank, N.A., as Co-Document
Agents, and Deutsche Bank AG, New York Branch as Administrative
Agent.
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.