UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER
SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
x | | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| | |
| | For the quarterly period ended September 29, 2007 |
| | |
| | OR |
| | |
o | | 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: 333-127781
SAFETY PRODUCTS HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware | | 34-2051198 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
| | |
2001 Spring Road, Suite 425 Oak Brook, Illinois | | 60523 |
(Address of Principal Executive Offices) | | (Zip Code) |
Registrant’s telephone number, including area code:
(630) 572-5715
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 o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer o Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
On November 8, 2007 Safety Products Holdings, Inc. had 11,030,884 common shares outstanding.
SAFETY PRODUCTS HOLDINGS, INC.
FORM 10-Q QUARTERLY REPORT
For the Quarterly Period Ended September 29, 2007
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
SAFETY PRODUCTS HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(Amounts in Thousands)
| | December 31,
2006 (1) | | September 29,
2007 | |
| | | | (Unaudited) | |
Assets | | | | | |
Current assets: | | | | | |
Cash and cash equivalents | | $ | 26,796 | | $ | 40,558 | |
Accounts receivable, less allowance of $2,323 and $2,484 in 2006 and 2007, respectively | | 73,306 | | 92,762 | |
Inventories | | 108,270 | | 111,316 | |
Deferred income taxes | | 2,143 | | 1,946 | |
Prepaid expenses and other current assets | | 3,624 | | 3,880 | |
Total current assets | | 214,139 | | 250,462 | |
Property, plant and equipment, net | | 69,627 | | 68,414 | |
Deferred financing costs, net | | 16,517 | | 13,991 | |
Goodwill | | 157,242 | | 163,073 | |
Other intangible assets, net | | 281,438 | | 276,998 | |
Other noncurrent assets | | 5,119 | | 6,224 | |
Total assets | | $ | 744,082 | | $ | 779,162 | |
| | | | | |
Liabilities and shareholders’ equity | | | | | |
Current liabilities: | | | | | |
Accounts payable | | $ | 21,891 | | $ | 22,215 | |
Accrued expenses | | 40,596 | | 37,205 | |
Current maturities of long-term obligations | | 4,820 | | 2,301 | |
Total current liabilities | | 67,307 | | 61,721 | |
Long-term liabilities: | | | | | |
Pension, post-retirement and deferred compensation | | 17,082 | | 13,553 | |
Long-term obligations | | 470,140 | | 482,046 | |
Other noncurrent liabilities | | 7,008 | | 11,717 | |
Deferred income taxes | | 55,460 | | 53,103 | |
Total long-term liabilities | | 549,690 | | 560,419 | |
| | | | | |
Minority interest | | 199 | | 222 | |
| | | | | |
Shareholders’ equity: | | | | | |
Common shares | | 110 | | 110 | |
Contributed capital | | 111,883 | | 113,007 | |
Retained earnings | | 4,098 | | 14,408 | |
Accumulated other comprehensive income | | 10,795 | | 29,275 | |
Total shareholders’ equity | | 126,886 | | 156,800 | |
Total liabilities and shareholders’ equity | | $ | 744,082 | | $ | 779,162 | |
(1) December 31, 2006 balances were obtained from audited financial statements.
See notes to unaudited consolidated financial statements.
1
SAFETY PRODUCTS HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in Thousands) (Unaudited)
| | Three months ended | | Nine months ended | |
| | September 30,
2006 | | September 29,
2007 | | September 30,
2006 | | September 29,
2007 | |
Net sales | | $ | 136,777 | | $ | 151,406 | | $ | 404,411 | | $ | 455,963 | |
Cost of goods sold | | 87,161 | | 93,161 | | 250,420 | | 278,249 | |
Gross profit | | 49,616 | | 58,245 | | 153,991 | | 177,714 | |
Operating expenses: | | | | | | | | | |
Selling | | 12,342 | | 13,790 | | 37,470 | | 40,944 | |
Distribution | | 8,028 | | 9,491 | | 23,428 | | 28,173 | |
General and administrative (1) | | 12,727 | | 15,325 | | 38,757 | | 43,179 | |
Amortization of intangibles | | 3,073 | | 2,869 | | 8,540 | | 8,746 | |
Total operating expenses | | 36,170 | | 41,475 | | 108,195 | | 121,042 | |
Income from operations | | 13,446 | | 16,770 | | 45,796 | | 56,672 | |
Other expense (income): | | | | | | | | | |
Interest expense | | 12,050 | | 12,510 | | 34,690 | | 37,089 | |
Interest income | | (105 | ) | (445 | ) | (419 | ) | (898 | ) |
Other, net | | (85 | ) | 115 | | (610 | ) | 514 | |
Income from continuing operations before income taxes and minority interest | | 1,586 | | 4,590 | | 12,135 | | 19,967 | |
Income tax expense | | 663 | | 66 | | 4,134 | | 6,444 | |
Minority interest | | 8 | | 10 | | 23 | | 24 | |
Income from continuing operations | | 915 | | 4,514 | | 7,978 | | 13,499 | |
Loss (income) from discontinued operations (including loss on disposal of subsidiary of $3,022 for the nine months ended September 29, 2007), net of income tax (Note 2) | | 26 | | — | | (67 | ) | 2,813 | |
Net income | | $ | 889 | | $ | 4,514 | | $ | 8,045 | | $ | 10,686 | |
(1) General and administrative expenses exclude amortization of intangibles and include $265 and $459 of management incentive compensation for the three months ended September 30, 2006 and September 29, 2007, respectively and $1,345 and $1,159 of management incentive compensation for the nine months ended September 30, 2006 and September 29, 2007, respectively.
See notes to unaudited consolidated financial statements.
2
SAFETY PRODUCTS HOLDINGS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in Thousands) (Unaudited)
| | Nine months ended | |
| | September 30,
2006 | | September 29,
2007 | |
Operating activities | | | | | |
Net income | | $ | 8,045 | | $ | 10,686 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | |
Depreciation (1) | | 10,008 | | 11,008 | |
Amortization of intangibles | | 8,540 | | 8,746 | |
Amortization of deferred financing costs | | 2,513 | | 2,526 | |
Amortization of original issue premium | | (109 | ) | (89 | ) |
Deferred income taxes | | (246 | ) | (400 | ) |
Minority interest | | 23 | | 24 | |
Noncash interest | | 12,431 | | 13,936 | |
Management incentive compensation | | 1,345 | | 1,124 | |
Loss on sale of property, plant and equipment | | 54 | | 153 | |
Loss on sale of subsidiary | | — | | 3,022 | |
Changes in operating assets and liabilities: | | | | | |
Accounts receivable | | (10,433 | ) | (19,064 | ) |
Inventories | | (16,055 | ) | (1,535 | ) |
Prepaid expenses and other current assets | | 408 | | 352 | |
Other noncurrent assets | | (265 | ) | (644 | ) |
Accounts payable | | 2,409 | | 1,534 | |
Accrued expenses | | (3,119 | ) | (4,761 | ) |
Pension, postretirement and deferred compensation | | (1,466 | ) | (3,549 | ) |
Other noncurrent liabilities | | (227 | ) | (84 | ) |
Net cash provided by operating activities | | 13,856 | | 22,985 | |
| | | | | |
Investing activities | | | | | |
Purchase of businesses, net of cash acquired | | (30,952 | ) | (1,247 | ) |
Proceeds from sale of subsidiary, net of cash disposed | | — | | 3,223 | |
Purchases of property, plant and equipment | | (7,681 | ) | (8,130 | ) |
Proceeds from sale of property, plant and equipment | | 113 | | 377 | |
Net cash used in investing activities | | (38,520 | ) | (5,777 | ) |
| | | | | |
Financing activities | | | | | |
Payments for deferred financing costs | | (201 | ) | — | |
Proceeds from borrowings | | 15,000 | | — | |
Payments of debt | | (1,399 | ) | (4,286 | ) |
Net borrowings under revolving credit facility | | 2,000 | | — | |
Proceeds from the issuance of shares | | 563 | | — | |
Net cash provided by (used in) financing activities | | 15,963 | | (4,286 | ) |
Effect of exchange rate changes on cash and cash equivalents | | 356 | | 840 | |
Net (decrease) increase in cash and cash equivalents | | (8,345 | ) | 13,762 | |
Cash and cash equivalents at beginning of period | | 20,819 | | 26,796 | |
Cash and cash equivalents at end of period | | $ | 12,474 | | $ | 40,558 | |
(1) Depreciation includes depreciation expense of $86 and $71 for the nine months ended September 30, 2006 and September 29, 2007, respectively, related to discontinued operations (Note 2).
See notes to unaudited consolidated financial statements
3
SAFETY PRODUCTS HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in Thousands) (Unaudited)
1. Transactions
On February 2, 2006, Safety Products Holdings, Inc. (the “Company”) completed the acquisition of all of the issued and outstanding capital stock of American Firewear, Inc. (“American Firewear”). The purchase price consisted of $4,453 in cash (including acquisition costs of $203 and net of cash acquired of $183) and a $1,000 subordinated seller note. In addition, the purchase price may be increased by $750 over a four year period based on American Firewear achieving certain financial and operating objectives. The Company financed the acquisition through cash on the balance sheet and the issuance of the $1,000 subordinated seller note. The Company believes the acquisition of American Firewear will strengthen its hand protection product line in the fire service segment. The results of operations of American Firewear are included in the Company’s consolidated statement of operations from the date of acquisition.
On June 9, 2006, the Company completed the acquisition of all of the issued and outstanding capital stock of The White Rubber Corporation (“White Rubber”). The purchase price was $22,182 (including acquisition costs of $636 and gross of outstanding checks of $773). The Company financed the acquisition through additional term borrowings under the senior credit facility and cash on the balance sheet. The Company believes the acquisition of White Rubber will strengthen its hand protection product line in the electrical safety segment. The results of operations of White Rubber are included in the Company’s consolidated statement of operations from the date of acquisition.
On September 19, 2006, the Company completed the acquisition of all of the issued and outstanding capital stock of The New England Overshoe Company, Inc. (“NEOS”). The purchase price consisted of $3,639 in cash (including acquisition costs of $139 and net of cash acquired of $6) and a $750 subordinated seller note. In addition, the purchase price may be increased over a five year period based on NEOS achieving certain net sales targets. The Company financed the acquisition through cash on the balance sheet and the issuance of the $750 subordinated seller note. The Company believes the acquisition of NEOS will broaden its footwear product portfolio in the general safety and preparedness segment. The results of operations of NEOS are included in the Company’s consolidated statement of operations from the date of acquisition.
Assuming all acquisitions had occurred on January 1, 2006, the pro forma net sales, income from operations and net income for the Company would have been $414,277, $46,742 and $7,379, respectively, for the nine months ended September 30, 2006.
2. Discontinued Operations
On June 29, 2007, the Company completed the sale of all of the issued and outstanding capital stock of North Safety Products (Africa) (Proprietary) Limited (“South Africa”), a subsidiary of the Company. The Company received net cash proceeds of $3,223 and recorded a net loss on disposal related to the transaction of $3,022 ($3,022 net of income tax). In accordance with Financial Accounting Standards Board (“FASB”) Statement of Accounting Standards (“SFAS”) No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company has reflected South Africa’s results of operations through the date of the sale and transaction loss as discontinued operations for all periods presented. Assets and liabilities of South Africa were not material and as a result have not been reclassified as discontinued operations in the Company’s consolidated statement of financial position as of December 31, 2006. The cash flows from discontinued operations have been combined with cash flows from continuing operations within each cash flow statement category as the cash flows from discontinued operations are not material to the Company’s consolidated results.
The following table sets forth the net sales, net (loss) income from discontinued operations and net loss on disposal of subsidiary for South Africa for the periods presented:
| | Three months ended | | Nine months ended | |
| | September 30,
2006 | | September 29,
2007 | | September 30,
2006 | | September 29,
2007 | |
Net sales | | $ | 5,101 | | $ | — | | $ | 15,589 | | $ | 8,152 | |
Net (loss) income from discontinued operations | | (26 | ) | — | | 67 | | 209 | |
Net loss on disposal of subsidiary | | — | | — | | — | | (3,022 | ) |
| | | | | | | | | | | | | |
4
3. Basis of Presentation
The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements.
In the opinion of management, all adjustments (consisting only of adjustments of a normal and recurring nature) considered necessary for a fair presentation of the financial position and results of operations have been included. Interim results are not necessarily indicative of the results that might be expected for any other interim period or for the fiscal year ending December 31, 2007. The financial statements presented should be read in conjunction with the consolidated financial statements and footnotes thereto included in our 2006 consolidated financial statements, included in the Company’s annual report on Form 10-K.
4. Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. The provisions of SFAS No. 157 are effective for the Company as of the beginning of its fiscal year ending December 31, 2008. The Company is in the process of determining the effects, if any, that adoption of SFAS No. 157 will have on its financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115. This statement is intended to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. It also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. The statement does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value and it does not establish requirements for recognizing dividend income, interest income or interest expense. It also does not eliminate disclosure requirements included in other accounting standards. The provisions of SFAS No. 159 are effective for the Company as of the beginning of its fiscal year ending December 31, 2008. The Company is in the process of determining the effects, if any, that adoption of SFAS No. 159 will have on its financial statements.
5. Management Incentive Compensation
Management incentive compensation related to stock based compensation was $265 and $459 for the three months ended September 30, 2006 and September 29, 2007, respectively and $1,345 and $1,159 for the nine months ended September 30, 2006 and September 29, 2007, respectively.
6. Inventories
Inventories consist of the following:
| | December 31,
2006 | | September 29,
2007 | |
At FIFO cost: | | | | | |
Raw materials | | $ | 24,823 | | $ | 30,148 | |
Work in process | | 13,756 | | 11,965 | |
Finished goods | | 70,799 | | 70,311 | |
| | 109,378 | | 112,424 | |
Adjustment to LIFO cost | | (1,108 | ) | (1,108 | ) |
Total inventory | | $ | 108,270 | | $ | 111,316 | |
5
7. Long-Term Obligations
The Company’s long-term obligations consist of the following:
| | December 31,
2006 | | September 29,
2007 | |
Revolving credit facilities | | $ | — | | $ | — | |
Term loan | | 165,720 | | 162,138 | |
Senior pay in kind notes | | 155,090 | | 169,026 | |
Senior subordinated notes | | 152,500 | | 152,500 | |
European term loans | | 173 | | — | |
Subordinated seller notes | | 1,750 | | 1,250 | |
Capital lease obligations | | 205 | | — | |
Unamortized discount on senior pay in kind notes | | (6,626 | ) | (5,877 | ) |
Unamortized premium on senior subordinated notes | | 6,148 | | 5,310 | |
| | 474,960 | | 484,347 | |
Less: Current maturities of long-term obligations | | 4,820 | | 2,301 | |
| | $ | 470,140 | | $ | 482,046 | |
Aggregate maturities of long-term obligations as of September 29, 2007, are as follows:
2008 | | $ | 2,301 | |
2009 | | 2,509 | |
2010 | | 45,732 | |
2011 | | 193,015 | |
2012 | | 240,790 | |
Thereafter | | — | |
| | $ | 484,347 | |
8. Income Taxes
Effective January 1, 2007, the Company adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"), which requires that the Company recognize in the financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. In addition, FIN 48 provides guidance on the derecognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions.
As a result of the implementation of FIN 48, the Company recorded at the date of adoption an additional liability of $5,961 for unrecognized tax benefits relating to uncertain tax positions. Of this amount, approximately $376 was accounted for as a reduction to the January 1, 2007 balance of retained earnings. During the three and nine months ended September 29, 2007, the unrecognized tax benefits decreased by $404 due to a foreign income tax audit settlement.
At January 1, 2007, the Company had $7,024 in unrecognized tax benefits, the recognition of which would have an effect of $776 on the effective tax rate. In addition, $4,261 of unrecognized tax benefits would, if realized, reduce goodwill.
Included in the balance of unrecognized tax benefits at January 1, 2007, is $1,525 related to tax positions for which it is reasonably possible that the total amounts could significantly change during the next twelve months. This amount represents the maximum potential decrease in unrecognized tax benefits comprised of items related to foreign income tax filings and audit settlement negotiations. During the three and nine months ended September 29, 2007, this amount has decreased by $404 due to a foreign income tax audit settlement.
The Company recognizes interest and penalties related to unrecognized tax benefits as a component of income tax expense. At January 1, 2007, the Company had accrued $219 and $279 for the potential payment of interest and penalties related to unrecognized tax benefits, respectively. There have been no significant changes to these amounts during the three and nine months ended September 29, 2007.
The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of multiple state and international jurisdictions. As of September 29, 2007, the Company is subject to U.S. Federal income tax examinations for the tax years 1998 through 2000 and 2002 through 2006 and to non-U.S. income tax examinations for the tax years of 2003
6
through 2006. In addition, the Company is subject to state and local income tax examinations for the tax years 1998 through 2006.
The income tax expense for the Company differs from the amount of income tax expense computed by applying the U.S. federal income tax rate to income before income taxes primarily due to: 1) state taxes and 2) the impact of varied foreign statutory rates on the Company’s foreign earnings. In addition, the income tax expense for the three and nine months ended September 29, 2007 was impacted by a reduction in the German statutory tax rate. Further, the nine months ended September 29, 2007 was impacted by the recording of a valuation allowance against capital losses associated with the sale of South Africa.
9. Employee Benefit Plans
The following table sets forth the components of net periodic benefit expense (income) for the Company’s pension benefits:
| | Three months ended | | Nine months ended | |
| | September 30,
2006 | | September 29,
2007 | | September 30,
2006 | | September 29,
2007 | |
Service cost | | $ | 594 | | $ | 24 | | $ | 1,576 | | $ | 78 | |
Interest cost | | 998 | | 1,014 | | 2,886 | | 2,976 | |
Expected return on plan assets | | (755 | ) | (1,069 | ) | (2,567 | ) | (3,206 | ) |
| | $ | 837 | | $ | (31 | ) | $ | 1,895 | | $ | (152 | ) |
The following table sets forth the components of net periodic benefit expense for the Company’s post-retirement benefits:
| | Three months ended | | Nine months ended | |
| | September 30,
2006 | | September 29,
2007 | | September 30,
2006 | | September 29,
2007 | |
Service cost | | $ | 7 | | $ | 3 | | $ | 19 | | $ | 8 | |
Interest cost | | 18 | | 13 | | 54 | | 45 | |
| | $ | 25 | | $ | 16 | | $ | 73 | | $ | 53 | |
10. Restructuring and Merger-Related Charges
In conjunction with the Fibre-Metal Transaction, the Company initiated a restructuring plan to close the Fibre-Metal manufacturing facility located in Concordville, Pennsylvania and move production to its Cranston, Rhode Island and Mexicali, Mexico facilities. In addition, the Company closed certain Fibre-Metal distribution centers and integrated Fibre-Metal distribution into its existing distribution facilities. The Company implemented this plan in order to increase profitability through utilizing excess capacity at its existing plants and moving manufacturing to locations with favorable labor costs. The restructuring was substantially completed in the second quarter of 2007. As of the date of the Fibre-Metal Transaction, the Company recorded an accrual for costs associated with the plan of $1,716, comprised of $1,383 in severance costs and $333 in facility closure and other exit costs. The restructuring liability was classified within the accrued expenses caption on the consolidated balance sheet.
In conjunction with the White Rubber Transaction, the Company initiated a restructuring plan to move certain production and distribution functions located in Ohio and Washington to its Charleston, South Carolina, Skokie, Illinois and Chicago, Illinois facilities. The Company initiated this plan in order to increase profitability by utilizing excess capacity and consolidating distribution functions. The restructuring was substantially completed in the second quarter of 2007. As of the date of the White Rubber Transaction, the Company recorded an accrual for costs associated with the plan of $1,018, comprised of severance and severance related costs. The restructuring liability is classified within the accrued expenses caption on the consolidated balance sheet.
A rollforward of the restructuring liability is as follows:
7
| | Severance
and
severance
related
costs | | Facility
closure and
other exit
costs | | Total | |
Balance as of January 1, 2007 | | $ | 1,880 | | $ | 173 | | $ | 2,053 | |
Payments | | (1,753 | ) | (174 | ) | (1,927 | ) |
Effect of foreign currency translation | | — | | 1 | | 1 | |
Balance as of September 29, 2007 | | $ | 127 | | $ | — | | $ | 127 | |
11. Legal Proceedings
The Company is subject to various claims arising in the ordinary course of business. Most of these lawsuits and claims are product liability matters that arise out of the use of respiratory product lines manufactured by the Company’s North Safety Products subsidiary. As of September 29, 2007, the Company’s North Safety Products subsidiary, along with its predecessors and/or the former owners of such business were named as defendants in approximately 649 lawsuits involving respirators allegedly manufactured and sold by it or its predecessors. The Company is also monitoring an additional two lawsuits in which it feels that North Safety Products, its predecessors and/or the former owners of such businesses may be named as defendants. Collectively, these 651 lawsuits represent a total of approximately 8,451 plaintiffs. Approximately 85% of these lawsuits involve plaintiffs alleging injury resulting from exposure to silica dust, with the remainder alleging injury resulting from exposure to other dust particles, including asbestos. These lawsuits typically allege that the purported injuries resulted in part from respirators that were negligently designed or manufactured. Invensys plc (“Invensys”), formerly Siebe plc, is contractually obligated to indemnify the Company for any losses, including costs of defending claims, resulting from respiratory products manufactured or sold prior to the acquisition of North Safety Products in October 1998.
In addition, the Company’s North Safety Products subsidiary is contractually entitled to indemnification from Norton Company, an affiliate of Saint-Gobain, which owned the North Safety Products business prior to Invensys. Pursuant to a December 14, 1982 asset purchase agreement, Siebe Norton, Inc., a newly formed wholly-owned subsidiary of Norton Company, acquired the assets of Norton’s Safety Products Division and the stock of this company was in turn acquired by Siebe Gorman Holdings plc. Under the terms of the agreement, Siebe Norton, Inc. did not assume any liability for claims relating to products shipped by Norton Company prior to the closing date. Moreover, Norton Company covenanted in the agreement to indemnify Siebe Norton, Inc. and its successors and assigns against any liability resulting from or arising out of any state of facts, omissions or events existing or occurring on or before the closing date, including, without limitation, any claims arising from products shipped by Norton Company or any of its affiliates prior to the closing date. Siebe Norton, Inc., whose name was subsequently changed to Siebe North Inc., was subsequently acquired by the Company as part of the 1998 acquisition of the North Safety Products business from Invensys.
Despite these indemnification arrangements, the Company could potentially be liable for losses or claims relating to products manufactured prior to the October 1998 acquisition date if Invensys fails to meet its obligations to indemnify the Company and the Company could potentially be liable for losses and claims relating to products sold prior to January 10, 1983 if both Invensys and Norton fail to meet their obligations to indemnify the Company. The Company believes that Invensys has the ability to pay these claims based on its current financial position, as publicly disclosed by Invensys. The Company could also be liable if the alleged exposure involved the use of a product manufactured by the Company after the October 1998 acquisition of the North Safety Products business.
Effective July 1, 2006, the Company entered into a joint defense agreement through December 31, 2008 with the former owners of the North Safety Products business (the “Joint Defense Agreement” or “JDA”). Under the terms of the Joint Defense Agreement, the Company agreed to pay a weighted average percentage of defense costs (including legal fees, expert witnesses and out of pocket expenses) associated with defending the Company and the prior owners of the North Safety Products business subject to a cap of $525, $960 and $1,000 for the period from July 1, 2006 through December 31, 2006, the year ended December 31, 2007 and the year ended December 31, 2008, respectively. The cap excludes settlement costs and other costs incurred exclusively by the Company (including trial costs and special requests of counsel), which it will be required to pay under the JDA. Separately, the Company agreed to pay Invensys $200 related to settled cases through June 30, 2006 in which Invensys claimed that the period of alleged exposure included periods after October 1998.
Although the JDA expires on December 31, 2008, the Company expects to incur additional defense and settlement costs beyond this date. The Company will consider its alternatives for defending the claims as the JDA nears expiration and determine the appropriate course of action, which could include an extension of the JDA.
8
Based upon information provided to the Company by Invensys, the Company believes activity related to these lawsuits was as follows for the nine months ended September 29, 2007:
| | Plaintiffs | | Cases | |
Beginning lawsuits as of January 1, 2007 | | 8,746 | | 644 | |
New lawsuits | | 19 | | 16 | |
Settlements | | — | | — | |
Dismissals and other | | (314 | ) | (9 | ) |
Ending lawsuits as of September 29, 2007 | | 8,451 | | 651 | |
Both the rate of new filings and the number of existing claimants have declined dramatically since 2003 as courts and legislatures have tightened the rules on when and where the silica claims can be pursued in an effort to reduce the large number of unmeritorious claims. The new rules make bringing silica cases on a mass level much less attractive to the plaintiffs’ bar. Plaintiffs’ attorneys in many jurisdictions can no longer (1) find a worker with some stated exposure to silica, (2) take an X-ray of his chest, (3) have it interpreted as demonstrating lung shadows by a radiologist, (4) then file a single lawsuit in a dangerous venue with hundreds of other plaintiffs against hundreds of defendants with the pleading containing little more than the parties’ names and some standard pleading language. More specifically, the legislatures of at least seven states — including former hotbeds of silica litigation such as Texas, Florida and Ohio — passed impairment-criteria legislation that redefined injury. These acts force plaintiffs to prove impairment as a result of their exposure to qualify for judicial treatment. The same legislation requires that each silica claimant be tried individually, and not in the multiple plaintiff format in which the potential for large verdicts resulted from increased plaintiffs and where a few meritorious claims could increase the value of unmeritorious ones. Further tort reform in Texas created a state-wide multi-district litigation (“MDL”) wherein one judge presides over the pretrial of all Texas-silica cases. In Mississippi, the Supreme Court changed the venue rules making it much more difficult to file out-of-state plaintiffs there. The Mississippi court also changed the pleading requirements making the plaintiffs’ attorneys include plaintiff-specific allegations against each defendant sued, instead of the vague allegations against hundreds of defendants.
Plaintiffs have asserted specific dollar claims in approximately 30% of the approximately 649 cases pending as of September 29, 2007 in which North Safety Products, its predecessors and/or the former owners of such businesses have been named as defendants. A majority of jurisdictions prohibit specifying damages in tort cases such as these, and most of the remaining jurisdictions do not require such specification. In those cases in which plaintiffs choose to assert specific dollar amounts in their complaints, the amounts claimed are typically not meaningful as an indicator of a company’s potential liability. This is because (1) the amounts claimed typically bear no relation to the level of the plaintiff’s injury, (2) the complaints typically assert claims against numerous defendants and (3) many cases are brought on behalf of plaintiffs who have not suffered any medical injury, and ultimately are resolved without any payment or payment of a small fraction of the damages initially claimed. Of the 649 complaints maintained in the Company’s records, 459 do not specify the amount of damages sought, 25 generally allege damages in excess of $50, one alleges compensatory damages in excess of $50 and an unspecified amount of punitive damages, 103 allege compensatory damages and punitive damages, each in excess of $25, two generally allege damages in excess of $100, two allege compensatory damages and punitive damages, each in excess of $50, 20 generally allege damages in excess of $15,000, one generally alleges damages of $23,000, one alleges compensatory damages and punitive damages, each in excess of $10, four allege general damages of $18,000 and punitive damages of $10,000, two allege general damages of $13,000 and punitive damages of $10,000, one alleges compensatory and punitive damages, each in excess of $15, one alleges punitive damages in excess of $50, one generally alleges damages in excess of $15, 12 generally allege damages in excess of $25, one alleges compensatory damages of $18,000 and punitive damages of $10,000, one alleges punitive damages of $13,500 and compensatory damages of $10,000, one alleges punitive damages of $13,000 and compensatory damages of $10,000, eight allege compensatory damages of $13,000 and punitive damages of $10,000, one alleges compensatory and punitive damages, each of $15 and two allege compensatory and punitive damages, each in excess of $15,000. The Company currently does not have access to the complaints with respect to the previously mentioned additional two monitored cases, and therefore it does not know whether these cases allege specific damages, or if so, the amount of such damages, but is in the process of seeking to obtain such information. Due to the reasons noted above and to the indemnification arrangements benefiting the Company, it does not believe that the damage amounts specified in these complaints are a meaningful factor in any assessment of the Company’s potential liability.
Norcross Safety Products L.L.C., the Company’s wholly owned subsidiary (“Norcross”), recorded a $1,250 reserve for respiratory claims during the year ended December 31, 2004. Norcross re-evaluated this reserve in its first and second quarter 2005 financial statements and concluded the $1,250 recorded reserve continued to be its best estimate of the probable loss for the respiratory contingency.
In the July 2005 acquisition purchase accounting (as first reported in the Form 10-Q for the third quarter of 2005),
9
the Company carried forward the $1,250 liability for this pre-acquisition contingency. Although management concluded that it was likely their estimate of this pre-acquisition contingent liability would be increased during the purchase accounting allocation period as the new ownership finalized their strategy for addressing the liability and gathered information (primarily related to case information and the working relationship among the prior owners of North), it was unlikely the amount would be lower than the $1,250. Thus, the $1,250 amount represented the low end of a probable loss range, subject to further adjustment during the allocation period.
In December 2005, the Company began negotiations with the former owners of the North business to enter into the JDA. The Company determined that the liability should be increased to $5,000 as of December 31, 2005 as part of the purchase price allocation process. The $5,000 reserve as of December 31, 2005 represented management’s best estimate of the liability based on the current status of negotiations. As of December 31, 2005, the estimate was still preliminary as the Company was awaiting finalization of the JDA negotiation process.
As discussed above, the Company entered into the JDA effective July 1, 2006 and completed its evaluation of the reserve. After all information was obtained, the Company adjusted the reserve to $7,000 as part of the purchase price allocation process during the permitted allocation period. As of September 29, 2007, the reserve balance was $6,800.
The final estimated amount recorded in purchase accounting related entirely to losses incurred before the July 2005 acquisition. The Company’s final estimate of the probable loss for the respiratory contingency incorporated the new ownerships’ decision to enter into the JDA. The decision represented a significantly different plan as new ownership agreed to assume losses related to claims with unknown years of exposure. In addition, the decision to enter into the JDA was being considered from the date of the acquisition and the ultimate decision was made during the allocation period.
The Company believes that this reserve represents a reasonable estimate of its probable and estimable liabilities for product claims alleging injury resulting from exposure to silica dust and other particles, including asbestos. The Company believes that a five-year projection of claims and related defense costs is the most reasonable approach. This reserve will be re-evaluated periodically and additional charges or credits will be recorded to operating expenses as additional information becomes available.
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 Company’s indemnification from Invensys, but recognizing the inherent uncertainties in the projection of any future events, the Company believes that these suits or claims should not result in final judgments or settlements in excess of its reserve.
The Company historically has not been required to pay any material liability claims. The Company maintains insurance against product liability claims (with the exception of asbestosis and silicosis cases, for which coverage is not commercially available), but it is possible that its insurance coverage will not continue to be available on terms acceptable to the Company or that such coverage will not be adequate for liabilities actually incurred.
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12. Segment Data
The following table presents information about the Company by segment:
| | General
Safety &
Preparedness | | Fire
Service | | Electrical
Safety | | Corporate
(1) | | Eliminations
(2) | | Total | |
Three Months Ended September 30, 2006 | | | | | | | | | | | | | |
Net sales—third parties | | $ | 93,624 | | $ | 21,817 | | $ | 21,336 | | $ | — | | $ | — | | $ | 136,777 | |
Net sales—intersegment | | 2,243 | | — | | — | | — | | (2,243 | ) | — | |
Income (loss) from operations | | 10,487 | | 1,430 | | 3,597 | | (2,068 | ) | — | | 13,446 | |
| | | | | | | | | | | | | |
Three Months Ended September 29, 2007 | | | | | | | | | | | | | |
Net sales—third parties | | 102,310 | | 25,674 | | 23,422 | | — | | — | | 151,406 | |
Net sales—intersegment | | 1,823 | | — | | 90 | | — | | (1,913 | ) | — | |
Income (loss) from operations | | 12,423 | | 3,238 | | 4,486 | | (3,377 | ) | — | | 16,770 | |
| | | | | | | | | | | | | |
Nine Months Ended September 30, 2006 | | | | | | | | | | | | | |
Net sales—third parties | | 277,531 | | 68,073 | | 58,807 | | — | | — | | 404,411 | |
Net sales—intersegment | | 7,146 | | — | | — | | — | | (7,146 | ) | — | |
Income (loss) from operations | | 33,220 | | 6,118 | | 12,745 | | (6,287 | ) | — | | 45,796 | |
| | | | | | | | | | | | | |
Nine Months Ended September 29, 2007 | | | | | | | | | | | | | |
Net sales—third parties | | 307,918 | | 75,213 | | 72,832 | | — | | — | | 455,963 | |
Net sales—intersegment | | 6,508 | | — | | 305 | | — | | (6,813 | ) | — | |
Income (loss) from operations | | 40,181 | | 9,612 | | 15,190 | | (8,311 | ) | — | | 56,672 | |
| | | | | | | | | | | | | | | | | | | |
(1) Corporate expenses include general and administrative expenses such as administrative, finance, human resources and legal, which are not directly associated with one of the reporting segments. In addition, the interest expense associated with the 11¾% senior pay in kind notes due 2012 is included within corporate expenses.
(2) The eliminations column includes the elimination of intersegment net sales among the three reporting segments.
13. Subsidiary Guarantors
Safety Products Holdings, Inc. (“Safety Products”) and NSP Holdings Capital Corp. (“NSP Capital”) are co-issuers of the 11¾% senior pay in kind notes due 2012. Both Safety Products and NSP Capital have no independent assets or operations. NSP Capital is a 100% owned finance subsidiary of Safety Products. The 11¾% senior pay in kind notes due 2012 are not guaranteed by any subsidiary of the Company. The terms of the senior credit facility significantly restrict Norcross from paying dividends and otherwise transferring assets to the Company. Further, the terms of the indenture governing its 9⅞% senior subordinated notes due 2011 significantly restrict Norcross and the Company’s other subsidiaries from paying dividends and otherwise transferring assets to the Company, except for ordinary course operating expenses.
14. Comprehensive Income
Total comprehensive income (which includes the impact of foreign currency translation) was $0 and $13,536 for the three months ended September 30, 2006 and September 29, 2007, respectively. Total comprehensive income was $14,096 and $29,166 for the nine months ended September 30, 2006 and September 29, 2007, respectively.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are a leading designer, manufacturer and marketer of branded products in the fragmented personal protection equipment industry. We manufacture and market a full line of personal protection equipment for workers in the general safety and preparedness, fire service and electrical safety industries. We sell our products under trusted, long-standing and well-recognized brand names, including North, KCL, Fibre-Metal, NEOS, Morning Pride, Ranger, Servus, Pro-Warrington, American Firewear, Salisbury and SafetyLine. Our broad product offering includes, among other things, respiratory protection, protective footwear, hand protection, turnout gear and linemen equipment.
We classify our diverse product offerings into three reporting segments:
General Safety and Preparedness. We offer a diverse portfolio of leading products for a wide variety of industries, including manufacturing, agriculture, automotive, construction, food processing and pharmaceutical industries and the military, under the North, KCL, Fibre-Metal, NEOS, Ranger and Servus brand names. Our product offering is one of the broadest in the personal protection equipment industry and includes respiratory protection, protective footwear, hand protection, eye, head and face protection, first aid, hearing protection and fall protection. We sell our general safety and preparedness products primarily through industrial distributors.
Fire Service. We manufacture and market one of the broadest lines of personal protection equipment for the fire service market, offering firefighters head-to-toe protection. Our products include turnout gear, fireboots, helmets, gloves and other accessories. We market our products under our Total Fire Group umbrella, using the brand names of Morning Pride, Ranger, Servus, Pro-Warrington and American Firewear. We are the vendor of choice for many of the largest fire departments in North America. We sell our fire service products primarily through specialized fire service distributors.
Electrical Safety. We manufacture and market a broad line of personal protection equipment for the utility market under the Salisbury, SafetyLine and Servus brands. Our products include linemen equipment, gloves, sleeves and footwear. All our products either meet or exceed the applicable standards of the American National Standards Institute (“ANSI”) and the American Society for Testing of Materials (“ASTM”). We distribute our electrical safety products through specialized distributors, test labs, utilities and electrical contractors.
Acquisitions
In February 2006, we completed the acquisition of all of the issued and outstanding capital stock of American Firewear. The purchase price consisted of $4.5 million in cash (including acquisition costs of $0.2 million and net of cash acquired of $0.2 million) and a $1.0 million subordinated seller note. In addition, the purchase price may be increased by $0.8 million over a four year period based on American Firewear achieving certain financial and operating objectives. We financed the acquisition through cash on the balance sheet and the issuance of the $1.0 million subordinated seller note.
In June 2006, we completed the acquisition of all of the issued and outstanding capital stock of White Rubber. The purchase price of $22.2 million (including $0.6 million of acquisition costs and gross of outstanding checks of $0.8 million) was financed through $15.0 million of additional term borrowings under the senior credit facility and cash on the balance sheet.
In September 2006, we completed the acquisition of all of the issued and outstanding capital stock of NEOS. The purchase price consisted of $3.6 million in cash (including acquisition costs of $0.1 million and net of cash acquired) and a $0.8 million subordinated seller note. In addition, the purchase price may be increased over a five year period based on NEOS achieving certain net sales targets. We financed the acquisition through cash on the balance sheet and the issuance of the $0.8 million subordinated seller note.
Discontinued Operations
In June 2007, we completed the sale of all of the issued and outstanding capital stock of South Africa. We received net cash proceeds of $3.2 million and recorded a net loss related to the transaction of $3.0 million. In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we have reflected South Africa’s results of operations through the date of the sale and transaction loss as discontinued operations for all periods presented. Assets and
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liabilities of South Africa were not material and as a result have not been reclassified as discontinued operations in our consolidated statement of financial position as of December 31, 2006. We have combined cash flows from discontinued operations with cash flows from continuing operations within each cash flow statement category as the cash flows from discontinued operations are not material to our consolidated results.
Gross Profit
We calculate gross profit as the difference between our net sales and cost of goods sold. We do not include certain purchasing and distribution costs as a component of cost of goods sold. As a result, our gross profit may not be comparable to other entities who may present all of purchasing and distribution costs as a component of cost of goods sold.
Expense Classifications
We include the following in each of the major expense categories:
Cost of Goods Sold. Primarily includes all direct and indirect costs related to our products including the following: raw materials, direct and indirect labor, including related benefits, overhead costs, inbound freight charges, receiving costs, inspection costs, purchasing costs, other internal transfer costs and cost of resale products.
Selling. Primarily includes all payroll and related benefits associated with sales and marketing employees, internal and external sales commission payments, marketing costs, advertising expenses and other miscellaneous selling expenses.
Distribution. Primarily includes all direct and indirect labor associated with distribution and related benefits, warehousing and freight-out costs and other miscellaneous distribution expenses.
General and Administrative. Primarily includes the following: finance and accounting, certain purchasing costs, information systems, human resources, legal, corporate overhead expenses and other miscellaneous administrative expenses.
Results of Operations
The following tables set forth our results of operations in dollars and as a percentage of net sales for the three and nine months ended September 30, 2006 and the three and nine months ended September 29, 2007 and have been derived from the unaudited statements of operations.
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| | Three months ended | | Nine months ended | |
| | September 30,
2006 | | September 29,
2007 | | September 30,
2006 | | September 29,
2007 | |
| | (dollars in thousands) | |
Net sales: | | | | | | | | | |
General Safety & Preparedness | | $ | 93,624 | | $ | 102,310 | | $ | 277,531 | | $ | 307,918 | |
Fire Service | | 21,817 | | 25,674 | | 68,073 | | 75,213 | |
Electrical Safety | | 21,336 | | 23,422 | | 58,807 | | 72,832 | |
Total net sales | | 136,777 | | 151,406 | | 404,411 | | 455,963 | |
Cost of goods sold | | 87,161 | | 93,161 | | 250,420 | | 278,249 | |
Gross profit | | 49,616 | | 58,245 | | 153,991 | | 177,714 | |
Operating expenses | | 36,170 | | 41,475 | | 108,195 | | 121,042 | |
Income from operations: | | | | | | | | | |
General Safety & Preparedness | | 10,487 | | 12,423 | | 33,220 | | 40,181 | |
Fire Service | | 1,430 | | 3,238 | | 6,118 | | 9,612 | |
Electrical Safety | | 3,597 | | 4,486 | | 12,745 | | 15,190 | |
Corporate | | (2,068 | ) | (3,377 | ) | (6,287 | ) | (8,311 | ) |
Total income from operations | | 13,446 | | 16,770 | | 45,796 | | 56,672 | |
Other expense (income): | | | | | | | | | |
Interest expense | | 12,050 | | 12,510 | | 34,690 | | 37,089 | |
Interest income | | (105 | ) | (445 | ) | (419 | ) | (898 | ) |
Other, net | | (85 | ) | 115 | | (610 | ) | 514 | |
Income from continuing operations before income taxes and minority interest | | 1,586 | | 4,590 | | 12,135 | | 19,967 | |
Income tax expense | | 663 | | 66 | | 4,134 | | 6,444 | |
Minority interest | | 8 | | 10 | | 23 | | 24 | |
Income from continuing operations | | 915 | | 4,514 | | 7,978 | | 13,499 | |
Loss (income) from discontinued operations, net of income tax | | 26 | | — | | (67 | ) | 2,813 | |
Net income | | $ | 889 | | $ | 4,514 | | $ | 8,045 | | $ | 10,686 | |
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| | Three months ended | | Nine months ended | |
| | September 30,
2006 | | September 29,
2007 | | September 30,
2006 | | September 29,
2007 | |
| | (as a percentage of net sales) | |
Net sales: | | | | | | | | | |
General Safety & Preparedness | | 68.5 | % | 67.6 | % | 68.6 | % | 67.5 | % |
Fire Service | | 16.0 | % | 17.0 | % | 16.8 | % | 16.5 | % |
Electrical Safety | | 15.5 | % | 15.4 | % | 14.6 | % | 16.0 | % |
Total net sales | | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
Cost of goods sold | | 63.7 | % | 61.5 | % | 61.9 | % | 61.0 | % |
Gross profit | | 36.3 | % | 38.5 | % | 38.1 | % | 39.0 | % |
Operating expenses | | 26.5 | % | 27.4 | % | 26.8 | % | 26.6 | % |
Income from operations: | | | | | | | | | |
General Safety & Preparedness | | 7.7 | % | 8.2 | % | 8.2 | % | 8.8 | % |
Fire Service | | 1.0 | % | 2.1 | % | 1.5 | % | 2.1 | % |
Electrical Safety | | 2.6 | % | 3.0 | % | 3.2 | % | 3.3 | % |
Corporate | | (1.5 | )% | (2.2 | )% | (1.6 | )% | (1.8 | )% |
Total income from operations | | 9.8 | % | 11.1 | % | 11.3 | % | 12.4 | % |
Other expense (income): | | | | | | | | | |
Interest expense | | 8.8 | % | 8.3 | % | 8.6 | % | 8.1 | % |
Interest income | | (0.1 | )% | (0.3 | )% | (0.1 | )% | (0.2 | )% |
Other, net | | (0.0 | )% | 0.1 | % | (0.2 | )% | 0.1 | % |
Income from continuing operations before income taxes and minority interest | | 1.1 | % | 3.0 | % | 3.0 | % | 4.4 | % |
Income tax expense | | 0.5 | % | 0.0 | % | 1.0 | % | 1.5 | % |
Minority interest | | 0.0 | % | 0.0 | % | 0.0 | % | 0.0 | % |
Income from continuing operations | | 0.6 | % | 3.0 | % | 2.0 | % | 2.9 | % |
Loss (income) from discontinued operations, net of income tax | | 0.0 | % | 0.0 | % | (0.0 | )% | 0.6 | % |
Net income | | 0.6 | % | 3.0 | % | 2.0 | % | 2.3 | % |
Three Months Ended September 29, 2007 as Compared to Three Months Ended September 30, 2006
Net sales. Net sales increased by $14.6 million, or 10.7%, from $136.8 million for the three months ended September 30, 2006 to $151.4 million for the three months ended September 29, 2007. In our general safety and preparedness segment, net sales increased by $8.7 million, or 9.3%, from $93.6 million for the three months ended September 30, 2006 to $102.3 million for the three months ended September 29, 2007. The increase reflects a combination of the following: combined organic growth in our international operations of $2.7 million, favorable exchange rates, which had an impact of $3.5 million and overall organic growth in our North American non-government business of $3.6 million, partially offset by a decrease in government contract shipments of $1.1 million. In our fire service segment, net sales increased by $3.9 million, or 17.7%, from $21.8 million for the three months ended September 30, 2006 to $25.7 million for the three months ended September 29, 2007, due in part to a more normalized pattern of fire act grants when compared to 2006. In addition, the issuance of the new National Fire Protection Association (“NFPA”) standard is creating increase demand for our patented products. In our electrical safety segment, net sales increased by $2.0 million, or 9.8%, from $21.4 million for the three months ended September 30, 2006 to $23.4 million for the three months ended September 29, 2007, primarily driven by strong market demand and new product penetration.
Gross profit. Gross profit increased by $8.6 million, or 17.4%, from $49.6 million for the three months ended September 30, 2006 to $58.2 million for the three months ended September 29, 2007, primarily due to the $14.6 million, or 10.7%, increase in net sales. Our gross profit margin increased from 36.3% for the three months ended September 30, 2006 to 38.5% for the three months ended September 29, 2007. In our general safety and preparedness segment, gross profit increased by $4.9 million, or 13.5%, from $36.0 million for the three months ended September 30, 2006 to $40.9 million for the three months ended September 29, 2007. This increase was primarily due to the overall net sales increase of $8.7 million, or 9.3%, and improved margin performance. In our fire service segment, gross profit increased by $2.5 million, or 45.5%, from $5.7 million for the three months ended September 30, 2006 to $8.2 million for the three months ended September 29, 2007, primarily due to the increase in net sales of $3.9 million, or 17.7%, and favorable margin realization. In our electrical safety segment, gross profit increased by $1.2 million, or 15.2%, from $7.9 million for the three months ended September 30, 2006 to $9.1 million for the three months ended September 29, 2007, primarily due to the increase in net sales of $2.0
15
million, or 9.8%, and the favorable impact of $0.3 million of lower inventory purchase accounting adjustments in the three months ended September 29, 2007 relative to the three months ended September 30, 2006.
Operating expenses. Operating expenses increased by $5.2 million, or 14.7%, from $36.3 million for the three months ended September 30, 2006 to $41.5 million for the three months ended September 29, 2007. In our general safety and preparedness segment, operating expenses increased by $2.9 million, or 11.4%, from $25.5 million for the three months ended September 30, 2006 to $28.4 million for the three months ended September 29, 2007, driven by increased variable selling and distribution expenses associated with the $8.7 million, or 9.3%, increase in net sales and higher payroll expenses. In our fire service segment, operating expenses increased by $0.7 million, or 18.1%, from $4.3 million for the three months ended September 30, 2006 to $5.0 million for the three months ended September 29, 2007, primarily due to increased variable selling and distribution expenses related to the $3.9 million, or 17.7%, increase in net sales and higher administrative expenses. In our electrical safety segment, operating expenses increased by $0.4 million, or 7.3%, from $4.3 million for the three months ended September 30, 2006 to $4.7 million for the three months ended September 29, 2007, primarily due to incremental administrative expenses. Corporate expenses for the three months ended September 30, 2006 consisted of $1.9 million of general and administrative expenses and $0.3 million of management incentive compensation expense. Corporate expenses for the three months ended September 29, 2007 consisted of $2.9 million of general and administrative expenses and $0.5 million of management incentive compensation expense. The increase in corporate general and administrative expenses of $1.0 million was primarily due to higher payroll, administrative expenses and professional fees. The increase in professional fees was partially due to $0.7 million of fees associated with the engagement of a supply-chain improvement consulting firm.
Income from operations. Income from operations increased by $3.3 million, or 24.7%, from $13.5 million for the three months ended September 30, 2006 to $16.8 million for the three months ended September 29, 2007. In our general safety and preparedness segment, income from operations increased by $1.9 million, or 18.5%, from $10.5 million for the three months ended September 30, 2006 to $12.4 million for the three months ended September 29, 2007. In our fire service segment, income from operations increased by $1.8 million, or 126.4%, from $1.4 million for the three months ended September 30, 2006 to $3.2 million for the three months ended September 29, 2007. In our electrical safety segment, income from operations increased by $0.8 million, or 24.7%, from $3.7 million for the three months ended September 30, 2006 to $4.5 million for the three months ended September 29, 2007. Corporate expenses for the three months ended September 30, 2006 consisted of $1.9 million of general and administrative expenses and $0.3 million of management incentive compensation expense. Corporate expenses for the three months ended September 29, 2007 consisted of $2.9 million of general and administrative expenses and $0.5 million of management incentive compensation expense. These segment variances were the result of the reasons discussed above.
Included in income from operations for the three months ended September 30, 2006 and September 29, 2007 were depreciation and amortization expenses of $6.6 million and $6.5 million, respectively. Of these amounts, $4.0 million, $1.2 million, and $1.4 million were attributable to the general safety and preparedness, fire service, and electrical safety segments, respectively, for the three months ended September 30, 2006 and $4.1 million, $1.1 million, and $1.3 million were attributable to these segments for the three months ended September 29, 2007.
Interest expense. Interest expense increased by $0.4 million, or 3.8%, from $12.1 million for the three months ended September 30, 2006 to $12.5 million for the three months ended September 29, 2007, primarily due to higher non-cash interest charges associated with the senior pay in kind notes. Included in interest expense were non-cash interest charges associated with the senior pay in kind notes of $4.3 million and $4.8 million for the three months ended September 30, 2006 and September 29, 2007, respectively.
Other, net. Other, net increased by $0.2 million from $(0.1) million for the three months ended September 30, 2006 to $0.1 million for the three months ended September 29, 2007.
Income tax expense. Income tax expense decreased by $0.6 million, from $0.7 million for the three months ended September 30, 2006 to $0.1 million for the three months ended September 29, 2007, as the benefit from a reduction in the German statutory tax rate was partially offset by higher income taxes associated with improved operating performance.
Net income. Net income increased by $3.6 million, from $0.9 million for the three months ended September 30, 2006 to $4.5 million for the three months ended September 29, 2007 as a result of the reasons discussed above.
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Nine Months Ended September 29, 2007 as Compared to Nine Months Ended September 30, 2006
Net sales. Net sales increased by $51.6 million, or 12.7%, from $404.4 million for the nine months ended September 30, 2006 to $456.0 million for the nine months ended September 29, 2007. In our general safety and preparedness segment, net sales increased by $30.4 million, or 10.9%, from $277.5 million for the nine months ended September 30, 2006 to $307.9 million for the nine months ended September 29, 2007. The increase reflects a combination of the following: combined organic growth in our international operations of $9.2 million, favorable exchange rates, which had an impact of $7.9 million, and overall organic growth in our North American non-government business of $17.7 million, which offset a decrease in government contract shipments of $4.4 million. In our fire service segment, net sales increased by $7.1 million, or 10.5%, from $68.1 million for the nine months ended September 30, 2006 to $75.2 million for the nine months ended September 29, 2007, due in part to a more normalized pattern of fire act grants when compared to 2006. In addition, the issuance of the new NFPA standard is creating increase demand for our patented products. In our electrical safety segment, net sales increased by $14.1 million, or 23.8%, from $58.7 million for the nine months ended September 30, 2006 to $72.8 million for the nine months ended September 29, 2007, primarily driven by strong market demand, new product penetration and incremental White Rubber net sales.
Gross profit. Gross profit increased by $23.7 million, or 15.4%, from $154.0 million for the nine months ended September 30, 2006 to $177.7 million for the nine months ended September 29, 2007, primarily due to the $51.6 million, or 12.7%, increase in net sales. Our gross profit margin was 39.0% for the nine months ended September 29, 2007 as compared to 38.1% for the nine months ended September 30, 2006. In our general safety and preparedness segment, gross profit increased by $15.4 million, or 14.0%, from $110.4 million for the nine months ended September 30, 2006 to $125.8 million for the nine months ended September 29, 2007. This increase was primarily due to the overall net sales increase of $30.4 million, or 10.9%, improved margin realization and the favorable impact of $0.8 million of lower inventory purchase accounting adjustments in the nine months ended September 29, 2007 relative to the nine months ended September 30, 2006. In our fire service segment, gross profit increased by $4.1 million, or 20.9%, from $19.9 million for the nine months ended September 30, 2006 to $24.0 million for the nine months ended September 29, 2007, primarily due to the increase in net sales of $7.1 million, or 10.5%, and favorable margin realization. In our electrical safety segment, gross profit increased by $4.2 million, or 17.5%, from $23.7 million for the nine months ended September 30, 2006 to $27.9 million for the nine months ended September 29, 2007, as result of the increase in net sales of $14.1 million, or 23.8%, and the favorable impact of $0.3 million of lower inventory purchase accounting adjustments in the three months ended September 29, 2007 relative to the three months ended September 30, 2006, partially offset by lower margin realization primarily due to White Rubber product line integration costs and the impact of product mix.
Operating expenses. Operating expenses increased by $12.8 million, or 11.9%, from $108.2 million for the nine months ended September 30, 2006 to $121.0 million for the nine months ended September 29, 2007. In our general safety and preparedness segment, operating expenses increased by $8.5 million, or 11.0%, from $77.1 million for the nine months ended September 30, 2006 to $85.6 million for the nine months ended September 29, 2007, driven by increased variable selling and distribution expenses associated with the $30.4 million, or 10.9%, increase in net sales, unfavorable exchange rates, which had an impact of $1.8 million, and higher payroll expenses. In our fire service segment, operating expenses increased by $0.6 million, or 4.8%, from $13.8 million for the nine months ended September 30, 2006 to $14.4 million for the nine months ended September 29, 2007, primarily due to increased variable selling and distribution expenses related to the $7.1 million, or 10.5%, increase in net sales and higher administrative expenses. In our electrical safety segment, operating expenses increased by $1.7 million, or 15.5%, from $11.0 million for the nine months ended September 30, 2006 to $12.7 million for the nine months ended September 29, 2007, due to increased variable selling and distribution expenses related to the $14.1 million, or 23.8%, increase in net sales, higher amortization expense of $0.3 million associated with intangible assets recorded as part of purchase accounting and incremental White Rubber operating expenses. Corporate expenses for the nine months ended September 30, 2006 consisted of $5.0 million of general and administrative expenses and $1.3 million of management incentive compensation expense. Corporate expenses for the nine months ended September 29, 2007 consisted of $7.1 million of general and administrative expenses and $1.2 million of management incentive compensation expense. The increase in corporate general and administrative expenses of $2.1 million was primarily due to higher payroll, administrative expenses and professional fees. The increase in professional fees was partially due to $0.7 million of fees associated with the engagement of a supply-chain improvement consulting firm.
Income from operations. Income from operations increased by $10.9 million, or 23.7%, from $45.8 million for the nine months ended September 30, 2006 to $56.7 million for the nine months ended September 29, 2007. In our general safety and preparedness segment, income from operations increased by $6.9 million, or 21.0%, from $33.3 million for the nine months ended September 30, 2006 to $40.2 million for the nine months ended September 29, 2007. In our fire service segment, income from operations increased by $3.5 million, or 57.1%, from $6.1 million for the nine months ended September 30, 2006 to $9.6 million for the nine months ended September 29, 2007. In our electrical safety segment, income
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from operations increased by $2.5 million, or 19.2%, from $12.7 million for the nine months ended September 30, 2006 to $15.2 million for the nine months ended September 29, 2007. Corporate expenses for the nine months ended September 30, 2006 consisted of $5.0 million of general and administrative expenses and $1.3 million of management incentive compensation expense. Corporate expenses for the nine months ended September 29, 2007 consisted of $7.1 million of general and administrative expenses and $1.2 million of management incentive compensation expense. These segment variances were the result of the reasons discussed above.
Included in income from operations for the nine months ended September 30, 2006 and September 29, 2007 were depreciation and amortization expenses of $18.5 million and $19.7 million, respectively. Of these amounts, $12.0 million, $3.4 million, and $3.1 million were attributable to the general safety and preparedness, fire service, and electrical safety segments, respectively, for the nine months ended September 30, 2006 and $12.3 million, $3.5 million, and $3.9 million were attributable to these segments for the nine months ended September 29, 2007.
Interest expense. Interest expense increased by $2.4 million, or 6.9%, from $34.7 million for the nine months ended September 30, 2006 to $37.1 million for the nine months ended September 29, 2007, primarily due to higher outstanding debt balances related to the White Rubber Transaction and higher non-cash interest charges associated with the senior pay in kind notes. Included in interest expense were non-cash interest charges associated with the senior pay in kind notes of $12.4 million and $13.9 million for the three months ended September 30, 2006 and September 29, 2007, respectively.
Other, net. Other, net increased by $1.1 million from $(0.6) million for the nine months ended September 30, 2006 to $0.5 million for the nine months ended September 29, 2007, primarily due to unrealized foreign exchange rate losses.
Income tax expense. Income tax expense increased by $2.3 million, from $4.1 million for the nine months ended September 30, 2006 to $6.4 million for the nine months ended September 29, 2007, as higher income taxes associated with improved operating performance were partially offset by the benefit from a reduction in the German statutory tax rate.
Loss (income) from discontinued operations. Loss from discontinued operations for the nine months ended September 29, 2007 included a $3.0 million loss related to the sale of South Africa and $(0.2) million of income associated with South Africa discontinued operations. Income from discontinued operations for the nine months ended September 30, 2006 included $(0.1) million of income associated with South Africa discontinued operations.
Net income. Net income increased by $2.7 million, from $8.0 million for the nine months ended September 30, 2006 to $10.7 million for the nine months ended September 29, 2007 as a result of the reasons discussed above.
Liquidity and Capital Resources
We have historically used internal cash flow from operations, commercial borrowings on our lines of credit, seller notes, investments from our equityholders and capital markets transactions to fund our operations, acquisitions, capital expenditures and working capital requirements. For the nine months ended September 29, 2007, net cash provided by operating activities was $23.0 million, as income from operations of $56.7 million was partially offset by an increase in accounts receivable due to higher net sales. For the nine months ended September 30, 2006, net cash provided by operating activities was $13.9 million, as income from operations of $45.8 million was partially offset by an increase in accounts receivables due to higher net sales and higher inventory in part due to pending plant consolidations.
Historically, our principal uses of cash have been capital expenditures, acquisitions and working capital. Our capital expenditures were $7.7 million for the nine months ended September 30, 2006 and $8.1 million for the nine months ended September 29, 2007. Investing activities for the nine months ended September 29, 2007 included $0.7 million of royalty payments made to the sellers of Arbin, $0.5 million for the purchase of Hungary and $3.2 million of cash proceeds from the sale of South Africa. For the nine months ended September 30, 2006, investing activities included $22.2 million for the acquisition of White Rubber, $4.5 million for the acquisition of American Firewear, $3.6 million for the acquisition of NEOS and $0.7 million of royalty payments made to the sellers of Muck Boot and Arbin. We received cash proceeds of $0.4 million and $0.1 million related to the sale of property, plant and equipment during the nine months ended September 29, 2007 and September 30, 2006, respectively.
As of September 29, 2007, we had working capital of $188.7 million and cash of $40.6 million. We maintain inventory levels sufficient to satisfy customer orders on demand, with generally a three month supply on hand. Turnout gear is an exception and is generally made to order. Our accounts receivable terms are generally 30 days, net.
For the nine months ended September 29, 2007, net cash used in financing activities was $4.3 million, consisting of
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$4.3 million of payments on long-term obligations (including an excess cash flow sweep payment of $2.3 million under the terms of our senior credit facility). For the nine months ended September 30, 2006, net cash provided by financing activities was $16.0 million, consisting of the following: proceeds from additional term borrowings of $15.0 million under the senior credit facility related to the White Rubber transaction, proceeds from borrowings under the revolving credit facility of $2.0 million, $1.4 million of payments on long-term obligations, $0.6 million of proceeds from the issuance of shares and $0.2 million of payments for deferred financing costs.
As of September 29, 2007, borrowings under the new senior credit facility bore interest at a weighted average rate of 7.3%. As of September 29, 2007, there was approximately $162.1 million of outstanding indebtedness under the senior credit facility and approximately $47.5 million of available borrowings under the revolving credit facility.
We believe that our internal cash flows and borrowings under our new senior credit facility will provide us with sufficient liquidity and capital resources to meet our current and future financial obligations for the foreseeable future, including funding our operations, debt service and capital expenditures. Our future operating performance will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control. If our future cash flow from operations and other capital resources are insufficient to pay our obligations as they mature or to fund our liquidity needs, we may be forced to reduce or delay our business activities and capital expenditures, sell assets, obtain additional debt or equity capital or restructure or refinance all or a portion of our debt, including the senior subordinated notes, on or before maturity. We cannot assure you that we would be able to accomplish any of these alternatives on a timely basis or on satisfactory terms, if at all. In addition, the terms of our existing and future indebtedness, including our senior subordinated notes and our senior credit facility, may limit our ability to pursue any of these alternatives.
Forward-Looking Statements
This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking information. These statements reflect management’s expectations, estimates, and assumptions based on information available at the time of the statement. Forward-looking statements include, but are not limited to, statements regarding future events, plans, goals, objectives, and expectations. The words “anticipate,” “believe,” “estimate,” “expect,” “plan,” “intent,” “likely,” “will,” “should,” and similar expressions are intended to identify forward-looking statements. Forward-looking statements are not guarantees of future performance and involve risks, uncertainties, and other factors, including those set forth below, which may cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by those statements. Important factors that could cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by those statements include, but are not limited to: (i) our high degree of leverage and significant debt service obligations; (ii) the impact of current and future laws and governmental regulations affecting us or our product offerings; (iii) the impact of governmental spending; (iv) our ability to retain existing customers, maintain key supplier status with those customers with which we have achieved such status, and obtain new customers; (v) the highly competitive nature of the personal protection equipment industry; (vi) any future changes in management; (vii) acceptance by consumers of new products we develop or acquire; (viii) the importance and costs of product innovation; (ix) unforeseen problems associated with international sales, including gains and losses from foreign currency exchange and restrictions on the efficient repatriation of earnings; (x) the unpredictability of patent protection and other intellectual property issues; (xi) cancellation of current orders; (xii) the outcome of pending product liability claims and the availability of indemnification for those claims; (xiii) general risks associated with the personal protection equipment industry; and (xiv) the successful integration of acquired companies on economically acceptable terms. We undertake no obligation to publicly update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, or changes to future results over time.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes to our exposure to market risk since December 31, 2006.
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Item 4. Controls and Procedures
Based on their evaluation as of the end of the period covered by this quarterly report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are effective. There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) identified in connection with the evaluation required by Rule 13a-15(d) of the Exchange Act that occurred during the period covered by this quarterly report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II
OTHER INFORMATION
Item 1. Legal Proceedings
We are subject to various claims arising in the ordinary course of business. Most of these lawsuits and claims are product liability matters that arise out of the use of respiratory product lines manufactured by our North Safety Products subsidiary. As of September 29, 2007, our North Safety Products subsidiary, along with its predecessors and/or the former owners of such business were named as defendants in approximately 649 lawsuits involving respirators allegedly manufactured and sold by it or its predecessors. We are also monitoring an additional two lawsuits in which we feel that North Safety Products, its predecessors and /or the former owners of such businesses may be named as defendants. Collectively, these 651 lawsuits represent approximately 8,451 (excluding spousal claims) plaintiffs. Approximately 85% of these lawsuits involve plaintiffs alleging injury resulting from exposure to silica dust, with the remainder alleging injury from exposure to other particles, including asbestos. These lawsuits typically allege that the purported injuries resulted in part from respirators that were negligently designed and/or manufactured. The defendants in these lawsuits are often numerous, and include, in addition to respirator manufacturers, employers of the plaintiffs and manufacturers of sand (used in sand blasting) and asbestos. We acquired our North Safety Products subsidiary on October 2, 1998 from Siebe plc. In connection with the acquisition, Siebe, which was subsequently merged with BTR plc (now known as “Invensys plc”), contractually agreed to indemnify us for any losses, including costs of defending claims, resulting from respiratory products manufactured or sold prior to our acquisition of North Safety Products in October 1998.
In addition, our North Safety Products subsidiary is contractually entitled to indemnification from Norton Company, an affiliate of Saint-Gobain, which owned the North Safety Products business prior to Invensys. Pursuant to a December 14, 1982 asset purchase agreement, Siebe Norton, Inc., a newly formed wholly-owned subsidiary of Norton Company, acquired the assets of Norton’s Safety Products Division and the stock of this company was in turn acquired by Siebe Gorman Holdings plc. Under the terms of the agreement, Siebe Norton, Inc. did not assume any liability for claims relating to products shipped by Norton Company prior to the closing date. Moreover, Norton Company covenanted in the agreement to indemnify Siebe Norton, Inc. and its successors and assigns against any liability resulting from or arising out of any state of facts, omissions or events existing or occurring on or before the closing date, including, without limitation, any claims arising from products shipped by Norton Company or any of its affiliates prior to the closing date. Siebe Norton, Inc., whose name was subsequently changed to Siebe North Inc., was subsequently acquired by us as part of the 1998 acquisition of the North Safety Products business from Invensys.
Despite these indemnification arrangements, we could potentially be liable for losses or claims relating to products manufactured prior to the October 1998 acquisition date if Invensys fails to meet its obligations to indemnify us and we could potentially be liable for losses and claims relating to products sold prior to January 10, 1983 if both Invensys and Norton fail to meet their obligations to indemnify us. We could also be liable if the alleged exposure involved the use of a product manufactured by us after our October 1998 acquisition of the North Safety Products business.
Effective July 1, 2006, we entered into a joint defense agreement through December 31, 2008 with the former owners of the North Safety Products business (the “Joint Defense Agreement” or “JDA”). Under the terms of the Joint Defense Agreement, we agreed to pay a weighted average percentage of defense costs (including legal fees, expert witnesses and out of pocket expenses) associated with defending ourselves and the prior owners of the North Safety Products business subject to a cap of $525,000, $960,000 and $1.0 million for the period from July 1, 2006 through December 31, 2006, the year ended December 31, 2007 and the year ended December 31, 2008, respectively. The cap excludes settlement costs and other costs incurred exclusively by us (including trial costs and special requests of counsel), which we will be required to pay under the JDA. Separately, we agreed to pay Invensys $200,000 related to settled cases through June 30, 2006 in which Invensys claims that the period of alleged exposure included periods after October 1998.
Although the JDA expires on December 31, 2008, we expect to incur additional defense and settlement costs beyond this date. We will consider our alternatives for defending the claims as the JDA nears expiration and determine the appropriate course of action, which could include an extension of the JDA.
Based upon information provided to us by Invensys, we believe activity related to these lawsuits was as follows for the three months ended September 29, 2007:
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| | Plaintiffs | | Cases | |
Beginning lawsuits as of January 1, 2007 | | 8,746 | | 644 | |
New lawsuits | | 19 | | 16 | |
Settlements | | — | | — | |
Dismissals and other | | (314 | ) | (9 | ) |
Ending lawsuits as of September 29, 2007 | | 8,451 | | 651 | |
Both the rate of new filings and the number of existing claimants have declined dramatically since 2003 as courts and legislatures have tightened the rules on when and where the silica claims can be pursued in an effort to reduce the large number of unmeritorious claims. The new rules make bringing silica cases on a mass level much less attractive to the plaintiffs’ bar. Plaintiffs’ attorneys in many jurisdictions can no longer (1) find a worker with some stated exposure to silica, (2) take an X-ray of his chest, (3) have it interpreted as demonstrating lung shadows by a radiologist, (4) then file a single lawsuit in a dangerous venue with hundreds of other plaintiffs against hundreds of defendants with the pleading containing little more than the parties’ names and some standard pleading language. More specifically, the legislatures of at least seven states — including former hotbeds of silica litigation such as Texas, Florida and Ohio — passed impairment-criteria legislation that redefined injury. These acts force plaintiffs to prove impairment as a result of their exposure to qualify for judicial treatment. The same legislation requires that each silica claimant be tried individually, and not in the multiple plaintiff format in which the potential for large verdicts resulted from increased plaintiffs and where a few meritorious claims could increase the value of unmeritorious ones. Further tort reform in Texas created a state-wide multi-district litigation (“MDL”) wherein one judge presides over the pretrial of all Texas-silica cases. In Mississippi, the Supreme Court changed the venue rules making it much more difficult to file out-of-state plaintiffs there. The Mississippi court also changed the pleading requirements making the plaintiffs’ attorneys include plaintiff-specific allegations against each defendant sued, instead of the vague allegations against hundreds of defendants.
Plaintiffs have asserted specific dollar claims in approximately 30% of the approximately 649 cases pending as of September 29, 2007 in which North Safety Products, its predecessors and/or the former owners of such businesses have been named as defendants. A majority of jurisdictions prohibit specifying damages in tort cases such as these, and most of the remaining jurisdictions do not require such specification. In those cases in which plaintiffs choose to assert specific dollar amounts in their complaints, the amounts claimed are typically not meaningful as an indicator of a company’s potential liability. This is because (1) the amounts claimed typically bear no relation to the level of the plaintiff’s injury, (2) the complaints typically assert claims against numerous defendants, and (3) many cases are brought on behalf of plaintiffs who have not suffered any medical injury, and ultimately are resolved without any payment or payment of a small fraction of the damages initially claimed. Of the 649 complaints maintained in our records, 459 do not specify the amount of damages sought, 25 generally allege damages in excess of $50,000, one alleges compensatory damages in excess of $50,000 and an unspecified amount of punitive damages, 103 allege compensatory damages and punitive damages, each in excess of $25,000, two generally allege damages in excess of $100,000, two allege compensatory damages and punitive damages, each in excess of $50,000, 20 generally allege damages in excess of $15.0 million, one generally alleges damages of $23.0 million, one alleges compensatory damages and punitive damages, each in excess of $10,000, four allege general damages of $18.0 million and punitive damages of $10.0 million, two allege general damages of $13.0 million and punitive damages of $10.0 million, one alleges compensatory and punitive damages, each in excess of $15,000, one alleges punitive damages in excess of $50,000, one generally alleges damages in excess of $15,000, 12 generally allege damages in excess of $25,000, one alleges compensatory damages of $18.0 million and punitive damages of $10.0 million, one alleges punitive damages of $13.5 million and compensatory damages of $10.0 million, one alleges punitive damages of $13.0 million and compensatory damages of $10.0 million, eight allege compensatory damages of $13.0 million and punitive damages of $10.0 million, one alleges compensatory and punitive damages, each of $15,000 and two allege compensatory and punitive damages, each in excess of $15.0 million. We currently do not have access to the complaints with respect to the previously mentioned additional two monitored cases, and therefore we do not know whether these cases allege specific damages, or if so, the amount of such damages, but are in the process of seeking to obtain such information. Due to the reasons noted above and to the indemnification arrangements benefiting us, we do not believe that the damage amounts specified in these complaints are a meaningful factor in any assessment of our potential liability.
Bankruptcy filings of companies with asbestos and silica-related litigation could increase our cost over time. If we were found liable in these cases and either Invensys or Norton Company failed to meet its indemnification obligations to us or the suit involved products manufactured by us after our October 1998 acquisition of North Safety Products, it would have a material adverse effect on our business.
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Norcross recorded a $1.25 million reserve for respiratory claims during the year ended December 31, 2004. Norcross re-evaluated this reserve in its first and second quarter 2005 financial statements and concluded the $1.25 million recorded reserve continued to be its best estimate of the probable loss for the respiratory contingency.
In the July 2005 acquisition purchase accounting (as first reported in the Form 10-Q for the third quarter of 2005), we carried forward the $1.25 million liability for this pre-acquisition contingency. Although management concluded that it was likely their estimate of this pre-acquisition contingent liability would be increased during the purchase accounting allocation period as the new ownership finalized their strategy for addressing the liability and gathered information (primarily related to case information and the working relationship among the prior owners of North), it was unlikely the amount would be lower than the $1.25 million. Thus, the $1.25 million amount represented the low end of a probable loss range, subject to further adjustment during the allocation period.
In December 2005, we began negotiations with the former owners of the North business to enter into the JDA. We determined that the liability should be increased to $5.0 million as of December 31, 2005 as part of the purchase price allocation process. The $5.0 million reserve as of December 31, 2005 represented management’s best estimate of the liability based on the current status of negotiations. As of December 31, 2005, the estimate was still preliminary as we were awaiting finalization of the JDA negotiation process.
As discussed above, we entered into the JDA effective July 1, 2006 and completed our evaluation of the reserve. After all information was obtained, we adjusted the reserve to $7.0 million as part of the purchase price allocation process during the permitted “allocation period”. As of September 29, 2007, the reserve balance was $6.8 million.
The final estimated amount recorded in purchase accounting related entirely to losses incurred before the July 2005 acquisition. Our final estimate of the probable loss for the respiratory contingency incorporated the new ownerships’ decision to enter into the JDA. The decision represented a significantly different plan as new ownership agreed to assume losses related to claims with unknown years of exposure. In addition, the decision to enter into the JDA was being considered from the date of the acquisition and the ultimate decision was made during the allocation period.
We believe that this reserve represents a reasonable estimate of our probable and estimable liabilities for product claims alleging injury resulting from exposure to silica dust and other particles, including asbestos. We believe that a five-year projection of claims and related defense costs is the most reasonable approach. This reserve will be re-evaluated periodically and additional charges or credits will be recorded to operating expenses as additional information becomes available.
It is possible that we may incur liabilities in an amount in excess of amounts currently reserved. However, taking into account currently available information, historical experience, and our indemnification from Invensys, but recognizing the inherent uncertainties in the projection of any future events, we believe that these suits or claims should not result in final judgments or settlements in excess of our reserve.
We historically have not been required to pay any material liability claims. We maintain insurance against product liability claims (with the exception of asbestosis and silicosis cases, for which coverage is not commercially available), but it is possible that insurance coverage will not continue to be available on terms acceptable to us or that such coverage will not be adequate for liabilities actually incurred.
We are subject to legal proceedings and claims that arise in the ordinary course of our business. In our opinion, the outcome of these actions will not have a material adverse effect on our financial position or results of operations.
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Item 1A. Risk Factors
There have been no material changes to the risks impacting our business since December 31, 2006.
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Item 6. Exhibits
Exhibit No. | | Description |
31.1 | | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | |
31.2 | | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | |
32.1 | | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | |
32.2 | | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, Safety Products Holdings, Inc. has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| SAFETY PRODUCTS HOLDINGS, INC. |
| |
| |
November 8, 2007 | By: | /s/ ROBERT A. PETERSON | |
| | Robert A. Peterson |
| | President, Chief Executive Officer and Director |
| | (Principal Executive Officer) |
| |
| |
November 8, 2007 | By: | /s/ DAVID F. MYERS, JR. |
| | David F. Myers, Jr. |
| | Executive Vice President, Chief Financial Officer, |
| | Secretary and Director |
| | (Principal Financial and Accounting Officer) |
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SAFETY PRODUCTS HOLDINGS, INC.
FORM 10-Q LISTING OF EXHIBITS
Exhibit No. | | Description |
31.1 | | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | |
31.2 | | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | |
32.1 | | Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | |
32.2 | | Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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