SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2001
Commission file number 33-96190
AEARO CORPORATION
(Exact name of registrant as specified in its charter)
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Delaware 13-3840450
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5457 West 79th Street
Indianapolis, Indiana 46268
(Address of principal executive offices) (Zip Code)
(317) 692-6666
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X ______ No
The number of shares of the registrant's common stock, par value $.01
per share, outstanding as of May 10, 2001 was 102,087.5
AEARO CORPORATION
TABLE OF CONTENTS
FORM 10-Q FOR THE QUARTERLY PERIOD
ENDED MARCH 31, 2001
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF
MARCH 31, 2001(UNAUDITED) AND SEPTEMBER 30, 2000 3-4
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED) FOR THE THREE MONTH AND SIX MONTH PERIODS
ENDED MARCH 31, 2001 AND 2000 5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) FOR THE SIX MONTHS ENDED MARCH 31, 2001 AND 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) 7-12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 13-20
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK 21-22
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 23
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 23
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS 23
ITEM 5. OTHER INFORMATION 23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 23
SIGNATURE PAGE
-2-
PART I
Item 1. Financial Statements
AEARO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS--ASSETS
(DOLLARS IN THOUSANDS)
March 31, September 30,
2001 2000
--------- ---------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 2,833 $ 3,495
Accounts receivable (net of reserve
for doubtful accounts of $ 798
and $1,354 respectively) 42,196 44,342
Inventories 36,283 34,310
Deferred and prepaid expenses 3,067 2,623
-------- --------
Total current assets 84,379 84,770
-------- --------
PROPERTY, PLANT AND EQUIPMENT, NET 51,878 53,163
INTANGIBLE ASSETS, NET 120,785 126,242
OTHER ASSETS 2,248 2,691
-------- --------
Total assets $259,290 $266,866
======== ========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
-3-
AEARO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS--LIABILITIES AND STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
March 31, September 30,
2001 2000
---------- ----------
(Unaudited)
CURRENT LIABILITIES:
Current portion of long-term debt $ 21,186 $ 19,313
Accounts payable and accrued liabilities 37,333 39,427
Accrued interest 3,380 3,423
U.S. and foreign income taxes 5,543 5,375
--------- ---------
Total current liabilities 67,442 67,538
--------- ---------
LONG-TERM DEBT 176,465 180,506
DEFERRED INCOME TAXES 403 507
OTHER LIABILITIES 2,421 2,466
--------- ---------
Total liabilities $ 246,731 $ 251,017
--------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value-
(Redemption value of $92,923 and $87,237, respectively)
Authorized--200,000 shares
Issued and outstanding--45,000 shares -- --
Common stock, $.01 par value-
Authorized--200,000 shares
Issued and outstanding--102,088 and 102,088 at
March 31, 2001 and September 30, 2000, respectively 1 1
Additional paid-in capital 32,353 32,213
Retained earnings (deficit) 34 (614)
Accumulated other comprehensive loss (19,829) (15,751)
--------- ---------
Total stockholders' equity 12,559 15,849
--------- ---------
Total liabilities and stockholders' equity $ 259,290 $ 266,866
========= =========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
-4-
AEARO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(Unaudited)
For the For the
Three Months Ended Six Months Ended
March 31, March 31,
-------------------- ----------------------
2001 2000 2001 2000
-------- --------- --------- ---------
NET SALES $ 73,938 $ 77,430 $ 142,207 $ 149,624
COST OF SALES 39,316 41,431 77,069 80,079
-------- --------- --------- ---------
Gross profit 34,622 35,999 65,138 69,545
SELLING AND ADMINISTRATIVE 21,610 23,350 45,497 46,958
RESEARCH AND TECHNICAL SERVICES 1,365 1,391 2,849 2,718
AMORTIZATION OF INTANGIBLES 1,634 1,766 3,289 3,491
OTHER CHARGES (INCOME), NET 514 (374) 523 (409)
-------- --------- --------- ---------
Operating income 9,499 9,866 12,980 16,787
INTEREST EXPENSE, NET 5,880 6,212 11,681 12,159
-------- --------- --------- ---------
Income before provision for income
taxes 3,619 3,654 1,299 4,628
PROVISION FOR INCOME TAXES 584 1,113 651 1,414
-------- --------- --------- ---------
Net income 3,035 2,541 648 3,214
PREFERRED STOCK DIVIDEND ACCRUED 2,857 2,544 5,686 5,036
-------- --------- --------- ---------
Net Income (Loss) applicable to
Common Shareholders $ 178 $ (3) $ (5,038) $ (1,822)
======== ========= ========= =========
AVERAGE COMMON AND DILUTED COMMON SHARES
OUTSTANDING 102,088 101,895 102,088 102,218
======== ========= ========= =========
BASIC AND DILUTED NET INCOME (LOSS)
PER COMMON SHARE $ 1.74 $ (0.03) $ (49.35) $ (17.82)
======== ========= ========= =========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
-5-
AEARO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(Unaudited)
For the Six Months Ended
March 31,
---------------------
-------- ---------
2001 2000
-------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 648 $ 3,214
Adjustments to reconcile net income to cash provided by operating activities-
Depreciation 5,121 4,863
Amortization of intangible assets and deferred financing costs 4,009 4,446
Deferred income taxes (85) (11)
Other, net 22 37
Changes in assets and liabilities-
Accounts receivable 1,389 (2,431)
Inventories (2,530) (1,741)
Accounts payable and accrued liabilities (1,699) (779)
Other, net (449) (904)
-------- --------
Net cash provided by operating activities 6,426 6,694
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (4,439) (4,778)
Cash paid for Norhammer -- (3,620)
Proceeds provided by disposals of property, plant and equipment 36 10
-------- --------
Net cash used by investing activities (4,403) (8,388)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from revolving credit facility, net 7,500 10,250
Repayment of term loans (8,895) (7,210)
Repayment of external long-term debt (5) (161)
(Repurchase) of common stock, net -- (286)
Increase in shareholder notes, net 139 (226)
-------- --------
Net cash provided (used) by financing activities (1,261) 2,367
-------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (1,424) (1,466)
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS (662) (793)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,495 4,050
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,833 $ 3,257
======== ========
CASH PAID FOR:
Interest $ 11,040 $ 11,060
======== ========
Income taxes $ 1,001 $ 845
======== ========
The accompanying notes are an integral part of these
condensed consolidated financial statements.
-6-
Aearo Corporation
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2001
(UNAUDITED)
(1) CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments necessary to
present fairly, in accordance with accounting principles generally
accepted in the United States, the Company's financial position, results
of operations and cash flows for the interim periods presented. The
results of operations for the interim periods shown in this report are
not necessarily indicative of results for any future interim period or
for the entire year. These condensed consolidated financial statements do
not include all disclosures associated with annual financial statements
and accordingly should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's Annual
Report on Form 10-K.
(2) FORMATION ACQUISITION AND FINANCING
Aearo Corporation, a Delaware corporation, and its direct wholly owned
subsidiary, Aearo Company, a Delaware corporation (collectively referred
to herein as "the Company") manufactures and sells products under the
brand names: AOSafety(R), E-A-R(R), and Peltor(R). These products are
sold through three reportable segments, which are Safety Products, Safety
Prescription Eyewear and Specialty Composites.
Aearo Corporation was formed by Vestar Equity Partners, L.P. (Vestar) in
June 1995 to effect the acquisition of substantially all of the assets
and liabilities of Cabot Safety Corporation and certain affiliates (the
Predecessor) all of which were wholly owned by Cabot Corporation (Cabot),
(the Formation Acquisition). The Formation Acquisition closed on July 11,
1995, when Aearo Corporation acquired substantially all of the assets and
certain liabilities of the Predecessor for cash, preferred stock and a
42.5% common equity interest in Aearo Corporation. Aearo Corporation
immediately contributed the acquired assets and liabilities to Aearo
Company, a wholly owned subsidiary of Aearo Corporation, pursuant to an
asset transfer agreement dated June 13, 1995. Aearo Corporation has no
other material assets, liabilities or operations other than those that
result from its ownership of the common stock of Aearo Company.
The Formation Acquisition has been accounted for as a purchase
transaction effective as of July 11, 1995, in accordance with Accounting
Principles Board Opinion No. 16, Business Combinations, and EITF Issue
No. 88-16, Basis in Leveraged Buyout Transactions, and accordingly, the
consolidated financial statements for the periods subsequent to July 11,
1995 reflect the purchase price, including transaction costs, allocated
to tangible and intangible assets acquired and liabilities assumed, based
on a portion of their estimated fair values as of July 11, 1995. The
valuation of assets and liabilities acquired reflect carryover basis for
the percentage ownership retained by Cabot.
(3) SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates. The preparation of the condensed consolidated financial
statements in conformity with accounting principles generally accepted in
the United States requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
Reclassifications. Certain amounts included in the prior period financial
statements may have been reclassified to conform to the current period
presentation. The reclassifications have no impact on net income
previously reported.
-7-
Revenue Recognition. The Company recognizes revenue upon shipment of its
products to customers, at which time title of ownership transfers to the
buyer.
Foreign Currency Translation. Assets and liabilities of the Company's
foreign operations are translated at period-end exchange rates. Income
and expenses are translated at the approximate average rate during the
period. Foreign currency translation adjustments are recorded as a
separate component of stockholders' equity. Foreign currency gains and
losses arising from transactions by any of the Company's subsidiaries are
reflected in net income.
Income Taxes. Deferred tax assets and liabilities are determined based on
the difference between the financial statement and tax basis of assets
and liabilities using enacted tax rates.
Intangible Assets. Intangible assets consist primarily of the goodwill,
patents, and trademarks purchased in business acquisitions. Intangible
assets are amortized over their estimated useful lives.
Income (Loss) per Common Share. Basic income (loss) per common share is
computed by dividing net income (loss) by the weighted average number of
shares of common stock outstanding during the period. Diluted income
(loss) per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or
converted. As of March 31, 2001 and 2000, there were 12,189 and 9,883
options outstanding, respectively. The stock options were not dilutive
and were not included in the diluted income (loss) per share calculation
for the three and six months ended March 31, 2001 and 2000. Basic and
diluted income (loss) per common share for the three and six months ended
March 31, 2001 and 2000, were equal; therefore, no reconciliation between
basic and diluted income (loss) per share is required.
Accounting for Derivative Instruments and Hedging Activities. The
Company adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 133, Accounting for Derivative Instruments and
Hedging Activities on October 1, 2000. SFAS No. 133 requires that every
derivative instrument be recorded in the balance sheet as either an asset
or a liability measured at its fair value. The adoption of SFAS No. 133
on October 1, 2000 resulted in a $0.4 million transition adjustment
charge to accumulated other comprehensive income to recognize the fair
value of all derivatives that are designated as cash flow hedges.
The Company has formally documented its hedging relationships, including
identification of the hedging instruments and the hedge items, as well as
its risk management objectives and strategies for undertaking each hedge
transaction. The Company has foreign currency exchange contracts and
interest rate swap agreements, which are derivatives as defined by SFAS
No. 133. The Company enters into foreign currency forward contracts to
mitigate the effects of changes in foreign currency rates on
profitability and enters into interest rate swap agreements to hedge
their variable interest rate risk. These derivatives are cash flow
hedges. For all qualifying and highly effective cash flow hedges, the
changes in the fair value of the derivatives are recorded in other
comprehensive income. Amounts accumulated in other comprehensive income
will be reclassified as earnings when the related product sales affect
earnings for forward currency contracts or when related interest payments
affect earnings for interest rate swaps. As a result of the foreign
currency forward contracts and the interest rate swap agreements, the
Company has recorded a derivative liability of $0.7 million at March 31,
2001. All forward contracts and swap agreements will expire over the next
6 months.
During the three month period ending March 31, 2001 the Company
reclassified into earnings a net loss of approximately $321,000 resulting
from the exercise of foreign currency contracts and a net loss of $7,000
resulting from interest rate swap settlements. All foreign currency
contracts and interest rate swap agreements were determined to be highly
effective whereby no ineffectiveness was recorded in earnings.
-8-
The Company also executes foreign currency contracts for up to 30 day
terms to protect against the adverse effects that exchange rate
fluctuations may have on the foreign-currency-denominated trade
activities (receivables, payables and cash) of foreign subsidiaries.
These contracts have not been designated as hedges under SFAS No. 133 and
accordingly, the gains and losses on both the derivative and
foreign-currency-denominated trade activities are recorded as transaction
adjustments in current earnings. The impact on earnings was a loss of
approximately $297,000 for the quarter ended March 31, 2001.
(4) COMPREHENSIVE INCOME
Comprehensive income consisted of the following (dollars in thousands):
Three Months Ended Six Months Ended
March 31, March 31,
2001 2000 2001 2000
------- ------- ------- --------
Net income $ 3,035 $ 2,541 $ 648 $ 3,214
Foreign currency translation
Adjustment (5,089) (886) (3,395) (3,686)
Unrealized gain (loss) on
derivative instruments 1,018 -- (683) --
------- ------- ------- -------
Comprehensive income (loss) $(1,034) $ 1,655 $(3,430) $ (472)
======= ======= ======= =======
(5) INVENTORIES
Inventories consisted of the following (dollars in thousands):
March 31, September 30,
2001 2000
-------------- --------------
(unaudited)
Raw materials $ 8,466 $ 8,246
Work in process 8,057 7,662
Finished goods 19,760 18,402
-------------- --------------
$ 36,283 $ 34,310
============== ==============
Inventories, which include materials, labor and manufacturing overhead,
are stated at the lower of cost or market, cost being determined using
the first-in, first-out method.
-9-
(6) DEBT
The Company's debt structure includes $100.0 million of Senior
Subordinated Notes (Notes) due 2005, as well as a senior bank facility
comprised of (i) term loans denominated in U.S., Canadian, British, and
German currencies (Term Loans) and (ii) a secured revolving credit
facility (Revolving Credit Facility) providing for up to $25.0 million of
revolving loans, a portion of which is to be used for general corporate
purposes, and as to $15.0 million thereof, to finance permitted
acquisitions (collectively the Senior Bank Facilities). Under the terms
of both the Senior Bank Facilities and the Notes indenture, Aearo Company
is required to comply with certain financial covenants and restrictions.
On December 14, 2000, the Senior Bank Facilities were amended to increase
the amount available to finance acquisitions from $15.0 million to $33.0
million and to modify certain financial covenants for periods ending on
and after December 31, 2000. Aearo Company was in compliance with all
financial covenants and restrictions at March 31, 2001. The amounts
outstanding on the term loans and the revolving credit facility at March
31, 2001 were approximately $77.4 million and $17.5 million,
respectively.
(7) COMMITMENTS AND CONTINGENCIES
Lease Commitments. The Company leases certain transportation vehicles,
warehouse facilities, office space, and machinery and equipment under
cancelable and non-cancelable leases, most of which expire within 10
years and may be renewed by the Company.
Contingencies. Various lawsuits and claims arise against the Company in
the ordinary course of its business. Most of these lawsuits and claims
relate to the Company's safety eyewear and respiratory product lines and
primarily involve accidents and/or exposures occurring after the
Company's predecessor acquired the AOSafety(R) Division from American
Optical Corporation in April 1990. The Company is contingently liable
with respect to numerous lawsuits involving respirators sold by American
Optical Corporation prior to the acquisition of the AOSafety(R) Division
in April 1990. These lawsuits typically involve plaintiffs alleging that
they suffer from asbestosis or silicosis, and that such condition results
in part from respirators which were negligently designed or manufactured.
The defendants in these lawsuits are often numerous, and include, in
addition to respirator manufacturers, employers of the plaintiffs and
manufacturers of sand (used in sand blasting) and asbestos.
Responsibility for legal costs, as well as for settlements and judgments,
is shared contractually by the Company, American Optical Corporation and
a prior owner of American Optical Corporation. The Company and Cabot have
entered into an arrangement whereby, so long as the Company pays to Cabot
an annual fee of $400,000, which the Company has elected to pay, Cabot
will retain responsibility and liability for, and indemnify the Company
against, certain legal claims asserted after July 11, 1995 (the date of
the Company's formation) alleged to arise out of the use of respirators
manufactured prior to July 1995. The Company has the right to discontinue
the payment of such annual fee at any time, in which case the Company
will assume responsibility for and indemnify Cabot with respect to such
claims however, management intends to continue the annual payment of
$400,000 to Cabot. The Company may be responsible for claims alleged to
arise out of the use of respirators manufactured by the Company as well
as products purchased for resale. The Company may also be responsible for
certain claims of acquired companies other than the AOSafety(R) division
that are not covered by the agreement with Cabot.
At March 31, 2001 the Company has reserved approximately $4.6 million for
product liabilities including those arising from asbestosis or silicosis
litigation. The reserve is re-evaluated periodically and additional
charges to operations may result as additional information becomes
available. Consistent with the general environment being experienced by
other companies involved in asbestos-related litigation, there has been
an increase in the number of asserted legal claims that could potentially
involve the Company. Various factors increase the difficulty in
determining the Company's potential liability, if any, in such claims,
including the fact that the defendants in these lawsuits are often
numerous and the claims generally do not specify the amount of damages
sought. Additionally, the bankruptcy filings of other companies with
asbestos related litigation could affect the Company's cost over time.
However, it is management's opinion, taking into account currently
available information, historical experience, uncertainties, the Cabot
agreement, and the Company's reserve, that these suits and claims should
not result in final judgments or settlements that, in the aggregate,
would have a material effect on the Company's financial condition or
results of operation.
-10-
(8) SEGMENT REPORTING
The Company manufactures and sells products under the brand names:
AOSafety(R), E-A-R(R), and Peltor(R). These products are sold through
three reportable segments, which are Safety Products, Safety Prescription
Eyewear and Specialty Composites. The Safety Products segment
manufactures and sells hearing protection devices, non-prescription
safety eyewear, face shields, reusable and disposable respirators, hard
hats, and first aid kits. The Safety Prescription Eyewear segment
manufactures and sells prescription eyewear products that are designed to
protect the eyes from the typical hazards encountered in the industrial
work environment. The Company's Safety Prescription Eyewear segment
purchases component parts (lenses and the majority of its frames) from
various suppliers, grinds, shapes and applies coatings to the lenses in
accordance with the customer's prescription, and then assembles the
glasses using the customer's choice of frame. The Specialty Composites
segment manufactures a wide array of energy-absorbing materials that are
incorporated into other manufacturers' products to control noise,
vibration and shock.
Net Sales to External Customers by Business Segment (Dollars in thousands)
Three Months Ended Six Months Ended
March 31, March 31,
2001 2000 2001 2000
------- ------- -------- --------
Safety Products $53,010 $54,335 $102,133 $106,009
Safety Prescription Eyewear 10,701 10,766 19,642 19,794
Specialty Composites 10,227 12,329 20,432 23,821
------- ------- -------- --------
Total $73,938 $77,430 $142,207 $149,624
======= ======= ======== ========
Intersegment sales of the Specialty Composites segment to the Safety Products
segment totaled $0.9 million and $0.7 million for the three months ended March
31, 2001 and 2000, respectively. Intersegment sales totaled $1.9 million and
$1.6 million for the six months ended March 31, 2001 and 2000, respectively. The
intersegment sales value is determined at fully absorbed inventory cost at
standard rates plus 25%.
-11-
EBITDA by Business Segment and reconciliation to Income before provision for
income taxes (Dollars in thousands)
Three Months Ended Six Months Ended
March 31, March 31,
2001 2000 2001 2000
-------- -------- -------- --------
Safety Products $ 11,027 $ 11,439 $ 17,586 $ 21,424
Safety Prescription Eyewear 1,074 1,388 1,074 1,928
Specialty Composites 616 1,137 1,214 2,172
Reconciling items 903 5 1,405 (454)
-------- -------- -------- --------
Total EBITDA 13,620 13,969 21,279 25,070
Depreciation 2,591 2,423 5,121 4,863
Amortization 1,634 1,766 3,289 3,491
Non-operating Costs (104) (86) (111) (71)
Interest 5,880 6,212 11,681 12,159
-------- -------- -------- --------
Income before tax provision $ 3,619 $ 3,654 $ 1,299 $ 4,628
======== ======== ======== ========
EBITDA is defined by the Company as earnings before interest, taxes,
depreciation, amortization, and non-operating income or expense. Non-operating
income or expense is further defined as extraordinary gains or losses, or gains
or losses from sales of assets other than in the ordinary course of business.
While the Company believes EBITDA is a useful indicator of its ability to
service debt, EBITDA should not be considered as a substitute for net income
(loss) determined in accordance with accounting principles generally accepted in
the United States as an indicator of operating performance or as an alternative
to cash flow as a measure of liquidity. Investors should be aware that EBITDA as
presented above may not be comparable to similarly titled measures presented by
other companies and comparisons could be misleading unless all companies and
analysts calculate this measure in the same fashion.
-12-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the Condensed
Consolidated Financial Statements of the Company, including notes thereto,
appearing elsewhere in this Report. This Report contains forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. The Company's actual results
could differ materially from those set forth in such forward-looking statements.
The factors that might cause such a difference include, among others, the
following: risks associated with indebtedness; risks related to acquisitions;
risks associated with the conversion to a new management information system;
high level of competition in the Company's markets; importance and costs of
product innovation; risks associated with international operations; product
liability exposure; unpredictability of patent protection and other intellectual
property issues; dependence on key personnel; the risk of adverse effect of
economic and regulatory conditions on sales; and risks associated with
environmental matters.
Results of Operations -- Three Months Ended March 31, 2001 Compared to Three
Months Ended March 31, 2000
Unaudited
(Dollars in Thousands, Except Per Share Amounts)
Three Months Ended March 31, Change - Favorable
---------------------------- ------------------
(Unfavorable)
2001 % 2000 % Amount Percent
Net Sales ---------- ------- ---------- ------- ---------- -------
Safety Products $ 53,010 71.7% $ 54,335 70.2% $ (1,325) (2.4)
Safety Prescription Eyewear 10,701 14.5 10,766 13.9 (65) (0.6)
Specialty Composites 10,227 13.8 12,329 15.9 (2,102) (17.0)
---------- ------- ---------- ------- ----------
Total net sales 73,938 100.0 77,430 100.0 (3,492) (4.5)
Cost of Sales 39,316 53.2 41,431 53.5 2,115 5.1
---------- ------- ---------- ------- ---------
Gross profit 34,622 46.8 35,999 46.5 (1,377) (3.8)
Operating Expenses-
Selling and administrative 21,610 29.2 23,350 30.2 1,740 7.5
Research and technical services 1,365 1.8 1,391 1.8 26 1.9
Amortization of intangibles 1,634 2.2 1,766 2.3 132 7.5
Other charges (income), net 514 0.7 (374) (0.5) (888) --
---------- ------- ---------- ------- ----------
Operating income 9,499 12.8 9,866 12.7 (367) (3.7)
Interest expense, net 5,880 8.0 6,212 8.0 332 5.3
---------- ------- ---------- ------- ----------
Income before provision for income
taxes 3,619 4.9 3,654 4.7 (35) (1.0)
Provision for income
taxes 584 0.8 1,113 1.4 529 47.5
---------- ------- ---------- ------- ---------
Net income 3,035 4.1 2,541 3.3 494 19.4
Preferred stock dividend accrued 2,857 3.9 2,544 3.3 (313) (12.3)
---------- ------- ---------- ------- ----------
Income (loss) applicable to common
shareholders $ 178 0.2 $ (3) -- $ 181 --
========== ======= ========== ======= ==========
Income (loss) per common share $ 1.74 -- $ (0.03) -- $ 1.77 --
========== ========== ==========
EBITDA $ 13,620 18.4% $ 13,969 18.0% $ (349) (2.5)
========== ======= ========== ======= ==========
-13-
Net Sales. Net sales in the three months ended March 31, 2001 decreased 4.5% to
$73.9 million from $77.4 million in the three months ended March 31, 2000. The
change in sales was primarily driven by a stronger US dollar relative to global
currencies and to a lesser extent by the slowing economy in North America.
Safety Products net sales in the three months ended March 31, 2001 decreased
2.4% to $53.0 million from $54.3 million in the three months ended March 31,
2000. The strength of the US dollar relative to global currencies had the impact
of reducing sales by approximately $1.5 million. On a constant currency basis
sales were up $0.2 million, or 0.4%, as compared to the three months ended March
31, 2000. The Safety Prescription Eyewear segment net sales in the three months
ended March 31, 2001 decreased 0.6% to $10.7 million from $10.8 million in the
three months ended March 31, 2000. Specialty Composites' net sales in the three
months ended March 31, 2001 decreased 17.0% to $10.2 million from $12.3 million
in the three months ended March 31, 2000. The decrease was primarily driven by a
30% volume decline in sales to the truck market as manufacturers adjusted
production levels due to excess inventories of new and used trucks.
Gross Profit. Gross profit in the three months ended March 31, 2001 decreased
3.8% to $34.6 million from $36.0 million in the three months ended March 31,
2000. Gross profit as a percentage of net sales in the three months ended March
31, 2001 improved to 46.8% as compared to 46.5% in the three months ended March
31, 2000. This improvement in the gross profit percentage of net sales is
primarily due to increased productivity in the manufacturing plants that was
strong enough to offset the negative impact of changes in foreign exchange
rates. The strong US dollar relative to European currencies negatively affects
gross profit since it depresses revenue while having a limited impact on
manufacturing costs. The average exchange rate used for the Euro in preparing
the condensed consolidated financial statements for the three months ended March
31, 2001 and 2000 was 0.936 and 0.981, respectively.
Selling and Administrative Expenses. Selling and administrative expenses in the
three months ended March 31, 2001 decreased 7.5% to $21.6 million from $23.4
million in the three months ended March 31, 2000. Selling and administrative
expenses as a percentage of net sales in the three months ended March 31, 2001
decreased to 29.2% as compared to 30.2% in the three months ended March 31,
2000. The decrease is primarily due to the Company's proactive measures to
reduce expenses in line with the slowdown in the economy.
Amortization of Intangibles. Amortization expense in the three months ended
March 31, 2001 decreased 7.5% to $1.6 million from $1.8 million in the three
months ended March 31, 2000.
Other Charges (Income), Net. Other charges (income), net was expense of $0.5
million for the three months ended March 31, 2001 as compared to income of $0.4
million for the three months ended March 31, 2000. This change was primarily a
result of net foreign currency transaction losses in the three months ended
March 31, 2001 as compared to net foreign currency transaction gains in the
three months ended March 31, 2000.
Operating Income. Operating income decreased 3.7% to $9.5 million in the three
months ended March 31, 2001 from $9.9 million in the three months ended March
31, 2000. Operating income as a percentage of net sales improved to 12.8% in the
three months ended March 31, 2001 as compared to 12.7% in the three months ended
March 31, 2000.
Interest Expense, Net. Interest expense, net in the three months ended March 31,
2001 decreased 5.3% to $5.9 million from $6.2 million in the three months ended
March 31, 2000. The reduction in interest expense was due to a reduction in
average borrowings partially offset by an increase in the weighted average
interest rates in effect for the three months ended March 31, 2001 as compared
to the three months ended March 31, 2000.
Provision For Income Taxes. The provision for income taxes in the three months
ended March 31, 2001 was $0.6 million compared to $1.1 million in the three
months ended March 31, 2000. The effective tax rate was 16.1% and 30.5% for the
three months ended March 31, 2001 and 2000, respectively. The decrease in the
effective tax rate reflects a change during the second quarter of 2001 in the
relationship of taxable income from foreign subsidiaries to domestic operations.
-14-
Net Income. Net income for the three months ended March 31, 2001 increased 19.4%
to $3.0 million from $2.5 million for the three months ended March 31, 2000.
EBITDA. EBITDA is defined by the Company as earnings before interest, taxes,
depreciation, amortization, and non-operating income or expense. Non-operating
income or expense is further defined as extraordinary gains or losses, or gains
or losses from sales of assets other than in the ordinary course of business.
While the Company believes EBITDA is a useful indicator of its ability to
service debt, EBITDA should not be considered as a substitute for net income
determined in accordance with accounting principles generally accepted in the
United States as an indicator of operating performance or as an alternative to
cash flow as a measure of liquidity. Investors should be aware that EBITDA as
presented below may not be comparable to similarly titled measures presented by
other companies and comparisons could be misleading unless all companies and
analysts calculate this measure in the same fashion.
EBITDA Calculation
Unaudited
(Dollars in Thousands)
Three Months Ended Change
March 31, Favorable (Unfavorable)
2001 2000 Amount Percent
-------- -------- ------ -------
Operating Income $ 9,499 $ 9,866 $ (367) (3.7)%
Add Backs:
Depreciation 2,591 2,423 168 6.9%
Amortization of Intangibles 1,634 1,766 (132) (7.5)%
Non-operating income, net (104) (86) (18) (20.9)%
-------- -------- ------ -------
EBITDA $ 13,620 $ 13,969 $ (349) (2.5)%
======== ======== ====== =======
EBITDA for the three months ended March 31, 2001 was $13.6 million as compared
to $14.0 million for the three months ended March 31, 2000. EBITDA as a
percentage of net sales in the three months ended March 31, 2001 improved to
18.4% as compared to 18.0% in the three months ended March 31, 2000.
-15-
Results of Operations -- Six Months Ended March 31, 2001 Compared to Six Months
Ended March 31, 2000
Unaudited
(Dollars in Thousands, Except Per Share Amounts)
Six Months Ended March 31, Change - Favorable
-------------------------- -----------------
(Unfavorable)
2001 % 2000 % Amount %
Net Sales ---------- ------- ----------- ------ --------- -------
Safety Products $ 102,133 71.8% $ 106,009 70.9% $ (3,876) (3.7)%
Safety Prescription Eyewear 19,642 13.8 19,794 13.2 (152) (0.8)
Specialty Composites 20,432 14.4 23,821 15.9 (3,389) (14.2)
---------- ------- ----------- ------ ---------
Total net sales 142,207 100.0 149,624 100.0 (7,417) (5.0)
Cost of Sales 77,069 54.2 80,079 53.5 3,010 3.8
---------- ------- ----------- ------ ---------
Gross profit 65,138 45.8 69,545 46.5 (4,407) (6.3)
Operating Expenses-
Selling and administrative 45,497 32.0 46,958 31.4 1,461 3.1
Research and technical services 2,849 2.0 2,718 1.8 (131) (4.8)
Amortization of intangibles 3,289 2.3 3,491 2.3 202 5.8
Other charges (income), net 523 0.4 (409) (0.3) (932) --
---------- ------- ----------- ------ ---------
Operating income 12,980 9.1 16,787 11.2 (3,807) (22.7)
Interest expense, net 11,681 8.2 12,159 8.1 478 3.9
---------- ------- ----------- ------ ---------
Income before provision
for income taxes 1,299 0.9 4,628 3.1 (3,329) (71.9)
Provision for income
taxes 651 0.5 1,414 0.9 763 54.0
---------- ------- ----------- ------ ---------
Net income 648 0.5 3,214 2.1 (2,566) (79.8)
Preferred stock dividend accrued 5,686 4.0 5,036 3.4 (650) (12.9)
---------- ------- ----------- ------ ---------
Loss applicable to common shareholders
$ (5,038) (3.5) $ (1,822) (1.2) $ (3,216) --
========== ======= =========== ====== =========
Loss per common share $ (49.35) -- $ (17.82) -- $ (31.53) --
========== =========== =========
EBITDA $ 21,279 15.0% $ 25,070 16.8% $ (3,791) (15.1)%
========== ======= =========== ======= =========
Net Sales. Net sales in the six months ended March 31, 2001 decreased 5.0% to
$142.2 million from $149.6 million in the six months ended March 31, 2000. The
change in sales was primarily driven by a stronger US dollar relative to global
currencies and to a lesser extent by the slowing economy in North America.
Safety Products net sales in the six months ended March 31, 2001 decreased 3.7%
to $102.1 million from $106.0 million in the six months ended March 31, 2000.
The strength of the US dollar relative to global currencies had the impact of
reducing sales by approximately $4.5 million in the six months ended March 31,
2001, as compared to the six months ended March 31, 2000. On a constant currency
basis sales were up $0.2 million, or 0.2%, as compared to the six months ended
March 31, 2000. The Safety Prescription Eyewear segment net sales in the six
months ended March 31, 2001 decreased 0.8% to $19.6 million from $19.8 million
in the six months ended March 31, 2000. Specialty Composites' net sales in the
six months ended March 31, 2001 decreased 14.2% to $20.4 million from $23.8
million in the six months ended March 31, 2000. The decrease was primarily
driven by a 35% volume decline in sales to the truck market as manufacturers
adjusted production levels due to excess inventories of new and used trucks.
Gross Profit. Gross profit in the six months ended March 31, 2001 decreased 6.3%
to $65.1 million from $69.5 million in the six months ended March 31, 2000.
Gross Profit as a percentage of net sales in the six months ended March 31, 2001
was 45.8% as compared to 46.5% in the six months ended March 31, 2000. The
slight decline in the gross profit percentage of net sales is primarily due to
the strength of the US dollar relative to European currencies. The lower Euro
creates an unfavorable impact on gross margins since it depresses revenue while
having a limited impact on manufacturing costs. The average exchange rate used
for the Euro in preparing the condensed consolidated financial statements for
the six months ended March 31, 2001 and 2000 was 0.9017 and 1.0128,
respectively.
-16-
Selling and Administrative Expenses. Selling and administrative expenses in the
six months ended March 31, 2001 decreased 3.1% to $45.5 million from $47.0
million in the six months ended March 31, 2000. Selling and administrative
expenses as a percentage of net sales in the six months ended March 31, 2001
increased to 32.0% of net sales as compared to 31.4% of net sales in the six
months ended March 31, 2000. The decrease is primarily due to the Company's
proactive measures to reduce expenses in line with the slowdown in the economy.
Research and Technical Service Expenses. Research and technical service expenses
in the six months ended March 31, 2001 increased 4.8% to $2.8 million from $2.7
million in the six months ended March 31, 2000. The increase is attributed to
additional focus in the design and development of new products and technologies.
Amortization of Intangibles. Amortization expense in the six months ended March
31, 2001 decreased 5.8% to $3.3 million from $3.5 million in the six months
ended March 31, 2000.
Other Charges (Income), Net. Other charges (income), net was expense of $0.5
million for the six months ended March 31, 2001 as compared to income of $0.4
million for the six months ended March 31, 2000. This change was primarily a
result of net foreign currency transaction losses in the six months ended March
31, 2001 as compared to net foreign currency transaction gains in the six months
ended March 31, 2000.
Operating Income. Operating income decreased 22.7% to $13.0 million in the six
months ended March 31, 2001 from $16.8 million in the six months ended March 31,
2000. Operating income as a percentage of net sales in the six months ended
March 31, 2001 was 9.1% as compared to 11.2% in the six months ended March 31,
2000.
Interest Expense, Net. Interest expense, net in the six months ended March 31,
2001 decreased 3.9% to $11.7 million from $12.2 million in the six months ended
March 31, 2000. The reduction in interest expense was due to a reduction in
average borrowings partially offset by an increase in the weighted average
interest rates in effect for the six months ended March 31, 2001 as compared to
the six months ended March 31, 2000.
Provision For Income Taxes The provision for income taxes in the six months
ended March 31, 2001 was $0.7 million compared to $1.4 million in the six months
ended March 31, 2000. The effective tax rate was 50.1% and 30.6% for the six
months ended March 31, 2001 and 2000, respectively. The Company's foreign
subsidiaries had taxable income in their foreign jurisdictions while the
Company's domestic subsidiaries generated a net operating loss. The domestic
subsidiaries have net operating loss carryforwards for income tax purposes. Due
to the uncertainty of realizing these tax benefits, the tax benefits generated
by the year-to-date net operating loss in 2001 has been fully offset by a
valuation allowance.
Net Income. Net income for the six months ended March 31, 2001 decreased 79.8%
to $0.6 million from $3.2 million for the six months ended March 31, 2000.
EBITDA. EBITDA is defined by the Company as earnings before interest, taxes,
depreciation, amortization, and non-operating income or expense. Non-operating
income or expense is further defined as extraordinary gains or losses, or gains
or losses from sales of assets other than in the ordinary course of business.
While the Company believes EBITDA is a useful indicator of its ability to
service debt, EBITDA should not be considered as a substitute for net income
determined in accordance with accounting principles generally accepted in the
United States as an indicator of operating performance or as an alternative to
cash flow as a measure of liquidity. Investors should be aware that EBITDA as
presented below may not be comparable to similarly titled measures presented by
other companies and comparisons could be misleading unless all companies and
analysts calculate this measure in the same fashion.
-17-
EBITDA Calculation
Unaudited
(Dollars in Thousands)
Six Months Ended Change
March 31, Favorable (Unfavorable)
2001 2000 Amount %
--------- --------- --------- -------
Operating Income $ 12,980 $ 16,787 $ (3,807) (22.7)%
Add Backs:
Depreciation 5,121 4,863 258 5.3
Amortization of Intangibles 3,289 3,491 (202) (5.8)
Non-operating costs (income), net (111) (71) (40) (56.3)
--------- --------- ---------
EBITDA $ 21,279 $ 25,070 $ (3,791) (15.1)%
========= ========= =========
EBITDA for the six months ended March 31, 2001 was $21.3 million as compared to
$25.1 million for the six months ended March 31, 2000. EBITDA as a percentage of
net sales in the six months ended March 31, 2001 was 15.0% as compared to 16.8%
in the six months ended March 31, 2000.
Effects of Changes in Exchange Rates
In general, the Company's results of operations are affected by changes in
exchange rates. Subject to market conditions, the Company prices its products in
Europe and Canada in local currency. While many of the Company's selling and
distribution costs are also denominated in these currencies, a large portion of
product costs are U.S. Dollar denominated. As a result, a decline in the value
of the U.S. Dollar relative to other currencies can have a favorable impact on
the profitability of the Company and an increase in the value of the U.S. Dollar
relative to these other currencies can have a negative effect on the
profitability of the Company. As a result of the acquisition of Peltor, the
Company's operations are also affected by changes in exchange rates relative to
the Swedish Krona. A decline in the value of the Krona relative to other
currencies can have a favorable impact on the profitability of the Company and
an increase in the value of the Krona relative to other currencies can have a
negative impact on the profitability of the Company. The Company utilizes
forward foreign currency contracts to mitigate the effects of changes in foreign
currency rates on profitability.
Effects of Inflation
For the three most recent fiscal years, inflation has been modest and has not
had a material impact upon the results of the Company's operations.
Effects of Economic Conditions
Softening of the North American economy began during the first fiscal quarter of
this year. Since that time the overall economic downturn has resulted in many
companies announcing layoffs which has also had an impact on overall consumer
confidence. The Company sells mainly into the manufacturing sector and, to a
lesser extent, the consumer marketplace. The announced layoffs have had a
significant impact on the number of employed industrial workers. As a result of
this there has been, and it is expected to continue for some time, a slowdown in
the market for our products. To address these changes the Company has taken, and
expects to continue to take, proactive measures which have included a reduction
of workforce, frozen hiring, a reduction of senior managers pay, and a reduction
of our planned capital spending and expense budgets.
-18-
Liquidity and Capital Resources
The Company's sources of funds have consisted primarily of operating cash flow
and debt financing. The Company's uses of those funds consist principally of
debt service, capital expenditures and acquisitions.
The Company's debt structure includes $100.0 million of Senior Subordinated
Notes (Notes) due 2005, as well as a senior bank facility comprised of (i) term
loans denominated in U.S., Canadian, British and German currencies aggregating
$140.0 million at inception (the Term Loans) and (ii) a revolving credit
facility providing for up to $25.0 million (the Senior Bank Facilities), for
general corporate purposes and, as to $33.0 million thereof, to finance
permitted acquisitions. On December 14, 2000, the Senior Bank Facilities were
amended to increase the amount available to finance acquisitions from $15.0
million to $33.0 million and to modify certain financial covenants for periods
ending on and after December 31, 2000. Aearo Company was in compliance with all
financial covenants and restrictions at March 31, 2001.
Maturities under the Company's Term Loans are: $9.9 million for the remainder of
fiscal 2001, $32.2 million in fiscal 2002, and $35.3 million in fiscal 2003.
Other than upon a change of control or as a result of certain asset sales, or in
the event that certain excess funds exist at the end of a fiscal year, the
Company will not be required to make any principal payments in respect of the
Notes until maturity. The Company is required to make interest payments with
respect to both the Senior Bank Facilities and the Notes. The Company's revolver
and Term Loans A mature in May 2002, and the Term Loans B mature in May 2003.
The Company's net cash provided by operating activities for the six months ended
March 31, 2001 totaled $6.4 million as compared to $6.7 million for the six
months ended March 31, 2000. The decrease was due primarily to a decrease of
$2.6 million in net income, offset by an increase of $2.6 million in the
Company's net changes in assets and liabilities. The Company's net changes in
assets and liabilities were primarily driven by a reduction in receivables
during the six months ended March 31, 2001 as compared to an increase in
receivables during the six months ended March 31, 2000, somewhat offset by a
larger growth in inventory for the six months ended March 31, 2001 as compared
to the prior period.
Net cash used by investing activities was $4.4 million for the six months ended
March 31, 2001 as compared to $8.4 million for the six months ended March 31,
2000. The decrease in net cash used by investing activities is primarily due to
the acquisition of Norhammer in the prior period.
Net cash used by financing activities for the six months ended March 31, 2001
was $1.3 million compared with net cash provided by financing activities for the
six months ended March 31, 2000 of $2.4 million. The increase of cash used by
financing activities of $3.6 million is primarily attributed to reduced net
borrowings from the revolving credit facility of $2.8 million combined with a
$1.7 million increase in cash used for the repayment of term loans. Scheduled
principal repayments on the Term Loans were $8.9 million and $7.2 million for
the six months ended March 31, 2001 and 2000, respectively.
The Company has a substantial amount of indebtedness. The Company relies on
internally generated funds, and to the extent necessary, on borrowings under the
Revolving Credit Facility (subject to certain customary drawing conditions) to
meet its liquidity needs. The Company anticipates that operating cash flow will
be adequate to meet its operating and capital expenditure requirements for the
next several years, although there can be no assurances that existing levels of
sales and normalized profitability, and therefore cash flow, will be maintained
in the future. Levels of sales and profitability may be impacted by service
levels, continued new product development, worldwide economic conditions and
competitive pressures. In particular, the Company expects that sales and
profitability over the remainder of fiscal 2001 will be adversely affected by
the strength of the U.S. Dollar relative to the global currencies. In addition,
the Company may make additional acquisitions in the future and would rely on
-19-
internally generated funds and, to the extent necessary, on borrowings to
finance such acquisitions. It is also anticipated that over the next several
quarters the level of debt service and the requirements placed on the Company
through the related financial covenants under the Company's Senior Bank
Facilities will require that the Company amend its credit agreement with its
syndicate of lenders, or otherwise change its capital structure.
-20-
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The Company is exposed to market risks related to change in foreign currencies,
interest rates and commodity pricing. The Company uses derivatives to mitigate
the impact of changes in foreign currencies and interest rates. All derivatives
are for purposes other than trading. The Company adopted the provisions of
Statement of Financial Accounting Standard (SFAS) No. 133, Accounting for
Derivative Instruments and Hedging Activities on October 1, 2000. The Company
has formally documented its hedging relationships, including identification of
hedging instruments and the hedge items, as well as its risk management
objectives.
Foreign Currency Risk
The Company's results of operations are subject to risk associated with
operating in foreign countries, including fluctuations in currency exchange
rates. While many of the Company's selling and distribution costs are
denominated in Canadian and European currencies, a large portion of product
costs are U.S. Dollar denominated. As a result, a decline in the value of the
U.S. Dollar relative to other currencies can have a favorable impact on the
profitability of the Company and an increase in the value of the U.S. Dollar
relative to these other currencies can have a negative effect on the
profitability of the Company. The Company executes two hedging programs, one for
transaction exposures, and the other for cash flow exposures on European
operations. The Company has utilized forward contracts for transaction and cash
flow exposures. During the three months ended March 31, 2001 net transaction
losses were $0.3 million, and cash flow hedges were a loss of $0.3 million. In
addition, the Company limits foreign exchange impact on the balance sheet with
foreign denominated debt in Great Britain Pound Sterling (GBP) and German Marks
(DM).
The adoption of SFAS No. 133 on October 1, 2000 resulted in a $0.3 million
transition adjustment charge to accumulated other comprehensive income to
recognize the fair value of foreign currency forward contracts designated as
cash flow hedges. During the three months ended March 31, 2001 the Company
recorded a reduction of $1.3 million to the derivative liability to recognize
the change in fair value of foreign currency forward contracts outstanding. As a
result of the foreign currency forward contracts the Company has recorded a
derivative liability of $0.1 million as of March 31, 2001. The foreign currency
forward contracts will expire over the next 6 months.
Interest Rates
The Company is exposed to market risk changes in interest rates through its
debt. The Company utilizes interest rate swaps to reduce the impact of potential
increased interest rates on its floating debt. On February 28, 2000, the Company
unwound its zero premium collar by rolling unrealized gains into a new interest
rate swap that matched the notional amounts of the credit agreement by each loan
currency. The interest rate swaps will expire August 31, 2001. During the
quarter ended March 31, 2001, the Company incurred an additional $7,000 of
interest expense as a result of the interest rate swaps and expects that the
additional interest expense as a result of the interest rate swaps will increase
until the maturity of the interest rate swap agreement.
The adoption of SFAS No. 133 on October 1, 2000 resulted in a $0.1 million
transition adjustment charge to accumulated other comprehensive income to
recognize the fair value of interest rate swap agreements designated as cash
flow hedges. During the three months ended March 31, 2001 the Company recorded
an additional $0.3 million of derivative liability to recognize the change in
fair value of the interest rate swap agreements. As a result of the interest
rate swap agreements the Company has recorded a derivative liability of $0.6
million as of March 31, 2001.
Commodity Risk
-21-
The Company is subject to market risks with respect to industry pricing in paper
and crude oil as it relates to various commodity items. The Company is also
exposed to market risks for electricity, fuel oil and natural gas consumed in
its operations. Items with potential impact are paperboard, packaging films,
nylons, resins, propylene, ethylene, plasticizer and freight. The Company
manages pricing exposures on larger volume commodities such as polycarbonate,
polyols and polyvinyl chloride via price negotiations utilizing alternative
supplier competitive pricing. The Company sources some products and parts from
Far East sources where resource availability, competition, and infrastructure
stability has provided a favorable purchasing environment. The Company does not
enter into derivative instruments to manage commodity risk.
-22-
PART II
Item 1. Legal Proceedings
Various lawsuits and claims arise against the Company in the ordinary course of
its business. Most of these lawsuits and claims relate to the Company's safety
eyewear and respiratory product lines and primarily involve accidents and/or
exposures occurring after the Company's predecessor acquired the AOSafety(R)
Division from American Optical Corporation in April 1990. The Company is
contingently liable with respect to numerous lawsuits involving respirators sold
by American Optical Corporation prior to the acquisition of the AOSafety(R)
Division in April 1990. These lawsuits typically involve plaintiffs alleging
that they suffer from asbestosis or silicosis, and that such condition results
in part from respirators which were negligently designed or manufactured. The
defendants in these lawsuits are often numerous, and include, in addition to
respirator manufacturers, employers of the plaintiffs and manufacturers of sand
(used in sand blasting) and asbestos. Responsibility for legal costs, as well as
for settlements and judgments, is shared contractually by the Company, American
Optical Corporation and a prior owner of American Optical Corporation. The
Company and Cabot have entered into an arrangement whereby, so long as the
Company pays to Cabot an annual fee of $400,000, which the Company has elected
to pay, Cabot will retain responsibility and liability for, and indemnify the
Company against, certain legal claims asserted after July 11, 1995 (the date of
the Company's formation) alleged to arise out of the use of respirators
manufactured prior to July 1995. The Company has the right to discontinue the
payment of such annual fee at any time, in which case the Company will assume
responsibility for and indemnify Cabot with respect to such claims however,
management intends to continue the annual payment of $400,000 to Cabot. The
Company may be responsible for claims alleged to arise out of the use of
respirators manufactured by the Company as well as products purchased for
resale. The Company may also be responsible for certain claims of acquired
companies other than the AO Safety(R) division that are not covered by the
agreement with Cabot.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security-Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
None
-23-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: May 15, 2001 AEARO CORPORATION
/s/ Jeffrey S. Kulka
--------------------------------------------------
Jeffrey S. Kulka
Vice President, Finance, Treasurer, and Secretary
(Principal Financial and Accounting Officer)
-24-
EXHIBIT INDEX
EXHIBITS DESCRIPTION
None
*Filed herewith.
-25-