AEARO CORPORATION
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 O 1934
For the quarterly period ended June 30, 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 (IRS Employer Identification No.)
incorporation or organization)
5457 West 79th Street 46268
Indianapolis, Indiana (Zip Code)
(Address of principal executive offices)
(317) 692-6666
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No_
The number of share of the registrant's common stock, par value $.01 per
share, outstanding as of August 14, 2001 was 102,087.5.
AEARO CORPORATION
Table of Contents
Form 10-Q for the Quarterly Period Ended June 30, 2001
PART I.........................................................................3
Item 1. Financial Statements.................................................3
Aearo Corporation...........................................................3
Condensed Consolidated Balance Sheets -- Assets.............................3
Condensed Consolidated Balance Sheets --
Liabilities and Stockholders' Equity......................................4
Condensed Consolidated Statements of Operations.............................5
Condensed Consolidated Statements of Cash Flows.............................6
Notes to Condensed Consolidated Financial Statements........................6
Notes to Condensed Consolidated Financial Statements........................7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..............................14
Item 3. Quantitative and Qualitative Disclosures about Market Risk...........22
PART II.......................................................................24
Item 1. Legal Proceedings...................................................24
Item 2. Changes in Securities and Use of Proceeds...........................24
Item 3. Defaults Upon Senior Securities.....................................24
Item 4. Submission of Matters to a Vote of Security-Holders.................24
Item 5. Other Information...................................................24
Item 6. Exhibits and Reports on Form 8-K....................................24
Signatures...................................................................25
Exhibit Index................................................................26
-2-
PART I
Item 1. Financial Statements
AEARO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS -- ASSETS
(Dollars in Thousands)
June 30, September 30,
2001 2000
--------- --------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 8,954 $ 3,495
Accounts receivable (net of reserve for doubtful
accounts of $883 and $1,354 respectively) 42,207 44,342
Inventories 34,690 34,310
Deferred and prepaid expenses 3,192 2,623
-------- --------
Total current assets 89,043 84,770
-------- --------
PROPERTY, PLANT AND EQUIPMENT, NET 50,239 53,163
INTANGIBLE ASSETS, NET 118,364 126,242
OTHER ASSETS 1,861 2,691
-------- --------
Total Assets 259,507 266,866
======== ========
The accompanying notes are an integral part of these
condensed consolidate financial statements.
-3-
AEARO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS -- LIABILITIES AND STOCKHOLDERS' EQUITY
(Dollars in Thousands)
June 30, September 30,
2001 2000
--------- ---------
(Unaudited)
CURRENT LIABILITIES:
Current portion of long-term debt $ 7,978 $ 19,313
Accounts payable and accrued liabilities 31,370 39,427
Accrued interest 6,064 3,423
U.S. and foreign income taxes 5,312 5,375
--------- ---------
Total current liabilities 50,724 67,538
--------- ---------
LONG-TERM DEBT 189,459 180,506
DEFERRED INCOME TAXES 332 507
OTHER LIABILITIES 2,407 2,466
--------- ---------
Total Liabilities $ 242,922 $ 251,017
--------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value-
(Redemption value of $95,903 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
June 30, 2001 and September 30, 2000, respectively 1 1
Additional paid-in-capital 32,386 32,213
Retained earnings (deficit) 5,047 (613)
Accumulated other comprehensive loss (20,849) (15,752)
--------- ---------
Total stockholders' equity 16,585 15,849
--------- ---------
Total liabilities and stockholders' equity $ 259,507 $ 266,866
========= =========
The accompanying notes are an integral part of these
condensed consolidate 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 Nine Months Ended
June 30, June 30,
--------- --------- --------- ---------
2001 2000 2001 2000
--------- --------- --------- ---------
NET SALES $ 72,043 $ 80,158 $ 214,250 $ 229,782
COST OF SALES 39,207 42,254 116,276 122,333
--------- --------- --------- ---------
Gross Profit 32,836 37,904 97,974 107,449
SELLING AND ADMINISTRATIVE 19,275 24,388 64,772 71,346
RESEARCH AND TECHNICAL SERVICES 1,138 1,423 3,987 4,141
AMORIZATION OF INTANGIBLES 1,593 1,684 4,882 5,175
OTHER CHARGES (INCOME), NET (87) (319) 437 (728)
--------- --------- --------- ---------
Operating Income 10,917 10,728 23,896 27,515
INTEREST EXPENSE, NET 5,451 6,140 17,131 18,299
--------- --------- --------- ---------
Income before provision for income taxes 5,466 4,588 6,765 9,216
PROVISION FOR INCOME TAXES 454 1,095 1,105 2,509
--------- --------- --------- ---------
Net Income 5,012 3,493 5,660 6,707
PREFERRED STOCK DIVIDEND ACCRUED 2,980 2,626 8,666 7,662
--------- --------- --------- ---------
Net Income (Loss) applicable to
Common Shareholders $ 2,032 $ 867 $ (3,006) $ (955)
========= ========= ========= =========
AVERAGE COMMON AND DILUTED
COMMON SHARES OUTSTANDING 102,088 102,088 102,088 102,175
========= ========= ========= =========
BASIC AND DILUTED NET INCOME (LOSS)
PER COMMON SHARE $ 19.90 $ 8.49 $ (29.45) $ (9.35)
========= ========= ========= =========
The accompanying notes are an integral part of these
condensed consolidate financial statements.
-5-
AEARO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(UNAUDITED)
For the Nine Months Ended
June 30,
-----------------------
2001 2000
-------- --------
CASH FLOWS FROM OPERATING ACTIVITES:
Net Income $ 5,660 $ 6,707
Adjustments to reconcile net income to cash provided by
operating activities--
Depreciation 7,695 7,488
Amortization of intangible assets and deferred financing cost 5,990 6,607
Deferred income taxes (150) (123)
Other, net 186 56
Changes in assets and liabilities--
Accounts receivable 1,276 (4,440)
Inventories (1,178) (1,232)
Accounts payable and accrued liabilities (4,809) 2,174
Other, net (731) 2,200
-------- --------
Net cash provided by operting activities 13,939 19,437
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (5,804) (7,155)
Cash paid for Norhammer -- (3,970)
Proceeds provided by disposals of property, plant and equipment 36 10
-------- --------
Net cash used by investing activities (5,768) (11,115)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from revolving credit facility, net 11,750 4,300
Repayment of term loans (13,301) (10,635)
Repayment of external long-term debt (97) (145)
Repurchase of common stock, net -- (286)
Increase (decrease) in shareholders notes, net 173 (87)
-------- --------
Net cash used by financing activities (1,475) (6,853)
-------- --------
EFFECT OF EXCHANGE RATES ON CASH (1,237) (1,739)
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 5,459 (270)
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 3,495 4,050
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 8,954 $ 3,780
======== ========
CASH PAID FOR:
Interest $ 13,646 $ 13,844
======== ========
Income Taxes $ 1,557 $ 1,709
======== ========
The accompanying notes are an integral part of these
condensed consolidate financial statements.
-6-
AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 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 of America requires management to make
estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of
revenues and expenses during the reporting periods. Actual results
could differ from those estimates.
-7-
AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
Reclassifications. Certain amounts included in the prior period
financial statements may have been reclassified to conform to the
current period presentation. The reclassifications have no impact on
net income previously reported.
Revenue Recognition. The Company recognizes revenue 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 June 30, 2001 and 2000, there were 12,189 and 9,789
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 nine months ended June 30, 2001 and 2000.
Basic and diluted income (loss) per common share for the three and nine
months ended June 30, 2001 and 2000, were equal; therefore, no
reconciliation between basic and diluted income (loss) per share is
required.
Business Combinations, Goodwill and Other Intangibles. In June 2001,
the Financial Accounting Standards Board issued two new pronouncements:
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" and SFAS No. 142 "Goodwill and Other Intangibles." SFAS
No. 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001 and that the use of
the pooling-of-interest method is no longer allowed. SFAS No. 142
requires that upon adoption, amortization of goodwill will cease and
instead, the carrying value of goodwill be evaluated for impairment on
an annual basis. Identifiable intangible assets will continue to be
amortized over their useful lives and reviewed for impairment in
accordance with SFAS No. 121 "Accounting for the Impairment of
Long-Lived Assets to be Disposed Of". SFAS No. 142 is effective for
fiscal years beginning after December 15, 2001; however, the Company
may elect early adoption of this statement on October 1, 2001, the
beginning of its 2002 fiscal year. The Company is evaluating the impact
of the adoption of these standards and has not yet determined the
effect of adoption on its financial position and results of operations.
-8-
Shipping and Handling Fees and Costs. In September 2000, the Emerging
Issues Task Force ("EITF") reached a consensus on issue No. 00-10 (EITF
00-10), "Accounting for Shipping and Handling Fees and Costs". The
Company is required to adopt the provisions of EITF 00-10 in the fourth
quarter of 2001. EITF 00-10 requires that the Company reclassify
amounts billed to customers for shipping and handling costs to revenue
and disclose costs related to shipping and handling that are not
included in cost of sales. This reclassification will have no effect on
income from operations or financial position.
Accounting for Derivative Instruments and Hedging Activities. The
Company adopted the provisions of 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. From time to time the Company
enters into foreign currency exchange contracts and interest rate swap
agreements, which are derivatives as defined by SFAS No. 133. The
Company enters into 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 $70,000 at June 30, 2001. All
forward contracts and swap agreements will expire over the next 3
months.
During the three month period ending June 30, 2001 the Company
reclassified into earnings a net gain of approximately $49,000
resulting from the exercise of foreign currency contracts and a net
loss of $259,000 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.
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 gain of approximately $31,000 for the quarter ended June 30, 2001.
-9-
(4) COMPREHENSIVE INCOME
Comprehensive income consisted of the following (dollars in thousands):
Three Months Ended Nine Months Ended
June 30, June 30,
2001 2000 2001 2000
------- ------- ------- -------
Net Income $ 5,012 $ 3,493 $ 5,660 $ 6,707
Foreign currency translation
adjustment (1,633) (1,663) (5,028) (5,349)
Unrealized gain (loss) on
derivative instruments 613 -- (70) --
------- ------- ------- -------
Comprehensive income $ 3,992 $ 1,830 $ 562 $ 1,358
======= ======= ======= =======
(5) INVENTORIES
Inventories consisted of the following (dollars in thousands):
June 30, September 30,
2001 2000
---------------- ----------------
(unaudited)
Raw Materials $ 8,169 $ 8,246
Work in process 8,176 7,662
Finished goods 18,345 18,402
---------------- ----------------
$ 34,690 $ 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.
(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 and (ii) a secured 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. The amounts outstanding on the term loans and
the revolving credit facility at June 30, 2001 were approximately $75.7
million and $21.8 million, respectively.
-10-
On July 13, 2001, the Company amended and restated its credit agreement
that provides for secured borrowings from a syndicate of lenders
consisting of (i) a secured term loan facility consisting of $100
million, (ii) a revolving credit facility for up to $30 million and
(iii) a UK Overdraft Facility of up to an equivalent of $5 million in
Great Britain Pounds (collectively the Restated Senior Bank
Facilities). As a result of the refinancing, the Company has reported
the current portion of long term debt under the terms of the Restated
Senior Bank Facilities per SFAS No. 6 "Classification of Short-Term
Obligations Expected to Be Refinanced".
(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. In addition, 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 June 30, 2001 the Company has reserved approximately $4.7 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
-11-
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.
(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 other products including 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 Nine Months Ended
June 30, June 30,
2001 2000 2001 2000
-------- -------- -------- --------
Safety Products $ 52,842 $ 58,040 $154,975 $164,049
Safety Prescription Eyewear 10,074 10,387 29,716 30,181
Specialty Composites 9,127 11,731 29,559 35,552
-------- -------- -------- --------
Total $ 72,043 $ 80,158 $214,250 $229,782
======== ======== ======== ========
Intersegment sales of the Specialty Composites segment to the Safety
Products segment totaled $1.1 million and $0.7 million for the three
months ended June 30, 2001 and 2000, respectively. Intersegment sales
totaled $3.1 million and $2.8 million for the nine months ended June
30, 2001 and 2000, respectively. The intersegment sales value is
determined at fully absorbed inventory cost at standard rates plus 25%.
-12-
EBITDA by Business Segment and reconciliation to Income before
provision for income taxes (dollars in thousands)
Three Months Ended Nine Months Ended
June 30, June 30,
2001 2000 2001 2000
-------- -------- -------- --------
Safety Products $ 11,367 $ 13,618 $ 28,953 $ 35,042
Safety Prescription Eyewear 650 1,113 1,724 3,041
Specialty Composites 408 1,237 1,622 3,409
Reconciling items 2,655 (771) 4,059 (1,226)
-------- -------- -------- --------
Total EBITDA 15,080 15,197 36,358 40,266
Depreciation 2,574 2,625 7,695 7,488
Amortization 1,593 1,684 4,882 5,175
Non-operating Costs (4) 160 (115) 88
Interest 5,451 6,140 17,131 18,299
-------- -------- -------- --------
Income before tax provision $ 5,466 $ 4,588 $ 6,765 $ 9,216
======== ======== ======== ========
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 of America 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.
Reconciling items include unallocated selling, administrative, research
and technical expenses as well as manufacturing profit realized on
inter-company transactions not allocable to a specific segment.
-13-
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 conversions to new management information systems; high
levels of competition in the Company's markets; risks and uncertainties of new
product innovations; risks associated with international operations; product
liability exposures; unpredictability of patent protections and other
intellectual property issues; dependencies on key personnel; risks of adverse
effects of economic and regulatory conditions; and risks associated with
environmental matters.
Results of Operations -- Three Months Ended June 30, 2001 Compared to Three
Months Ended June 30, 2000
Unaudited
(Dollars in Thousands, Except Per Share Amounts)
Three Months Ended June 30,
2001 % 2000 %
-------- ------- -------- ------
Net Sales
Safety Products $ 52,842 73.3 $ 58,040 72.4
Safety Prescription Eyewear 10,074 14.0 10,387 13.0
Specialty Composites 9,127 12.7 11,731 14.6
-------- ------- -------- ------
Total net sales 72,043 100.0 80,158 100.0
Cost of Sales 39,207 54.4 42,254 52.7
-------- ------- -------- ------
Gross profit 32,836 45.6 37,904 47.3
Operating Expenses-
Selling and administrative 19,275 26.8 24,388 30.4
Research and technical services 1,138 1.6 1,423 1.8
Amortization of intangibles 1,593 2.2 1,684 2.1
Other charges (income), net (87) (0.1) (319) (0.4)
-------- ------- -------- ------
Operating income 10,917 15.2 10,728 13.4
Interest expense, net 5,451 7.6 6,140 7.7
-------- ------- -------- ------
Income before provision for 5,466 7.6 4,588 5.7
income taxes
Provision for income
taxes 454 0.6 1,095 1.4
-------- ------- -------- ------
Net income 5,012 7.0 3,493 4.4
Preferred stock dividend accrued 2,980 4.1 2,626 3.3
-------- ------- -------- ------
Income applicable to common shareholders $ 2,032 2.8 $ 867 1.1
======== ======= ======== ======
Income per common share $ 19.90 8.49
======== ========
EBITDA $ 15,080 20.9 $ 15,197 19.0
======== ======= ======== ======
-14-
Net Sales. Net sales in the three months ended June 30, 2001 decreased 10.1% to
$72.0 million from $80.2 million in the three months ended June 30, 2000. The
change in sales was primarily driven by the significant slowdown in the
manufacturing sector of the economy as well as weakness in global currencies
relative to the U.S. dollar. Safety Products net sales in the three months ended
June 30, 2001 decreased 9.0% to $52.8 million from $58.0 million in the three
months ended June 30, 2000. The strength of the U.S. dollar relative to foreign
currencies had the impact of reducing Safety Products sales by approximately
$2.1 million. On a constant currency basis sales were down $3.1 million, or
5.5%, as compared to the three months ended June 30, 2000. The Safety
Prescription Eyewear segment net sales in the three months ended June 30, 2001
decreased 3.0% to $10.1 million from $10.4 million in the three months ended
June 30, 2000. Specialty Composites' net sales in the three months ended June
30, 2001 decreased 22.2% to $9.1 million from $11.7 million in the three months
ended June 30, 2000. The decrease was primarily driven by continued weakness in
the North American economy and resulted in volume declines in the truck market
and the electronics segment of the precision equipment market, which includes
computers and personal communication system (PCS) applications.
Gross Profit. Gross profit in the three months ended June 30, 2001 decreased
13.4% to $32.8 million from $37.9 million in the three months ended June 30,
2000. Gross profit as a percentage of net sales in the three months ended June
30, 2001 decreased to 45.6% as compared to 47.3% in the three months ended June
30, 2000. This decrease in the gross profit percentage of net sales is primarily
due to lower capacity utilization, higher utility costs and the adverse impact
of foreign currencies partially offset by productivity improvements and cost
reduction efforts to manage expenses relative to the decline in volume. 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 June 30, 2001 and
2000 was 0.861 and 0.931, respectively.
Selling and Administrative Expenses. Selling and administrative expenses in the
three months ended June 30, 2001 decreased 21.0% to $19.3 million from $24.4
million in the three months ended June 30, 2000. Selling and administrative
expenses as a percentage of net sales in the three months ended June 30, 2001
decreased to 26.8% as compared to 30.4% in the three months ended June 30, 2000.
The decrease is primarily due to the Company's proactive measures to reduce
expenses in line with the continued slowdown in the manufacturing sector of the
economy.
Research and Technical Service Expenses. Research and technical service expenses
in the three months ended June 30, 2001 decreased 20.0% to $1.1 million from
$1.4 million in the three months ended June 30, 2000.
Amortization of Intangibles. Amortization expense in the three months ended June
30, 2001 decreased 5.4% to $1.6 million from $1.7 million in the three months
ended June 30, 2000.
Other Charges (Income), Net. Other charges (income), net was income of $0.1
million for the three months ended June 30, 2001 as compared to income of $0.3
million for the three months ended June 30, 2000. This reduction of income was
primarily a result of a lower level of gains from foreign currency cash flow
hedges in the three months ended June 30, 2001 as compared to the three months
ended June 30, 2000.
Operating Income. Operating income increased 1.8% to $10.9 million in the three
months ended June 30, 2001 from $10.7 million in the three months ended June 30,
2000. Operating income as a percentage of net sales improved to 15.2% in the
three months ended June 30, 2001 as compared to 13.4% in the three months ended
June 30, 2000. The increase is primarily due to the Company's proactive measures
to reduce expenses in line with the slowdown in the economy.
-15-
Interest Expense, Net. Interest expense, net in the three months ended June 30,
2001 decreased 11.2% to $5.5 million from $6.1 million in the three months ended
June 30, 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 June 30, 2001 as compared to
the three months ended June 30, 2000.
Provision For Income Taxes. The provision for income taxes in the three months
ended June 30, 2001 was $0.5 million compared to $1.1 million in the three
months ended June 30, 2000. The effective tax rate was 8.3% and 23.9% for the
three months ended June 30, 2001 and 2000, respectively. The decrease in the
effective tax rate reflects a change in the relationship of taxable income from
foreign subsidiaries to domestic operations.
Net Income. Net income for the three months ended June 30, 2001 increased 43.5%
to $5.0 million from $3.5 million for the three months ended June 30, 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 of America 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
June 30, Favorable/(Unfavorable)
2001 2000 Amount %
-------- -------- -------- -------
Operating Income $ 10,917 $ 10,728 $ 189 1.8 %
Add Backs:
Depreciation 2,574 2,625 (51) (1.9)
Amortization of Intangibles 1,593 1,684 (91) (5.4)
Non-operating income, net (4) 160 (164) (102.5)
-------- -------- --------- -------
EBITDA $ 15,080 $ 15,197 $ (117) (0.8)%
======== ======== ======== =======
EBITDA for the three months ended June 30, 2001 was $15.1 million as compared to
$15.2 million for the three months ended June 30, 2000. EBITDA as a percentage
of net sales in the three months ended June 30, 2001 improved to 20.9% as
compared to 19.0% in the three months ended June 30, 2000.
-16-
Results of Operations -- Nine Months Ended June 30, 2001, Compared to Nine
Months Ended June 30, 2000
Unaudited
(Dollars in Thousands, Except Per Share Amounts)
Nine Months Ended June 30,
2001 % 2000 %
--------- ------- --------- --------
Net Sales
Safety Products $ 154,975 72.3 164,049 71.4
Safety Prescription Eyewear 29,716 13.9 30,181 13.1
Specialty Composites 29,559 13.8 35,552 15.5
--------- ------- --------- -------
Total net sales 214,250 100.0 229,782 100.0
Cost of Sales 116,276 54.3 122,333 53.2
--------- ------- --------- -------
Gross profit 97,974 45.7 107,449 46.8
Operating Expenses-
Selling and administrative 64,772 30.2 71,346 31.0
Research and technical services 3,987 1.9 4,141 1.8
Amortization of intangibles 4,882 2.3 5,175 2.3
Other charges (income), net 437 0.2 (728) (0.3)
--------- ------- --------- -------
Operating income 23,896 11.2 27,515 12.0
Interest expense, net 17,131 8.0 18,299 8.0
--------- ------- --------- ------
Income before provision
for income taxes 6,765 3.2 9,216 4.0
Provision for income
taxes 1,105 0.5 2,509 1.1
--------- ------- --------- -------
Net income 5,660 2.6 6,707 2.9
Preferred stock dividend accrued 8,666 4.0 7,662 3.3
Loss applicable to common
shareholders $ (3,006) (1.4) $ (955) (0.4)
========= ======= ========= =======
Loss per common share $ (29.45) $ (9.35)
========= =========
EBITDA $ 36,358 17.0 $ 40,266 17.5
========= ======= ========= =======
Net Sales. Net sales in the nine months ended June 30, 2001 decreased 6.8% to
$214.3 million from $229.8 million in the nine months ended June 30, 2000. The
change in sales was primarily driven by the significant slowdown in the
manufacturing sector of the economy as well as weakness in foreign currencies as
compared to the U.S. dollar. Safety Products net sales in the nine months ended
June 30, 2001 decreased 5.8% to $154.6 million from $164.0 million in the nine
months ended June 30, 2000. The strength of the U.S. dollar relative to foreign
currencies had the impact of reducing Safety Products sales by approximately
$6.5 million in the nine months ended June 30, 2001, as compared to the nine
months ended June 30, 2000. On a constant currency basis sales were down $2.9
million, or 1.8%, as compared to the nine months ended June 30, 2000. The Safety
Prescription Eyewear segment net sales in the nine months ended June 30, 2001
decreased 1.5% to $29.7 million from $30.2 million in the nine months ended June
30, 2000. Specialty Composites' net sales in the nine months ended June 30, 2001
decreased 15.7% to $30.0 million from $35.6 million in the nine months ended
June 30, 2000. The decrease was primarily driven by continued weakness in the
North American economy and resulted in volume declines in the truck market and
the electronic segment of the precision equipment market, which includes
computers and PCS applications.
-17-
Gross Profit. Gross profit in the nine months ended June 30, 2001 decreased 8.8%
to $98.0 million from $107.4 million in the nine months ended June 30, 2000.
Gross Profit as a percentage of net sales in the nine months ended June 30, 2001
was 45.7% as compared to 46.8% in the nine months ended June 30, 2000. The
decrease in the gross profit percentage of net sales is primarily due to lower
capacity utilization, higher utility costs and the adverse impact of foreign
currencies partially offset by productivity improvements and cost reduction
efforts to manage expenses relative to the decline in volume.. 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 the condensed consolidated financial statements for the nine
months ended June 30, 2001 and 2000 was 0.888 and 0.973, respectively.
Selling and Administrative Expenses. Selling and administrative expenses in the
nine months ended June 30, 2001 decreased 9.2% to $64.8 million from $71.3
million in the nine months ended June 30, 2000. Selling and administrative
expenses as a percentage of net sales in the nine months ended June 30, 2001
decreased to 30.2% of net sales as compared to 31.0% of net sales in the nine
months ended June 30, 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 nine months ended June 30, 2001 decreased 3.7% to $4.0 million from $4.1
million in the nine months ended June 30, 2000.
Amortization of Intangibles. Amortization expense in the nine months ended June
30, 2001 decreased 5.7% to $4.9 million from $5.2 million in the nine months
ended June 30, 2000.
Other Charges (Income), Net. Other charges (income), net was expense of $0.4
million for the nine months ended June 30, 2001 as compared to income of $0.7
million for the nine months ended June 30, 2000. This change was primarily a
result of net foreign currency cash flow hedge losses in the nine months ended
June 30, 2001 as compared to net foreign currency cash flow losses in the nine
months ended June 30, 2000.
Operating Income. Operating income decreased 13.2% to $23.9 million in the nine
months ended June 30, 2001 from $27.5 million in the nine months ended June 30,
2000. Operating income as a percentage of net sales in the nine months ended
June 30, 2001 was 11.2% as compared to 12.0% in the nine months ended June 30,
2000. The decrease is primarily due to the softening global economy partially
offset by the Company's proactive measures to reduce expenses in line with the
slowdown.
Interest Expense, Net. Interest expense, net in the nine months ended June 30,
2001 decreased 6.4% to $17.1 million from $18.3 million in the nine months ended
June 30, 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 nine months ended June 30, 2001 as compared to
the nine months ended June 30, 2000.
Provision For Income Taxes The provision for income taxes in the nine months
ended June 30, 2001 was $1.1 million compared to $2.5 million in the nine months
ended June 30, 2000. The effective tax rate was 16.3% and 27.2% for the nine
months ended June 30, 2001 and 2000, respectively. The decrease in the effective
tax rate reflects a change in the relationship of taxable income from foreign
subsidiaries to domestic operations.
Net Income. Net income for the nine months ended June 30, 2001 decreased 15.6%
to $5.7 million from $6.7 million for the nine months ended June 30, 2000.
-18-
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 of America 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)
Nine Months Ended Change
June 30, Favorable/(Unfavorable)
2001 2000 Amount %
-------- -------- -------- --------
Operating Income $ 23,896 $ 27,515 $ (3,619) (13.2)%
Add Backs:
Depreciation 7,695 7,488 207 2.8
Amortization of Intangibles 4,882 5,175 (293) (5.7)
Non-operating costs (income), net (115) 88 (203) (230.7)
-------- -------- --------
EBITDA $ 36,358 $ 40,266 $ (3,908) (9.7)%
======== ======== ========
EBITDA for the nine months ended June 30, 2001 was $36.4 million as compared to
$40.3 million for the nine months ended June 30, 2000. EBITDA as a percentage of
net sales in the nine months ended June 30, 2001 was 17.0% as compared to 17.5%
in the nine months ended June 30, 2000.
-19-
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 currencies. 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.
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 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.
On July 13, 2001, the Company amended and restated its credit agreement that
provides for secured borrowings from a syndicate of lenders consisting of (i) a
secured term loan facility consisting of $100 million, (ii) a revolving credit
facility for up to $30 million and (iii) a UK overdraft facility of up to an
equivalent of $5 million in Great Britain Pounds (collectively the Restated
Senior Bank Facilities). As a result of the refinancing, the Company has
reported the current portion of long term debt under the terms of the Restated
Senior Bank Facilities per SFAS No. 6 "Classification of Short-Term Obligations
Expected to Be Refinanced".
-20-
Term Loan maturities under the Restated Senior Bank Facilities are $2.0 million
for the remainder of fiscal 2001, $8.0 million in fiscal 2002, $12.0 million in
fiscal 2003, and $78.0 million thereafter. 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 Restated Senior Bank
Facilities and the Notes. The Company's revolver and Term Loan matures in March
2005.
The Company's net cash provided by operating activities for the nine months
ended June 30, 2001 totaled $13.9 million as compared to $19.4 million for the
nine months ended June 30, 2000. The decrease was due primarily to a decrease of
$1.0 million in net income and a $4.5 million decrease 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 accounts payable and accrued
liabilities, a reduction in other assets and liabilities partially offset by a
decrease in receivables.
Net cash used by investing activities was $5.8 million for the nine months ended
June 30, 2001 as compared to $11.1 million for the nine months ended June 30,
2000. The decrease in net cash used by investing activities is primarily due to
a decrease in capital additions and the acquisition of Norhammer in the prior
period.
Net cash used by financing activities for the nine months ended June 30, 2001
was $1.5 million compared with $6.9 million for the nine months ended June 30,
2000. The decrease of cash used by financing activities of $5.3 million is
primarily attributed to an increase in borrowings from the revolving credit
facility of $7.5 million offsetting a $2.7 million increase in cash used for the
repayment of term loans.
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 significant slowdown in the manufacturing sector of the economy and 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
internally generated funds and, to the extent necessary, on borrowings to
finance such acquisitions.
-21-
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 June 30, 2001 net transaction
gains were $31,000, and cash flow hedges were a gain of $99,000. In addition,
the Company limits foreign exchange impact on the balance sheet with foreign
denominated debt in Great Britain Pound Sterling (GBP) and euros.
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 June 30, 2001 the Company
recorded a reduction of $0.4 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 $0.4 million as of June 30, 2001. The foreign currency
forward contracts will expire over the next 3 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 June 30, 2001, the Company incurred an additional $259,000 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 continue
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 June 30, 2001 the Company recorded an
reduction of $0.2 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 $0.4
million as of June 30, 2001.
-22-
Commodity Risk
The Company is subject to market risks with respect to industry pricing in paper
and crude oil as it relates to various commodity items. The Company is also
exposed to market risks for electricity, fuel oil and natural gas consumed in
its operations. Items with potential 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.
-23-
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
Credit Agreement, dated as of July 11, 1995 and Amended and Restated as of
July 13, 2001.
(b) Reports on form 8-K
On May 17, 2001, the Company filed a Current Report on Form 8-K disclosing
a change in its certifying accountant from Arthur Andersen to Deloitte and
Touche.
On July 19, 2001, the Company filed a Current Report on Form 8-K containing
its press release regarding the refinancing of its indebtedness.
-24-
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: August 14, 2001 AEARO CORPORATION
/s/ Jeffrey S. Kulka
---------------------------------------------------
Jeffrey S. Kulka
Vice President, Finance, Treasurer, and Secretary
(Principal Financial and Accounting Officer)
-25-
Exhibit Index
EXHIBITS DESCRIPTION
*Credit Agreement
Dated as of July 11, 1995 and Amended and Restated as of
July 13, 2001 among Aearo Corporation, Aearo Company I,
Certain of its Subsidiaries, Various Banks, and Bankers
Trust Company, as Administrative Agent.
*Filed herewith.
-26-