SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K405
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended September 30, 2003
Commission file number 0-26942
Aearo Corporation
(Exact name of registrant as specified in its charter)
--------------------------
Delaware
(State or other jurisdiction of 13-3840450
incorporation or organization) (I.R.S. Employer 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)
--------------------------
Securities registered pursuant to Section 12(b) of the Act: none
Securities registered pursuant to Section 12(g) of the Act: none
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No[X]
As of December 22, 2003, all voting and non-voting common equity of
the Registrant was held by affiliates of the Registrant.
The number of shares of the Registrant's common stock, par value $.01 per
share, outstanding as of December 22, 2003 was 59,412.5.
TABLE OF CONTENTS
Part I 3
Item 1. Business..........................................................3
Item 2. Properties.......................................................11
Item 3. Legal Proceedings................................................12
Item 4. Submission of Matters to a Vote of Security Holders..............13
Part II 14
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters......................................................14
Item 6. Selected Financial Data..........................................15
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................17
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.......24
Item 8. Financial Statements and Supplementary Data......................26
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.....................................54
Item 9A. Controls and Procedures..........................................55
PART III 56
Item 10. Directors and Executive Officers.................................56
Item 11. Executive Compensation...........................................59
Item 12. Security Ownership of Certain Beneficial Owners and
Management...................................................63
Item 13. Certain Relationships and Related Transactions...................65
Item 14. Principal Accountant Fees and Services...........................68
PART IV 69
Item 15. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K..................................................69
-2-
PART I
Item 1. Business
General
Aearo Corporation, a Delaware corporation ("Aearo"), and its direct wholly owned
subsidiary, Aearo Company I, doing business as Aearo Company, a Delaware
corporation (the "Subsidiary"), are collectively referred to herein as the
"Company". The Company is one of the leaders in the hearing, eye, face, head and
respiratory protection segments of the personal protection equipment ("PPE")
market worldwide. PPE encompasses all articles of equipment and clothing worn
for the purpose of protecting against bodily injury, including safety eyewear
and goggles, earmuffs and earplugs, respirators, hard hats, fall protection,
gloves, safety clothing and safety shoes. The Company manufactures and sells
hearing protection devices, communication headsets, prescription and
non-prescription safety eyewear, face shields, reusable and disposable
respirators, fall protection, hard hats and first aid kits in more than 70
countries under its well-known brand names: AOSafety(R), E-A-R(R), Peltor(R) and
SafeWaze(TM). The Company attributes its leading market positions to:
- Strong, well-recognized brand names
- A reputation for providing innovative, quality products
- Intensive coverage of multiple distribution channels targeting a wide
array of end-users
- One of the industry's broadest product offerings, and
- A commitment to providing the highest level of customer service.
The Company also manufactures a wide array of energy-absorbing materials that
are incorporated into other manufacturers' products to control noise, vibration
and shock. These products are marketed under its brand name E-A-R(R) Specialty
Composites. Aearo derives all of its operating income and cash flow from the
Subsidiary, and its only material assets are the shares of common stock of the
Subsidiary that Aearo owns. Other than its ownership of the Subsidiary and its
guarantee of the indebtedness of the Subsidiary, Aearo has no business or
operations. Aearo was incorporated in the State of Delaware in June 1995.
Detailed information with respect to the Company's segment reporting is
presented in Note 14 of Notes to Consolidated Financial Statements of Aearo
Corporation contained in Item 8 hereof.
Segments
The Company operates three business segments. The Safety Products segment
manufactures and sells hearing protection devices, communication headsets,
non-prescription safety eyewear, face shields, reusable and disposable
respirators, hard hats, fall protection equipment and first aid kits in more
than 70 countries under its well-known brand names: AOSafety(R), E-A-R(R),
Peltor(R) and SafeWaze(TM). The Safety Products segment accounted for
approximately 77% of the Company's net sales in fiscal 2003 and approximately
73% in fiscal 2002 and fiscal 2001, respectively.
The Safety Prescription Eyewear segment manufactures and sells products under
the AOSafety(R) brand name that are designed to protect the eyes from the
typical hazards encountered in the industrial work environment. The Company
purchases component parts (lenses and the majority of its frames) from various
suppliers, grinds and shapes the lenses to the end-user's prescription, and then
assembles the glasses using the end-user's choice of frame. The Safety
Prescription Eyewear segment accounted for approximately 13% of the Company's
net sales in fiscal 2003 and approximately 14% in fiscal 2002 and fiscal 2001,
respectively.
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 problems in other manufacturers' products. Specific
product applications for Specialty Composites' materials, technology and
engineering expertise include thermal acoustic systems in business and regional
jet aircraft; protective and performance-enhancing components in precision
electronic equipment; thermal and acoustic treatments for heavy-duty trucks; and
treatments to control noise, vibration and shock in a wide range of industrial
and commercial equipment. Specialty Composites also produces specially
formulated foam used in the manufacture of the Safety Products segment's
polyvinyl chloride ("PVC") and polyurethane ("PU") earplugs. Specialty
Composites accounted for approximately 10% of the Company's net sales in fiscal
2003 and approximately 13% in fiscal 2002 and fiscal 2001, respectively.
-3-
Products - Safety Products Segment
Within Safety Products, the Company classifies its products in five main
categories: hearing protection and communication headsets; eye protection; face
and head protection; respiratory protection; fall protection and other
protection products. These products serve a variety of end users, such as in the
construction, heavy machinery, airport, forestry, textile, mining, military,
motor sports, health care and two-way radio markets.
Hearing Protection and Communication Headsets: The Company's hearing protection
products primarily consist of disposable earplugs, reusable earplugs, earmuffs,
and communication headsets. The Company has been a leader in hearing
conservation research and development since 1972, when it first introduced the
PVC disposable earplug. Today, this product is known as the "Classic(R)" and its
color yellow is a registered trademark in the United States of America, Canada,
Belgium, Netherlands and Luxembourg, and is recognized throughout the world.
This product, and the recently introduced and patented SuperFit(R) product, is
designed to be "rolled down" or compressed before being inserted into the ear,
and, as a result of its unique slow recovery characteristics, the plug slowly
expands (or "recovers") to fill the ear canal and provide the desired
protection. In addition, the Company manufactures a full line of disposable
polyurethane earplugs, including its E-Z-Fit(R), TaperFit(R), and E-A-Rsoft(R)
products. The Company's disposable earplugs are available corded and uncorded
and in a variety of packaging options.
In the reusable earplug segment of the market, the Company offers its patented
UltraFit(R) and E-A-R(R) Express(R) products. The E-A-R(R) Express(R) product
features a polyurethane pod and a short plastic stem to facilitate sanitary and
easy insertion of the plug into the ear. The Company also offers the "Flex"(TM)
line of "semi-aural" banded products. These products feature articulating arms
that allow for use in multiple positions and for easy storage around the neck.
The Company manufactures, assembles and sells a broad line of earmuffs and
communication headsets under its Peltor brand. The Company is a leader in
providing noise attenuating headsets and wireless and hardwire communication
headsets. These products provide protection from harmful high and low frequency
noise and also allow for easy communication in noisy or remote environments. The
Company also offers auditory systems products, which are sold to audiologists
and are used in the testing of hearing.
In 2003 E-A-R Push-Ins(TM) were introduced, offering all the performance and
convenience of a reusable earplug for the price of a disposable earplug. The
product's flexible stem allows for easy insertion and removal with no rolling
down, and the patented foam tip is sized to mold comfortably to fit virtually
every size of ear canal. The quick and easy fit and sure seal combine to provide
high noise attenuation.
Eye Protection: Non-prescription eye protection is used in work environments
where a number of hazards present a danger to the eyes including dust, flying
particles, metal fragments, chemicals, extreme glare and optical radiation. The
Company offers a large number of task-specific non-prescription safety eyewear
products under the AOSafety(R) brand. The basic categories of non-prescription
eyewear protection products are non-prescription (or "plano") eyewear and
goggles:
Plano (Non-prescription) Eyewear. Plano eyewear accounts for the majority
of the Company's sales in this category and encompasses a full range of
protective needs including visitor spectacles, over-the-glass, single lens
and dual lens products. Within these categories are a variety of styles,
frame colors and lens options in addition to a number of adjustability and
comfort options. Many of these AOSafety(R) products feature our DX(R)
coating, combining the benefits of chemical and scratch resistance with
anti-fog. Flywear(TM), Maxim(TM), X-SeriesTM, MetaliksTM and X.SportTM
eyewear offer modern sport styling with numerous comfort features. NuvoTM
eyewear has the classic dual lens look reinterpreted for today's worker.
Lexa(R) eyewear blends a wrapping, single lens with a lightweight,
frameless design. Virtua(TM) offers stylish eyewear at an economical price.
Visitor spectacles and over-the-glass products are represented by Seepro(R)
and Tourguard(R) eyewear.
Goggles. The Company manufactures and sells a broad line of goggles, which
are typically required in work environments where a higher degree of impact
protection is required, where increased protection against dust, mist or
chemical splash is needed and/or for use in welding operations. To meet
these requirements, the Company offers a variety of vented and non-vented
goggles with varying fields of view including Dust GoggleGearTM for
Lexa(R), Splash GoggleGearTM for Lexa(R) and Centurion(R), all under the
AOSafety(R) brand.
Face and Head Protection: Face and head protection is used in work environments
where a number of hazards present a danger to the face and head, including dust,
flying particles, metal fragments, chemicals, extreme glare, optical radiation
and items dropped from above. The basic categories of face and head protection
are faceshields and hard hats:
-4-
Faceshields. Faceshields are designed to protect against heat, splash and
flying particles and are worn in conjunction with other protective
equipment, such as Plano eyewear and respirators. The Company offers a wide
variety use specific faceshield windows under both AOSafety(R) and
Peltor(R) brands. The patented AO TuffMaster(R) line of faceshields is one
of the leading brands in the market.
Hard Hats. The Company manufactures and sells a broad line of hard hats,
including "bump" caps, full-brim hats and traditional hard hats, featuring
four or six point suspension, ratchet adjustment, and a wide selection of
colors and custom imprinting. The XLR8(R) line of hard hats represents the
latest design and functionality under the AOSafety(R) brand.
Respiratory Protection: Respiratory protection products are used to protect
against the harmful effects of contamination and pollution caused by dust,
gases, fumes, sprays and other contaminants. The Company offers a broad line of
disposable dust and mist masks, cartridge-equipped quarter, half and full-face
respirators, and "escape" respirators (a single-use respirator for emergencies)
under the AOSafety(R) brand. Pleats PlusTM offers the latest design in
particulate respirators. QuickLatch(R) half mask respirators offer an
innovative, patented on-and-off latching system that can be accomplished with
just one hand.
Fall Protection: The Company offers a line of fall protection equipment under
the SafeWaze(TM) brand name as a result of the acquisition of VH Industries,
Inc. in March of 2003.
Other Protection Products: The Company also offers first aid kits predominantly
through the Consumer/Do-It-Yourself (DIY) market. First aid kits are either for
general use or for industrial or commercial uses. Additional products in this
group include safety vests, flagging tape, and safety cones.
Products - Safety Prescription Eyewear Segment
The Company's Safety Prescription Eyewear ("SRx") products are designed to
protect the eyes from the typical hazards encountered in the industrial work
environment. The Company purchases component parts (lenses and the majority of
its frames) from various suppliers, grinds and shapes the lenses to the end
user's prescription, and then assembles the glasses using the end user's choice
of frame. The Company views its ability to provide individual attention to each
patient through Company-employed, as well as independently contracted eyecare
professionals as an essential part of its SRx business. These products serve a
wide variety of end user markets such as utilities, transportation, industrial
manufacturing and federal, state and local governments.
Products - Specialty Composites Segment
The Company's Specialty Composites segment manufactures a wide array of
energy-absorbing materials that are incorporated into other manufacturers'
products to control noise, vibration and shock. Specialty Composites' products
fall into three broad categories: (i) barriers and absorbers for airborne noise
control, (ii) damping and isolation products for vibration and shock control,
and (iii) energy control products for vibration, shock control and comfort
management. Some examples of end user applications for such materials include
noise- and vibration-damping materials used in under-hood and cab treatments for
transportation equipment such as Class 8 heavy trucks, as well as shock
protection parts for electronic devices such as computer hard disk drives,
servers and highly damped proprietary materials for the interior cabins of
business and regional jet aircraft. The Company's products include Tufcote(R)
polyurethane foams for acoustical applications, Confor(R) heavily damped
viscoelastic foams for ergonomic cushioning applications and shock protection
and Isodamp(R) foams for the reduction of mechanical vibration, noise and shock.
Specialty Composites also produces the specially formulated foams used in the
manufacture of Safety Products' earplugs. The principal strengths of Specialty
Composites are its specialized polyurethane formulations, its thin-sheet casting
capability, its composite technologies and its applications and materials
engineering. These strengths allow the Company to manufacture in a single
process, high value-added composites using casting, extrusion and molding
processes.
-5-
Sales and Marketing
The Company divides its sales and marketing force into its three business
segments, as follows:
Sales and Marketing - Safety Products Segment
Within Safety Products, sales are managed through five channels: North American
Industrial Distribution; Consumer/Do-It-Yourself ("DIY"); Europe, construction
and International. Each of these channels has its own sales force and its own
distinct yet synergistic sales strategies. In addition, through the acquisitions
of Peltor(R) and Norhammer, the Company significantly expanded its sales
coverage, including a dedicated effort to serve the specialty communications
earmuff market. The Company also produces versions of the PVC plug for many
international airlines for inclusion in their amenity kits.
North American Industrial Distribution (NAI). This is the largest
sales channel for Safety Products and includes approximately 1,041
North American distributors and dealers of which, approximately 213
qualify for the Dialog(TM) rebate program. Participation in the
Dialog(TM) program requires minimum annual purchase levels while
encouraging support across the full product line. Dialog distributors
qualify for annual volume and growth rebates, and cooperative
advertising. The Company also offers Dialog(TM) distributors financial
incentives for establishing electronic order entry/invoicing
interfaces with the Company, and for developing marketing programs
that promote the Company's products.
Consumer. Under the AOSafety(R) brand name, the Company is North
America's leading supplier of personal safety products. The
AOSafety(R) brand offers a wide variety of quality products to meet
existing and emerging consumer personal safety needs in many
marketplaces. Within the Hardware/Do-it-Yourself marketplace,
AOSafety(R) is the primary brand carried by The Home Depot, Ace
Hardware, TruServ Corporation, Lowe's Home Improvement Warehouse and
other retailers. AOSafety(R) also has the leading position in the
sporting goods safety marketplace and AOSafety(R) products are
marketed in the lawn and garden, paint, drug and mass merchandise
channels.
Europe. The Company has a significant presence in Europe with
manufacturing facilities in England, Sweden, and France, and sales
offices in the U.K., Sweden, Norway, Germany, France, Italy and Spain.
The Company's historical strength in this market has been in passive
hearing protection products (E-A-R(R)) sold through over 1000
industrial distributors, and Peltor Communications products sold to
the military, sport shooting, and rally sports market segments.
AOSafety is the number one prescription eyewear brand in France.
International. The Company exports its products around the world, and
this channel is managed through independent sales representatives
located in Singapore, Miami (covering the Caribbean and Central
America), Brazil, Australia, New Zealand and South Africa (covering
the Middle East).
Sales and Marketing - Safety Prescription Eyewear Segment (SRx)
The SRx segment employs its own sales force to sell its products throughout
North America. Approximately 85% of the Company's safety prescription eyewear
are sold directly to more than 15,000 industrial locations, including a majority
of the industrial companies in the Fortune 500. The remainder of the Company's
SRx products are sold through the industrial distribution channel and directly
to eyecare professionals.
Sales and Marketing - Specialty Composites Segment
The Company utilizes an inside sales and marketing team, independent
manufacturers representatives and select distributors to identify global sales
opportunities in target markets for Specialty Composites' products and
technologies. Once such applications have been identified, the Company's
marketing, sales and technical staffs work closely with customer product
development teams to provide the customer with cost-effective, integrated
solutions for noise, vibration, shock, cushioning and/or comfort management
problems. Currently, Specialty Composites' marketing efforts are aimed at four
key, strategic segments worldwide: aircraft, precision electronic equipment,
heavy-duty trucks and original equipment manufacturing (OEM).
-6-
Aircraft Market. Specialty Composites provides integrated thermal acoustic
systems for aircraft manufacturers and refurbishers worldwide. Designed
primarily for business and regional jets, the systems include high performance,
weight-efficient, multi-function composites that the Company has developed
specifically to meet the requirements of aircraft applications and meet FAA
regulations.
Precision Equipment Market. This global market has increasingly focused on
compact designs and highly portable devices. Specialty Composites' engineering
expertise and advanced energy-control materials and technology are critical to
customers' product development, helping in the design of quieter, more rugged,
more accurate and faster devices. Key applications include portable and desk top
computers, hand held devices, disk drives, data servers and data storage units.
Heavy-duty Truck Market. Focusing mainly on Class 5 through Class 8 vehicles,
Specialty Composites' strategy in the truck market has been to assist
manufacturers in meeting regulatory pass-by noise standards and thermal
underhood and in-cab requirements in differentiating vehicles. Incorporating
acoustical foams, barriers and multi-function composite products, thermal and
acoustic treatment packages are designed for maximum performance and minimum
installation labor.
Industrial and OEM Market. Specialty Composites' energy-control technology base,
broad product line and depth of engineering experience enable the Company to
provide highly effective, targeted solutions to manufacturers in a wide range of
industries, ranging from noise control treatments for pumps, generators and
compressors, to vibration damping and shock isolation in garage door openers,
laboratory centrifuges and high-speed printers.
Research and Development
The Company has a strong emphasis on new product development, innovation and
protection of intellectual property in each of its three business segments.
Research and Development - Safety Products Segment
The Company believes that its Research and Development facilities, personnel and
programs are among the best in the PPE industry. Since its inception in 1972,
the Company's ultimate predecessor, the former E-A-R(R) (Energy Absorbing
Resins) Division of Cabot Corporation ("Cabot"), has been a leader in the
development of technology for understanding noise, measuring noise and hearing
loss, and in developing products and programs to encourage hearing protection
and conservation. In order to test the efficacy of its hearing protection
products, the Company owns and operates a National Voluntary Laboratory
Accreditation Program ("NVLAP") laboratory in the United States. The Company
also operates sound chambers and testing facilities in the United States and
Sweden that measure the performance of its materials and designs. With these and
other capabilities, the Company believes it is a leader in the development of
both passive and active hearing protection products. Similarly, the Company
believes that it has been a pioneer and leader in the development and testing of
safety eyewear as extensive facilities are operated for the design and testing
of these products. The Company also has facilities for the design and testing of
respiratory safety equipment. Many of the Research and Development personnel of
the Company are recognized experts in the safety products industry and are
members of various committees of standard setting organizations.
Research and Development - Safety Prescription Eyewear Segment
This segment shares resources with the Safety Products Segment in the areas of
coating technology, automation and manufacturing process improvements. This
segment works extensively with outside suppliers for development of frames,
lenses and coatings.
Research and Development - Specialty Composites Segment
Specialty Composites' research and development efforts focus on developing
proprietary materials and enhancing existing products in order to meet market
and customer needs identified by the Company's marketing, sales and technical
staffs. Products such as VersaDamp(TM) thermoplastic elastomers and Confor(R)
environmentally friendly, energy-absorbing foams are being introduced in a
growing number of applications across all markets served by Specialty
Composites.
Raw Materials and Suppliers
The Company buys and consumes a wide variety of raw materials, component parts,
office supplies, and maintenance and repair parts. Significant categories
purchased include corrugated paper products, poly packaging films, chemicals,
eyewear frames and optical lenses. The chemical category includes plastic resins
such as polycarbonates, propionates, polyols, plasticizers, substrates,
pre-polymers, isocyanates and adhesives. The eyewear frames are for both the
non-prescription and SRx products.
-7-
The Company has a diverse base of material suppliers and is subject to market
risks with respect to industry pricing in paper and crude oil as it relates to
various commodity items. Items with potential risk of price volatility include
paperboard, packaging films, nylons, resins, propylene, ethylene, plasticizer
and freight. With reference to supplier agreements that allow for price changes
based upon an index, the Company builds anticipated commodity price movements
into each year's planning cycle. The Company manages pricing pressure exposure
on large volume commodities such as polycarbonate, polyols and polyvinyl
chloride via price negotiations utilizing alternative supplier competitive
pricing. However, where appropriate, the Company will use a single source for
supply of certain items. In addition, based on the material, availability of
supply, level of quality and the technical difficulty to produce, the Company
will use a major and minor source to insure continued best pricing and a ready
back up supply. The Company does not enter into derivative instruments to manage
commodity risk.
The Company's commodity pricing and negotiating strategy is to consolidate
suppliers where applicable, leverage competitive pricing, identify alternate
lower cost materials and work with existing suppliers to reduce costs through
engineering and innovation.
Although the Company outsources the production of less than 25% of its assembled
parts and products to various manufacturers, the Company has found resource
availability, abundant supplier competition and infrastructure stability in the
Far East to provide favorable supply opportunities.
Manufacturing and Distribution Operations
The Company maintains a high degree of vertical integration, allowing it to
manufacture over 75% of the products that it sells. The Company's strengths
include the manufacture of foams (casting, molding and fabricating) for
Specialty Composites' products (including the foam used in the manufacture of
PVC and PU earplugs); high speed assembly and packaging of earplugs; plastic
injection molding, coating and assembly of non-prescription eyewear; and
assembly, grinding, polishing and coating of prescription eyewear. The Company
also utilizes a limited number of contract manufacturers in the United States of
America, Mexico, and Europe to supplement internal operations and to assemble
and/or manufacture products where the Company does not have world class
processing capabilities. The Company uses selected Asian suppliers for some
product lines to complement Company manufactured products and fill in product
families, where it is advantageous to minimize capital expenditures and
accelerate new product introductions. The Company will continue to use contract
manufacturers where appropriate to remain competitive and maximize profit
margins. Consistent across all of the Company's manufacturing operations is an
emphasis on producing high quality products. Currently, all of the Company's
manufacturing facilities have been awarded ISO 9002 or ISO 9001 certification,
indicating that the Company has achieved and sustained a high degree of quality
and consistency with respect to its products. The Company has also attained QS
9000 certification for the Specialty Composites operations in Indianapolis and
Newark. The Company believes that ISO certification is an increasingly important
selling feature both domestically and internationally, and certain customers
require ISO certification from all their vendors.
The Company's products are generally shipped within several days from the
receipt of a purchase order. As a result, backlog is not material to the
Company's business.
Manufacturing and Distribution Operations - Safety Products Segment
The Company's Indianapolis, Indiana plant is the largest earplug manufacturing
facility in the world. It fabricates, molds, assembles and packages hundreds of
millions of pairs of earplugs annually, utilizing automated, high-speed assembly
and packaging equipment. The economies of scale present in this operation are
unique in the hearing protection products industry and management believes that
they offer the Company a competitive advantage in lowering costs. The plant's
high-speed robotic fabrication, assembly and packaging of earplugs facilitate
cost-savings, high-volume production and improved cycle times and inventory
management. The Southbridge, Massachusetts facility is the Company's largest
manufacturing site and manufactures a wide variety of Personal Protection
Equipment. These manufactured safety products include respiratory, plug and muff
type hearing, head and face, and a broad offering of safety eyewear protection.
All Company manufacturing sites have implemented a number of initiatives
including lean manufacturing concepts and an extensive KAIZEN event schedule,
resulting in significant improvements in the areas of safety, quality, cost, and
customer service.
-8-
The Company's principal international manufacturing operations are located in
Poynton, England and Varnamo, Sweden. The Poynton facility serves customers in
Western Europe, producing and packaging earplugs and other hearing and eyewear
products. The Varnamo, Sweden plant is the principal Peltor manufacturing
location supplying finished goods and components to customers and other
subsidiaries from this location.
The Company fills virtually all of its domestic and certain of its international
orders through its distribution center located in Indianapolis, Indiana which
has bar-code scanning capabilities to assure rapid turn-around time and service
levels for customer orders. Recent freight studies, having taken into
consideration Aearo Company manufacturing locations in conjunction with domestic
customer locations, have shown Indianapolis to be the ideal single warehouse and
distribution location for our safety business. Over the road carriers are
readily available in Indianapolis, which contributes to competitive pricing for
both our inbound and outbound business. European orders are filled from
distribution facilities near Manchester, U.K. and in Varnamo, Sweden.
Manufacturing and Distribution Operations - Safety Prescription Eyewear Segment
The SRx production operations are comprised of two facilities located in the
U.S., one in Canada and two in Europe. The U.S. locations are in Indiana and
Oklahoma. In Canada, the Mississauga, Ontario plant fabricates prescription
eyewear and, together with a small customer service operation in Montreal,
produces SRx products for the Canadian market. In both Poynton, England and
Joinville, France, the Company has small SRx laboratories that perform edging
and assembly operations and serve primarily the U.K. and French market,
respectively. The remaining facilities possess lens surfacing, edging, grinding
and coating machinery capable of handling glass, plastic and polycarbonate
lenses. The lenses are then fitted into frames and the finished product is
shipped to customers. These facilities currently manufacture and distribute
approximately 500,000 pairs of safety prescription glasses annually.
Prescription eyewear fulfillment is predominantly by US Postal Service.
Manufacturing and Distribution Operations - Specialty Composites Segment
Specialty Composites' products are manufactured in Indianapolis, Indiana, and
Newark, Delaware. The Indianapolis plant supplies specially formulated foam for
the Company's earplugs, manufactures and fabricates sheet and roll PVC and
polyurethane materials and molds polyurethanes. This facility also houses
technical support functions, including research and development, applications
engineering, sales and marketing administration, quality assurance and customer
service support. The Newark, Delaware, facility manufactures polyurethane foams
and houses the Company's proprietary, thin sheet foam casting line, which
permits the casting of both sheet and composite materials, including facings and
substrates, in a single pass through the line. Product development for this
facility is onsite.
Competition and the Personal Protection Equipment Market
The PPE market is highly fragmented as a large number of relatively small,
independent manufacturers with limited product lines serve the PPE market. The
Company estimates that there are several hundred manufacturers of PPE (other
than safety clothing, gloves and shoes) in the United States of America, Europe
and Southeast Asia. Participants in the industry range in size from small,
independent, single-product companies with annual sales of less than $15
million, to a small number of multinational corporations with annual sales in
excess of $100 million. The Company believes that participants in the PPE market
compete primarily on the basis of product characteristics (such as design, style
and functional performance), product quality, service, brand name recognition
and, to a lesser extent, price. From a positive competitive standpoint, the
Company believes it is currently well situated, primarily because of its large
size and its broad product offerings, to compete in this fragmented industry.
The Company enjoys certain economies of scale that are not available to smaller
competitors. The Company's advanced distribution center further facilitates
timely and accurate deliveries. However, the industry has undergone some degree
of consolidation that could potentially increase long-term competitive pressures
on the Company.
Several manufacturers compete in noise and vibration control, but few if any
competitors offer the complete range of technology and energy-control materials
as Specialty Composites. Thus the Company is able to differentiate itself by
bundling its technology, engineering and wide ranges of proprietary products
into energy control solutions or systems that add value to customers' products
and supply chain management. In markets where technology is of particular value,
Specialty Composites is able to command better margins, but price is a
significant factor in other highly competitive markets sectors in which the
Company participates.
-9-
Employees
As of September 30, 2003, the Company had 1,603 employees, of whom 989 were
primarily engaged in manufacturing, 429 in sales, marketing and distribution, 55
in research and development and 130 in general and administrative. The Company
believes its employee relations are good. The Company has one domestic U.S.
facility that employs union members. This facility, located in Plymouth,
Indiana, employs 72 members of the International Union of Electronic,
Electrical, Salaried, Maritime and Furniture Workers (out of a total of 79
employees), and the Company's relations with these union members are fully
satisfactory. The union contract expires on June 26, 2004.
Patents and Trademarks
The Company owns and has obtained licenses to various domestic and foreign
patents, patent applications and trademarks related to its products, processes
and business. The Company places significant value on its trademark for the
color yellow for earplugs in the United States and Canada and on its overall
patent portfolio. However, no single patent or patent application is material to
the Company. The Company's patents expire at various times in the future not
exceeding 20 years.
Government Regulation
As a manufacturer of safety products, the Company is subject to regulation by
numerous governmental bodies. Principal among the federal regulatory agencies in
the United States of America are: the Occupational Safety and Health
Administration ("OSHA"), which regulates the occupational usage of all PPE, the
Environmental Protection Agency ("EPA"), which regulates labeling of hearing
protection devices; the Mine Safety and Health Administration ("MSHA") and the
National Institute of Occupational Safety and Health ("NIOSH"), both of which
certify respirators. These agencies generally mandate that the Company's
products meet standards established by private groups, such as American National
Standards Institute ("ANSI"). The Company's products are also subject to foreign
laws and regulations. In particular, they must comply with the Canadian
Standards Association, European Committee for Normalization and Standards
Australia. The Company believes it is in compliance in all material respects
with the regulations and standards of these governmental bodies.
Environmental Matters
The Company is subject to various evolving federal, state and local
environmental laws and regulations governing, among other things, emissions to
air, discharge to waters and the generation, handling, storage, transportation,
treatment and disposal of hazardous substances and wastes. The Company believes
that it is in substantial compliance with all such laws and regulations. The
Company has an active program to ensure environmental compliance and achievement
of environmental goals and objectives. The Company will continue to implement
Environmental Management Systems at its manufacturing facilities. In October
2003, the Company's Varnamo, Sweden facility achieved ISO 14001 certification.
-10-
Item 2. Properties
The Company owns and/or leases facilities in the United States of America,
Canada, and Europe. The following table sets forth the location of each, its
square footage and the principal function as of December 23, 2003.
Approx
Location Square Ft Function
SAFETY PRODUCTS
Southbridge, Massachusetts 198,984 Manufacturing/Administration
Indianapolis, Indiana (1) 226,794 Distribution/Customer Service
Indianapolis, Indiana 81,540 Manufacturing/Corporate Headquarters
Poynton, England (2) 74,331 Manufacturing/Distribution/Customer Service
Varnamo, Sweden 124,130 Manufacturing/Distribution/Customer Service
Ettlingen, Germany 14,661 Manufacturing/Distribution/Customer Service
Concord, North Carolina 17,500 Manufacturing/Distribution/Customer Service
Paris, France 1,894 Sales Office
Barcelona, Spain (*) Sales Office
Milan, Italy (*) Sales Office
Barrie, Ontario, Canada 4,768 Manufacturing/Distribution/Customer Service
Oslo, Norway 6,300 Sales/Distribution/Customer Service
Joinville-le-Pont, France 10,200 Sales/Distribution/Customer Service
SAFETY PRESCRIPTION EYEWEAR
Chickasha, Oklahoma 35,000 Manufacturing/Customer Service
Plymouth, Indiana 9,500 Manufacturing/Customer Service
Mississauga, Ontario, Canada 12,300 Manufacturing/Customer Service
Montreal, Quebec, Canada 1,800 Customer Service
Brooklyn Park, Maryland 1,200 Customer Service
Dundalk, Maryland 1,050 Customer Service
Newport News, Virginia 1,400 Customer Service
Richmond, Virginia 1,800 Customer Service
SPECIALTY COMPOSITES
Indianapolis, Indiana 155,800 Manufacturing/Distribution/Customer Service
Newark, Delaware 79,650 Manufacturing/Distribution
Newark, Delaware 61,642 Warehouse/Distribution
- ---------------------
(1) This facility also serves as an international distribution center.
(2) This facility's primary function is manufacturing safety products.
(*) Less than 1,000 square feet.
The Company believes that its facilities are suitable for its operations and
provide sufficient capacity to meet the Company's requirements for the
foreseeable future. All of the Company's facilities are leased except for the
following facilities owned by the Company: (i) the Safety Products manufacturing
facility in Indianapolis, (ii) the Specialty Composites
manufacturing/distribution facility in Indianapolis, (iii) the Specialty
Composites manufacturing facility in Newark, (iv) the Peltor
manufacturing/distribution facility in Varnamo, Sweden and (v) the Safety
Products manufacturing facility in Ettlingen, Germany. The Company believes that
it will be able to renew each of its leases upon their respective expiration
dates on commercially reasonable terms. In addition, the Company believes that
it would be able to lease suitable additional or replacement space on
commercially reasonable terms.
-11-
Item 3. Legal Proceedings
Various lawsuits and claims arise against the Company in the ordinary course of
its business. Most of these lawsuits and claims are products liability matters
that arise out of the use of safety eyewear and respiratory product lines
manufactured by the Company as well as products purchased for resale.
In addition, the Company is a defendant in lawsuits by plaintiffs alleging that
they suffer from respiratory medical conditions, such as asbestosis or
silicosis, relating to exposure to asbestos and silica, and that such conditions
result, in part, from the use of respirators that, allegedly, were negligently
designed or manufactured. The defendants in these lawsuits are often numerous,
and include, in addition to manufacturers and distributors of respirators,
manufacturers, distributors and installers of sand (used in sand blasting),
asbestos and asbestos-containing products. Most of these claims are covered by
the Asset Transfer Agreement entered into on June 13, 1995 by the Company and
Aearo Company, on the one hand, and Cabot and certain of its subsidiaries (the
"Sellers"), on the other hand (the "1995 Asset Transfer Agreement"). In the 1995
Asset Transfer Agreement, so long as the Company makes an annual payment of
$400,000 to Cabot, the Sellers agreed to retain, and Cabot and the Sellers
agreed to defend and indemnify the Company against, any liability or obligation
relating to or otherwise arising under any proceeding or other claim against the
Company or Cabot or their respective affiliates or other parties with whom any
Seller directly or indirectly has a contractual liability sharing arrangement
which sounds in product liability or related causes of action arising out of
actual or alleged respiratory medical conditions caused or allegedly caused by
the use of respirators or similar devices sold by Sellers or their predecessors
(including American Optical Corporation and its predecessors) prior to July 11,
1995. To date, the Company has elected to pay the annual fee and intends to
continue to do so. The Company could potentially be liable for claims currently
retained by Sellers if the Company elects to cease paying the annual fee or if
Cabot and the Sellers no longer are able to perform their obligations under the
1995 Asset Transfer Agreement. Cabot acknowledged in the Stock Purchase
Agreement that it and the Company entered into on June 27, 2003 (providing for
the sale by Cabot to the Company of all of the common and preferred stock of the
Company owned by Cabot) that the foregoing provisions of the 1995 Asset Transfer
Agreement remain in effect. The 1995 Asset Transfer Agreement does not apply to
claims relating to the business of Eastern Safety Equipment, the stock of which
the Company acquired in 1996.
At September 30, 2003, the Company has recorded liabilities of approximately
$4.5 million, which represents reasonable estimates of its probable liabilities
for product liabilities substantially related to asbestos and silica-related
claims as determined by the Company in consultation with an independent
consultant. This reserve is re-evaluated periodically and additional charges or
credits to operations may result as additional information becomes available.
Consistent with the current environment being experienced by companies involved
in asbestos and silica-related litigation, there has been an increase in the
number of asserted claims that could potentially involve the Company. Various
factors increase the difficulty in determining the Company's potential
liability, if any, in such claims, including the fact that the defendants in
these lawsuits are often numerous and the claims generally do not specify the
amount of damages sought. Additionally, the bankruptcy filings of other
companies with asbestos and silica-related litigation could increase the
Company's cost over time. In light of these and other uncertainties inherent in
making long-term projections, the Company has determined that the five-year
period through fiscal 2008 is the most reasonable time period for projecting
asbestos and silica-related claims and defense costs. It is possible that the
Company may incur liabilities in an amount in excess of amounts currently
reserved. However, taking into account currently available information,
historical experience, and the 1995 Asset Transfer Agreement, but recognizing
the inherent uncertainties in the projection of any future events, it is
management's opinion that these suits or claims should not result in final
judgments or settlements in excess of the Company's reserve that, in the
aggregate, would have a material effect on the Company's financial condition,
liquidity or results of operations.
-12-
Item 4. Submission of Matters to a Vote of Security Holders
On October 7, 2003, the Company held a special meeting of stockholders. The
stockholders approved the selection of Deloitte & Touche LLP as the Company's
independent public accountants for the year ending September 30, 2004 with a
total of 56,971.5 votes in favor, 50 votes in opposition and 2,391 abstention
votes. The stockholders voted to elect the following directors for the ensuing
year with a total of 57,021.5 votes in favor of each director and 2,391
abstention votes for each director: Norman W. Alpert, Bryan P. Marsal, John D.
Curtin, Jr., William E. Kassling, Michael A. McLain, Arthur J. Nagle, Daniel S.
O'Connell.
-13-
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
As of December 1, 2003 there were outstanding 59,412.5 shares of common stock,
par value $0.01 per share, of Aearo ("Aearo Common Stock"). All of the Aearo
Common Stock is held, collectively, by Vestar Equity Partners, L.P. (together
with certain related persons, "Vestar") and management. As of December 1, 2003
there were 34 shareholders of record of Aearo Common Stock. In July 1995,
Vestar, Cabot and management effected through the Company the acquisition of
substantially all of the assets and certain liabilities of Cabot CSC Corporation
("Old Cabot Safety Corporation"), a wholly-owned subsidiary of Cabot, and
certain of its affiliates (the "Formation Acquisition") for $206.1 million. To
effectuate the Formation Acquisition, the Company sold $100 million of 12 1/2%
senior subordinated notes due 2005 (the "Senior Subordinated Notes"), issued
pursuant to the Indenture dated July 11, 1995 among Aearo Company, the Company
and U.S. Bank, N.A. (the "Note Indenture"), issued to Vestar and Cabot an
aggregate of $45 million of 12 1/2% redeemable preferred stock (the "Aearo
Preferred Stock"), and issued to Vestar, Cabot and certain members of management
and key employees of the Company an aggregate of 100,000 shares of Aearo Common
Stock. In August 2003, the Company redeemed the Aearo Common Stock and Aearo
Preferred Stock held by Cabot ("Cabot Stock Redemption") for a total cost of
$38.5 million, including $4.0 million for fees. The Company financed this
transaction with $8.0 million in cash, $15.5 million from its revolver facility
for up to $30.0 million for general purposes ("Revolving Credit Facility") and
$15.0 million of new senior subordinated notes due July 15, 2005 ("Holding
Company Notes") issued pursuant to the Note Purchase Agreement dated August 18,
2003 ("Note Purchase Agreement"). See Item 12, "Security Ownership of Certain
Beneficial Owners and Management." All of the common stock of the Subsidiary is
owned by Aearo, and thus no trading market exists for such stock. Accordingly,
no trading market exists for any capital stock of the Company.
The Company has never paid cash dividends on the Aearo Common Stock. Payment of
dividends on the Aearo Common Stock is limited by the terms of the Company's
Credit Agreement, Senior Subordinated Notes and Holding Company Notes and is
subordinated to payment of dividends on the Aearo Preferred Stock. See Note 7 to
the Consolidated Financial Statements.
-14-
Item 6. Selected Financial Data
The selected historical financial data as of and for the periods ended September
30, 1999, 2000, 2001, 2002, and 2003 are derived from the consolidated financial
statements of Aearo Corporation and subsidiaries. The data should be read in
conjunction with the consolidated financial statements and related notes,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and other financial information included herein.
AEARO CORPORATION
SELECTED FINANCIAL DATA
(Dollars in Millions, Except Fixed Charge Ratio)
Years Ended September 30,
1999 2000 2001 2002 2003
-------------- ------------- ---------- ----------- ----------
Statement of Operations Data:
Net Sales--
Safety Products $ 212.7 $ 219.7 $ 206.3 $ 208.5 $ 242.3
Safety Prescription Eyewear 35.5 39.9 39.1 40.8 40.0
Specialty Composites 42.9 45.9 38.5 37.6 34.1
-------------- ------------- ---------- ----------- ----------
Total net sales 291.1 305.5 283.9 286.9 316.4
Cost of Sales 156.7 160.8 155.2 (2) 150.4 (3) 164.0 (4)
-------------- ------------- ---------- ----------- ----------
Gross profit 134.4 144.7 128.7 136.5 152.4
Operating Expenses--
Selling and administrative 87.5 95.6 87.3 91.9 101.3
Research and technical service 4.7 5.5 5.2 5.7 6.4
Amortization expense 6.8 6.9 6.5 6.3 .3
Other charges (income), net 0.8 (0.3) 0.7 1.5 1.7
Restructuring charge - - 9.1 (2) (0.1) (3) -
-------------- ------------- ---------- ----------- ----------
Operating income 34.6 37.0 19.9 31.2 42.7
Interest expense, net 24.3 24.4 23.7 20.1 19.6
-------------- ------------- ---------- ----------- ----------
Income (loss) before
income taxes 10.3 12.6 (3.8) 11.1 23.1
Provision for (benefit from)
income taxes 3.2 3.6 (1.9) 1.8 2.5
-------------- ------------- ---------- ----------- ----------
Net income (loss) $ 7.1 $ 9.0 $ (1.9) $ 9.3 $ 20.6
============== ============= ========== =========== ==========
Other Data:
Depreciation and amortization 18.3 18.7 18.7 17.3 11.4
Capital expenditures 8.4 9.6 7.8 9.7 10.3
Ratio of earnings to fixed
Charges (1) 1.4 1.5 - 1.5 2.1
Balance Sheet Data (at period-end):
Total assets $ 282.3 $ 266.8 $ 261.3 $ 270.2 $293.5
Debt 214.8 199.8 202.2 195.6 213.6
Stockholders' equity 16.5 15.8 9.9 21.5 18.4
-15-
Notes to Selected Financial Data:
1. Ratio of earnings to fixed charges is defined as pretax income from
continuing operations plus fixed charges divided by fixed charges. Fixed
charges include interest expense (including amortization of debt issuance
costs). Earnings for the period ended September 30, 2001 were inadequate to
cover fixed charges by $3.8 million.
2. On September 30, 2001, the Company recorded a restructuring charge of $11.4
million related to a restructuring plan announced by the Company to improve
its competitive position and long-term profitability. The plan includes the
closure of its Ettlingen, Germany plant, significantly reorganizing
operations at the Company's Varnamo, Sweden plant, rationalizing the
manufacturing assets and product mix of its Specialty Composites business
unit and a reduction of products and product lines (See Note 16 of Notes to
Consolidated Financial Statements).
3. During fiscal 2002, the Company reversed $0.6 million of reserves related
to the September 30, 2001 restructuring provision. The adjustment
represents a change in estimate of the plan for the disposal of certain
items of inventory and the closure of its Ettlingen, Germany plant. The
inventory provision of $0.5 million was classified as cost of sales with
the remaining $0.1 million classified as operating expenses.
4. During fiscal 2003, the Company reversed $0.3 million of reserves related
to the September 30, 2001 restructuring provision. The adjustment
represents a change in estimate of the plan for the disposal of certain
items of inventory. The inventory provision of $0.3 million was classified
as cost of sales.
-16-
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with "Selected Financial
Data," and the 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.
General
The following discussion provides a summary of major developments affecting the
Company over the past few years.
The Company benefited from new product launches including the Lexa(R) product
line first introduced in 1998, which continued with very positive growth during
1999. In addition, new hearing products introduced during 1999 included
E-A-Rsoft(TM), Yellow Neons(R), SuperFit(R), and several new Peltor(R)
communication products. New eyewear products introduced during 1999 included
Nassau Rave(R) and new safety prescription eyewear frames.
During fiscal year 2000, the sales increased 4.9%, despite a stronger US dollar,
which had the affect of depressing reported sales by approximately $6.6 million.
On a currency adjusted basis sales were 7.7% higher than the previous year.
Although sales were higher in all three of the Company's segments, the Specialty
Composites trucking market began to soften during the fourth quarter. The
continued productivity improvements in purchasing and manufacturing, especially
in the manufacture of non-prescription eyewear product lines, drove a strong
improvement in gross profit performance, resulting in a 0.8% improvement in the
gross profit percentage of sales. The gross profit would have been approximately
an additional 0.6% higher had it not been for the weakness of the Euro, which
depressed revenue while having a more limited impact on manufacturing costs.
During fiscal year 2001, continued softening of the Specialty Composites'
trucking market that began in the fourth quarter of the previous year was
followed by overall softness in the North American economy. Order softness began
with the consumer marketplace and then the industrial marketplace as consumer
confidence and manufacturing employment in North America declined during the
year. In addition, the US dollar continued to strengthen against most global
currencies, which had the affect of depressing reported sales by approximately
$7.8 million. Continued productivity improvements in purchasing and
manufacturing enabled the Company to offset much of the negative currency impact
as well as the impact on manufacturing overhead absorption due to reduced
volume. Selling and administrative expenses decreased $8.3 million primarily due
to the Company's proactive measures to reduce expenses in line with the slowdown
in the economy. In May 2001 the Company completed an upgrade of its SAP
management information system to version 3.1i and it intends to continue to
apply information system version upgrades, as it deems appropriate. In July
2001, the Company successfully completed the refinancing of its indebtedness
under its prior $165.0 million credit agreement with a new $135.0 million credit
agreement and ended the year with undrawn revolver commitments of approximately
$30.0 million, an available U.K. overdraft facility of $5.0 million and cash of
$18.2 million. On September 30, 2001 the Company recorded a restructuring charge
of $11.4 million related to a restructuring plan announced by the Company to
improve its competitive position and long-term profitability.
The terrorist events of September 11, 2001, coupled with the previously weak
economy, made for a challenging start for fiscal year 2002. Sales for the first
quarter were off 9.8% versus the prior year due to the resulting significant
slowdown in the manufacturing sectors of the economy in which the Company
markets its products. The following three quarters showed comparable
improvements with sales down only 4.5% in the second quarter and then up 6.0%
and 12.7% in quarters three and four.
Despite the difficult economy in fiscal 2002, the Company was able to improve
performance through continued reliance on its strategy of ongoing productivity
improvements, global new product development and value-creating acquisitions.
Productivity improvements in purchasing and manufacturing as well as the
benefits of the restructuring program implemented toward the end of fiscal 2001
allowed the Company to improve gross profits to 47.6% of net sales (up 230 basis
-17-
points). The initiatives on global new product development resulted in the
Company launching 36 new or improved product lines including the Quick-Latch(R)
respiratory line, the X-Factor(TM) eyewear line for the Consumer channel, and PU
shaped earplugs under the EARsoft(R) name. In addition, the Company also
released new and improved Peltor passive muffs as well as the new and improved
Comtac(TM) and PowerCom Plus(TM) communication muffs. In addition, the difficult
economy did provide acquisition opportunities and the Company was able to
complete four value creating acquisitions during the fiscal year. These
acquisitions are in the Company's core product offerings and enhance the
Company's global eyewear positions. In prescription eyewear the Company added to
SRx's number one global market share position under its single AOSafety(R) brand
name, and in non-prescription eyewear the Company acquired an eyewear line that
was restaged under the X-Series(TM) line which is being expanded through the
International, Consumer, European and North American channels. The overall
result was that the Company ended its fiscal year with operating income of $31.2
million, as compared to $19.9 million in the previous fiscal year, with undrawn
revolver commitments of approximately $30.0 million, an available U.K. overdraft
facility of $5.0 million and cash of $14.5 million.
In fiscal 2003, the Company continued with the momentum gained during the
previous fiscal year and increased its sales by $29.6 million, or 10.3%. The
impact of a strong new product development program allowed the Company's Safety
Segment to register its fifth straight quarter of organic growth ending the year
with organic growth of 5.9%. The Company's SRx and Specialty Composite segments
were negatively impacted by the weak economy in North America resulting in total
Company organic growth of 1.7%.
During the year the Company introduced new eyewear products including Maxim(TM),
Metaliks(TM) and X.Sport(TM). In the hearing product line, the Company launched
EAR PushIns(TM), and HearPlug products. A major launch in respiratory was the
launch of Quick-Latch with Voice Transmission. Acquisitions accounted for $10.9
million of incremental sales led by the acquisition of the SafeWaze branded fall
protection product line. SafeWaze sells into the US non-residential construction
market and allows the Company access to that channel for its existing personal
protection equipment. In addition, the acquired fall protection product line is
being introduced to the North American industrial market via the Company's
strong presence in that channel. A weaker US dollar added $13.7 million to net
sales and gross profit as a percentage of net sales increased 0.6% to 48.2%
primarily as a result of productivity improvements in purchasing and
manufacturing. Operating income improved $11.5 million, or 36.8% to $42.7
million.
In August 2003, the Company effected the Cabot Stock Redemption for a total cost
$38.5 million, including $4.0 million for fees. The Company financed this
transaction with $8.0 million in cash, $15.5 million from its Revolving Credit
Facility and $15.0 million of Holding Company Notes. The Company ended the year
with cash of $7.3 million and a revolver balance of $11.7 million.
Critical Accounting Policies
The Company's discussion and analysis of its financial condition and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America ("GAAP"). GAAP requires the use of estimates,
judgments and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses. The Company believes its use of estimates
and underlying accounting assumptions adhere to GAAP and are consistently
applied except for the change in the method of accounting for goodwill and
intangibles. The Company revises its estimates and assumptions as new
information becomes available.
The Company believes that of its significant accounting policies (see the
accompanying Notes to the Consolidated Financial Statements) the following
policies involve a higher degree of judgment and/or complexity.
Income Taxes - The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for
Income Taxes", which requires deferred tax assets and liabilities be recognized
using enacted tax rates for the effect of temporary differences between book and
tax bases of recorded assets and liabilities. SFAS No. 109 also requires
deferred tax assets be reduced by a valuation allowance if it is more likely
than not that some portion or all of the deferred tax assets will not be
realized. Recognition of a deferred tax asset is dependent on generating
sufficient future taxable income in the United States prior to the expiration of
the tax loss and credit carryforwards, which expire over various periods ranging
from 2010 to 2021. In its evaluation of the adequacy of the valuation allowance,
the Company assesses prudent and feasible tax planning strategies. Due to the
uncertainties of realizing these tax benefits, the Company has recorded a full
valuation allowance against these losses and credit carryforwards. The ultimate
amount of deferred tax assets realized could be different from those recorded,
as influenced by potential changes in enacted tax laws and the availability of
future taxable income.
-18-
Product Liabilities -The Company has established reserves for potential product
liabilities that arise out of the use of the Company's products. A significant
amount of judgment is required to quantify the Company's ultimate exposure in
these matters and the valuation of reserves is estimated based on currently
available information, historical experience and, from time to time, the Company
may seek the assistance of an independent consultant. While the Company believes
that the current level of reserves is adequate, changes in the future could
impact these determinations.
Restructuring - The Company recorded an unusual charge in fiscal 2001 based on a
restructuring plan to improve its competitive position and long-term
profitability. The provision recorded was based on estimates of the expected
costs associated with site closures, consolidation of products and product
lines, disposal of assets, contract terminations or other costs directly related
to the restructuring. To the extent that actual costs may differ from amounts
recorded, revisions to the estimated reserves would be required. The
restructuring provision included a reduction of $0.6 million and $0.3 million in
fiscal years 2002 and 2003, respectively, to account for new information made
available during the year.
Impairment of Long-Lived Assets - The Company evaluates long-lived assets,
including other intangibles and related goodwill, of identifiable reporting
units for impairment when events or changes in circumstances indicate, in
management's judgment, that the carrying value of such assets may not be
recoverable. Cash flows used in the potential impairment evaluation are based on
management's estimates and assumptions. Changes in business conditions could
potentially require future adjustments to asset valuations.
Revenue Recognition - The Company recognizes revenue when title and risk
transfer to the customer, which is generally when the product is shipped to
customers (FOB shipping point). At the time revenue is recognized, certain
provisions may also be recorded, including pricing discounts, rebates and
incentives. In addition, an allowance for doubtful accounts is generally
recorded based on a percentage of aged receivables. However, management judgment
is involved with the final determination of the allowance based on several
factors including specific analysis of a customers credit worthiness, historical
bad debt experience, changes in payment history and general economic and market
trends.
Results of Operations
The following table sets forth the major components of the Company's
consolidated statements of operations expressed as a percentage of net sales.
Years Ended September 30,
---------------------------------------------
2001 2002 2003
------------- ------------ ------------
Net sales:
Safety Products 72.7 % 72.7 % 76.6 %
Safety Prescription Eyewear 13.8 14.2 12.6
Specialty Composites 13.5 13.1 10.8
------------- ------------ ------------
Total net sales 100.0 100.0 100.0
Cost of sales 54.7 52.4 51.8
------------- ------------ ------------
Gross profit 45.3 47.6 48.2
Selling and administrative 30.8 32.0 32.0
Research and technical services 1.8 2.0 2.1
Amortization expense 2.3 2.2 0.0
Other charges (income), net 0.0 0.5 0.6
Restructuring charge 3.2 0.0 0.0
------------- ------------ ------------
Operating income 7.2 % 10.9 % 13.5 %
============= ============ ============
-19-
Fiscal 2003 Compared to Fiscal 2002
Net Sales. Net sales in the year ended September 30, 2003 increased 10.3% to
$316.4 million from $286.9 million in the year ended September 30, 2002. The
increase in sales was primarily driven by organic growth in the Safety Products
segment, the impact of foreign currency translation, and acquisitions, partially
offset by declines in the Safety Prescription Eyewear and Specialty Composites
segments. The weakness of the U.S. dollar relative to other currencies and
acquisitions favorably impacted net sales by $13.7 million and $10.9 million,
respectively. The Safety Products segment net sales in the year ended September
30, 2003 increased 16.2% to $242.3 million from $208.5 million in the year ended
September 30, 2002. The increase in net sales resulted from a 5.9% increase due
to organic growth, a 6.5% increase due to foreign currency translation and a
3.8% increase due to acquisitions. The Safety Prescription Eyewear segment net
sales in the year ended September 30, 2003 decreased 2.0% to $40.0 million from
$40.8 million in the year ended September 30, 2002. The decrease in net sales
resulted from a 9.9% reduction in volume, partially offset by a 7.3% increase
due to acquisitions, with the remainder due to the impact of foreign currency
translation. The Specialty Composites segment net sales in the year ended
September 30, 2003 decreased 9.0% to $34.1 million from $37.5 million in the
year ended September 30, 2002. The decrease was primarily driven by volume
declines in the automotive and truck markets.
Gross Profit. Gross profit in the year ended September 30, 2003 increased 11.7%
to $152.4 million from $136.5 million in the year ended September 30, 2002. The
increase in gross profit is primarily due to productivity improvements,
acquisitions, volume and the impact of foreign currency translation,. Gross
profit as a percentage of net sales in the year ended September 30, 2003
improved by 0.6% to 48.2% as compared to 47.6% in the year ended September 30,
2002. The increase in gross margin percentage was primarily due to product mix,
productivity improvements, volume and the impact of foreign currency
translation.
Operating Expenses. Operating expenses in the year ended September 30, 2003
increased 4.1% to $109.7 million from $105.3 million in the year ended September
30, 2002. The increase in operating expenses was primarily driven by an increase
in selling and administrative expenses and research and technical services
expense, partially offset by a decrease in amortization expense. The 10.2%
increase in selling and administrative expenses resulted from a 3.3% increase
due to foreign currency translation, a 3.5% increase due to acquisitions, a 2.6%
increase due to compensation expense, which includes the costs of increased
benefits and variable incentives, and the remaining 0.6% due to product launches
and marketing support. Research and technical services expense increased $0.7
million due to product development initiatives. Amortization expense decreased
$6.0 million due to the adoption of SFAS No. 142 which requires the Company to
discontinue amortizing goodwill and other intangible assets with indefinite
useful lives. Amortization expense would have been reduced by approximately $6.0
million had the provisions of SFAS No. 142 been adopted in the year ended
September 30, 2002. Selling and administrative expenses as a percentage of net
sales were unchanged at 32.0% in the years ended September 30, 2003 and 2002,
respectively.
Operating Income. Primarily as a result of the factors discussed above,
operating income increased $11.6 million or 37.2% in the year ended September
30, 2003 from $31.1 million in the year ended September 30, 2002. Operating
income as a percentage of net sales in the year ended September 30, 2003 was
13.5% as compared to 10.9% in the year ended September 30, 2002.
Interest Expense, Net. Interest expense, net in the year ended September 30,
2003 decreased 2.5% to $19.6 million from $20.1 million in the year ended
September 30, 2002. The decrease is attributed to lower interest rates during
the year ended September 30, 2003 as compared to the year ended September 30,
2002.
Income (Loss) Before Provision for (Benefit From) Income Taxes. Income before
provision for income taxes increased $12.1 million to $23.2 million in the year
ended September 30, 2003 compared to $11.1 million in the year ended September
2002.
Provision for (Benefit From) Income Taxes. The provision for income taxes in the
year ended September 30, 2003 was $2.6 million compared to $1.8 million in the
year ended September 30, 2002. The Company's effective tax rate was different
from the statutory rate due to the mix of income between the Company's foreign
and domestic subsidiaries. The Company's foreign subsidiaries had taxable income
in their foreign jurisdictions while the Company's domestic subsidiaries have
net operating loss carry-forwards for income tax purposes. Due to the
uncertainty of realizing these tax benefits, the tax benefits generated by the
net operating loss carry-forwards have been fully offset by a valuation
allowance.
Net Income. For the year ended September 30, 2003, the Company recorded net
income of $20.6 million as compared to $9.3 million for the year ended September
30, 2002.
-20-
Fiscal 2002 Compared to Fiscal 2001
Net Sales. Net sales in the year ended September 30, 2002 increased 1.1% to
$286.9 million from $283.9 million in the year ended September 30, 2001. The
increase in sales was primarily driven by new product launches and acquisitions.
The Safety Products segment net sales in the year ended September 30, 2002
increased 1.1% to $208.5 million from $206.3 million in the year ended September
30, 2001. The Safety Products segment included approximately $5.0 million of
sales from the acquisition of Leader Industries in January 2002. The Safety
Prescription Eyewear segment net sales in the year ended September 30, 2002
increased 4.3% to $40.8 million from $39.1 million in the year ended September
30, 2001. The Safety Prescription Eyewear segment included approximately $2.7
million of sales from the acquisition of Iron Age Vision in December 2001 and
Chesapeake Optical in May 2002. The Specialty Composites segment net sales in
the year ended September 30, 2002 decreased 2.3% to $37.6 million from $38.5
million in the year ended September 30, 2001. The decrease was primarily driven
by volume declines in the industrial equipment market segment.
Gross Profit. Gross profit in the year ended September 30, 2002 increased 6.1%
to $136.5 million from $128.7 million in the year ended September 30, 2001.
Gross profit as a percentage of net sales in the year ended September 30, 2002
improved by 2.3% to 47.6% as compared to 45.3% in the year ended September 30,
2001. The increase in gross margin was primarily due to productivity
improvements and the impact of the restructuring plan that was charged during
the year ended September 30, 2001.
Selling and Administrative Expenses. Selling and administrative expenses in the
year ended September 30, 2002 increased 5.3% to $91.9 million from $87.3 million
in the year ended September 30, 2001. The increase is primarily due to the
impact of the acquisitions in addition to increased spending in sales and
marketing to support new product launches and build brand recognition. Selling
and administrative expenses as a percentage of net sales in the year ended
September 30, 2002 were 32.0%, compared to 30.8% in the year ended September 30,
2001.
Research and Technical Services. Research and technical services expense in the
year ended September 30, 2002 increased 9.6% to $5.7 million from $5.2 million
in the year ended September 30, 2001. The increase is primarily due to increased
spending for new product development. Research and technical services expenses
as a percentage of net sales in the year ended September 30, 2002 were 2.0%
compared to 1.8% in the year ended September 30, 2001.
Other Charges (Income), Net. Other charges (income), net was expense of $1.5
million for the year ended September 30, 2002 as compared to expense of $0.7
million for the year ended September 30, 2001. The $1.5 million expense for the
year ended September 30, 2002 was primarily attributed to foreign currency
transaction and hedge losses of approximately $0.8 million and $0.5 million of
asset write-offs. The $0.7 million expense for the year ended September 30, 2001
was primarily attributed to foreign currency transaction and hedge losses of
approximately $0.8 million. The foreign currency transaction and hedge losses
were largely due to a weakening U.S. dollar, mainly in the second half of the
fiscal year, as compared to European currencies. This currency shift, although
unfavorable to other charges (income), net, was favorable to overall operating
income.
Restructuring Charge. On September 30, 2001 the Company recorded a restructuring
charge of $11.4 million related to a restructuring plan announced by the Company
to improve its competitive position and long-term profitability. The plan
included the closure of its Ettlingen, Germany plant, significantly reorganizing
operations at the Company's Varnamo, Sweden plant, rationalizing the
manufacturing assets and product mix of its Specialty Composites business unit
and a reduction of products and product lines. On September 30, 2002, the
Company revised its estimate relating to the disposal of certain items of
inventory and to the closure of its Ettlingen, Germany operation and adjusted
the restructuring provision by $0.6 million, of which $0.5 million was
classified as cost of sales relating to inventory. As of September 30, 2002,
there is approximately $4.2 million accrued relating to the restructuring.
Operating Income. Primarily as a result of the factors discussed above,
operating income increased $11.3 million or 56.8% in the year ended September
30, 2002 from $19.9 million in the year ended September 30, 2001. Operating
income as a percentage of net sales in the year ended September 30, 2002 was
10.9% as compared to 7.0% in the year ended September 30, 2001.
Interest Expense, Net. Interest expense, net in the year ended September 30,
2002 decreased 15.3% to $20.1 million from $23.7 million in the year ended
September 30, 2001. The decrease is attributed to lower weighted average
borrowings and lower interest rates during the year ended September 30, 2002 as
compared to the year ended September 30, 2001.
Income (Loss) Before Provision for (Benefit From) Income Taxes. Income before
provision for income taxes increased $14.9 million to $11.1 million in the year
ended September 30, 2002 compared to a loss of $3.8 million in the year ended
September 2001. Income before provision for income taxes excluding restructuring
charges increased $2.8 million to $10.5 million in the year ended September 30,
2002 compared to $7.6 million in the year ended September 30, 2001.
-21-
Provision for (Benefit From) Income Taxes. The provision for income taxes in the
year ended September 30, 2002 was $1.8 million compared to a benefit of $1.9
million in the year ended September 30, 2001. The Company's effective tax rate
was lower than the statutory rate due to a decrease in the valuation allowance.
The valuation allowance at September 30, 2002 and 2001 relates to the
uncertainty of realizing the tax benefits of reversing temporary differences and
net operating loss carryforwards.
Net Income (Loss). For the year ended September 30, 2002, the Company recorded
net income of $9.3 million as compared to a net loss of $1.9 million for the
year ended September 30, 2001.
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 is 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(R), 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
In recent years, inflation has been modest and has not had a material impact
upon the Company's revenues or results of operations.
Liquidity and Capital Resources
The Company's sources of funds have consisted primarily of operating cash flow
and debt financing. The Company's uses of those funds consist principally of
debt service, capital expenditures and acquisitions.
On August 18, 2003, the Company authorized the issuance and sale of $15.0
million aggregate principal of Holding Company Notes due July 15, 2005. The
proceeds of the Holding Company Notes were used along with $15.5 million from
the Revolver Credit Facility and $8.0 million cash to effect the Cabot Stock
Redemption.
The Company's debt structure includes: (a) $98.0 million of Senior Subordinated
Notes (Notes) due 2005, which are publicly held and are redeemable at the option
of the Company, in whole or in part, at various redemption prices, (b) $15.0
million of Holding Company Notes due 2005, and (c) up to an aggregate of $135.0
million under a credit agreement with various banks comprised of (i) a secured
term loan facility consisting of loans providing for up to $100.0 million of
term loans (collectively the "Term Loans") with a portion of the Term Loans
denominated in foreign currencies, (ii) the Revolving Credit Facility providing
for up to $30.0 million of revolving loans for general corporate purposes, and
(iii) a U.K. overdraft facility of up to an equivalent of $5.0 million in Great
Britain Pounds for working capital requirements as needed (collectively the
"Senior Bank Facilities"). The amount outstanding on the Term Loans and
Revolving Credit Facility at September 30, 2003, were approximately $85.1 and
$11.7 million, respectively. No amounts were outstanding under the U.K.
overdraft facility. At September 30, 2003, the Company's available lines of
credit totaled approximately $22.3 million.
Under the terms of the Senior Bank Facilities, the Note Indenture and the Note
Purchase Agreement for the Holding Company Notes, Aearo Company is required to
comply with certain financial covenants and restrictions. Aearo Company was in
compliance with all financial covenants and restrictions at September 30, 2003.
During the first quarter of fiscal 2002, the Company's Board of Directors
authorized management to repurchase, from time to time, a portion of the
Company's 12.5% Notes, subject to market conditions and other factors. No
assurances can be given as to whether or when or at what price such repurchases
will occur. Subsequently, pursuant to a first amendment to the Senior Bank
Facilities, the Company purchased and retired $2.0 million of the Notes during
the first quarter of fiscal 2002.
Maturities under the Company's Term Loans are: $17.4 million in fiscal 2004 and
$67.7 million in fiscal 2005. 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 additional
principal payments in respect of the Term Loans until maturity in 2005. The
Company is required to make interest payments with respect to the Senior Bank
Facilities, the Notes and the Holding Company Notes. The Company's Revolving
Credit Facility and Term Loans mature in March 2005.
-22-
The Company's net cash provided by operating activities for the year ended
September 30, 2003 totaled $36.7 million as compared to $26.6 million for the
year ended September 30, 2002. The increase of $10.1 million was primarily due
to a $4.7 million increase in net income adjusted for cash and non cash charges
(depreciation, amortization, deferred taxes and other) and a $5.4 million net
change in assets and liabilities. The Company's net changes in assets and
liabilities was primarily driven by an increase in cash from receivables, taxes,
and accrued liabilities, partially offset by a reduction of cash for inventories
and other, net.
The Company typically makes capital expenditures related primarily to the
maintenance and improvement of manufacturing facilities. The Company spent $9.9
million for capital expenditures, plus an additional $0.4 million under capital
leases, for the year ended September 30, 2003 as compared to $8.2 million for
capital expenditures for the year ended September 30, 2002 and $7.8 million for
the year ended September 30, 2001. The Company's capital spending cycle is of a
relatively short duration with a typical project completion time of less than
one year. The Company plans to spend up to $11.0 million for capital
expenditures in fiscal year 2004.
Net cash used by investing activities was $22.5 million for the year ended
September 30, 2003 as compared to $17.7 million for the year ended September 30,
2002. The increase of $4.7 million in net cash used by investing activities is
primarily attributed to the acquisitions of VH Industries, Inc. and Industrial
Protection Products, Inc.
Net cash used by financing activities for the year ended September 30, 2003 was
$25.0 million compared with $10.7 million for the year ended September 30, 2002.
The change of $13.9 million is primarily due to the Cabot Stock Redemption of
$38.5 million, which includes debt issuance costs of $4.0 million. In addition,
there was an increased use of cash of $4.6 million for the repayment of Term
Loans, partially offset by a lower repayment of Senior Subordinated Notes
compared to the prior year, additional borrowing under the Revolving Credit
Facility for $11.7 million and the issuance of the Holding Company Notes of
$15.0 million.
The Company maintains a non-contributory defined benefit cash balance pension
plan. The Company utilizes an outside actuarial firm to estimate pension expense
and funding based on various assumptions including the discount rate and the
expected long-term rate of return on plan assets. In developing the expected
long-term rate of return assumption, the Company's management evaluates input
from outside investment advisors and actuaries as of the measurement date.
Actual assets returns for the Company's pension plan improved in fiscal 2003
after two years of negative returns. Although recent trends have been positive,
the Company lowered the long-term rate of return on plan assets from 8.5% to
8.0% for the year ended September 30, 2003. The Company's management believes
that this rate is reasonable based on historical trends over a 20-30 year
period. The estimated effect of a 1% change in the expected long-term rate of
return on plan assets results in a $0.1 million impact on pension expense. The
discount rate has also been lowered from 6.75% to 6.00% for the fiscal year
ended September 30, 2003. The Company bases the discount rate on the AA
Corporate bond yields. The estimated impact of a 1% change in the discount rate
results in a $0.2 million impact on pension expense.
The variability of asset returns and discount rates may have either a favorable
or unfavorable impact on the Company's pension expense and the funded status of
the pension plan. Under minimum funding rules, no additional pension
contributions were required to be made in fiscal 2003. However, contributions
may increase in future years. Due to the uncertainty of the future returns of
the equity and corporate bond markets, it is difficult to estimate the impact of
pension contributions in the future.
The Company has a substantial amount of indebtedness. The Company relies on
internally generated funds, and to the extent necessary, on borrowings under the
Revolving Credit Facility (subject to certain customary drawing conditions) to
meet its liquidity needs. The Company anticipates that operating cash flow will
be adequate to meet its operating 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 particular, during fiscal 2001 and 2002, the Company was affected by the
significant slowdown in the manufacturing sector of the economies in which the
Company markets its products that began in earnest during the first fiscal
quarter of fiscal 2001, exacerbated by the impact of the terrorist events of
September 11, 2001. The Company expects to arrange for new financing of both the
Senior Bank Facilities and the Notes before the maturity of the Senior Bank
Facilities in March 2005. There can be no assurances that any additional
financing or other sources of capital will be available to the Company at
acceptable terms, or at all. The inability to obtain additional financing would
have a material adverse effect on the Company's business, financial condition
and results of operations.
-23-
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements or financing arrangements
involving variable interest entities.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to market risks related to changes in foreign currencies,
interest rates and commodity pricing. The Company uses derivatives to mitigate
the impact of changes in foreign currencies and interest rates. All derivatives
are for purposes other than trading. The Company adopted the provisions of 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 risks associated with
operating in foreign countries, including fluctuations in currency exchange
rates. While many of the Company's selling and distribution costs are
denominated in Canadian and European currencies, a large portion of product
costs are U.S. Dollar denominated. As a result, a decline in the value of the
U.S. Dollar relative to other currencies can have a favorable impact on the
profitability of the Company and an increase in the value of the U.S. Dollar
relative to these other currencies can have a negative effect on the
profitability of the Company. 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.
To mitigate the effects of changes in foreign currency rates on profitability
the Company executes two hedging programs, one for transaction exposures, and
the other for cash flow exposures in foreign operations. The Company utilizes
forward foreign currency contracts for transaction as well as cash flow
exposures. For the year ended September 30, 2003, 2002 and 2001, transaction
exposures were a gain of $0.3 million and losses of $0.2 million and $0.4
million, respectively. For the year ended September 30, 2003, 2002 and 2001,
cash flow exposures were losses of $2.0 million, $0.6 million and $0.2 million,
respectively. In addition, the Company limits the foreign exchange impact on the
balance sheet with foreign denominated debt in Great Britain Pound Sterling,
Euros, Swedish Krona and Canadian dollars.
SFAS No. 133 requires that every derivative instrument be recorded in the
balance sheet as either an asset or liability measured at its fair value. As a
result of foreign currency contracts the Company has recorded a derivative
payable of $0.4 million as of September 30, 2003. The forward foreign currency
contracts will expire over the next twelve months.
Interest Rates
The Company is exposed to market risk changes in interest rates through its
debt. The Company utilizes interest rate instruments to reduce the impact of
either increases or decreases in interest rates on its floating rate debt.
As a result of the current economic slowdown and corresponding interest rate
reductions, the Company entered into an interest rate collar arrangement in
October 2001 to protect $25.0 million of the outstanding variable rate term loan
debt from future interest rate volatility through September 30, 2003. The collar
floor was set at 2% LIBOR (London Interbank Offering Rate) and cap at 6.25%
LIBOR. The collar was not designated as a hedge under SFAS No. 133 and
accordingly, the fair value gains or losses were charged to earnings.
Approximately $0.2 million was expensed during the fiscal year ended September
30, 2003. No amounts were recorded to income or expense related to the interest
collar for the years ended September 30, 2001 and 2002, respectively.
As part of the August 2003 financing incurred to redeem the common and preferred
Aearo stock owned by Cabot, the Company entered into an interest rate cap
arrangement to protect its $30.5 million of variable debt from LIBOR rates above
1.13% through December 31, 2004. The cap was not designed as a hedge under SFAS
No. 133 and accordingly, the fair value of gains or losses will be charged to
earnings. Approximately $0.1 million was recorded as income as of September 30,
2003.
-24-
The Company is of the opinion that it is well positioned to manage interest
exposures in the short term. The Company continues to monitor interest rate
movements and has mitigated the risks of potential interest rate fluctuations
through the use of the aforementioned interest rate instruments.
Commodity Risk
The Company is subject to market risks with respect to industry pricing in paper
and crude oil as it relates to various commodity items. The Company is also
exposed to market risks for electricity, fuel oil and natural gas consumed in
its operations. Items with potential risk of price volatility are paperboard,
packaging films, nylons, resins, propylene, ethylene, plasticizer and freight.
The Company manages pricing exposures on larger volume commodities such as
polycarbonate, polyols and polyvinyl chloride via price negotiations utilizing
alternative supplier competitive pricing. The Company sources some products and
parts from Far East sources where resource availability, competition, and
infrastructure stability has provided a favorable purchasing environment. The
Company does not enter into derivative instruments to manage commodity risks.
-25-
Item 8. Financial Statements and Supplementary Data
Index to Financial Statements
INDEPENDENT AUDITORS' REPORT.................................................27
CONSOLIDATED BALANCE SHEETS..................................................28
CONSOLIDATED STATEMENTS OF OPERATIONS........................................29
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY..............................30
CONSOLIDATED STATEMENTS OF CASH FLOWS........................................31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS...................................32
-26-
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Aearo Corporation:
We have audited the accompanying consolidated balance sheets of Aearo
Corporation and subsidiaries as of September 30, 2003 and 2002, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended September 30, 2003. Our audits also
included the financial statement schedules listed in the Index at Item 15. These
financial statements and financial statement schedules are the responsibility of
the Corporation's management. Our responsibility is to express an opinion on the
financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Aearo Corporation and subsidiaries
as of September 30, 2003 and 2002, and the results of their operations and their
cash flows for each of the three years in the period ended September 30, 2003,
in conformity with accounting principles generally accepted in the United States
of America. Also, in our opinion, such financial statement schedules, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects the information set forth
therein.
As discussed in Note 2 to the consolidated financial statements, in 2003, the
Corporation changed its method of accounting for goodwill and other intangible
assets.
DELOITTE & TOUCHE LLP
Indianapolis, Indiana
December 12, 2003
-27-
AEARO CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands, Except Share Amounts)
September 30, September 30,
2002 2003
------------- --------------
ASSETS
Current Assets:
Cash and cash equivalents $ 14,480 $ 7,301
Accounts receivable
(net of reserve for doubtful accounts
of $1,524 and $1,358, respectively) 46,478 49,146
Inventories 33,161 37,269
Deferred and prepaid expenses 3,449 7,321
------------- --------------
Total current assets 97,568 101,037
------------- --------------
Long Term Assets:
Property, plant and equipment, net 48,096 48,869
Goodwill, net 67,821 81,770
Other intangible assets, net 54,158 57,887
Other assets 2,526 3,953
------------- -------------
Total Assets $ 270,169 $ 293,516
============= =============
LIABILITIES
Current Liabilities:
Current portion of long-term debt $ 12,847 $ 17,767
Accounts payable and accrued liabilities 36,410 44,043
Accrued interest 2,568 2,736
U.S. and foreign income taxes 1,156 1,885
------------- -------------
Total current liabilities 52,981 66,431
------------- -------------
Long-term debt 182,715 195,786
Deferred income taxes 800 1,609
Other liabilities 12,129 11,334
------------- -------------
Total Liabilities 248,625 275,160
------------- -------------
COMMITMENTS AND CONTINGENCIES
Preferred stock, $.01 par value-
(Redemption value of $109,480 and $61,910,
respectively)
Authorized - 200,000 shares
Issued and outstanding - 45,000 and 22,500, - -
respectively)
Stockholders' Equity:
Common stock $.01 par value-
Authorized -- 200,000 shares
Issued and outstanding -- 101,913 and 1 1
59,413, respectively
Additional paid-in-capital 33,614 -
Stock subscription receivables (1,360) (1,399)
Retained earnings 6,825 26,541
Accumulated other comprehensive loss (17,536) (6,787)
------------- -------------
Total Stockholders' Equity 21,544 18,356
------------- -------------
Total Liabilities and Stockholders' Equity $ 270,169 $ 293,516
============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
-28-
AEARO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands)
Years Ended September 30,
2001 2002 2003
----------- ----------- -----------
Net sales $ 283,862 $ 286,867 $ 316,428
Cost of sales 152,849 150,897 164,289
Restructuring charges (income) 2,364 (500) (270)
----------- ----------- -----------
Gross profit 128,649 136,470 152,409
Selling and administrative 87,286 91,903 101,257
Research and technical services 5,162 5,740 6,402
Amortization expense 6,530 6,293 267
Other charges (income), net 680 1,475 1,737
Restructuring charges (income) 9,077 (100) -
----------- ----------- -----------
Operating income 19,914 31,159 42,746
Interest income (203) (211) (146)
Interest expense 23,869 20,266 19,733
----------- ----------- -----------
Income (loss) before provision (3,752) 11,104 23,159
for (benefit from) income taxes
Provision for (benefit from) (1,872) 1,785 2,551
income taxes
----------- ----------- -----------
Net income (loss) $ (1,880) $ 9,319 $ 20,608
=========== =========== ===========
-29-
AEARO CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in Thousands)
Additional Accumulated
Paid Stock Retained Other Comprehensive
Preferred Common In Subscriptions Earnings Comprehensive Income
Shares Shares Amount Capital Receivables (Deficit) Loss Total (Loss)
-------- ------- -------- ---------- ----------- ---------- ------------- ------- ------------
Balance, October 1, 2000 45,000 102,088 $ 1 $ 33,709 $ (1,496) $ (614) $ (15,751) $ 15,849
Repayment of shareholder notes - - - - 161 - - 161
Foreign currency translation
adjustment - - - - - - (4,252) (4,252) $ (4,252)
Unrealized loss on derivative
instruments - - - - - - (22) (22) (22)
Net income - - - - - (1,880) - (1,880) (1,880)
-------------
Comprehensive loss - - - - - - $ (6,154)
------- ------- -------- ---------- ----------- ---------- ------------- -------- =============
Balance, September 30, 2001 45,000 102,088 1 33,709 (1,335) (2,494) (20,025) 9,856
Accrued interest on shareholder
notes - - - - (25) - - (25)
Redemption of common stock, net - (175) - (95) - - - (95)
Foreign currency translation
adjustment - - - - - - 4,758 4,758 $ 4,758
Unrealized gain on derivative
instruments - - - - - - 22 22 22
Net minimum pension liability
adjustment - - - - - - (2,291) (2,291) (2,291)
Net income - - - - - 9,319 - 9,319 9,319
-------------
Comprehensive loss - - - - - - - - $ 11,808
------- ------- -------- ---------- ----------- ---------- ------------ ---------- =============
Balance, September 30, 2002 45,000 101,913 1 33,614 (1,360) 6,825 (17,536) 21,544
Redemption of stock (22,500) (42,500) - (33,614) - (892) - (34,506)
Accrued interest on shareholder
notes - - - - (39) - - (39)
Unrealized loss on derivative
instruments - - - - - - (390) (390) $ (390)
Foreign currency translation
adjustment - - - - - - 9,079 9,079 9,079
Net minimum pension liability
adjustment - - - - - - 2,060 2,060 2,060
Net income - - - - - 20,608 - 20,608 20,608
-------------
Comprehensive income - - - - - - - - $ 31,357
=============
------- ------- -------- ---------- ----------- ---------- ------------ ----------
Balance, September 30, 2003 22,500 59,413 $ 1 $ - $ (1,399) $ 26,541 $ (6,787) $ 18,356
======= ======= ======== ========== =========== ========== ============ ==========
-30-
AEARO CORPORATION AND SUBSIDIRARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
Years Ended September 30,
2001 2002 2003
----------- ----------- -----------
Cash Flows from Operating Activities:
Net income (loss) $ (1,880) $ 9,319 $ 20,608
Adjustments to reconcile net income (loss) to cash provided by operating
activities --
Depreciation 10,123 10,958 11,102
Amortization 8,715 7,848 1,775
Deferred income taxes (101) 401 (986)
Provision for restructuring charges 11,441 (600) (270)
Other non-cash items, net (2,993) 526 356
Changes in assets and liabilities, net of effects of acquisitions--
Accounts receivable, net 1,210 (25) 1,067
Inventories 1,758 (5) (443)
Accounts payable and accrued liabilities (5,394) (1,983) 4,620
Income taxes, net (2,957) (1,441) 805
Other 1,616 1,553 (1,934)
----------- ----------- -----------
Net cash provided by operating activities 21,538 26,551 36,700
----------- ----------- -----------
Cash Flows from Investing Activities:
Cash paid for acquisitions, net of cash acquired - (9,515) (12,600)
Additions to property, plant and equipment (7,799) (8,232) (9,886)
Proceeds provided by disposals of property, plant and equipment 38 13 28
----------- ----------- -----------
Net cash used by investing activities (7,761) (17,734) (22,458)
----------- ----------- -----------
Cash Flows from Financing Activities:
Issuance of shareholder notes 161 - -
Redemption of common and preferred stock - (95) (34,506)
Debt issuance costs - - (3,990)
(Repayment of) issuance of senior subordinated notes - (2,000) 15,000
(Repayment of) proceeds from revolving credit facility, net (10,000) - 11,650
(Repayment of) proceeds from of term loans 11,700 (8,178) (12,826)
Repayment on capital lease obligations - (143) (224)
Repayment of other long-term debt (222) (215) (107)
----------- ----------- -----------
Net cash (used in) provided by financing activities 1,639 (10,631) (25,003)
----------- ----------- -----------
Effect of Exchange Rate Changes on Cash (678) (1,939) 3,582
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 14,738 (3,753) (7,179)
Cash and cash equivalents, beginning of year 3,495 18,233 14,480
----------- ----------- -----------
Cash and cash equivalents, end of year $ 18,233 $ 14,480 $ 7,301
=========== =========== ===========
Non Cash Investing and Financing Activities:
Capital Lease Obligations $ - $ 1,421 $ 430
=========== =========== ===========
Cash Paid for:
Interest $ 22,023 $ 18,697 $ 18,096
Income Taxes $ 1,983 $ 2,649 $ 1,444
=========== =========== ===========
-31-
AEARO CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
Aearo Corporation, a Delaware corporation ("Aearo"), and its direct wholly owned
subsidiary, Aearo Company I, doing business as Aearo Company, a Delaware
corporation (the "Subsidiary") (collectively referred to herein as the Company)
manufactures and sells products through three reportable segments. The Company's
segments 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 under the brand names:
AOSafety(R), E-A-R(R), and Peltor(R). 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 and shapes the lenses to the customer's prescription, and then assembles
the glasses using the customer's choice of frame. The Specialty Composites
segment manufactures and sells a wide array of energy-absorbing materials that
are incorporated into other manufacturers' products to control noise, vibration
and shock.
Aearo Corporation was formed by Vestar Equity Partners, L.P. ("Vestar") and
Cabot Corporation ("Cabot") in June 1995 to effect the acquisition of
substantially all of the assets and liabilities of Cabot Safety Corporation and
certain affiliates, all of which were wholly owned by Cabot, (the "Formation
Acquisition"). Separate financial statements of Aearo Company are not presented
because they do not provide any additional information from what is presented in
the consolidated financial statements of Aearo Corporation that would be
meaningful to the holders of the senior subordinated notes (the Senior
Subordinated Notes) (see Note 7).
2. Significant Accounting Policies
The accompanying consolidated financial statements have been prepared in
conformity with accounting principles generally accepted in the United States of
America. All significant intercompany balances and transactions have been
eliminated in consolidation. The significant accounting policies of the Company
are described below.
Use of Estimates
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the consolidated 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 year's consolidated financial statements
have been reclassified to conform to the current year presentation. The
reclassifications have no impact on stockholders' equity or net income (loss)
previously reported.
Revenue Recognition
The Company recognizes revenue when title and risk transfer to the customer,
which is generally when the product is shipped to customers. At the time revenue
is recognized, certain provisions may also be recorded including pricing
discounts and incentives. In addition, an allowance for doubtful accounts is
generally recorded based on a percentage of aged receivables. However,
management judgment is involved with the final determination of the allowance
based on several factors including specific analysis of a customers credit
worthiness, historical bad debt experience, changes in payment history and
general economic and market trends.
Advertising
The Company expenses the costs of advertising as incurred. These expenses were
approximately $5.9 million, $6.1 million, and $7.3 million for the years ended
September 30, 2001, 2002 and 2003, respectively.
-32-
Cash Equivalents
The Company considers all time deposits and short-term investments with an
original maturity of three months or less to be cash equivalents.
Foreign Currency Translation and Transactions
Foreign Currency Translation:
Assets and liabilities of the Company's foreign subsidiaries are translated at
the exchange rate as of the end of the year. Income and expenses are translated
at the approximate average exchange rates during the year. Foreign currency
translation adjustments are recorded as a separate component of stockholders'
equity.
Foreign Currency Transactions:
Foreign currency gains and losses arising from transactions by any of the
Company's subsidiaries are reflected in net income (loss). For the years ended
September 30, 2001, 2002 and 2003 the accompanying consolidated statements of
operations include approximately $0.4 million, $0.2 million, and ($0.3) million,
respectively, of transaction (gains)/losses included in other (income) charges,
net.
To mitigate the effects of changes in foreign currency rates on profitability
related to trade accounts receivable and trade accounts payable denominated in
foreign currencies, the Company enters into forward foreign currency contracts.
Gains and losses related to contracts designated as hedges of trade accounts
receivable and trade accounts payable denominated in foreign currencies are
accrued as exchange rates change and are recognized in the accompanying
consolidated statements of operations as transaction (gains) and losses and
included in other (income) charges, net. As of September 30, 2003, relative to
these exposures, the Company had forward foreign currency contracts open in the
following amounts:
Currency Amount (000s) Contract Position
-------- ------------- -----------------
British Pound 3,981 Buy
Canadian Dollar 1,625 Sell
Norwegian Krona 2,862 Sell
Swedish Krona 158,780 Buy
Swiss Franc 80 Sell
Euro 9,521 Sell
Danish Krona 2,412 Sell
As of September 30, 2003, the Company has recorded an unrealized gain of $1.0
million associated with the above forward foreign currency contract commitments.
In addition, the Company enters into forward foreign currency contracts to hedge
a portion of anticipated sales denominated in Great Britain Pound Sterling,
Euro, and Canadian Dollar to mitigate the impact of the effects of changes in
foreign currency rates on profitability related to cash flows from foreign
operations. Gains and losses on these hedge contracts are deferred and
recognized as an adjustment to the other charges (income), net. For the year
ended September 30, 2002 and 2003, the consolidated statement of operations
includes approximately $0.6 million and $2.0 million, respectively, of losses
related to these instruments.
The Company has entered into Canadian dollar hedges as of September 30, 2003.
The US dollar equivalent notional amount of outstanding Canadian dollar forward
foreign currency contracts is approximately $14.2 million at September 30, 2003.
Deferred losses related to hedge of future Canadian sales transactions were
approximately $0.4 million at September 30, 2003. Contracts will mature at
various dates through September 30, 2004. The Company does not enter into
forward foreign contracts for trading purposes.
Inventories
Inventories are stated at the lower of cost or market, cost being determined
using the first-in, first-out (FIFO) method.
-33-
Property, Plant and Equipment
Property, plant and equipment is recorded at cost. Depreciation of property,
plant and equipment is calculated using the straight-line method based on
estimated economic useful lives. Expenditures for maintenance and repairs and
minor renewals are charged to expense. Expenses for maintenance and repairs
totaled approximately $2.4 million, $2.6 million and $2.4 million for the years
ended September 30, 2001, 2002 and 2003, respectively.
Property, plant, equipment, and the related estimated useful lives are as
follows:
Asset Classification Estimated Useful Life
Buildings 25-40 years
Leasehold improvements Life of the lease or useful life, whichever is shorter
Machinery and equipment 3-10 years
Furniture and fixtures 3-10 years
Upon the sale or retirement of assets, the cost and related accumulated
depreciation are removed from the consolidated financial statements, and any
resultant gain or loss is recognized.
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
currently enacted tax rates.
Goodwill and Intangible Assets
Effective October 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangibles". Under the
provisions of SFAS No. 142, goodwill and intangible assets that have indefinite
useful lives are no longer amortized but are tested at least annually for
impairment. The Company performed its first annual impairment test as of January
1, 2003 and determined there was no impairment. Intangible assets that have
finite useful lives will continue to be amortized over their useful lives. The
following presents a summary of the changes in goodwill and intangible assets as
of September 30, 2003 (dollars in thousands):
Goodwill Trademarks Other Total
----------- ------------ ----------- ------------
Balance October 1, 2001 $ 61,323 $ 55,678 $ 1,199 $ 118,200
Additions 394 394
Acquisitions 5,534 5,534
Translation adjustment 4,143 4,143
Amortization (3,179) (2,965) (148) (6,292)
----------- ------------ ----------- ------------
Balance September 30, 2002 $ 67,821 $ 52,713 $ 1,445 $ 121,979
Additions 46 46
Acquisitions 6,808 1,600 2,350 10,758
Translation adjustment 7,141 7,141
Amortization (267) (267)
----------- ------------ ----------- ------------
Balance September 30, 2003 $ 81,770 $ 54,313 $ 3,574 $ 139,657
----------- ------------ ----------- ------------
-34-
As a result of the non-amortization provisions of SFAS No. 142, the Company will
no longer record approximately $6.1 million of annual amortization relating to
goodwill and indefinite lived intangibles. The following presents amortization
expense and proforma net income for the years ended September 30, 2001, 2002 and
2003, respectively, as if SFAS No. 142 had been adopted (dollars in thousands):
September 30,
------------------------------------------
2001 2002 2003
-------------- ------------- -------------
Net income (loss) as reported $ (1,880) $ 9,319 $ 20,608
Goodwill amortization 2,965 2,965 --
Trademark amortization 3,212 3,179 --
-------------- ------------- -------------
Adjusted net income $ 4,297 $ 15,463 $ 20,608
============== ============= =============
Impairment
The Company accounts for long-lived and certain intangible assets in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of". The Company continually reviews its long-lived assets and finite-lived
intangible assets for events or changes in circumstances that might indicate the
carrying amount of the assets may not be recoverable. The Company assesses the
recoverability of the assets by determining whether the amortization of such
assets over their remaining lives can be recovered through projected
undiscounted future cash flows. The amount of impairment, if any, is measured
based on projected discounted future cash flows using a discount rate reflecting
the Company's average cost of funds. During the year ended September 30, 2001,
the Company identified certain manufacturing assets in the Newark, Delaware
facility that were determined by the Company to be impaired. As a result, the
Company wrote off approximately $2.9 million related to those assets (see Note
16) as part of its restructuring plan. During the years ended September 30, 2002
and 2003, as a result of normal product/equipment obsolescence and productivity
or capacity enhancement projects, the Company wrote off approximately $0.5
million and $0.3 million of manufacturing assets, respectively.
Deferred Financing Costs
Deferred financing costs are stated at cost as a component of other assets and
amortized over the life of the related debt. Amortization of deferred financing
costs is included in interest expense and aggregated $2.0 million, $1.3 million
and $1.4 million for the years ended September 30, 2001, 2002 and 2003,
respectively.
Fair Value of Financial Instruments
In accordance with the requirements of SFAS No. 107, "Disclosures about Fair
Value of Financial Instruments", the Company has determined the estimated fair
value of its financial instruments using appropriate market information and
valuation methodologies. Considerable judgment is required to develop the
estimates of fair value; thus, the estimates are not necessarily indicative of
the amounts that could be realized in a current market exchange. The Company's
financial instruments consist of cash and cash equivalents, accounts receivable,
accounts payable, Senior Subordinated Notes, Holding Company Notes, bank debt
(including Term Loans, the Revolving Credit Facility and other debt) and
interest rate instruments. The carrying value of these assets and liabilities is
a reasonable estimate of their fair market value at September 30, 2003.
The Company has approximately $30.5 million of variable rate debt protected
under an interest rate cap arrangement through December 31, 2004. The fair value
of the cap at September 30, 2003 was $0.1 million. The Company has not elected
to take hedge accounting treatment for the interest rate collar as defined under
SFAS No. 133 and, as a result, any fair value adjustment is charge directly to
other income/(expense).
The Company also uses financial instruments in the form of forward foreign
currency contracts. Current market prices were used to estimate the fair value
of the forward foreign currency contracts.
The future value of the forward foreign currency contracts and the related
currency positions are subject to offsetting market risk resulting from foreign
currency exchange rate volatility. The counter-parties to these contracts are
-35-
substantial and creditworthy financial institutions. Neither the risks of
counter-party non-performance nor the economic consequences of counter-party
non-performance associated with these contracts are considered by the Company to
be material.
Accounting for Stock-based Compensation
SFAS No. 123 "Accounting for Stock-Based Compensation" addresses accounting and
reporting requirements for stock options and other equity instruments issued or
granted based on their fair market values. The Company intends to continue
accounting for its stock-based compensation plans for employees in accordance
with Accounting Principals Board ("APB") No. 25, "Accounting for Stock Issued to
Employees". Under SFAS No. 123, companies choosing to continue to use APB No. 25
to account for stock-based compensation plans for employees must make footnote
disclosure of the pro forma effects on earnings per share, had the principles
contained within SFAS No. 123 been applied. The following table illustrates the
effect on net income as if the fair value method had been applied to all
outstanding and unvested option awards:
2001 2002 2003
---------- ---------- ----------
Net income (loss) as reported $ (1,880) $ 9,319 $ 20,608
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of tax (94) (188) (147)
---------- ---------- ----------
Adjusted net income (loss) $ (1,974) $ 9,131 $ 20,461
========== ========== ==========
The fair value of each option grant was estimated on the grant date using the
Black-Scholes pricing model with the following weighted average assumptions:
2001 2002 2003
---------- ---------- ----------
Risk-free interest rate 5.22% 4.52% 4.71%
Expected life of options granted 10 years 10 years 10 years
Expected volatility of underlying stock 0% 0% 0%
Dividend yield 0% 0% 0%
Shipping and Handling Fees and Costs
Shipping and handling costs include payments to third parties for the delivery
of products to customers, as well as internal salaries and overhead costs
incurred to store, move and prepare finished products for shipment. Shipping and
handling costs are included with selling and administrative expenses in the
accompanying consolidated statement of operations and totaled $17.1 million,
$17.2 million and $18.3 million in fiscal 2001, 2002 and 2003, respectively. The
Company recovers a portion of its shipping and handling costs from its customers
and records this recovery in net sales.
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 forward foreign currency contracts to
mitigate the effects of changes in foreign currency rates on profitability and
enters into interest rate swap agreements to hedge its variable interest rate
risk. These derivatives are cash flow hedges. For all qualifying and highly
effective cash flow hedges, the changes in the fair value of the derivatives are
recorded in other comprehensive income (loss). Amounts accumulated in other
comprehensive income (loss) will be reclassified as earnings when the related
-36-
product sales affect earnings for forward foreign currency contracts or when
related interest payments affect earnings for interest rate swaps. There were no
forward foreign currency contracts or interest rate derivatives at September 30,
2002 as defined under SFAS No. 133. For the year ended September 30, 2003, 2002
and 2001, the Company reclassified into earnings net losses of $2.0 million,
$0.6 million and $0.2 million, respectively, resulting from the exercise of
forward foreign currency contracts for cash flow hedges. All forward foreign
currency contracts were determined to be highly effective whereby no
ineffectiveness was recorded in earnings.
The Company entered into an interest rate collar arrangement in October 2001 to
protect $25.0 million of the outstanding variable rate term loan debt from
future interest rate volatility through September 30, 2003. The collar floor was
set at 2% LIBOR (London Interbank Offering Rate) and cap at 6.25% LIBOR. The
collar was not designated as a hedge under SFAS No. 133 and accordingly, the
fair value gains or losses were charged to earnings. Approximately $0.2 million
was expensed during the fiscal year ended September 30, 2003. No amounts were
recorded to income or expense related to the interest collar for the years ended
September 30, 2001 and 2002, respectively.
The Company has approximately $30.5 million of variable rate debt protected
under an interest rate cap arrangement through December 31, 2004. The fair value
of the cap at September 30, 2003 was $0.1 million. The Company has not elected
to take hedge accounting treatment for the interest rate collar as defined under
SFAS No. 133 and, as a result, any fair value adjustment is charge directly to
other income/(expense). Approximately $0.1 million was recorded as income during
the fiscal year ended September 30, 2003.
The Company also executes forward foreign currency contracts for up to 30 day
terms to protect against the adverse effects that exchange rate fluctuations may
have on the foreign-currency-denominated trade activities (receivables, payables
and cash) of foreign subsidiaries. These contracts have not been designated as
hedges under SFAS No. 133 and accordingly, the gains and losses on both the
derivative and foreign-currency-denominated trade activities are recorded as
transaction adjustments in current earnings. For the year ended September 30,
2003, 2002 and 2001, the impact on earnings for trade activities were a net gain
of $0.3 million, and net losses of $0.2 million and $0.4 million, respectively.
New Accounting Pronouncements
Effective October 1, 2002, the Company adopted SFAS No. 143, "Accounting for
Asset Retirement Obligations". SFAS No. 143 requires the Company to record the
fair value of liabilities associated with the retirement of long-lived assets in
the period in which they are incurred. The adoption of SFAS No. 143 had no
material impact on the Company's results of operations or financial position.
Effective October 1, 2002, the Company adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", which supercedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of", and APB No. 30, "Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions". SFAS No. 144 retains the
fundamental provisions with respect to the recognition and measurement of
long-lived asset impairments but does not apply to goodwill and other intangible
assets. The adoption of SFAS No. 144 had no material impact on the Company's
results of operations or financial position.
Effective October 1, 2002, the Company adopted SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". This statement rescinds SFAS No. 4, "Reporting Gains and Losses
from Extinguishment of Debt", and an amendment of that Statement, SFAS No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements". This
Statement also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor
Carriers". This Statement amends SFAS No. 13, "Accounting for Leases", to
eliminate the inconsistency between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that
have economic effects that are similar to sale-leaseback transactions. The
adoption of SFAS No. 145 had no material impact on the Company's results of
operations or financial position.
Effective October 1, 2002, the Company adopted SFAS No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities". SFAS No. 146 requires that a
liability for costs associated with exit or disposal activities be recognized
and measured at fair value only when the liability is incurred. SFAS No. 146 is
effective for exit or disposal activities that are initiated after December 31,
2002. The adoption of SFAS No. 146 did not material impact on the Company's
results of operations or financial position.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123". SFAS No 148 provides alternative methods of transition for a voluntary
-37-
change to the fair value based method of accounting for stock based employee
compensation. In addition, this statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock based employee
compensation and the effect of the method used on reported results. As permitted
under SFAS No. 148, the Company adopted the disclosure only provisions of SFAS
No. 148 in the 2nd quarter of fiscal 2003.
In April 2003, the FASB issued Statement of Financial Accounting Standards No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." This Statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives) and for
hedging activities under FASB Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement is effective for contracts
entered into or modified after June 30, 2003, and for hedging relationships
designated after June 30, 2003. In addition, generally all provisions of this
statement should be applied prospectively. The adoption of this statement did
not have a material effect on the Company's financial position, results of
operations and its cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150
establishes standards for how an issuer classifies and measures three classes of
freestanding financial instruments with characteristics of both liabilities and
equity. It requires that an issuer classify a financial instrument that is
within its scope as a liability or an asset in some circumstances. SFAS No. 150
is effective for mandatorily redeemable financial instruments of non-public
entities for the first fiscal period beginning after December 15, 2003, and for
all other instruments for interim periods beginning after June 15, 2003. The
Company has not entered into any financial instruments within the scope of SFAS
No. 150 since June 15, 2003 and does not hold any significant financial
instruments within its scope.
In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". FIN No. 45 expands upon the
disclosure requirements to be made by a guarantor in its interim and annual
financial statements regarding its obligations under certain guarantees that it
has issued. Additionally, FIN No. 45 requires that the guarantor recognize, at
the inception of a guarantee, a liability for the fair value of the obligation
undertaken in issuing the guarantee. Footnote disclosures are required in
interim and year-end financial statements ending after December 15, 2002.
Liability recognition and measurement provisions apply prospectively to
guarantees issued or modified starting January 1, 2003. The adoption of FIN No.
45 had no effect on the Company's results of operations or financial position.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities, an Amendment of ARB No. 51". FIN No. 46 addresses consolidation of
business enterprises of certain variable interest entities, and is effective for
variable interest entities created after January 31, 2003 and to variable
interest entities in which an enterprise obtains an interest after that date.
The adoption of FIN No. 46 had no effect on the Company's results of operations
or financial position.
-38-
3. Inventories
Inventories consisted of the following at September 30 (dollars in thousands):
2002 2003
-------------- -----------------
Raw materials $ 7,514 $ 8,301
Work in process 10,196 11,976
Finished goods 15,451 16,992
-------------- -----------------
$ 33,161 $ 37,269
============== =================
4. Property, Plant and Equipment
Property, plant and equipment consisted of the following at September 30
(dollars in thousands):
2002 2003
----------- -----------
Land $ 2,589 $ 2,658
Building and improvements 20,774 23,391
Machinery and equipment 59,687 65,770
Furniture and fixtures 23,486 25,797
Construction in progress 4,670 5,276
----------- -----------
111,206 122,892
Less - accumulated depreciation 63,110 74,023
----------- -----------
$ 48,096 $ 48,869
=========== ===========
5. Intangible Assets
Intangible assets consisted of the following at September 30 (dollars in
thousands):
2002 2003
------------- --------------
Goodwill $ 93,804 $ 114,144
Trademarks and trade names 74,122 74,122
Patents 1,916 2,078
Non-compete agreement 701 1,335
Other 215 215
------------- --------------
$ 170,758 $ 191,894
Less - accumulated amortization 48,779 52,237
------------- --------------
$ 121,979 $ 139,657
------------- --------------
The weighted average life of patents is 17 years. The Company expects
amortization expense to be approximately $0.3 million for each of the next five
years.
-39-
6. Accounts Payable and Accrued Liabilities
Accounts payable and accrued liabilities consisted of the following at September
30 (dollars in thousands):
2002 2003
----------- -----------
Accounts payable - trade $ 15,733 $ 21,205
Accrued liabilities --
Employee compensation and benefits (Note 8) 12,269 11,785
Restructuring reserve 3,497 2,405
Other 4,911 8,648
----------- -----------
$ 36,410 $ 44,043
=========== ===========
7. Debt
The long-term debt consisted of the following at September 30 (dollars in
thousands):
2002 2003
---------- ----------
Term loans, due 2003 $ 12,529 $ --
Term loans, due 2004 16,706 17,357
Term loans, due 2005 64,641 79,349
Senior subordinated notes, due 2005, 12.5% 98,000 98,000
Holding Company subordinated notes, due 2005 - 15,000
Mortgage note, due 1998 - 2006, 10.1% 2,165 2,087
Other 1,521 1,760
---------- ----------
195,562 213,553
Less-- Current portion of long-term debt 12,847 17,767
---------- ----------
Total $ 182,715 $ 195,786
========== ==========
Senior Bank Facilities
The Company's debt structure includes up to an aggregate of $135.0 million under
its Credit Agreement with various banks comprised of (i) a secured term loan
facility consisting of loans providing for up to $100.0 million of term loans
(collectively the "Term Loans") with a portion of the Term Loans denominated in
foreign currencies, (ii) a secured revolving credit facility ("Revolving Credit
Facility") providing for up to $30.0 million of revolving loans for general
corporate purposes, and (iii) a U.K. overdraft facility of up to an equivalent
of $5.0 million in Great Britain Pounds for working capital requirements as
needed (collectively, the "Senior Bank Facilities"). The amounts outstanding on
the Term Loans and Revolving Credit Facility at September 30, 2003, were
approximately $85.1 and $11.7 million, respectively. No amounts were outstanding
under the U.K. overdraft facility. The Revolving Credit Facility provides for
the issuance of letters of credit in an aggregate face amount of up to $10.0
million. The Term Loans amortize quarterly over a four-year period. Amounts
repaid or prepaid in respect of the Term Loans may not be re-borrowed. Loans and
letters of credit under the Revolving Credit Facility will be available until
the Revolving Loan Maturity Date, which is March 31, 2005.
At the Company's option, the interest rates per annum applicable to the Senior
Bank Facilities are either (a) an adjusted rate based on the London Interbank
Offered Rate ("LIBOR") plus a margin of 3.25% in the case of Term Loans and
2.75% for revolving loans or (b) the Base Rate, as defined, plus a margin of
2.25% in the case of Term Loans and 1.75% for revolving loans. The Base Rate is
the higher of Bankers Trust Company's announced prime lending rate or the
-40-
Overnight Federal Funds rate plus 0.50%. The Company must pay certain fees in
connection with the Senior Bank Facilities, including a commitment fee ranging
from 0.375% to 0.50% on the undrawn portion of the commitments in respect of the
Revolving Credit Facility based upon the Company's leverage ratio, and a 0.25%
facing fee relating to the issuance of letters of credit.
The Company is entitled to an Interest Reduction Discount of .25% when the
Company achieves a leverage ratio of less then 3.50. The discount would apply to
all Term Loans and the Revolving Credit Facility.
Under the terms of the Senior Bank Facilities, the Company is required to comply
with a number of affirmative and negative covenants. Among other restrictions,
Aearo Company must satisfy certain financial covenants and ratios, including
interest coverage ratios, leverage ratios, fixed charge coverage ratios and
limits on the amount of permitted capital acquisitions. The Senior Bank
Facilities also impose limitations on certain business activities of the
Company. The Senior Bank Facilities restrict, among other things, the incurrence
of additional indebtedness, creation of certain liens, the payment of dividends
on the Company's Common Stock, sales of certain assets and limitations on
transactions with affiliates. As of September 30, 2003, Aearo Company was in
compliance with the covenants of the Senior Bank Facilities. The Senior Bank
Facilities are unconditionally guaranteed by Aearo Corporation and secured by
first priority security interests in substantially all the capital stock and
tangible and intangible assets of the Company.
During the first quarter of fiscal 2002, the Company's Board of Directors
authorized management to repurchase, from time to time, a portion of the
Company's 12.5% Notes, subject to market conditions and other factors. No
assurances can be given as to whether or when or at what price such repurchases
will occur. Subsequently, pursuant to a first amendment to the Senior Bank
Facilities, the Company purchased and retired $2.0 million of the Notes during
the first quarter of fiscal 2002.
Term Loans
At September 30, 2003, the total balance outstanding of the Term Loans was $85.1
million and interest rates were 4.4% for the U.S. Dollar Term Loan ($46.3
million US dollars outstanding at September 30, 2003), 7.0% for the British
Pound Term Loan (13.6 million British Pounds outstanding at September 30, 2003),
5.4% for the Euro Term Loan (9.9 million Euro outstanding at September 30,
2003), and 6.0% for the Canadian Term Loan (6.2 million Canadian dollars
outstanding at September 30, 2003). For the year ended September 30, 2003, the
weighted average interest rates paid were 4.7%, 7.1%, 6.0%, and 6.3% for the
U.S. Dollar Term Loan, the British Pounds Term Loan, the Euro Term Loan and the
Canadian Term Loan, respectively.
At September 30, 2002, the total balance outstanding on the Term Loans was $93.9
million and interest rates were 5.0% for the U.S. Dollar Term Loan ($53.8
million US dollars outstanding at September 30, 2002), 7.2% for the British
Pound Term Loan (15.8 million British Pounds outstanding at September 30, 2002),
6.5% for the Euro Term Loan (11.5 million Euro outstanding at September 30,
2002), and 6.2% for the Canadian Term Loan (6.2 million Canadian dollars
outstanding at September 30, 2002). For the year ended September 30, 2002, the
weighted average interest rates paid were 5.4%, 7.6% 6.7% and 5.9% for the U.S.
Dollar Term Loan, the British Pounds Term Loan, the Euro Term Loan and the
Canadian Term Loan, respectively.
Revolving Credit Facility
At September 30, 2003 the balance on the Revolving Credit Facility was $11.7
million, which $5.0 million bore interest at LIBOR (3.89%) and $6.7 million at
Base Rate (5.75%). For the year ended September 30, 2003, the maximum amount
outstanding was $16.5 million, the average was $1.7 million and the weighted
average interest rate paid was 5.7%. At September 30, 2003, approximately $17.3
million was available for additional borrowings and $11.3 million to finance
additional permitted acquisitions.
At September 30, 2002, no amounts were outstanding on the Revolving Credit
Facility. For the year ended September 30, 2002, the maximum amount outstanding
was $1.5 million, the average was approximately zero and the weighted average
interest rate paid was 6.5%. At September 30, 2002, approximately $29.0 million
was available for additional borrowings and $22.9 million to finance additional
permitted acquisitions.
Senior Subordinated Notes
In connection with the Formation Acquisition, Aearo Company issued $100.0
million of Notes due 2005, which are unsecured obligations of the Company. The
Notes bear interest at a rate of 12.5% per annum and interest is payable
semiannually on each January 15 and July 15.
-41-
The Notes are redeemable at the option of the Company, on or after July 15,
2000. From and after July 15, 2000, the Notes will be subject to redemption at
the option of the Company, in whole or in part, at various redemption prices,
declining from 106.3% of the principal amount to par on and after July 15, 2004.
The Company repurchased $2.0 million of Notes in October 2001.
The Notes indenture contains affirmative and negative covenants and restrictions
similar to those required under the terms of the Senior Bank Facilities
discussed above. As of September 30, 2003, the Company was in compliance with
the various covenants of the Notes agreement. The Notes are unconditionally
guaranteed on an unsecured senior subordinated basis by Aearo Corporation.
Holding Company Notes
To finance part of the redemption of Aearo's common and preferred stock owned by
Cabot, the Company issued $15.0 million of Holding Company Notes due in 2005.
The Holding Company Notes are unsecured obligation of the Company. The initial
applicable interest rate was 9.5%, with an increase of 50 basis points each
subsequent four-month period beginning December 15, 2003. The applicable
interest rate shall not exceed 12%. Interest will be paid three times per year
on April 15, August 15, and December 15. The first payment was made on December
15, 2003.
The Note Purchase Agreement contains affirmative and negative covenants and
restrictions similar to those required under the terms of the Senior Bank
Facility and Notes discussed above. As of September 30, 2003 the Company was in
compliance with the various covenants of the Notes Purchase Agreement.
Maturities
As of September 30, 2003, the scheduled maturity of indebtedness for each of the
next five years and thereafter is as follows (dollars in thousands):
Amount
-------------
2004 $ 17,767
2005 192,742
2006 2,211
2007 329
2008 282
Thereafter 222
-------------
$ 213,553
=============
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8. Employee Benefit Plans
The Company maintains a noncontributory defined benefit cash balance pension
plan. Benefits provided under the plan are primarily based on years of service
and the employee's compensation.
The following represents information summarizing the Company's defined benefit
cash balance pension plan (dollars in thousands):
Years Ended September 30,
Change in benefit obligation 2001 2002 2003
---------- ----------- -----------
Benefit obligation at beginning of year $ 9,887 $ 11,343 $ 12,995
Service cost 1,336 1,286 1,510
Interest cost 721 790 833
Plan amendments -- 30 --
Benefits paid (993) (1,581) (707)
Actuarial gain (loss) 392 1,127 (1,600)
---------- ----------- -----------
Benefit obligation at end of year $ 11,343 $ 12,995 $ 13,031
---------- ----------- -----------
Change in plan assets
Fair value of plan assets
at beginning of year $ 10,535 $ 9,259 $ 7,956
Actual return of plan assets (1,491) (945) 1,119
Employer contributions 1,208 1,223 563
Benefits paid (993) (1,581) (707)
--------- ---------- -----------
Fair value of plan assets at end of year $ 9,259 $ 7,956 $ 8,931
--------- ---------- -----------
Reconciliation of funded status
Funded status $ (2,084) $ (5,039) $ (4,101)
Unrecognized prior service cost 96 117 107
Unrecognized actuarial (gain) loss (572) 2,285 176
--------- ---------- -----------
Net pension liability included in
accrued liabilities $ (2,560) $ (2,637) $ (3,818)
--------- ---------- -----------
Amounts recognized in
statement of financial position
Prepaid benefit cost $ -- $ -- $ --
Accrued benefit liability (2,560) (4,860) (3,818)
Intangible asset -- 116 --
Accumulated other comprehensive income -- 2,107 --
--------- ---------- -----------
Net amount recognized $ (2,560) $ (2,637) $ (3,818)
--------- ---------- -----------
Components of net periodic benefit cost
Service cost $ 1,336 $ 1,286 $ 1,510
Interest cost 721 790 833
Expected return on plan assets (842) (785) (672)
Unrecognized prior service cost 7 9 9
Recognized actuarial gain (loss) (145) -- 63
--------- ---------- -----------
Net periodic benefit cost $ 1,077 $ 1,300 $ 1,743
========= ========== ===========
The weighted average assumptions used in determining net periodic benefit cost
and the projected benefit obligation were as follows:
-43-
Years Ended September 30,
2001 2002 2003
--------- --------- ---------
Discount rate 7.50% 6.75% 6.00%
Expected long-term rate of return of plan assets 8.00% 8.50% 8.00%
Rate of compensation increase 4.00% 4.00% 4.00%
In addition, the Company has an unfunded, noncontributory defined benefit
pension plan, the Aearo Company Supplemental Executive Retirement Plan (the SERP
Plan), which is also a cash balance plan. The SERP Plan, effective January 1,
1994, covers certain employees in the United States. The costs to the Company
for the SERP Plan were $148,000, $111,000 and $113,000 for the years ended
September 30, 2001, 2002 and 2003, respectively. The aggregate liability for the
SERP Plan was $524,000, $486,000 and $540,000 for the years ended September 30,
2001, 2002 and 2003, respectively.
A 401(k) plan, the Aearo Company Employees' 401(k) Savings Plan, was established
as of May 1, 1990. Employees normally scheduled to work a minimum of 1,000 hours
per year can join the plan immediately and may contribute up to 60% of their
compensation. The Company contributes amounts equal to 50% of the employee's
contribution to a maximum of 3% of the employee's pay. The costs to the Company
for this Plan were $903,000, $866,000 and $891,000 for the years ended September
30, 2001, 2002 and 2003, respectively.
The Company has a defined contribution savings plan for U.K. employees, under
which eligible employees are allowed to contribute up to 15% of their
compensation. The Company contributes 5% of pay for all eligible employees and
additional amounts equal to 40% of the employee's contribution to a maximum of
2% of the employee's pay. For the years ended September 30, 2001, 2002 and 2003,
the Company contributed approximately $212,000, $197,000, and $228,000,
respectively.
9. Related Party Transactions
Pursuant to an agreement with Cabot and Vestar, dated as of July 11, 1995, an
annual management fee is payable by the Company equal to the greater of (i)
$400,000 or (ii) 1.25% of the consolidated net income of the Company and its
subsidiaries before cash interest, taxes, depreciation and amortization for such
fiscal year. Payments totaled approximately $728,000, $519,000 and $611,000
during the years ended September 30, 2001, 2002 and 2003, respectively. Until
August 18, 2003, this annual management fee was shared by Cabot and Vestar based
on their relative equity ownership of the Company. On August 18, 2003, the
Company redeemed all of the shares of common and preferred stock of Aearo owned
by Cabot in the Cabot Stock Redemption, which had no effect on the calculation
of the management fee. All payments subsequent August 18, 2003 have been and
will be paid to Vestar. Of the $611,00 in management fees paid by the Company
during the year ended September 30, 2003, the Company paid Vestar $167,000 in
management fees for the interim period from August 18, 2003 through September
30, 2003.
See Note 12 for a description of certain ongoing liability retention and
indemnity agreements between the Company and Cabot relating to respiratory
medical conditions. The Company paid Cabot $400,000 for each of the years ended
September 30, 2001, 2002 and 2003.
The Company has made available to certain members of management ("Management
Investors") loans in order to provide such Management Investors with funds to be
applied to a portion of the purchase price of the Common Stock purchased by such
Management Investors under the Stock Purchase Plan. Each such loans (i) is
secured by Common Stock purchased with the proceeds thereof, (ii) bears interest
at an annual rate of 2.73%, and (iii) is subject to mandatory prepayment in the
event the employment of the Management Investor terminates or of maturity.
Maturity, at the earliest, is at the option of the note-holder, or at the
latest, at the time of the Vestar realization event as defined in the
Stockholder's Agreement. The aggregate amount of these loans was approximately
$1,363,000 and $1,399,000 at September 30, 2002 and 2003, respectively.
-44-
10. Income Taxes
Income (loss) before provision for income taxes was as follows (dollars in
thousands):
Years Ended September 30,
2001 2002 2003
---------- --------- -----------
Domestic $ 10,865) $ 4,762 $ 12,128
Foreign 7,113 6,342 11,031
---------- --------- -----------
Total $ (3,752) $ 11,104 $ 23,159
========== ========= ===========
A summary of provision (benefit) for income taxes was as follows (dollars in
thousands):
Years Ended September 30,
U.S. Federal and State: 2001 2002 2003
---------- --------- -----------
Current $ (3,525) $ 125 $ 620
Deferred -- 203 --
---------- --------- -----------
$ (3,525) $ 328 $ 620
========== ========= ===========
Foreign:
Current 1,957 1,226 1,148
Deferred (304) 231 783
---------- --------- -----------
1,653 1,457 1,932
---------- --------- -----------
Total $ (1,872) $ 1,785 $ 2,551
========== ========= ===========
The provision (benefit) for income taxes at the Company's effective tax rate
differed from the provision (benefit) for income taxes at the statutory rate as
follows (dollars in thousands):
Years Ended September 30,
2001 2002 2003
--------- --------- ---------
Computed tax expense (benefit) at the $ (1,277) $ 3,740 $ 7,875
expected statutory rate
State taxes, net of federal effect (51) 82 85
Foreign income taxed at different rates (1,172) (166) (1,174)
Foreign dividends -- 324 --
Non-deductible goodwill amortization 308 309 --
Non-deductible expenses 267 99 125
Increase (decrease) in valuation
allowance 110 (2,302) (4,710)
Other, net (57) (301) 350
--------- --------- ---------
Provision (benefit) for income taxes $ (1,872) $ 1,785 $ 2,551
========= ========= =========
Significant components of deferred income taxes are as follows at September 30
(dollars in thousands):
As of September 30,
Deferred tax assets 2002 2003
--------- ---------
Pension and other benefits $ 1,862 $ 1,673
Property, plant and equipment (3,158) (2,422)
Intangible assets 459 (4,940)
Restructuring charges 1,349 530
Inventory 1,147 1,759
Unrealized foreign currency exchange -- 1,254
Net operating loss and credit
carryforwards - Domestic 11,298 8,096
Accrued expenses and other 345 1,705
--------- ---------
Subtotal 13,302 7,655
Valuation allowances (14,102) (9,263)
========= =========
Total deferred tax liability $ (800) $ (1,608)
========= =========
-45-
The valuation allowance at September 30, 2002 and 2003 relates to the
uncertainty of realizing the tax benefits of reversing temporary differences and
net operating loss carryforwards. The gross amount of domestic net operating
loss carryforwards, before the tax effect, is approximately $22.6 million as of
September 30, 2003. The net operating loss carryforwards expire at various
periods ranging from 2010 to 2021. Of the valuation allowance recorded as of
September 30, 2003, approximately $6.9 million will be used to reduce goodwill
if the benefits are realized.
11. Stockholders' Equity
Stock Ownership and Stockholders' Agreement
As of September 30, 2003, Vestar, and its affiliates, owns 71.5% of the
outstanding shares of Aearo Common Stock (42,500 shares) and 100% of the
outstanding shares of Aearo Preferred Stock (22,500 shares) and Management
Investors and certain other employees of the Company own 28.5% of the
outstanding shares of Aearo Common Stock (16,912.5 shares). At September 30,
2002, Vestar, and its affiliates, owned 41.7% of the outstanding shares of Aearo
Common Stock (42,500 shares) and 50% of the outstanding shares of Aearo
Preferred Stock (22,500 shares), Cabot owned 41.7% of the outstanding shares of
Aearo Common Stock (42,500 shares) and 50% of the outstanding shares of Aearo
Preferred Stock (22,500 shares) and the Management Investors and certain other
employees of the Company owned 16.6% of outstanding shares of Aearo Common Stock
(16,912.5 shares). Vestar and the Management Investors are parties to a
stockholders' agreement (the "Stockholders' Agreement"). The Stockholders'
Agreement contains stock transfer restrictions, as well as provisions granting
certain tag-along rights, drag-along rights, registration rights and
participation rights.
The Aearo Preferred Stock is cumulative redeemable $.01 par value stock.
Dividends accrue whether or not dividends are declared or funds are available at
an annual rate of 12.5%, compounded quarterly. To date, no dividends have been
declared. Accrued dividends may be paid in cash or in additional shares of
preferred stock. Shares are redeemable for cash at any time, subject to certain
exceptions, at the option of the Company at a redemption price equal to the
actual or implied purchase price ($22.5 million) plus a redemption payment based
on the dividend rate. As of September 30, 2002 and 2003, the redemption value of
the preferred stock was $109.5 million and $61.9 million, respectively.
Aearo Company is permitted to pay cash dividends to Aearo Corporation for taxes
and expenses in the ordinary course of business. The maximum amount of cash
dividends paid to Aearo Corporation for ordinary business expenses may not
exceed $1,000,000 in any fiscal year. As long as no event of default would
result, Aearo Corporation and Aearo Company are permitted to pay dividends
consisting of shares of qualified capital stock, as defined in the Senior Bank
Facilities, and Aearo Corporation may redeem or purchase shares of its capital
stock held by former employees of Aearo Corporation or any of its subsidiaries
following the termination of their employment, provided that the aggregate
amount paid by Aearo Corporation with respect to such purchases or redemptions
does not exceed $5.0 million in any fiscal year and $7.5 million in the
aggregate. Aearo Company may pay cash dividends to Aearo Corporation for the
latter purpose. Additionally, Aearo Corporation may pay dividends on its
preferred stock in additional shares of Aearo Preferred Stock. To date, Aearo
Corporation has not paid dividends on either Aearo Common or Aearo Preferred
Stock.
Stock Option Plans
On June 27, 1996, Aearo's Board of Directors adopted the Executive Stock Option
Plan (the "Executive Plan") under which non-qualified options to purchase up to
5,000 shares of Aearo Common Stock may be granted to certain officers and key
employees of Aearo and its subsidiaries. In July 1997, the Company's Board of
Directors adopted and the stockholders subsequently approved the 1997 Stock
Option Plan (the "1997 Option Plan") under which 10,000 shares of Aearo Common
Stock were reserved for issuance. During the year ended September 30, 2002, an
additional 1,800 shares were reserved for issuance under the 1997 Option Plan.
Under the 1997 Option Plan, non-qualified and qualified options may be granted
to employees, directors and consultants of Aearo and its subsidiaries. Options
granted under the Executive Plan and the 1997 Option Plan will vest and become
exercisable upon the earlier of the date on which a stipulated return (as
defined) is achieved by Vestar on its investment in the Company or the tenth
anniversary of the date of grant. The option term will be 10 years, except that
options shall expire in certain instances of termination of employment and upon
the sale of the Company. As of September 30, 2003, options to purchase a total
of 3,993 shares were outstanding under the Executive Plan and options to
purchase a total of 7,930 shares were outstanding under the 1997 Option Plan. A
total of 1,077 options are available for grant under the Executive Plan and
3,800 options are available for grant under the 1997 Option Plan.
-46-
Pro Forma Stock-Based Compensation Expense
SFAS No. 123, "Accounting for Stock-Based Compensation", sets forth a
fair-value-based method of recognizing stock-based compensation expense. As
permitted by SFAS No. 123, the Company has elected to continue to apply APB No.
25 to account for its stock-based compensation plans.
Stock Option Activity
Stock option data for the Executive Plan and the 1997 Option Plan for the years
ended September 30, 2001, 2002 and 2003, respectively, was as follows:
Number Weighted Average
of Shares Exercise Price
Outstanding, October 1, 2000 9,883 $ 630
Granted 2,500 800
Forfeited (218) 600
Forfeited (94) 800
Outstanding, September 30, 2001 12,071 664
Granted 4,274 600
Granted 31 800
Forfeited (456) 600
Outstanding, September 30, 2002 15,920 649
Forfeited (3,997) 800
------- ---------
Outstanding, September 30, 2003 11,923 $ 600
======= =========
-47-
The following table sets forth information regarding options outstanding at
September 30, 2003:
Weighted
Weighted Average
Number Weighted Average Exercise
of Shares Number Average Remaining Price for
Covered by Exercise Currently Exercise Contractual Currently
Options Price Exercisable Price Life Exercisable
- --------- --------- ----------- --------- ---------- -----------
11,923 $ 600.00 -- $ 600.00 5.74 years N/A
12. Commitments and Contingencies
Lease Commitments
The Company leases certain transportation vehicles, warehouse facilities, office
space, and machinery and equipment under cancelable and non-cancelable operating
leases. Rent expense under such arrangements totaled $5.8 million, $6.0 million
and $6.4 million for the years ended September 30, 2001, 2002 and 2003,
respectively. Future minimum rental commitments under non-cancelable leases in
effect at September 30, 2003 are as follows (dollars in thousands):
2004 $ 4,336
2005 3,702
2006 2,341
2007 1,053
2008 1,053
Thereafter 2,070
--------------
Total $ 14,555
==============
Contingencies
Various lawsuits and claims arise against the Company in the ordinary course of
its business. Most of these lawsuits and claims are products liability matters
that arise out of the use of safety eyewear and respiratory product lines
manufactured by the Company as well as products purchased for resale.
In addition, the Company is a defendant in lawsuits by plaintiffs alleging that
they suffer from respiratory medical conditions, such as asbestosis or
silicosis, relating to exposure to asbestos and silica, and that such conditions
result, in part, from the use of respirators that, allegedly, were negligently
designed or manufactured. The defendants in these lawsuits are often numerous,
and include, in addition to manufacturers and distributors of respirators,
manufacturers, distributors and installers of sand (used in sand blasting),
asbestos and asbestos-containing products. Most of these claims are covered by
the Asset Transfer Agreement entered into on June 13, 1995 by the Company and
Aearo Company, on the one hand, and Cabot and certain of its subsidiaries (the
"Sellers"), on the other hand (the "1995 Asset Transfer Agreement"). In the 1995
Asset Transfer Agreement, so long as the Company makes an annual payment of
$400,000 to Cabot, the Sellers agreed to retain, and Cabot and the Sellers
agreed to defend and indemnify the Company against, any liability or obligation
relating to or otherwise arising under any proceeding or other claim against the
Company or Cabot or their respective affiliates or other parties with whom any
Seller directly or indirectly has a contractual liability sharing arrangement
which sounds in product liability or related causes of action arising out of
actual or alleged respiratory medical conditions caused or allegedly caused by
the use of respirators or similar devices sold by Sellers or their predecessors
(including American Optical Corporation and its predecessors) prior to July 11,
1995. To date, the Company has elected to pay the annual fee and intends to
continue to do so. The Company could potentially be liable for claims currently
retained by Sellers if the Company elects to cease paying the annual fee or if
Cabot and the Sellers no longer are able to perform their obligations under the
1995 Asset Transfer Agreement. Cabot acknowledged in the Stock Purchase
Agreement that it and the Company entered into on June 27, 2003 (providing for
the sale by Cabot to the Company of all of the common and preferred stock of the
Company owned by Cabot) that the foregoing provisions of the 1995 Asset Transfer
Agreement remain in effect. The 1995 Asset Transfer Agreement does not apply to
claims relating to the business of Eastern Safety Equipment, the stock of which
the Company acquired in 1996.
-48-
At September 30, 2003, the Company has recorded liabilities of approximately
$4.5 million, which represents reasonable estimates of its probable liabilities,
for product liabilities substantially related to asbestos and silica-related
claims as determined by the Company in consultation with an independent
consultant. This reserve is re-evaluated periodically and additional charges or
credits to operations may result as additional information becomes available.
Consistent with the current environment being experienced by companies involved
in asbestos and silica-related litigation, there has been an increase in the
number of asserted claims that could potentially involve the Company. Various
factors increase the difficulty in determining the Company's potential
liability, if any, in such claims, including the fact that the defendants in
these lawsuits are often numerous and the claims generally do not specify the
amount of damages sought. Additionally, the bankruptcy filings of other
companies with asbestos and silica-related litigation could increase the
Company's cost over time. In light of these and other uncertainties inherent in
making long-term projections, the Company has determined that the five-year
period through fiscal 2008 is the most reasonable time period for projecting
asbestos and silica-related claims and defense costs. It is possible that the
Company may incur liabilities in an amount in excess of amounts currently
reserved. However, taking into account currently available information,
historical experience, and the 1995 Asset Transfer Agreement, but recognizing
the inherent uncertainties in the projection of any future events, it is
management's opinion that these suits or claims should not result in final
judgments or settlements in excess of the Company's reserve that, in the
aggregate, would have a material effect on the Company's financial condition,
liquidity or results of operations.
13. Acquisitions
On December 14, 2001, the Company acquired Iron Age Vision from Iron Age
Corporation of Pittsburgh, Pennsylvania. The acquisition has been accounted for
as a purchase transaction in accordance with SFAS No. 141, and, accordingly, the
consolidated financial statements for the periods subsequent to December 14,
2001 reflect the purchase price, including transaction costs, allocated to
tangible and intangible assets acquired and liabilities assumed, based on their
estimated fair values as of December 14, 2001. The purchase price of $0.9
million, inclusive of acquisition fees and costs to restructure operations, was
allocated based on the fair value of assets acquired, which consisted primarily
of receivables and fixed assets. The excess of purchase price over the fair
market value of assets acquired of $0.5 million was allocated to goodwill.
On January 21, 2002, the Company acquired the industrial safety business of
Montreal, Canada based Leader Industries, Inc. The acquisition has been
accounted for as a purchase transaction in accordance with SFAS No. 141, and,
accordingly, the consolidated financial statements for the periods subsequent to
January 21, 2002 reflect the purchase price, including transaction costs,
allocated to tangible and intangible assets acquired and liabilities assumed,
based on their estimated fair values as of January 21, 2002. The purchase price
of $5.1 million, inclusive of acquisition fees and costs to restructure
operations, was allocated based on the fair value of assets acquired, which
consisted primarily of inventory, receivables, fixed assets and accrued
liabilities. The excess of purchase price over the fair market value of assets
acquired of $2.2 million was allocated to goodwill.
On May 7, 2002, the Company acquired Chesapeake Optical Company of Baltimore,
Maryland. The acquisition has been accounted for as a purchase transaction in
accordance with SFAS No. 141, and, accordingly, the consolidated financial
statements for the periods subsequent to May 7, 2002 reflect the purchase price,
including transaction costs, allocated to tangible and intangible assets
acquired and liabilities assumed, based on their estimated fair values as of May
7, 2002. The purchase price of $3.6 million, inclusive of acquisition fees and
costs to restructure operations, was allocated based on the fair value of assets
acquired, which consisted primarily of inventory, receivables, fixed assets and
accrued liabilities. The excess of purchase price over the fair market value of
assets acquired of $2.9 million was allocated to goodwill.
On October 7, 2002, the Company acquired the Safety Prescription Eyewear assets
Industrial Protection Products, Inc. ("IPP") of Wilmington, Massachusetts for
$1.5 million. The acquisition has been accounted for as a purchase transaction
in accordance with SFAS No. 141, and, accordingly, the consolidated financial
statements for the periods subsequent to October 7, 2002 reflect the purchase
price, including transaction costs, allocated to tangible and intangible assets
acquired and liabilities assumed, based on their estimated fair values as of
October 7, 2002. The purchase price of $1.5 million, inclusive of acquisition
fees and costs to restructure operations, was allocated based on the fair value
of assets acquired, which consisted primarily of inventory, receivables, fixed
assets and accrued liabilities. The excess of purchase price over the fair
market value of assets acquired of $1.4 million consisted of $0.9 million of
goodwill and $0.5 million of other intangibles.
These operations have been included in the consolidated results from the dates
of acquisition. Had the acquisitions been consolidated at the beginning of the
year prior to the acquisitions, they would not have materially affected results.
-49-
On March 14, 2003, the Company acquired VH Industries, Inc. ("VH") of Concord,
North Carolina for $11.6 million. The acquisition has been accounted for as a
purchase transaction in accordance with SFAS No. 141, and, accordingly, the
consolidated financial statements for the periods subsequent to March 14, 2003
reflect the purchase price, including transaction costs, allocated to tangible
and intangible assets acquired and liabilities assumed, based on their estimated
fair values as of March 14, 2003. The purchase price of $11.6 million, inclusive
of acquisition fees and costs to restructure operations, was allocated on a
preliminary basis based on the fair value of assets acquired, which consisted
primarily of inventory, receivables, fixed assets and accrued liabilities. The
excess of purchase price over the fair market value of assets acquired of $9.4
million consisted of $5.9 million of goodwill and $1.6 million of trademarks and
$1.9 million of other intangibles. The following unaudited proforma information
presents results as if the acquisition had occurred at the beginning of the
respective periods (dollars in thousands):
2001 2002 2003
----------- ----------- ----------
Sales as reported $ 283,862 $ 286,867 $ 316,428
Proforma sales 292,456 297,223 320,918
Net income (loss)as
reported (1,880) 9,319 20,608
Proforma net income (loss) (1,212) 9,803 21,296
14. Segment Data
As defined by SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information", the Company's three reportable segments are Safety
Products, Safety Prescription Eyewear and Specialty Composites. The Safety
Products segment manufactures and sells hearing protection devices,
communication headsets, non-prescription safety eyewear, face shields, reusable
and disposable respirators, hard hats 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 Safety Prescription Eyewear
segment purchases component parts (lenses and the majority of its frames) from
various suppliers, grinds and shapes the lenses to 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):
2001 2002 2003
---------- ---------- ----------
Safety Products $ 206,311 $ 208,538 $ 242,263
Safety Prescription Eyewear 39,076 40,834 40,028
Specialty Composites 38,475 37,495 34,137
----------- ----------- ----------
Total $ 283,862 $ 286,867 $ 316,428
=========== =========== ==========
Profit by business segment and reconciliation to income before (benefit from)
provision for income taxes (dollars in thousands):
2001 2002 2003
---------- ---------- ----------
Safety Products $ 43,102 $ 42,608 $ 50,670
Safety Prescription Eyewear 2,922 1,714 462
Specialty Composites 1,984 3,488 2,713
---------- ----------- -----------
Segment profit $ 48,008 $ 47,810 $ 53,845
========== ========== ==========
Depreciation 10,123 10,958 11,102
Amortization of intangibles 6,530 6,293 267
Restructuring charges 11,441 (600) (270)
Interest, net 23,666 20,055 19,587
---------- ---------- -----------
Income (loss) before provision
for/(benefit from)
income taxes $ (3,752) $ 11,104 $ 23,159
========== ========== ==========
-50-
Segment profit is defined as earnings before depreciation, amortization,
interest expense and income taxes and presents the measure used by the chief
operating decision maker to assess segment performance and make decisions about
the allocation of resources to business segments.
Intersegment sales of the Specialty Composites segment to the Safety Products
segment totaled $4.2 million, $3.5 million and $3.2 million for the years ended
September 30, 2001, 2002 and 2003, respectively. The intersegment sales value is
generally determined at fully absorbed inventory cost at standard rates plus
25%.
Depreciation by business segment (dollars in thousands):
2001 2002 2003
----------- ----------- -----------
Safety Products $ 7,966 $ 8,657 $ 8,978
Safety Prescription Eyewear 378 717 707
Specialty Composites 1,779 1,584 1,417
----------- ----------- -----------
Total $ 10,123 $ 10,958 $ 11,102
=========== =========== ===========
Identifiable assets by business segment (dollars in thousands):
2002 2003
----------- -----------
Safety Products $ 217,091 $ 249,553
Safety Prescription Eyewear 18,088 17,748
Specialty Composites 20,510 18,914
Cash 14,480 7,301
----------- -----------
Total $ 270,169 $ 293,516
=========== ===========
Cash is not allocated to segments.
Capital expenditures including capital leases by business segment (dollars in
thousands):
2001 2002 2003
---------- ---------- -----------
Safety Products $ 5,788 $ 7,921 $ 8,888
Safety Prescription Eyewear 425 499 379
Specialty Composites 1,075 791 619
Reconciling items 511 442 430
----------- ----------- -----------
Total $ 7,799 $ 9,653 $ 10,316
=========== =========== ===========
Reconciling items include corporate expenditures such as information technology
and other shared systems.
-51-
Net sales by principal geographic areas (dollars in thousands):
2001 2002 2003
----------- ----------- -----------
United States of America $ 179,398 $ 175,358 $ 187,106
Canada 20,370 20,997 22,965
United Kingdom 13,501 13,115 15,562
Germany 11,447 10,984 11,859
Sweden 10,981 10,710 15,392
France 6,975 10,097 9,967
Italy 5,156 4,933 7,044
All others 36,034 40,673 46,533
----------- ----------- -----------
Total $ 283,862 $ 286,867 $ 316,428
=========== =========== ===========
The sales as shown above represent the value of shipments into the customer's
country of residence. For the years ended September 30, 2001, 2002 and 2003, no
single customer accounted for more than 10% of sales.
Net identifiable assets by principal geographic areas (dollars in thousands):
2001 2002 2003
----------- ----------- -----------
United States of America $ 173,076 $ 173,068 $ 183,910
Canada 9,584 10,252 10,293
United Kingdom 19,304 18,426 21,870
Germany 2,138 144 299
Sweden 56,673 61,860 70,744
France 43 5,869 5,773
All others 484 550 627
----------- ----------- -----------
Total $ 261,302 $ 270,169 $ 293,516
=========== =========== ===========
15. Quarterly Financial Data (Unaudited)
The following table contains selected unaudited quarterly financial data for
fiscal years 2002 and 2003.
QUARTERLY FINANCIAL DATA
(In Thousands, Except Per Share Amounts)
-----------------------------------------------------------------------------------------
Fiscal Year Fiscal Year
2002 2003
------------------------------------------ ------------------------------------------
First Second Third Fourth First Second Third Fourth
--------- --------- --------- --------- --------- --------- --------- ---------
Net Sales $ 61,644 $ 70,683 $ 76,435 $ 78,105 $ 68,717 $ 76,686 $ 86,723 $ 84,302
Cost of Sales 32,928 37,360 40,024 40,085 35,645 39,912 45,767 42,695
--------- --------- -------- --------- --------- --------- --------- ---------
Gross Profit 28,716 33,323 36,411 38,020 33,072 36,774 40,956 41,607
Restructuring Charge -- -- -- (100) -- -- -- --
Income (Loss)
before provision
for (benefit from)
income taxes (188) 2,580 3,132 5,580 1,652 4,765 7,750 8,992
Net Income (Loss) (711) 2,017 2,282 5,731 1,042 2,691 6,383 10,492
16. Restructuring
On September 30, 2001 the Company recorded an unusual charge of $11.4 million
related to a restructuring plan announced by the Company to improve its
competitive position and long-term profitability. The plan includes the closure
of its Ettlingen, Germany plant, significantly reorganizing operations at the
Company's Varnamo, Sweden plant, rationalizing the manufacturing assets and
product mix of its Specialty Composites business unit and a reduction of
products and product lines.
-52-
The restructuring charge included cash charges totaling $2.3 million consisting
of $1.8 million for severance and related costs to cover the reduction of 5% of
the Company's work force and $0.5 million for other costs associated with this
plan. The restructuring also included non-cash charges totaling $9.1 million
consisting of $3.2 million for non-cancelable long term lease obligations, asset
impairment charges of $2.9 million, $2.4 million for the write-off of inventory
and $0.6 million related to the sale of the Company's Ettlingen, Germany
location.
During 2003, the Company reversed $0.3 million of reserves related to the
September 30, 2001 restructuring provision. The adjustment represents a change
in estimate of the plan for the disposal of certain items of inventory and was
classified as a reduction in cost of sales.
The following table displays the activity and balances of the restructuring
reserve account as of and for the year ended September 30, 2003 (in thousands):
September 30, September 30,
2002 Charges 2003
------------- --------- -------------
Employee termination costs $ 730 $ (506) $ 224
Lease agreements 2,352 (896) 1,456
Loss on disposal of assets 700 (9) 691
Other 47 (30) 17
------------- --------- -------------
Total $ 3,829 $ (1,541) $ 2,388
------------ --------- -------------
The Company expects that all charges related to the restructuring provision will
be settled in fiscal 2004 except for the lease agreement which will end in March
2005.
-53-
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
-54-
Item 9A. Controls and Procedures
Disclosure controls and procedures are defined by the Securities and Exchange
Commission as those controls and other procedures that are designed to ensure
that information required to be disclosed in the Company's filings under the
Securities Act of 1934 is recorded, processed, summarized and reported within
the time periods specified in the Securities and Exchange Commission's rules and
forms. The Company's Chief Executive Officer and Chief Financial Officer have
evaluated the Company's disclosure controls and procedures within 90 days prior
to the filing of this Annual Report on Form 10-K405 and have determined that
such disclosure controls and procedures are effective.
Subsequent to the Company's evaluation, there were no significant changes in
internal controls or other factors during the fourth fiscal quarter that could
materially affect internal controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
-55-
PART III
Item 10. Directors and Executive Officers
The following table sets forth certain information with respect to the directors
and executive officers of the Company as of December 22, 2003.
Name Age Position
- ---------------------------- ---- ---------- -------- ----------------------
Michael A. McLain (1) 53 Chief Executive Officer, President,
and Chairman of the Board of Directors
Jeffrey S. Kulka 46 Senior Vice President, Chief Financial
Officer, Treasurer, and Secretary
James H. Bernhardt 59 Senior Vice President and Chief Marketing
Officer
James H. Floyd 48 President, Aearo Europe, Managing
Director, International
Joseph C. Marlette 60 Senior Vice President, Operations and
Research and Development
M. Rand Mallitz 61 Senior Vice President, Specialty
Composites
D. Garrad (Gary) Warren, III 51 President, North American Safety
Products Group
James M. Phillips 51 Senior Vice President, Human Resources
Rahul Kapur 52 Senior Vice President, Corporate
Development and Chief Strategy Officer
Norman W. Alpert (1) 44 Director
Daniel S. O'Connell 48 Director
Arthur J. Nagle 67 Director
Bryan P. Marsal (2) 52 Director
William E. Kassling (2) 58 Director
John D. Curtin, Jr. 70 Director
1. Member of Compensation Committee
2. Member of Audit Committee
-56-
Michael A. McLain has been President, Chief Executive Officer and Director of
the Company since February 1998. Effective May 30, 2001, he was named Chairman
of the Board of Directors. Prior to joining the Company, he was President and
Chief Executive Officer of DowBrands, Inc., a large manufacturer of household
consumer products. Mr. McLain is a Director of Cluett American Corporation, and
Little Rapids Corporation.
Jeffrey S. Kulka, Senior Vice President, Chief Financial Officer, Treasurer and
Secretary joined the Company in March 1997 as Corporate Controller. Prior to
joining Aearo, he spent ten years with Augat Inc. in a variety of assignments
including Divisional Controllerships and Business Development in domestic and
international settings.
James H. Bernhardt, Senior Vice President and Chief Marketing Officer, joined
the Company in February 2001. Prior to joining Aearo, he was Senior Vice
President/General Manager of the Miracle-Gro Division of the Scotts Company.
Altogether, he has 30 years of experience in packaged goods marketing.
James H. Floyd, President, Aearo Europe, Managing Director, International,
joined Aearo in April 1998. Prior to 1998, he was responsible for global
logistics and packaging functions at DowBrands. He began his career at Procter
and Gamble where he worked for seven years.
Joseph C. Marlette, Senior Vice President, Operations and Research and
Development, joined the Company in April 1998. Prior to joining Aearo, he spent
33 years in various manufacturing positions with the Dow Chemical Company.
M. Rand Mallitz, Senior Vice President and General Manager, E-A-R(R) Specialty
Composites, joined the Company in January 1992 as. In December 1999, he was
promoted to Vice President Aearo, Senior Vice President Specialty Composites.
Prior to joining the Company, Mr. Mallitz was CEO/President of Roth Office
Products until 1992.
D. Garrad (Gary) Warren, III joined the Company in November 1999 and currently
serves as President - North American Safety Products Group. Prior to that, Mr.
Warren was Senior Vice President, Sales and Customer Development for
International Home Foods in Parsippany, New Jersey.
James M. Phillips, Senior Vice President, Human Resources joined the Company in
May 1998. He worked for Dow Chemical Company for more than 20 years and has
worked in recruiting, training and compensation for many diverse divisions of
Dow.
Rahul Kapur joined the Company in April 1998 as Vice President of Corporate
Development. He currently is Senior Vice President of Corporate Development and
chief Strategy Officer. Mr. Kapur joined DowBrands in 1985 in New Product
Development and held various positions in Marketing and Strategic Development,
including Director of Marketing for Europe. He began his career with Richardson
Vicks and Unilever.
Norman W. Alpert is a Managing Director of Vestar Capital Partners and was a
founding partner of Vestar at its inception in 1988. In addition to Aearo, Mr.
Alpert is a director of MCG Capital Corporation and Cluett American Group, all
companies in which Vestar or its affiliates have a significant equity interest.
He became a director of the Company in July 1995.
Daniel S. O'Connell is the Chief Executive Officer and founder of Vestar Capital
Partners. In addition to Aearo, Mr. O'Connell is a director of Cluett American
Corporation, Insight Communications Company, Inc., Sunrise Medical, Inc., St.
John Knits Co., Inc. and Agrilink Foods, Inc. All are companies in which Vestar
or its affiliates have a significant equity interest. He became a director of
the Company in July 1995.
Arthur J. Nagle is a Managing Director of Vestar Capital Partners and was a
founding partner of Vestar at its inception in 1988. In addition to Aearo, Mr.
Nagle is a director of Advanced Organics, Inc., Gleason Corporation and Sheridan
Healthcare, Inc., all companies in which Vestar or its affiliates have a
significant equity interest. He became a director of the Company in July 1995.
Bryan P. Marsal, is co-founder of Alvarez & Marsal, Inc. ("A&M"), a global
professional services firm specializing in providing corporate advisory and
management services to distressed and underperforming companies. Previously, he
served as Director of Republic Health Corporation, Anthony Manufacturing, and
Gitano. He was also Chief Operating Officer of Alexander's Department Stores.
Mr. Marsal holds both a B.B.A. and a M.B.A from the University of Michigan. He
currently serves on the boards of Timex Corporation, and Cluett American
Corporation (Gold Toe Socks). He became a director of the Company in October
1998.
-57-
William E. Kassling was named Chairman of the Board of Wabtec Corporation in
February 2001, after having served as Chairman and Chief Executive Officer since
1990. Between 1984 and 1990, Mr. Kassling served as Vice President, Group
Executive for the Railway Products Group of American Standard Incorporated.
Prior to 1984, he held various operating and strategic planning assignments with
American Standard, Clark Equipment Company and Boston Consulting Group. Mr.
Kassling earned an MBA from the University of Chicago and a BS in industrial
management from Purdue University. In addition to Aearo, Mr. Kassling is a board
member of the Pittsburgh Penguins and Scientific Atlanta. He became a director
of the Company in July 1998.
John D. Curtin, Jr. retired as Chairman and Chief Executive Officer of the
Company in February 1998. Mr. Curtin was named Chief Executive Officer of the
Company in April 1994 and became a director of the Company in July 1995. Mr.
Curtin joined Cabot in 1989 as Chief Financial Officer and Executive Vice
President. Prior to joining Cabot he was President, Chief Executive Officer and
Director of Curtin & Co., Inc., a private investment-banking firm. Mr. Curtin is
also a director of Harbor Global Company, LTD, Hamilton Thorne Biosciences,
Inc., and Nano-C, LLC.
Prior to the Cabot Stock Redemption on August 18, 2003, the number of directors
of the Company was fixed at nine. Since that time, the number of directors has
been fixed at seven. Under the Stockholders' Agreement, Vestar has the right to
designate five directors and the Management Investors have the right to
designate two directors. Prior to the Cabot Stock Redemption, Cabot had the
right to designate two directors. Messrs. Alpert, O'Connell, Nagle, Kassling and
Marsal are the directors designated by Vestar and Mr. McLain and Mr. Curtin are
currently the directors designated by the Management Investors. See Item 13,
"Certain Relationships and Related Transactions -- Stock Ownership and
Stockholders' Agreement -- Election and Removal of Directors." The term of
office for each director ends when his or her successor elected at the annual
meeting of stockholders or upon his or her removal or resignation.
The Board of Directors has established an audit committee consisting of William
E. Kassling and Bryan P. Marsal (the "Audit Committee"). The Audit Committee
recommends the firm to be appointed as independent accountants to audit
financial statements and to perform services related to the audit, reviews the
scope and results of the audit with the independent accountants, reviews with
management and the independent accountants the Company's annual operating
results, considers the adequacy of the internal accounting procedures, considers
the effect of such procedures on the accountants' independence and establishes
policies for business values, ethics and employee relations. Mr. Marsal has been
designated as the audit committee financial expert and is independent of
management.
The Company has adopted a code of ethics that applies to, among others, its
Chief Executive Officer, Chief Financial Officer, and Controller. The Code of
Ethics is available upon request by contacting the Corporate Counsel at (508)
764-5500. If the Company makes substantive amendments to the Code of Ethics or
grant any waiver, including any implicit waiver, from a provision of the Code
applicable to our Chief Executive Officer, Chief Financial Officer or
Controller, the Company will make a public disclosure of the nature of such
amendment or waiver.
Officers and directors of Aearo and the Subsidiary are not subject to Section 16
of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
-58-
Item 11. Executive Compensation
The compensation of executive officers of the Company is determined by the Board
of Directors. The following table sets forth certain information concerning
compensation received by the Chief Executive Officer and the other four most
highly-compensated executive officers of the Company serving at the end of
fiscal 2003 (the "Named Executive Officers") for services rendered to the
Company in all capacities (including service as an officer or director) in
fiscal 2003.
Summary Compensation Table
Annual Compensation
Fiscal All Other Annual
Year Salary Bonus Compensation
Michael A. McLain
Chief Executive Officer, 2003 $ 515,007 $ 398,125 $ 81,855 (1)
President, and Chairman 2002 $ 500,004 $ 225,069 $ 86,797
of the Board of Directors 2001 $ 496,667 $ 56,250 $ 84,977
D. Garrad Warren, III 2003 $ 250,281 $ 155,284 $ 44,496 (2)
President, North American 2002 $ 243,000 $ 87,507 $ 64,250
Safety Products Group 2001 $ 240,833 $ 21,870 $ 43,316
James H. Floyd 2003 $ 216,300 $ 133,988 $ 34,934 (3)
President, Aearo Europe, 2002 $ 207,934 $ 75,623 $ 52,721
Managing Director, 2001 $ 195,066 $ 17,784 $ 42,122
International
M. Rand Mallitz 2003 $ 212,832 $ 131,626 $ 27,882 (4)
Senior Vice President and 2002 $ 206,604 $ 74,399 $ 22,907
General Manager, 2001 $ 205,267 $ 18,594 $ 25,180
Specialty Composites
Rahul Kapur 2003 $ 202,152 $ 125,458 $ 33,394 (5)
Senior Vice President, 2002 $ 192,108 $ 69,177 $ 40,495
Corporate Development 2001 $ 190,873 $ 17,289 $ 34,336
and Chief Strategy
Officer
1. Includes contributions made on behalf of Mr. McLain to the Company's 401(k)
Savings Plan ($5,800) and to the Company's Cash Balance Plan ($12,541).
Also includes expenses recognized by the Company for unfunded accruals made
on Mr. McLain's behalf to the Company's Supplemental Executive Retirement
Plan ($43,206) as well as Company match and interest credits to the
Company's Deferred Compensation Plan ($20,308).
2. Includes contributions made on behalf of Mr. Warren to the Company's 401(k)
Savings Plan ($5,800) and to the Company's Cash Balance Plan ($12,541).
Also includes expenses recognized by the Company for unfunded accruals made
on Mr. Warren's behalf to the Company's Supplemental Executive Retirement
Plan ($11,023) as well as Company match and interest credits to the
Company's Deferred Compensation Plan ($15,132).
3. Includes contributions made on behalf of Mr. Floyd to the Company's 401(k)
Savings Plan ($5,700); to the Company's Cash Balance Plan ($12,541). Also
includes expenses recognized by the Company for unfunded accruals made on
Mr. Floyd's behalf to the Company's Supplemental Executive Retirement Plan
($7,354) as well as Company match and interest credits to the Company's
Deferred Compensation Plan ($9,339).
4. Includes contributions made on behalf of Mr. Mallitz to the Company's
401(k) Savings Plan ($5,945) and to the Company's Cash Balance Plan
($12,541). Also includes expenses recognized by the Company for unfunded
accruals made on Mr. Mallitz's behalf to the Company's Supplemental
Executive Retirement Plan ($6,978) as well as Company match and interest
credits to the Company's Deferred Compensation Plan ($2,418).
-59-
5. Includes contributions made on behalf of Mr. Kapur to the Company's 401(k)
Savings Plan ($6,522) and to the Company's Cash Balance Plan ($12,541).
Also includes expenses recognized by the Company for unfunded accruals made
of Mr. Kapur's behalf to the Company's Supplemental Executive Retirement
Plan ($5,706) as well as Company match and interest credits to the
Company's Deferred Compensation Plan ($8,625).
The following table sets forth information concerning the number and value of
unexercised options to purchase Aearo Common Stock held by the Named Executive
Officers at the end of fiscal 2003. None of the Named Executive Officers
exercised any options during fiscal 2003.
Value of Outstanding
Number of Shares Covered by In-the-money Options
Shares Options at Fiscal Year-end At Fiscal Year-end (1)
Acquired On Value
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
- --------------------- -------- -------- ----------- -------------- ----------- -------------
Michael A. McLain -- -- -- 1,100 $ -- $ --
D. Garrad Warren, III -- -- -- 1,250 -- --
M. Rand Mallitz -- -- -- 256 -- --
Rahul Kapur -- -- -- 275 -- --
James H. Floyd -- -- -- 300 -- --
1. There was no public market for the Aearo Common Stock as of September 30,
2003. Accordingly, these values have been calculated on the basis of an
assumed fair market value of $600 per share as established by the Company's
Board of Directors.
Director Compensation
Directors (other than two Directors unaffiliated with Vestar (the "Outside
Directors")) serve without compensation (other than reimbursement of expenses)
in connection with rendering services as such. The Outside Directors receive
$10,000 annually for their service as Directors and an additional $2,500 per
meeting, plus reimbursement of expenses. In connection with their appointment,
Outside Directors appointed in prior fiscal years have been given the
opportunity to purchase a limited number of shares of Aearo Common Stock. No
Outside Directors were appointed to the Board during fiscal 2003. Outside
Directors may also elect to participate in the Deferred Compensation Plan.
Employee Stock and Other Benefit Plans
Stock Purchase Plan. In connection with the Formation Acquisition, the Company
adopted the Cabot Safety Holdings Corporation 1995 Stock Purchase Plan, as
amended and restated (the "Stock Purchase Plan"), in order to encourage
ownership of Aearo Common Stock by selected officers and employees and
independent directors of the Company. Under the Stock Purchase Plan, 15,000
shares of Aearo Common Stock have been reserved for purchase by the Company's
executive officers and other senior members of management as determined by the
Board of Directors. As of December 1, 2003, 13,200 of such shares were issued
and outstanding.
Aearo Common Stock acquired under the Stock Purchase Plan is subject to
forfeiture through various puts and calls. In the event of death, permanent
disability or retirement, which retirement occurs at age 65 or older with at
least 3 years of service, such stock may be put to the Company by the holder at
fair market value and the Company has a call on such stock at the same price. In
the event of termination for cause, the Company has a call at the lesser of
initial cost and fair market value. In the event of termination by the Company
other than for cause and in the case of voluntary resignation, the Company has a
call (i) with respect to a percentage of such stock equal to the number of years
elapsed since the Formation Acquisition multiplied by 20% at fair market value,
and (ii) with respect to the remainder of such stock at the lesser of initial
cost and fair market value. Shares repurchased by the Company are held in
reserve, and may be issued to existing and future employees or non-employee
directors. These puts and calls expire (i) on the date on which certain
financial performance benchmarks (which, following an initial public offering of
the Aearo Common Stock, depend in part on the future market value of the Aearo
Common Stock) are achieved by the Company or (ii) on various dates, none
exceeding five years from the date of purchase. Each Management Investor is also
required to be a party to the Stockholders' Agreement. See Item 13, "Certain
Relationships and Related Transactions -- Stockholders' Agreement."
-60-
Stock Option Plans. In June 1996, Aearo's Board of Directors adopted and the
stockholders subsequently approved the Executive Stock Option Plan (the
"Executive Plan") under which 5,000 shares of Aearo Common Stock have been
reserved for issuance. Under the Executive Plan, non-qualified options may be
granted to officers and key employees of the Company and its subsidiaries. In
July 1997, Aearo's Board of Directors adopted and the stockholders subsequently
approved the 1997 Stock Option Plan (the "1997 Option Plan") under which 11,800
shares of Aearo Common Stock have been reserved for issuance. Under the 1997
Option Plan non-qualified and qualified options may be granted to employees,
directors and consultants of the Company.
Each of the Executive Plan and the 1997 Option Plan is administered by a
committee of the Board of Directors consisting of all non-employee directors. As
of September 30, 2003, non-qualified options to acquire 11,923 shares at a price
of $600 per share have been granted to officers and key employees of the Company
and its subsidiaries under the Company's stock option plans and 4,877 options
remain available for issuance. Of outstanding options, 3,181 in the aggregate
have been granted to Named Executive Officers, including Mr. McLain (options to
purchase 1,100 shares), Mr. Warren (options to purchase 1,250 shares), Mr. Floyd
(options to purchase 300 shares), Mr. Kapur (options to purchase 275 shares) and
Mr. Mallitz (options to purchase 256 shares). Each option will vest and become
exercisable upon the earlier of: (i) the date on which certain financial
performance benchmarks (which depend in part on the future market value of the
Aearo Common Stock) are achieved by the Company and (ii) the tenth anniversary
of the date of grant. The option term is 10 years; provided, however, that
unexercised options expire earlier in certain instances of termination of
employment of the option holder and may expire in the event of a merger or
liquidation of the Company or a sale of substantially all the assets of the
Company. Aearo Common Stock acquired upon exercise of options granted under the
Executive Plan or 1997 Option Plan is subject to the same restrictions,
including puts and calls and drag-along rights as Aearo Common Stock acquired
under the Stock Purchase Plan. See "Stock Purchase Plan."
There were no option grants for Named Executive Officers pursuant to the
Executive Plan and the 1997 Option Plan during the year ended September 30,
2003.
Management Incentive Plan. The Company provides performance-based compensation
awards to executive officers and key employees for achievement during each year
as part of a management incentive plan. Such compensation awards are a function
of individual performance and consolidated corporate results. Business unit
performance also is a factor in determining compensation awards with respect to
key employees who are not executive officers. The specified qualitative and
quantitative criteria employed by the Board of Directors of the Company in
determining bonus awards varies for each individual and from year to year.
Phantom Equity Plan. Aearo maintains a management phantom equity program,
pursuant to which specified members of management may be entitled to receive
proceeds upon Aearo's achievement of specified financial goals relating to the
value of the common equity. In general, subject to a participant's continued
employment, the participant's right to receive such proceeds will vest
immediately upon an outright sale of the majority of Aearo by existing
shareholders or a recapitalization which results in a significant distribution
to the common equity (each, a "realization event"). However, the Board of
Directors of Aearo has the right to accelerate vesting for individual
participants. The proceeds under the management phantom equity program generally
will be distributed upon a realization event.
Supplemental Severance Pay Policy. The Company has adopted a severance pay
policy providing executive officers and key employees with salary continuation
in the event of a termination. Termination resulting from cause, retirement,
death and disability are not eligible. Subject to the Company's discretion, the
policy generally provides for one month's base pay for each full year of service
with a minimum amount payable of three month and a maximum amount payable of
twelve months.
Deferred Compensation Plan. The Company has adopted a Deferred Compensation Plan
which is a non-qualified savings plan under the IRS code and which provides
executive officers and paid directors the opportunity to defer the receipt of
base salary and/or bonus. The plan is effective for fiscal years beginning with
fiscal year 2000 and provides unfunded deferred compensation payments upon a
participant's retirement or termination from the Company. Participant deferrals
are credited annually with amounts based upon the prime rate (plus 450 basis
points) and with amounts replicating the Company match in the 401(k) for savings
from income above the qualified plan limits.
401(k) Plan. The Company has adopted a savings plan (the "Savings Plan"), which
is qualified under Section 401(a) and 401(k) of the Code. All regular employees
of the Company in the United States of America normally scheduled to work a
-61-
minimum of 1,000 hours per year are eligible to participate in the Savings Plan
immediately. For each employee who elects to participate in the Savings Plan and
makes a contribution thereto, the Company will make a matching contribution. The
Company matches 50.0% of the first 6.0% of compensation contributed. The maximum
contribution for any participant for any year is 60.0% of such participant's
eligible compensation, not to exceed the 401(k) plan elective deferral limit set
forth by the IRS. Contributions to the Savings Plan will be invested, as the
employee directs, in any combination of investment options.
Employment Contracts and Termination of Employment and Change-In-Control
Arrangements. Effective January 23, 1998, the Company entered into an agreement
with Michael A. McLain which covers the terms and conditions of his employment.
It contains a provision for separation benefits in the event of a change of
control or other termination not related to performance.
Pension Plans. The Company has adopted a Cash Balance Pension Plan. Under such
plan, the Company will provide participants with annual credits of 4.0% of
eligible compensation up to the Social Security Wage Base as set forth annually
by the Social Security Administration and Department of Health and Human
Services. An additional annual credit of 4.0% of eligible compensation from the
Social Security Wage Base up to the Qualified Plan Compensation Limit set forth
by the Internal Revenue Service (IRS) is provided. All balances in the accounts
of participants will be credited with interest based on the prior year's U.S.
Treasury bill rate. At retirement, participants eligible for benefits may
receive the balance standing in their account in a lump sum or as a monthly
pension having equivalent actuarial value.
Additionally, the Company has adopted a Supplemental Executive Retirement Plan,
which is a non-qualified plan under the Internal Revenue Code, and which
provides unfunded deferred compensation benefits to certain individuals whose
salary exceeds the Qualified Plan Compensation Limit set forth by the IRS.
Pursuant to the plan, participants are credited annually with amounts
representing 8% of compensation in excess of the Qualified Plan Compensation
Limit.
The following table sets forth, for the Named Executive Officers, the estimated
annual benefits payable upon retirement at normal retirement age, from both the
qualified and non-qualified pension plans assuming in each case that such
officer elects payment over time rather that in a lump sum:
Name and Principal Position Annual Benefits
Payable
- ------------------------------------------------- ------------
Michael A. McLain $ 82,672
Chief Executive Officer, President,
and Chairman of the Board of Directors
D. Garrad Warren, III $ 34,785
President, North American Safety Products Group
M. Rand Mallitz $ 25,158
Senior Vice President and General Manager,
Specialty Composites
Rahul Kapur $ 29,045
Senior Vice President, Corporate Development
and Chief Strategy Officer
James H. Floyd $ 41,119
President, Aearo Europe, Managing Director,
International
Compensation Committee Interlocks and Insider Participation
The Company has a Compensation Committee of the Board of Directors. As of
December 1, 2003, the committee consists of Messrs. Alpert and McLain, two
directors of the Company. Mr. McLain is also the Chief Executive Officer and
President of the Company as well as Chairman of the Board of Directors. This
committee makes all executive officer compensation decisions, with Mr. McLain
abstaining with respect to decisions affecting his own compensation, and submits
them to the full Board of Directors of the Company for final review and
approval.
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Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information with respect to the
beneficial ownership of Aearo Common Stock, including beneficial ownership by
each person or entity known by the Company to own beneficially 5% or more of the
Company's voting capital stock, by the Directors, the Named Executive Officers
and all of the Company's Directors and executive officers as a group as of
December 1, 2003. All of the Subsidiary's issued and outstanding capital stock
is owned by Aearo.
Name and Address of Beneficial Owner Number of Shares of Percentage of
Aearo Common Stock Outstanding
Shares
Vestar Equity Partners, L.P. (1) 42,500 71.5%
245 Park Avenue
New York, New York 10167
Norman W. Alpert (2) 42,500 71.5%
Daniel S. O'Connell (2) 42,500 71.5%
Arthur J. Nagle (2) 42,500 71.5%
Michael A. McLain 4,050 6.82%
John D. Curtin, Jr. 3,713 6.25%
Rahul Kapur 1,000 1.68%
James H. Floyd 1,000 1.68%
M. Rand Mallitz 950 1.68%
D. Garrad Warren, III 600 1.01%
Bryan P. Marsal 250 *
William E. Kassling 250 *
Directors and executive officers
as a group (15 persons)(3) 55,863 94.0%
- -------------------------------------
* Less than 1%.
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1. The general partner of Vestar is Vestar Associates L.P., a limited
partnership whose general partner is Vestar Associates Corporation
("V.A.C."). In such capacity, V.A.C. exercises sole voting and investment
power with respect to all of the shares held of record by Vestar. Messrs.
Alpert, O'Connell and Nagle, who are directors of the Company, are
affiliated with Vestar in the capacities described under "Management --
Directors and Executive Officers" and are stockholders of V.A.C.
2. Messrs. Alpert, O'Connell and Nagle are affiliated with Vestar in the
capacities described under "Directors and Executive Officers." Ownership of
Aearo Common Stock for these individuals includes 42,500 shares of Aearo
Common Stock included in the above table beneficially owned by Vestar,
although such persons believe that they do not have such beneficial
ownership. Each such person's business address is c/o Vestar Equity
Partners, L.P. at the address set forth above.
3. Vestar and the Management Investors have entered into a Stockholders'
Agreement, the terms of which are described more fully under Item 13,
"Certain Relationships and Related Transactions -- Stock Ownership and
Stockholders' Agreement." Does not include 3,550 shares of Aearo Common
Stock held by Management Investors who are not executive officers.
-64-
Item 13. Certain Relationships and Related Transactions
The Asset Transfer Agreement
The Company is a party to the 1995 Asset Transfer Agreement dated as of June 13,
1995 with Cabot and certain of its subsidiaries (including Old Cabot Safety
Corporation) (the "Asset Transfer Agreement") entered into in connection with
the Formation Acquisition. The 1995 Asset Transfer Agreement contains customary
representations, warranties and covenants. Cabot and certain of its
subsidiaries, on the one hand, and Aearo and the Subsidiary on the other, have
also agreed to indemnify and hold each other and their affiliates harmless
against certain breaches of representations or covenants and certain other
liabilities.
The Company has the right to pay an annual fee of $400,000 to Cabot , and has
elected to make this payment, with the result that Cabot and the other
subsidiaries retain responsibility and liability for, and indemnify the Company
against, certain legal claims alleged to arise out of the use of respirators
sold prior to July 11, 1995. See Item 3, Legal Proceedings, for a more detailed
discussion of the respective rights and obligations of the parties under this
arrangement.
Stock Ownership and Stockholders' Agreement
As of September 30, 2003, Vestar and its affiliates own 71.5% of the outstanding
shares of Aearo Common Stock (42,500 shares) and 100% of the outstanding shares
of Aearo Preferred Stock (22,500 shares). Management Investors and certain other
employees of the Company own 28.5% of Aearo Common Stock (16,912.5 shares).
Under a Stockholders' Agreement originally among Aearo, Vestar, Cabot and the
Management Investors, the parties agreed to various stock transfer restrictions,
as well as provisions granting certain tag-along rights, drag-along rights,
registration rights and participation rights, which are described below. Vestar
and Cabot had identical or similar rights until Cabot's rights terminated as a
result of the Cabot Stock Redemption on August 18, 2003.
Election and Removal of Directors. Prior to the Cabot Stock Redemption, the
number of directors of the Company was fixed at nine. Since that time, the
number of directors has been fixed at seven. Under the Stockholders' Agreement,
the parties agreed to vote all shares of Aearo Common Stock owned or controlled
by them so as to elect as members of the Board of Directors persons designated
as follows: (i) Vestar designates three directors so long as Vestar and its
affiliates beneficially own on a fully diluted basis at least 21,250 shares of
Aearo Common Stock (50% of the shares of Aearo Common Stock acquired by them in
the Formation Acquisition), (ii) Vestar may designate two additional directors
who are not partners, officers or employees of any of Vestar or its affiliates
so long as Vestar and its affiliates beneficially own at least 31,875 shares of
Aearo Common Stock (75% of the shares of Aearo Common Stock acquired by them in
the Formation Acquisition, and (iii) the Management Investors may designate two
directors so long as the Management Investors together own beneficially on a
fully diluted basis at least 3,750 shares of Aearo Common Stock (25% of the
shares of Aearo Common Stock acquired by all Management Investors in the
Formation Acquisition), provided that the two designees of the Management
Investors must be initial designees as of the closing date, and in the case of
subsequent designees other than the initial designees, shall be officers serving
in similar capacities. The foregoing provisions relating to the election of
directors terminate in the event that Vestar and its affiliates own on a fully
diluted basis fewer than 4,250 shares of Aearo Common Stock (10% of the shares
of Aearo Common Stock acquired by them in the Formation Acquisition). Messrs.
Alpert, O'Connell and Nagle were designated by Vestar as described in clause (i)
above, Messrs. Kassling and Marsal were designated by Vestar as described in
clause (ii) above and Mr. McLain and Mr. Curtin were designated by the
Management Investors as described in clause (iii) above. All directors can be
removed, with or without cause, and replaced by the stockholders who have the
right to designate them.
Tag-along Rights. So long as a public offering of Aearo Common Stock shall not
have occurred and subject to certain exceptions, with respect to any proposed
transfer of Aearo Common Stock or Aearo Preferred Stock by Vestar, other than
transfers to affiliates, each other stockholder will have the right to require
that the proposed transferee purchase a certain percentage of the shares owned
by such stockholder at the same price and upon the same terms and conditions.
-65-
Drag-along Rights. The Stockholders' Agreement provides that, so long as Vestar
and its affiliates beneficially own at least 21,250 shares of Aearo Common Stock
(50% of the shares of Aearo Common Stock acquired by them in the Formation
Acquisition), if Vestar receives an offer from a third party to purchase all but
not less than all outstanding shares of Aearo Common Stock and Aearo Preferred
Stock and such offer is accepted by Vestar, then each party to the Stockholders'
Agreement will transfer all shares of Aearo Common Stock and Aearo Preferred
Stock owned or controlled by such party on the terms of the offer so accepted by
Vestar, provided that all such transfers occur on substantially identical terms
and the number of shares to be acquired by the third party after giving effect
to all such transfers would be sufficient under the certificate of incorporation
and by-laws of the Company, any applicable agreements and applicable law to
permit such third party to eliminate all remaining minority interests through a
merger opposed by such minority interests. These so-called "drag-along" rights
do not apply to sales in a public offering or to stock that has been sold by a
party to the Stockholders' Agreement in a public offering or pursuant to Rule
144.
Other Voting Matters. So long as the drag-along rights are in effect, the
parties to the Stockholders' Agreement are obligated to vote all shares of Aearo
Common Stock owned or controlled by them to ratify, approve and adopt the
following actions to the extent that they are adopted and approved by the Board
of Directors: (i) any merger or consolidation involving the Company that is, in
substance, an acquisition of another Company by the Company or a sale of the
Company and in either case does not affect in any way the relative rights of
Vestar or result in any benefit to Vestar other than the benefits to it as a
stockholder of the Company equal to the benefits received by other stockholders,
share for share, and (ii) any amendment to the certificate of incorporation of
the Company whereby such amendment does not adversely affect such stockholder in
a manner different from that in which any other stockholder is affected. In
addition, so long as the voting agreements providing for the election of
directors remain in effect, the parties to the Stockholders' Agreement agreed
not to vote to approve, ratify or adopt any amendment to the by-laws of the
Company unless such amendment is expressly authorized by the Stockholders'
Agreement or recommended by the Board of Directors.
Transfers of Common Stock. Subject to certain limitations, transfers of Aearo
Common Stock and Aearo Preferred Stock by parties to the Stockholders' Agreement
are restricted unless the transferee agrees to become a party to, and be bound
by, the Stockholders' Agreement, provided that such restrictions do not apply to
sales in a public offering or pursuant to Rule 144. In addition, subject to
certain limitations, the Management Investors agreed not to transfer their
shares of Aearo Common Stock or Aearo Preferred Stock without the prior written
consent of Vestar. Under certain circumstances, the transfer of Aearo Common
Stock or Aearo Preferred Stock by Vestar and its affiliates is permitted.
Participation Rights. Under certain circumstances, if Aearo proposes to issue
any capital stock to Vestar or any of their respective affiliates, each other
stockholder shall have the opportunity to purchase such capital stock on a pro
rata basis.
Approval of Affiliate Transactions. The Stockholders' Agreement provides that
the Company shall not, and shall cause its subsidiaries not to, enter into any
transaction with any affiliate of the Company unless such transaction (i) is on
fair and reasonable terms no less favorable to the Company or such subsidiary
than it could obtain in a comparable arm's length transaction, (ii) is
contemplated by the Stockholders' Agreement, the Asset Transfer Agreement or the
Management Advisory Agreement among the Company and Vestar or (iii) is for the
payment of reasonable and customary regular fees to outside directors. In no
event will the Company issue Aearo Common Stock or other equity securities to
Vestar or any affiliate of the Company, subject to certain limitations, below
the fair market value of such shares of Aearo Common Stock or equity securities.
Registration Rights. The Stockholders' Agreement provides that, subject to
certain limitations, upon a written request by Vestar, the Company will use its
best efforts to effect the registration of all or part of the Aearo Common Stock
owned by such requesting stockholder, provided that (i) the Company will not be
required to effect more than one registration within any 360 day period and (ii)
Vestar will be entitled to request more than two registrations. Under certain
circumstances, if the Company proposes to register shares of Aearo Common Stock,
it will, upon the written request of any stockholder, use all reasonable efforts
to effect the registration of such stockholders' Aearo Common Stock.
Termination. The Stockholders' Agreement will terminate as to any Aearo Common
Stock or Aearo Preferred Stock, subject to certain limitations, on the date,
such Aearo Common Stock is sold in a public offering or pursuant to Rule 144.
The rights of Vestar will terminate under the Stockholders' Agreement when
Vestar and its affiliates own no Aearo Common Stock, common stock equivalents or
Aearo Preferred Stock.
-66-
Management Advisory Agreement.
In connection with the Formation Acquisition, the Company became a party to a
Management Advisory Agreement with Vestar and Cabot (the "Management Advisory
Agreement"), pursuant to which the Company is obligated to pay an annual
management fee in an aggregate amount with respect to each fiscal year equal to
the greater of (i) $400,000 and (ii) 1.25% of the consolidated net income of the
Company before cash interest, taxes, depreciation and amortization for such
fiscal year. Until the Cabot Stock Redemption on August 18, 2003, the fee was
shared by Cabot and Vestar based on their relative equity ownership of the
Company. Thereafter, the fee has been and will be paid solely to Vestar. These
payments totaled approximately $728,000, $519,000 and $611,000 during the years
ended September 30, 2001, 2002 and 2003, respectively. Of the $611,000 in
manegment fees paid by the Company in the year ended September 30, 2003, the
Company paid Vestar $167,000 in management fees for the interim period from
August 18, 2003 through September 30, 2003. Messrs. Alpert, O'Connell and Nagle,
three of the directors of the Company, are affiliated with Vestar in the
capacities described under Item 10, "Directors and Executive Officers" and,
accordingly, benefit from any payments received by Vestar.
Management and Director Loans.
The Company has made available to certain Management Investors loans in order to
provide such Management Investors with funds to be applied to a portion of the
purchase price of the Aearo Common Stock purchased by such Management Investors
under the Stock Purchase Plan. Such loans (i) are secured by the Aearo Common
Stock purchased with the proceeds thereof, (ii) bear interest at an annual rate
of 2.73% and (iii) are subject to mandatory prepayment in the event the
employment of such Management Investor terminates or event of maturity. At
December 1, 2003, amounts outstanding in thousands of dollars were:
Aggregate
Amount Amount
Outstanding Outstanding at Interest
Management Investors December 1, 2003 September 30, 2003 Rate
- ---------------------------- ---------------- ------------------ ---------
Michael A. McLain $ 665 $ 661 2.73%
D. Garrad (Gary) Warren, III 248 246 2.73%
Rahul Kapur 72 72 2.73%
Joseph C. Marlette 72 72 2.73%
James H. Floyd 72 72 2.73%
M. Rand Mallitz 82 81 2.73%
-67-
Item 14. Principal Accountant Fees and Services
Audit Fees
The firm of Deloitte and Touche, LLP (Deloitte) has served as the Company's
independent public accountants for each of the last three fiscal years ended
September 30, 2001, 2002 and 2003. The aggregate fees billed by Deloitte for the
audit of our financial statements included in the Annual Report on Form 10-K405
and for the review of our financial statements included in our Quarterly Reports
on Form 10-Q for the fiscal years ended September 30, 2001, 2002 and 2003 were
$221,000, $256,000 and $275,000, respectively.
Tax Fees
The aggregate fees billed by Deloitte for the tax compliance for the fiscal
years ended September 30, 2001, 2002 and 2003 were $80,000, $76,000 and $84,000,
respectively.
Other Fees
The aggregate fees billed by Deloitte for additional professional services for
the fiscal years ended September 30, 2001, 2002 and 2003 were $60,000, $132,000
and $312,000, respectively.
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PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
The following documents are filed as part of this Annual Report on Form
10-K405:
a) 1. Financial Statements:
See Index to financial statements under Item 8 on page 26 of this report.
2. Financial Statement Schedules: See Schedule II on page 70 of this
report.
3. Exhibits:
See Index of Exhibits on pages 72 to 75 hereof.
b) Current Reports on Form 8-K
On July 24, 2003, the Company filed a Current Report on Form 8-K to
announce its third quarter results of operations.
On August 18, 2003, the Company filed a Current Report on Form 8-K to
announce the Cabot Stock Redemption.
c) Exhibits
See Index of Exhibits on pages 72 to 75 hereof.
d) Financial Statement Schedule See Schedule II on page 70 of this report.
-69-
SCHEDULE II
AEARO CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
For the years ended September 30, 2001,
2002, and 2003
(Dollars in thousands)
Additions
Balance at Provisions Charged to
beginning of Charged to Other Net Deductions Balance at
Period Operations Accounts From Allowances end of Period
------------- ---------- ---------- ---------------- -------------
Year ended September 30, 2001
Bad Debt Reserve 1,354 450 -- (973) 831
Year ended September 30, 2002
Bad Debt Reserve 831 999 -- (306) 1,524
Year ended September 30, 2003
Bad Debt Reserve 1,524 243 -- (409) 1,358
-70-
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.
Aearo Corporation
Date: December 22, 2003 By: /s/ Michael A. McLain
---------------------
Michael A. McLain
Chief Executive Officer,
President, and Chairman
of the Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Date: December 22, 2003 /s/ Michael A. McLain
---------------------
Michael A. McLain
President, Chief Executive
Officer and Chairman
(Principal Executive Officer)
Date: December 22, 2003 /s/ Jeffrey S. Kulka
--------------------
Jeffrey S. Kulka
Senior Vice President,
Chief Financial Officer,
Treasurer and Secretary
/s/ John D. Curtin, Jr.*
------------------------
John D. Curtin, Jr., Director
/s/ Norman W. Alpert*
---------------------
Norman W. Alpert, Director
/s/ Arthur J. Nagle*
--------------------
Arthur J. Nagle, Director
/s/ Daniel S. O'Connell*
------------------------
Daniel S. O'Connell, Director
/s/ William Kassling*
---------------------
William Kassling, Director
/s/ Bryan Marsal*
-----------------
Bryan Marsal, Director
*By Michael A. McLain, as attorney-in-fact under a Power of Attorney executed by
the Directors listed above, which Power of Attorney is being filed with the
Securities and Exchange Commission as an exhibit hereto.
Date: December 22, 2003 /s/ Michael A. McLain
----------------------
Michael A. McLain
Attorney-In-Fact
-71-
INDEX OF EXHIBITS
Exhibit
Number Description
2.1 Asset Transfer Agreement, dated as of June 13, 1995, among Aearo
Company (formerly, Cabot Safety Corporation), Cabot Canada Ltd., Cabot
Safety Limited, Cabot Corporation, Aearo Corporation (formerly, Cabot
Safety Holdings Corporation), and Cabot Safety Acquisition
Corporation. (Incorporated by reference to Exhibit No. 2.1 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company and
Aearo Corporation.)
2.2 Trademark Coexistence Agreement, dated July 11, 1995, between Cabot
Corporation and Cabot Safety Intermediate Corporation. (Incorporated
by reference to Exhibit No. 2.2 to the Registration Statement on Form
S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety
Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings
Corporation).)
2.4 Stockholders' Agreement, dated as of July 11, 1995, among Vestar
Equity Partners, L.P., Cabot CSC Corporation, Aearo Corporation
(formerly, Cabot Safety Holdings Corporation), Cabot Corporation, and
the Management Investors. (Incorporated by reference to Exhibit No.
2.4 to the Registration Statement on Form S-4, No. 33-96190, of Aearo
Company (formerly, Cabot Safety Corporation) and Aearo Corporation.)
2.7 Assignment and Assumption Agreement, dated as of July 11, 1995, by and
between Aearo Corporation (formerly, Cabot Safety Holdings
Corporation), Cabot Safety Acquisition Corporation and Cabot Safety
Intermediate Corporation. (Incorporated by reference to Exhibit No.
2.7 to the Registration Statement on Form S-4, No. 33-96190, of Aearo
Company (formerly, Cabot Safety Corporation) and Aearo Corporation.)
2.8 Assignment and Assumption Agreement, dated as of July 11, 1995, by and
between Aearo Corporation (formerly, Cabot Safety Holdings
Corporation), Cabot Safety Acquisition Corporation and Cabot Safety
Acquisition Limited (UK). (Incorporated by reference to Exhibit No.
2.8 to the Registration Statement on Form S-4, No. 33-96190, of Aearo
Company (formerly, Cabot Safety Corporation) and Aearo Corporation.)
2.9 Assignment and Assumption Agreement, dated as of July 11, 1995, by and
between Aearo Corporation (formerly, Cabot Safety Holdings
Corporation), Cabot Safety Acquisition Corporation and Cabot Safety
Canada Acquisition Ltd. (Canada). (Incorporated by reference to
Exhibit No. 2.9 to the Registration Statement on Form S-4, No.
33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and
Aearo Corporation.)
2.10 Bill of Sale and Assignment, dated as of July 11, 1995, made by Aearo
Company (formerly, Cabot Safety Corporation), Cabot Canada Ltd., and
Cabot Safety Limited in favor of Aearo Corporation (formerly, Cabot
Safety Holdings Corporation), Cabot Safety Acquisition Corporation,
Cabot Safety Intermediate Corporation, Cabot Safety Acquisition
Limited and Cabot Safety Canada Acquisition Ltd. (Incorporated by
reference to Exhibit No. 2.10 to the Registration Statement on Form
S-4, No. 33-96190, of Aearo Company and Aearo Corporation.)
2.11 Assumption Agreement dated as of July 11, 1995, by Aearo Corporation
(formerly, Cabot Safety Holdings Corporation), Cabot Safety
Acquisition Corporation, Cabot Intermediate Corporation, Cabot Safety
Acquisition Limited and Cabot Safety Canada Acquisition Ltd. in favor
of Cabot Corporation, Aearo Company (formerly, Cabot Safety
Corporation), Cabot Canada Ltd. and Cabot Safety Limited.
(Incorporated by reference to Exhibit No. 2.11 to the Registration
Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo
Corporation.)
2.12 Worldwide Trademark Assignment dated July 11, 1995, by Aearo Company
(formerly, Cabot Safety Corporation) to Cabot Safety Intermediate
Corporation. (Incorporated by reference to Exhibit No. 2.12 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company and
Aearo Corporation (formerly, Cabot Safety Holdings Corporation).)
-72-
2.13 Worldwide Copyright Assignment dated July 11, 1995, by Aearo Company
(formerly, Cabot Safety Corporation) to Cabot Safety Intermediate
Corporation. (Incorporated by reference to Exhibit No. 2.13 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company and
Aearo Corporation (formerly, Cabot Safety Holdings Corporation).)
2.14 Worldwide Patent Assignment dated July 11, 1995, by Aearo Company
(formerly, Cabot Safety Corporation) to Cabot Safety Intermediate
Corporation. (Incorporated by reference to Exhibit No. 2.14 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company and
Aearo Corporation (formerly, Cabot Safety Holdings Corporation).)
2.15 Management Advisory Agreement made as of July 11, 1995, among Aearo
Company (formerly, Cabot Safety Corporation), Aearo Corporation
(formerly, Cabot Safety Holdings Corporation), Certain Subsidiaries of
Aearo Corporation, Vestar Capital Partners and Cabot Corporation.
(Incorporated by reference to Exhibit No. 2.15 to the Registration
Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo
Corporation.)
2.21* Amendment to Stockholder's Agreement dated as of July 3, 1996, by and
among Vestar Equity Partners, L.P., Cabot CSC Corporation, Aearo
Corporation (formerly, Cabot Safety Holdings Corporation) Cabot
Corporation, and certain other stockholders of Aearo Corporation.
3.3** Certificate of Amendment of Amended and Restated Certificate of
Incorporation of Cabot Safety Holdings Corporation dated May 29, 1996
3.4** Certificate of Incorporation of Aearo Corporation as Amended through
May 29, 1996
3.5** Aearo Corporation By-Laws as Amended through May 29, 1996
4.1 Indenture dated as of July 11, 1995 between Aearo Company (formerly,
Cabot Safety Corporation), Aearo Corporation (formerly, Cabot Safety
Holdings Corporation), and Fleet National Bank of Connecticut
(formerly, Shawmut Bank Connecticut, National Association), as
Trustee. (Incorporated by reference to Exhibit No. 4.1 to the
Registration Statement on Form S-4, No. 33-96190, of Aearo Company and
Aearo Corporation.)
4.3 Form of Exchange Note. (Incorporated by reference to Exhibit No. 4.3
to the Registration Statement on Form S-4, No. 33-96190, of Aearo
Company (formerly, Cabot Safety Corporation) and Aearo Corporation
(formerly, Cabot Safety Holdings Corporation).)
4.5 First Supplemental Indenture dated December 6, 1995. (Incorporated by
reference to Exhibit No. 4.5 to the Annual Report on Form 10-K of
Aearo Corporation (formerly, Cabot Safety Holdings Corporation) for
the fiscal year ended September 30, 1995.)
10.2* Amended and Restated US Pledge Agreement dated as of July 11, 1995, as
made by Cabot Safety Acquisition Corporation, Aearo Corporation
(formerly, Cabot Safety Holdings Corporation), Cabot Safety
Intermediate Corporation and CSC FSC, Inc., in favor of Bankers Trust
Company as Collateral Agent for the Benefit of the Secured Creditors.
10.3* Amended and Restated Foreign Pledge Agreement as of July 11, 1995,
amended and restated as of May 30, 1996, made by Cabot Safety Canada
Acquisition Limited and Cabot Safety Acquisition Limited in favor of
Bankers Trust Company as Collateral Agent for the Benefit of the
Secured Creditors.
10.5* Amended and Restated US Security Agreement dated as of July 11, 1995,
as amended and restated as of May 30, 1996, among Aearo Corporation
(formerly, Cabot Safety Holdings Corporation), Cabot Safety
Acquisition Corporation, Cabot Safety Intermediate Corporation, CSC
FSC, Inc., and Bankers Trust Company as Collateral Agent for the
Benefit of the Secured Creditors.
10.6* Amended and Restated Canadian Security Agreement dated as of July 11,
1995, as amended and restated as of May 30, 1996, granted by Cabot
Safety Canada Acquisition Limited in favor of Bankers Trust Company as
Collateral Agent for the Benefit of the Secured Creditors.
10.16* Aearo Corporation (formerly, Cabot Safety Holdings Corporation)
Amended and Restated 1995 Employee and Non-Employee Director Stock
Purchase Plan. (M)
10.17* Form of Executive Security Purchase Agreement. (M)
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10.18* Aearo Corporation (formerly, Cabot Safety Holdings Corporation)
Executive Stock Option Plan, adopted June 26, 1996. (M)
10.19* Amended and Restated US Subsidiary Guaranty dated July 11, 1995
delivered by Cabot Safety Intermediate Corporation, CSC FSC, Inc. and
Eastern Safety Equipment Co., Inc. in favor of Bankers Trust Company.
10.25* Amended and Restated US Subsidiary Guaranty dated July 11, 1995 as
amended and restated as of May 30, 1996, delivered by Cabot Safety
Intermediate Corporation, CSC FSC, Inc. and Eastern Safety Equipment
Co., Inc. in favor of Bankers Trust Company.
10.27 Aearo Corporation 1997 Stock Option Plan (incorporated by reference to
the same numbered exhibit of the Company's Annual Report on 1998 10-K
for the year ended September 30, 1998), adopted June 3, 1997. (M)
10.29 Credit Agreement dated July 11, 1995, and Amended and Restated as of
July 13, 2001 (incorporated by reference to the same numbered exhibit
of the Company's Quarterly Report on Form 10-Q for the quarterly
period ending June 30, 2001).
10.30 First Amendment to the Amended and Restated Credit Agreement as of
July 13, 2001, dated October 17, 2001 (incorporated by reference to
the same numbered exhibit of the Company's Quarterly Report on Form
10-Q for the quarterly period ending December 31, 2001).
10.31 Employment Agreement between the Company and Michael A. McLain
(incorporated by reference to Exhibit 10.1 of the Company's Quarterly
Report on Form 10-Q for the Quarterly period ending March 31, 1998).
(M)
10.32** Form of Executive Security Purchase Agreement Investor Note. (M)
10.33** Form of Pledge and Security Agreement related to Executive Security
Purchase Agreement Investor Note. (M)
10.34** Form of Amendment No. 1 to Executive Security Purchase Agreement
Investor Note, effective 2002. (M)
10.35** Summary of Management Incentive Plan for Executives other than the
CEO. (M)
10.36** Summary of Management Incentive Plan for the CEO. (M)
10.37** Nonqualified Deferred Compensation Plan, effective August 5, 1999. (M)
10.38** Summary of Executive Supplemental Severance Pay Policy, as in effect
December 1, 2002. (M)
10.39** Supplemental Executive Retirement Plan, revised January 1, 1999. (M)
10.40 Stock Purchase Agreement, dated June 27, 2003, between Aearo
Corporation, Cabot Corporation and Cabot CSC Corporation, a wholly
owned subsidiary of Cabot Corporation (incorporated by reference to
the same numbered exhibit of the Company's Current Report on Foam 8-K
dated August 18, 2003).
10.41 Second Amendment to the Amended and Restated Credit Agreement as of
July 13, 2001, dated August 15, 2003 (incorporated by reference to the
same numbered exhibit of the Company's Current Report on Foam 8-K
dated August 18, 2003).
10.42 Note Purchase Agreement, dated August 18, 2003, for $15,000,000 of
Senior Subordinated Notes due July 15, 2005 (incorporated by reference
to the same numbered exhibit of the Company's Current Report on Foam
8-K dated August 18, 2003).
10.43+ Promissory Note, Indenture of Mortgage and Assignment of Rents and
Leases, each dated April 16, 1991, pertaining to a loan to Cabot
Safety Corporation by American United Life Insurance Company
10.44+ Assignment and Assumption Agreement, dated April 11, 1995, between
Cabot Safety Corporation and Cabot Safety Acquisition Corporation
(currently Aearo Company) for Assignment of Rents and Leases to
American United Life Insurance Company
10.45+ Assignment and Assumption Agreement, dated April 11, 1995, between
Cabot Safety Corporation and Cabot Safety Acquisition Corporation
(currently Aearo Company) for Indenture of Mortgage to American United
Life Insurance Company
10.46+ Summary of Phantom Equity Program (M)
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12.1+ Statements re: Computation of Ratios.
14.1+ Code of Ethics
21.1+ List of Subsidiaries.
24.1+ Powers of Attorney (see page 71 of this report).
31.1+ Certification of Principal Executive Officer
31.2+ Certification of Principal Financial Officer
* Incorporated by reference to the same numbered exhibit to the registration
statement on Form S-l, No. 333-05047, of Aearo Corporation (formerly, Cabot
Safety Holdings Corporation).
** Incorporated by reference to the same numbered exhibit of the Company's
Annual Report on Form 10-K dated September 30, 2002.
+ Filed herewith.
(M) Identifies management contract or compensatory plan.
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