1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2000
Commission file number 33-96190
AEARO CORPORATION
(Exact name of registrant as specified in its charter)
--------------------
Delaware 13-3840450
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5457 West 79th Street
Indianapolis, Indiana 46268
(Address of principal executive offices) (Zip Code)
(317) 692-6666
(Registrant's telephone number, including area code)
--------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
The number of shares of the registrant's common stock, par value $.01
per share, outstanding as of February 13, 2001 ws 102,087.5.
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AEARO CORPORATION
TABLE OF CONTENTS
FORM 10-Q FOR THE QUARTERLY PERIOD
ENDED DECEMBER 31, 2000
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF
DECEMBER 31, 2000 (UNAUDITED) AND SEPTEMBER 30, 2000 3-4
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
FOR THE THREE MONTHS ENDED DECEMBER 31, 2000 AND 1999 5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) FOR THE THREE MONTHS ENDED DECEMBER 31, 2000
AND 1999 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) 7-12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 13-17
ITEM 3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK 18
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 19
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 19
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 19
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS 19
ITEM 5. OTHER INFORMATION 19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 20
SIGNATURE PAGE 21
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PART I
ITEM 1. FINANCIAL STATEMENTS
AEARO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS--ASSETS
(DOLLARS IN THOUSANDS)
DECEMBER 31, SEPTEMBER 30,
2000 2000
------------ -----------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 3,917 $ 3,495
Accounts receivable (net of reserve for doubtful
accounts of $1,111 and $1,354, respectively) 40,659 44,342
Inventories 35,025 34,310
Deferred and prepaid expenses 3,036 2,623
------------ -----------
Total current assets 82,637 84,770
------------ -----------
PROPERTY, PLANT AND EQUIPMENT, NET 52,389 53,163
INTANGIBLE ASSETS, NET 125,929 126,242
OTHER ASSETS 2,636 2,691
------------ -----------
Total assets $ 263,591 $ 266,866
============ ===========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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AEARO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS--LIABILITIES AND STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
DECEMBER 31, SEPTEMBER 30,
2000 2000
-------------- -----------
(Unaudited)
CURRENT LIABILITIES:
Current portion of long-term debt $ 20,733 $ 19,313
Accounts payable and accrued liabilities 36,101 39,427
Accrued interest 6,512 3,423
U.S. and foreign income taxes 5,145 5,375
---------- -----------
Total current liabilities 68,491 67,538
---------- -----------
LONG-TERM DEBT 178,780 180,506
DEFERRED INCOME TAXES 435 507
OTHER LIABILITIES 2,450 2,466
---------- -----------
Total liabilities $ 250,156 $ 251,017
---------- -----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value-
(Redemption value of $90,066 and $87,237, respectively)
Authorized--200,000 shares
Issued and outstanding--45,000 shares -- --
Common stock, $.01 par value-
Authorized--200,000 shares
Issued and outstanding--102,088 at December 31, 2000 and
September 30, 2000 1 1
Additional paid-in capital 32,193 32,213
Accumulated deficit (3,001) (614)
Accumulated other comprehensive income (15,758) (15,751)
---------- -----------
Total stockholders' equity 13,435 15,849
---------- -----------
Total liabilities and stockholders' equity $ 263,591 $ 266,866
========== ===========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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AEARO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(Unaudited)
FOR THE THREE MONTHS ENDED
DECEMBER 31,
--------------------------------
2000 1999
----------- -----------
NET SALES $ 68,269 $ 72,194
COST OF SALES 37,753 38,648
----------- -----------
Gross profit 30,516 33,546
SELLING AND ADMINISTRATIVE 23,887 23,608
RESEARCH AND TECHNICAL SERVICES 1,484 1,327
AMORTIZATION OF INTANGIBLES 1,655 1,725
OTHER (INCOME) CHARGES, NET 9 (35)
----------- ------------
Operating income 3,481 6,921
INTEREST EXPENSE, NET 5,801 5,947
----------- -----------
Income (loss) before provision for income taxes (2,320) 974
PROVISION FOR INCOME TAXES 67 301
----------- -----------
Net income (loss) (2,387) 673
PREFERRED STOCK DIVIDEND ACCRUED 2,829 2,492
----------- -----------
Net loss available to Common Shareholders $ (5,216) $ (1,819)
============ ============
AVERAGE COMMON AND DILUTED COMMON SHARES OUTSTANDING
102,088 102,538
============ ===========
BASIC AND DILUTED NET LOSS PER COMMON SHARE $ (51.09) $ (17.74)
============ ===========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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AEARO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(Unaudited)
FOR THE THREE MONTHS ENDED
DECEMBER 31,
--------------------------
2000 1999
---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(2,387) $ 673
Adjustments to reconcile net income (loss) to cash provided by operating
activities-
Depreciation 2,529 2,440
Amortization of intangible assets and deferred financing costs 1,988 2,202
Deferred income taxes (75) 28
Other, net 16 7
Changes in assets and liabilities-
Accounts receivable 3,131 2,715
Inventories (1,454) (3,796)
Accounts payable and accrued liabilities 367 805
Other, net (680) 303
------- -------
Net cash provided by operating activities 3,435 5,377
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (1,595) (1,937)
Cash paid for Norhammer -- (3,620)
Proceeds provided by disposals of property, plant and equipment 33 10
------- -------
Net cash used by investing activities (1,562) (5,547)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from revolving credit facility, net 3,700 5,250
Repayment of term loans (4,409) (3,627)
Proceeds (Repayment) of long-term debt 30 (122)
Issuance of shareholder notes, net (20) (18)
------- -------
Net cash provided (used) by financing activities (699) 1,483
------- -------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (752) (1,177)
------- -------
INCREASE IN CASH AND CASH EQUIVALENTS 422 136
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 3,495 4,050
------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,917 $ 4,186
======= =======
CASH PAID FOR:
Interest $ 2,423 $ 2,285
======= =======
Income taxes $ 433 $ 331
======= =======
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
(UNAUDITED)
(1) CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments necessary to
present fairly, in accordance with accounting principles generally
accepted in the United States, the Company's financial position, results
of operations and cash flows for the interim periods presented. The
results of operations for the interim periods shown in this report are
not necessarily indicative of results for any future interim period or
for the entire year. These condensed consolidated financial statements do
not include all disclosures associated with annual financial statements
and accordingly should be read in conjunction with the consolidated
financial statements and notes thereto included in the Company's Annual
Report on Form 10-K.
(2) FORMATION ACQUISITION AND FINANCING
Aearo Corporation, a Delaware corporation, and its direct wholly owned
subsidiary, Aearo Company, a Delaware corporation (collectively referred
to herein as "the Company") manufactures and sells products under the
brand names: AOSafety(R), E-A-R(R), and Peltor(R). These products are
sold through three reportable segments which are Safety Products, Safety
Prescription Eyewear and Specialty Composites.
Aearo Corporation was formed by Vestar Equity Partners, L.P. (Vestar) in
June 1995 to effect the acquisition of substantially all of the assets
and liabilities of Cabot Safety Corporation and certain affiliates (the
Predecessor) all of which were wholly owned by Cabot Corporation (Cabot),
(the Formation Acquisition). The Formation Acquisition closed on July 11,
1995, when Aearo Corporation acquired substantially all of the assets and
certain liabilities of the Predecessor for cash, preferred stock and a
42.5% common equity interest in Aearo Corporation. Aearo Corporation
immediately contributed the acquired assets and liabilities to Aearo
Company, a wholly owned subsidiary of Aearo Corporation, pursuant to an
asset transfer agreement dated June 13, 1995. Aearo Corporation has no
other material assets, liabilities or operations other than those that
result from its ownership of the common stock of Aearo Company.
The Formation Acquisition has been accounted for as a purchase
transaction effective as of July 11, 1995, in accordance with Accounting
Principles Board Opinion No. 16, Business Combinations, and EITF Issue
No. 88-16, Basis in Leveraged Buyout Transactions, and accordingly, the
consolidated financial statements for the periods subsequent to July 11,
1995 reflect the purchase price, including transaction costs, allocated
to tangible and intangible assets acquired and liabilities assumed, based
on a portion of their estimated fair values as of July 11, 1995. The
valuation of assets and liabilities acquired reflect carryover basis for
the percentage ownership retained by Cabot.
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AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
(UNAUDITED)
(3) SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates. The preparation of the consolidated financial
statements in conformity with accounting principles generally accepted in
the United States 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 condensed
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 period financial
statements may have been reclassified to conform to the current period
presentation. These reclassifications have no impact on net operating
results previously reported.
Revenue Recognition. The Company recognizes revenue upon shipment of its
product to customers, at which time title of ownership transfers to the
buyer.
Foreign Currency Translation. Assets and liabilities of the Company's
foreign operations are translated at period-end exchange rates. Income
and expenses are translated at the approximate average rate during the
period. Foreign currency translation adjustments are recorded as a
separate component of stockholders' equity. Foreign currency gains and
losses arising from transactions by any of the Company's subsidiaries are
reflected in net income.
Income Taxes. Deferred tax assets and liabilities are determined based on
the difference between the financial statement and tax basis of assets
and liabilities using currently enacted tax rates.
Intangible Assets. Intangible assets consist primarily of goodwill,
patents and trademarks purchased in business acquisitions. Intangible
assets are amortized over their estimated useful lives.
Loss per Common Share. Basic loss per common share is computed by
dividing net loss by the weighted average number of shares of common
stock outstanding during the period. Diluted loss per share reflects the
potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted. Potentially dilutive
securities consisted of stock options. As of December 31, 2000 and 1999,
there were 11,283 and 9,883 options outstanding, respectively. The stock
options were not dilutive and were not included in the diluted loss per
share calculation for the three months ended December 31, 2000 and 1999.
Basic and diluted loss per common share for the three months ended
December 31, 2000 and 1999, were equal; therefore, no reconciliation
between basic and diluted loss per share is required.
Accounting for Derivative Instruments and Hedging Activities. The Company
adopted the provisions of Statement of Financial Accounting Standards
(SFAS) No. 133, Accounting for Derivative Instruments and Hedging
Activities on October 1, 2000. SFAS No. 133 requires that every
derivative instrument be recorded in the balance sheet as either an asset
or a liability measured at its fair value. The adoption of SFAS No. 133
on October 1, 2000 resulted in a $0.4 million transition adjustment
charge to accumulated other comprehensive income to recognize the fair
value of all derivatives that are designated as cash flow hedges.
The Company has formally documented its hedging relationships, including
identification of the hedging instruments and the hedge items, as well as
its risk management objectives and strategies for undertaking each hedge
transaction. The Company has foreign currency exchange contracts and
interest rate swap agreements, which are derivatives as defined by SFAS
No. 133. The Company enters into foreign currency
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AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
(UNAUDITED)
forward contracts to mitigate the effects of changes in foreign currency
rates on profitability and enters into interest rate swap agreements to
hedge their variable interest rate risk. These derivatives are cash flow
hedges. For all qualifying and highly effective cash flow hedges, the
changes in the fair value of the derivatives are recorded in other
comprehensive income. Amounts accumulated in other comprehensive income
will be reclassified as earnings when the related product sales affect
earnings for forward currency contracts or when related interest payments
affect earnings for interest rate swaps. As a result of the foreign
currency forward contracts and the interest rate swap agreements, the
Company has recorded a derivative liability of $1.7 million at December
31, 2000. All forward contracts and swap agreements will expire over the
next 9 months.
During the period ending December 31, 2000 the Company reclassified into
earnings a net gain of approximately $89,000 resulting from the exercise
of foreign currency contracts and a net loss of $16,000 resulting from
interest rate swap settlements. All foreign currency contracts and
interest rate swap agreements were determined to be highly effective
whereby no ineffectiveness was recorded in earnings.
The Company also executes foreign currency contracts for up to 30 day
terms to protect against the adverse effects that exchange rate
fluctuations may have on the foreign-currency-denominated trade
activities (receivables, payables and cash) of foreign subsidiaries.
These contracts have not been designated as hedges under SFAS No. 133,
accordingly, the gains and losses on both the derivative and
foreign-currency-denominated trade activities are recorded as transaction
adjustments in current earnings. The impact on earnings was a loss of
approximately $104,000 for the quarter ended December 31, 2000.
(4) COMPREHENSIVE INCOME
Comprehensive income consisted of the following (dollars in thousands):
THREE MONTHS ENDED
DECEMBER 31,
---------------------------
2000 1999
----------- ----------
(unaudited) (unaudited)
Net income (loss) $ (2,387) $ 673
Foreign currency translation adjustment 1,694 (2,800)
Unrealized losses on derivative
instruments (1,701) --
----------- ----------
Comprehensive income (loss) $ (2,394) $ (2,127)
=========== ==========
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AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
(UNAUDITED)
(5) INVENTORIES
Inventories consisted of the following (dollars in thousands):
DECEMBER 31, SEPTEMBER 30,
2000 2000
----------- ----------
(unaudited)
Raw materials $ 8,600 $ 8,246
Work in process 8,750 7,662
Finished goods 17,675 18,402
---------- ----------
$ 35,025 $ 34,310
========== ==========
Inventories, which include materials, labor and manufacturing overhead,
are stated at the lower of cost or market, cost being determined using
the first-in, first-out method.
(6) DEBT
The Company's debt structure includes $100.0 million of Senior
Subordinated Notes (Notes) due 2005, as well as a senior bank facility
comprised of (i) term loans denominated in U.S., Canadian, British, and
German currencies (Term Loans) and (ii) a secured revolving credit
facility (Revolving Credit Facility) providing for up to $25.0 million of
revolving loans, a portion of which is to be used for general corporate
purposes, and as to $15.0 million thereof, to finance permitted
acquisitions (collectively the Senior Bank Facilities). Under the terms
of both the Senior Bank Facilities and the Notes indenture, Aearo Company
is required to comply with certain financial covenants and restrictions.
On December 14, 2000, the Senior Bank Facilities were amended to increase
the amount available to finance acquisitions from $15.0 million to $33.0
million and to modify certain financial covenants for periods ending on
and after December 31, 2000. Aearo Company was in compliance with all
financial covenants and restrictions at December 31, 2000. The amounts
outstanding on the term loans and the revolving credit facility at
December 31, 2000 were approximately $83.0 million and $13.7 million,
respectively.
(7) COMMITMENTS AND CONTINGENCIES
Lease Commitments. The Company leases certain transportation vehicles,
warehouse facilities, office space, and machinery and equipment under
cancelable and non-cancelable leases, most of which expire within 10
years and may be renewed by the Company.
Contingencies. Various lawsuits and claims arise against the Company in
the ordinary course of its business. Most of these lawsuits and claims
relate to the Company's safety eyewear and respiratory product lines and
primarily involve accidents and/or exposures occurring after the
Company's predecessor acquired the AOSafety(R) Division from American
Optical Corporation in April 1990. The Company is contingently liable
with respect to numerous lawsuits involving respirators sold by American
Optical Corporation prior to the acquisition of the AOSafety(R) Division
in April 1990. These lawsuits typically involve plaintiffs alleging that
they suffer from asbestosis or silicosis, and that such condition results
in part from respirators which were negligently designed or manufactured.
The defendants in these lawsuits are often numerous, and
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AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
(UNAUDITED)
include, in addition to respirator manufacturers, employers of the
plaintiffs and manufacturers of sand (used in sand blasting) and
asbestos. Responsibility for legal costs, as well as for settlements and
judgments, is shared contractually by the Company, American Optical
Corporation and a prior owner of American Optical Corporation. The
Company and Cabot have entered into an arrangement relating to certain
respirator claims asserted after July 11, 1995 (the date of the Company's
formation) whereby, so long as the Company pays to Cabot an annual fee of
$400,000, which the Company has elected to pay, Cabot will retain
responsibility and liability for, and indemnify the Company against,
certain legal claims alleged to arise out of the use of respirators
manufactured prior to July 1995. The Company has the right to discontinue
the payment of such annual fee at any time, in which case the Company
will assume responsibility for and indemnify Cabot with respect to such
claims however, management intends to continue the annual payment of
$400,000 to Cabot.
At December 31, 2000 and September 30, 2000 the Company has reserved
approximately $4.5 million and $4.6 million, respectively, for
liabilities arising from asbestosis or silicosis litigation. The reserve
is re-evaluated periodically and may result in additional charges to
operations if additional information becomes available. However, it is
management's opinion, taking into account currently available
information, uncertainties, the Cabot agreement, and the Company's
reserve, that these suits and claims should not result in final
judgments or settlements that, in the aggregate, would have a material
effect on the Company's financial condition or results of operation.
As part of a trademark dispute with Moldex-Metric, Inc. involving the
Company's "Yellow Neon Blasts"(TM) polyurethane earplugs, a federal
district court in Southern California issued a preliminary injunction in
October, 2000 that required the Company to immediately withdraw the
current version of "Yellow Neon Blasts"(TM) polyurethane earplugs from
the U.S. market, and to also advise its distributors to withdraw this
product from the market, until the trademark issue could be resolved. In
accordance with this ruling, the Company ceased manufacturing and
distributing "Yellow Neon Blasts"(TM). The Company appealed the
preliminary injunction and the court granted a stay of the injunction
pending appeal to the Ninth Circuit. "Yellow Neon Blasts"(TM) was
introduced approximately one year ago as part of the Company's new line
of polyurethane earplugs called E-A-Rsoft(TM). Over the twelve months
prior to October 2000, "Yellow Neon Blasts"(TM) had accounted for
approximately $1 million of the Company's U.S. sales (the trademark
dispute and the preliminary injunction do not include the E-A-Rsoft(TM)
"Yellow Neons"(TM) solidly colored earplugs or any other Company
products). In December, 2000 the Company reached a non-cash settlement
with Moldex-Metric, Inc. whereby the "Yellow Neon Blasts"(TM) would be
taken off the market in the U.S. and Canada. In the opinion of
management, this will not have a material impact on operations.
(8) SEGMENT REPORTING
The Company manufactures and sells products under the brand names:
AOSafety(R), E-A-R(R), and Peltor(R). These products are sold through
three reportable segments, which are Safety Products, Safety Prescription
Eyewear and Specialty Composites. The Safety Products segment
manufactures and sells hearing protection devices, non-prescription
safety eyewear, face shields, reusable and disposable respirators, hard
hats and first aid kits. The Safety Prescription Eyewear segment
manufactures and sells prescription eyewear products that are designed to
protect the eyes from the typical hazards encountered in the industrial
work environment. The Company's Safety Prescription Eyewear segment
purchases component parts (lenses and the majority of its frames) from
various suppliers, grinds, shapes and applies coatings to the lenses in
accordance with the customer's prescription, and then assembles the
glasses using the customer's choice of frame. The Specialty Composites
segment manufactures a wide array of energy-absorbing materials that are
incorporated into other manufacturers' products to control noise,
vibration and shock.
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AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
(UNAUDITED)
NET SALES BY BUSINESS SEGMENT (DOLLARS IN THOUSANDS):
THREE MONTHS ENDED
DECEMBER 31,
-----------------------------
2000 1999
----------- -----------
(unaudited) (unaudited)
Safety Products $ 49,123 $ 51,674
Safety Prescription Eyewear 8,941 9,028
Specialty Composites 10,205 11,492
---------- ----------
TOTAL $ 68,269 $ 72,194
========== ==========
Inter-segment sales of the Specialty Composites segment to the Safety
Products segment totaled $1.1 million for the three months ended December
31, 2000 and 1999. The inter-segment sales value is determined at fully
absorbed inventory cost at standard rates plus 25%.
EBITDA BY BUSINESS SEGMENT AND RECONCILIATION TO INCOME (LOSS) BEFORE
PROVISION FOR INCOME TAXES (DOLLARS IN THOUSANDS)
THREE MONTHS ENDED
DECEMBER 31
---------------------------
2000 1999
----------- ----------
(unaudited) (unaudited)
Safety Products $ 6,559 $ 9,985
Safety Prescription Eyewear -- 540
Specialty Composites 598 1,035
Reconciling Items 502 (459)
---------- ----------
Total EBITDA 7,659 11,101
Depreciation 2,529 2,440
Amortization 1,655 1,725
Non-operating Costs (6) 15
Interest 5,801 5,947
---------- ----------
Income (loss) before provision for
income taxes $ (2,320) $ 974
========== ==========
EBITDA is defined by the Company as earnings before interest, taxes,
depreciation, amortization, and non-operating income or expense.
Non-operating income or expense is further defined as extraordinary gains
or losses, or gains or losses from sales of assets other than in the
ordinary course of business. While the Company believes EBITDA is a
useful indicator of its ability to service debt, EBITDA should not be
considered as a substitute for net income (loss) determined in accordance
with accounting principles generally accepted in the United States as an
indicator of operating performance or as an alternative to cash flow as a
measure of liquidity. Investors should be aware that EBITDA as presented
above may not be comparable to similarly titled measures presented by
other companies and comparisons could be misleading unless all companies
and analysts calculate this measure in the same fashion.
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AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000
(UNAUDITED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements of the Company, including notes thereto. 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.
2000 COMPARED TO 1999 RESULTS
THREE MONTHS ENDED DECEMBER 31
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended Three Months Ended Change - Favorable
--------------------------- -------------------------- (Unfavorable)
December 31, Percent of December 31, Percent of ---------------------
2000 Net Sales 1999 Net Sales Amount Percent
----------- --------- ------------ ---------- --------- -------
Net Sales
Safety Products $ 49,123 72.0 $ 51,674 71.6 $ (2,551) (4.9)
Safety Prescription Eyewear 8,941 13.1 9,028 12.5 (87) (1.0)
Specialty Composites 10,205 14.9 11,492 15.9 (1,287) (11.2)
--------- ------- ---------- ------- ---------
Total net sales 68,269 100.0 72,194 100.0 (3,925) (5.4)
Cost of Sales 37,753 55.3 38,648 53.5 895 2.3
--------- ------- ---------- ------- --------
Gross profit 30,516 44.7 33,546 46.5 (3,030) (9.0)
Operating Expenses-
Selling and administrative 23,887 35.0 23,608 32.7 (279) (1.2)
Research and technical services 1,484 2.2 1,327 1.8 (157) (11.8)
Amortization of intangibles 1,655 2.4 1,725 2.4 70 4.1
Other (income) charges, net 9 -- (35) -- 44 --
--------- ------- --------- ------- -------- ------
Operating income 3,481 5.1 6,921 9.6 (3,440) (49.7)
Interest expense, net 5,801 8.5 5,947 8.2 146 2.5
--------- ------- --------- ------- -------- ------
Income (loss) before provision for
income taxes (2,320) (3.4) 974 1.3 (3,294) --
Provision for income
taxes 67 0.1 301 0.4 234 77.7
--------- ------- --------- ------- --------
Net income (loss) (2,387) (3.5) 673 0.9 (3,060) --
Preferred stock dividend accrued 2,829 4.1 2,492 3.5 (337) (13.5)
--------- ------- --------- ------- --------
Net loss applicable to
common shareholders $ (5,216) (7.6) $ (1,819) (2.5) $ (3,397) --
========= ======= ========= ======= ========
Basic and diluted net loss per
common share $ (51.09) $ (17.74) $ (33.35) --
========= ========= ========
EBITDA $ 7,659 11.2 $ 11,101 15.4 $ (3,442) (31.0)
========= ======= ========= ======= ========
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RESULTS OF OPERATIONS -- THREE MONTHS ENDED DECEMBER 31, 2000 COMPARED TO THREE
MONTHS ENDED DECEMBER 31, 1999
Net Sales. Net sales in the three months ended December 31, 2000 decreased 5.4%
to $68.3 million from $72.2 million in the three months ended December 31, 1999.
The change in sales was primarily driven by a stronger US dollar relative to
European currencies and to a lesser extent by the slowing economy in North
America. The Safety Products segment net sales in the three months ended
December 31, 2000 decreased 4.9% to $49.1 million from $51.7 million in the
three months ended December 31, 1999. This decrease was driven by a combination
of a low Euro and a softening North American economy. The strength of the US
dollar relative to global currencies had the impact of reducing sales by
approximately $3.1 million. On a constant currency basis sales were up $0.5
million or 1.1% as compared to the previous year. The Safety Prescription
Eyewear segment net sales in the three months ended December 31, 2000 decreased
1.0% to $8.9 million from $9.0 million in the three months ended December 31,
1999. Specialty Composites' net sales in the three months ended December 31,
2000 decreased 11.2% to $10.2 million from $11.5 million in the three months
ended December 31, 1999. The decrease was primarily driven by a 41% volume
decline in the truck market as manufacturers adjusted production levels due to
excess inventories of new and used trucks.
Gross Profit. Gross Profit in the three months ended December 31, 2000 decreased
9.0% to $30.5 million from $33.5 million in the three months ended December 31,
1999. Gross Profit as a percentage of net sales in the three months ended
December 31, 2000 decreased to 44.7% as compared to 46.5% in the three months
ended December 31, 1999. The decline in the Gross Profit percentage of net sales
is primarily due to a combination of lower production volumes, the strength of
the US dollar relative to European currencies, and unfavorable product mix.
Production levels were lower due to lower sales volume and a lower increase in
inventory levels during the three months ended December 31, 2000 as compared to
the three months ended December 31, 1999. The inventory increased by $0.7
million during the three months ended December 31, 2000 as compared to an
inventory increase of $4.7 million during the three months ended December 31,
1999. The higher inventory build of a year ago was a result of the Company's Y2K
plan to prepare for potential inventory shortages subsequent to January 1, 2000.
The lower Euro creates an unfavorable impact on gross margins since it depresses
revenue while having a limited impact on manufacturing costs. The average
exchange rate used for the euro in preparing the condensed consolidated
financial statements for the three months ended December 31, 2000 and 1999 was
0.8678 and 1.0443, respectively. In addition, Gross Profit declined due to an
unfavorable mix of sales driven primarily by the mix of products sold in the
Classic(R) and Lexa(R) eyewear product platforms.
Selling and Administrative Expenses. Selling and administrative expenses in the
three months ended December 31, 2000 increased 1.2% to $23.9 million from $23.6
million in the three months ended December 31, 1999. Selling and administrative
expenses as a percentage of net sales in the three months ended December 31,
2000 increased to 35.0% of net sales as compared to 32.7% of net sales in the
three months ended December 31, 1999. The Company increased spending in selling
and marketing in an effort to increase awareness of the Company's brand names.
Research and Technical Service Expenses. Research and technical service expenses
in the three months ended December 31, 2000 increased 11.8% to $1.5 million from
$1.3 million in the three months ended December 31, 1999. The increase is
attributed to additional focus in the design and development of new products and
technologies.
Operating Income. Operating income decreased 49.7% to $3.5 million in the three
months ended December 31, 2000 from $6.9 million in the three months ended
December 31, 1999. Operating income as a percentage of net sales in the three
months ended December 31, 2000 decreased to 5.1% as compared to 9.6% in the
three months ended December 31, 1999.
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Interest Expense, Net. Interest expense, net in the three months ended December
31, 2000 decreased 2.5% to $5.8 million from $5.9 million in the three months
ended December 31, 1999. The reduction in interest expense was due to a
reduction in average borrowings partially offset by an increase in the weighted
average interest rates in effect for the three months ended December 31, 2000 as
compared to the three months ended December 31, 1999.
Provision For Income Taxes. The provision for income taxes decreased 77.7% to
$0.1 million in the three months ended December 31, 2000 from $0.3 million in
the three months ended December 31, 1999. In the results for the three months
ended December 31, 2000, the Company's foreign subsidiaries had taxable income
in their foreign jurisdictions, but the domestic subsidiaries had a net
operating loss. Although the domestic subsidiaries have a loss carryforward for
income tax purposes, during the three months ended December 31, 2000 the
Company had not recognized any of the tax benefits that will occur in future
periods if there is taxable income.
Net Income (Loss). For the three months ended December 31, 2000 the Company had
a net loss of $2.4 million as compared to net income of $0.7 million for the
three months ended December 31, 1999.
EBITDA. EBITDA is defined by the Company as earnings before interest, taxes,
depreciation, amortization, and non-operating income or expense. Non-operating
income or expense is further defined as extraordinary gains or losses, or gains
or losses from sales of assets other than in the ordinary course of business.
While the Company believes EBITDA is a useful indicator of its ability to
service debt, EBITDA should not be considered as a substitute for net income
determined in accordance with accounting principles generally accepted in the
United States as an indicator of operating performance or as an alternative to
cash flow as a measure of liquidity. Investors should be aware that EBITDA as
presented below may not be comparable to similarly titled measures presented by
other companies and comparisons could be misleading unless all companies and
analysts calculate this measure in the same fashion.
EBITDA CALCULATION
THREE MONTHS ENDED DECEMBER 31
(DOLLARS IN THOUSANDS)
Three Months Ended Change
December 31, Favorable (Unfavorable)
---------------------- -----------------------
2000 1999 Amount Percent
-------- --------- --------- --------
Operating Income $ 3,481 $ 6,921 $ (3,440) (49.7%)
Add Backs:
Depreciation 2,529 2,440 89 3.6%
Amortization of intangibles 1,655 1,725 (70) (4.1%)
Non-operating costs, net (6) 15 (21) --
-------- --------- ---------
EBITDA $ 7,659 $ 11,101 $ (3,442) (31.0%)
======== ========= =========
EBITDA for the three months ended December 31, 2000 decreased 31.0% to $7.7
million from $11.1 million for the three months ended December 31, 1999. EBITDA
as a percentage of net sales in the three months ended December 31, 2000 was
11.2% as compared to 15.4% in the three months ended December 31, 1999. The
decline in the Gross Profit percentage of net sales is primarily due to a
combination of lower production volumes, the strength of the US dollar relative
to European currencies, and unfavorable product mix.
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EFFECTS OF CHANGES IN EXCHANGE RATES
In general, the Company's results of operations are affected by changes in
exchange rates. Subject to market conditions, the Company prices its products in
Europe and Canada in local currency. While many of the Company's selling and
distribution costs are also denominated in these currencies, a large portion of
product costs are U.S. Dollar denominated. As a result, a decline in the value
of the U.S. Dollar relative to other currencies can have a favorable impact on
the profitability of the Company and an increase in the value of the U.S. Dollar
relative to these other currencies can have a negative effect on the
profitability of the Company. As a result of the acquisition of Peltor, the
Company's operations are also affected by changes in exchange rates relative to
the Swedish Krona. A decline in the value of the Krona relative to other
currencies can have a favorable impact on the profitability of the Company due
to an extensive cost base denominated in Krona. 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, and other hedging instruments, to mitigate the effects of changes in
foreign currency rates on profitability.
EFFECTS OF INFLATION
In recent years, inflation has been modest and has not had a material impact
upon the results of the Company's operations.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of funds have consisted primarily of operating cash flow
and debt financing. The Company's uses of those funds consist principally of
debt service, capital expenditures and acquisitions.
The Company's debt structure includes $100.0 million of Senior Subordinated
Notes (Notes) due 2005, as well as a senior bank facility comprised of (i) term
loans denominated in U.S., Canadian, British and German currencies aggregating
$140.0 million at inception (the Term Loans) and (ii) a Revolving Credit
Facility providing for up to $25.0 million (the Senior Bank Facilities), for
general corporate purposes and, as to $33.0 million thereof, to finance
permitted acquisitions. On December 14, 2000, the Senior Bank Facilities were
amended to increase the amount available to finance acquisitions from $15
million to $33 million and to modify certain financial covenants for periods
ending on and after December 31, 2000. Aearo Company was in compliance with all
financial covenants and restrictions at December 31, 2000.
Maturities under the Company's Term Loans are: $14.8 million for the remainder
of fiscal 2001, $32.9 million in fiscal 2002, and $35.3 million in fiscal 2003.
Other than upon a change of control or as a result of certain asset sales, or in
the event that certain excess funds exist at the end of a fiscal year, the
Company will not be required to make any principal payments in respect of the
Notes until maturity. The Company is required to make interest payments with
respect to both the Senior Bank Facilities and the Notes. TheCompany's revolver
and Term Loans A mature in May, 2002, and the Term Loans B mature in May, 2003.
The Company's net cash provided by operating activities for the three months
ended December 31, 2000 totaled $3.4 million as compared to $5.4 million for the
three months ended December 31, 1999. The decrease of $1.9 million was due
primarily to a $3.1 million decrease in Net Income, a $0.2 million decrease due
to amortization of deferred financing costs, partially offset by a favorable
change of $1.3 million in the Company's net changes in assets and liabilities.
The Company's net changes in assets and liabilities was primarily driven by a
decrease in the change in receivables of $0.4 million, a decrease in the change
in inventories of $2.3 million, partially offset by an increase in the change in
accounts payable and other liabilities of $0.4 million, as well as a $1.0
million increase in the net change in other assets and liabilities. The $1.0
million increase in other assets and liabilities is primarily related to an
increase in prepaid/deferred charges.
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Net cash used by investing activities was $1.6 million for the three months
ended December 31, 2000 as compared to $5.5 million for the three months ended
December 31, 1999. The decrease of $3.9 million in net cash used by investing
activities is primarily attributed to the acquisition of Ontario based Norhammer
Limited for $3.6 million in October 1999 and a decrease of $0.3 million in
capital expenditures for the three months ended December 31,1999.
Net cash used by financing activities for the three months ended December 31,
2000 was $0.7 million compared with net cash provided by financing activities
for the three months ended December 31, 1999 of $1.5 million. The decrease of
$2.2 million consisted of $1.5 million of net repayments of the revolving credit
facility and an increase of $0.8 million for the repayment of term loans.
The Company has a substantial amount of indebtedness. The Company relies on
internally generated funds, and to the extent necessary, on borrowings under the
Revolving Credit Facility (subject to certain customary drawing conditions) to
meet its liquidity needs. The Company anticipates that operating cash flow will
be adequate to meet its operating and capital expenditure requirements for the
next several years, although there can be no assurances that existing levels of
sales and normalized profitability, and therefore cash flow, will be maintained
in the future. Levels of sales and profitability may be impacted by service
levels, continued new product development, worldwide economic conditions and
competitive pressures. In particular, the Company expects that sales and
profitability over the remainder of fiscal year 2001 will be adversely affected
by the strength of the U.S. Dollar relative to the Euro. In addition, the
Company may make additional acquisitions in the future and would rely on
internally generated funds and, to the extent necessary, on borrowings to
finance such acquisitions. It is also anticipated that over the next several
years the level of debt service and the requirements placed on the Company
through the related financial covenants under the Company's Senior Bank
Facilities will require that the Company amend its credit agreement with its
syndicate of lenders, or otherwise change its capital structure.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risks related to change in foreign currencies,
interest rates and commodity pricing. The Company uses derivatives to mitigate
the impact of changes in foreign currencies and interest rates. All derivatives
are for purposes other than trading. The Company adopted the provisions of
Statement of Financial Accounting Standard (SFAS) No. 133, Accounting for
Derivative Instruments and Hedging Activities on October 1, 2000. The Company
has formally documented its hedging relationships, including identification of
hedging instruments and the hedge items, as well as its risk management
objectives.
FOREIGN CURRENCY RISK
The Company's results of operations are subject to risk associated with
operating in foreign countries, including fluctuations in currency exchange
rates. With a large portion of product sold in Europe produced in the United
States and Sweden, a decline in the dollar or krona can have a negative impact
on the profitability of the Company. The Company executes two hedging programs;
one for transaction exposures, and the other for cash flow impact on European
operations. The Company has utilized forward contracts for transaction and cash
flow exposures. During the quarter ended December 31, 2000 net transaction
losses were $0.1 million, while cash flow hedges were a gain of $0.1 million. In
addition, the Company limits foreign exchange impact on the balance sheet with
foreign denominated debt in Great Britain Pound Sterling (GBP) and German Marks
(DM).
The adoption of SFAS No. 133 on October 1, 2000 resulted in a $0.3 million
transition adjustment charge to accumulated other comprehensive income to
recognize the fair value of foreign currency forward contracts designated as
cash flow hedges. The Company recorded an additional $1.1 million of derivative
liability at December 31, 2000 to recognize the change in fair value of foreign
currency forward contracts outstanding. The foreign currency forward contracts
will expire over the next 9 months.
INTEREST RATES
The Company is exposed to market risk changes in interest rates through its
debt. The Company utilizes interest rate swaps to reduce the impact of potential
increased interest rates on its floating debt. On February 28, 2000, the Company
unwound its zero premium collar by rolling unrealized gains into a new interest
rate swap that matched the notional amounts of the credit agreement by each loan
currency. The new interest rate swaps will expire August 31, 2001. The Company
is of the opinion that it is well positioned to manage interest rate
increases and the related impact on the Company's financial statements through
these efforts. During the quarter ended December 31, 2000, the Company incurred
an additional $16,000 of interest expense as a result of the interest rate
swaps.
The adoption of SFAS No. 133 on October 1, 2000 resulted in a $0.1 million
transition adjustment charge to accumulated other comprehensive income to
recognize the fair value of interest rate swap agreements designated as cash
flow hedges. The Company recorded an additional $0.2 million of derivative
liability at December 31, 2000 to recognize the change in fair value of the
interest rate swap agreements.
COMMODITY RISK
The Company is subject to market risks with respect to industry pricing in paper
and crude oil as it relates to various commodity items. The Company is also
exposed to market risks for electricity, fuel oil and natural gas consumed in
its operations. Items with potential impact are paperboard, packaging films,
nylons, resins, propylene, ethylene, plasticizer and freight. The Company
manages pricing exposures on larger volume commodities such as polycarbonate,
polyols and polyvinyl chloride via price negotiations utilizing alternative
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supplier competitive pricing. The Company sources some products and parts from
Far East sources where resource availability, competition, and infrastructure
stability has provided a favorable purchasing environment. The Company does not
enter into derivative instruments to manage commodity risk.
PART II
ITEM 1. LEGAL PROCEEDINGS
Various lawsuits and claims arise against the Company in the ordinary course of
its business. Most of these lawsuits and claims relate to the Company's safety
eyewear and respiratory product lines and primarily involve accidents and/or
exposures occurring after the Company's predecessor acquired the AOSafety(R)
Division from American Optical Corporation in April 1990. The Company is
contingently liable with respect to numerous lawsuits involving respirators sold
by American Optical Corporation prior to the acquisition of the AOSafety(R)
Division in April 1990. These lawsuits typically involve plaintiffs alleging
that they suffer from asbestosis or silicosis, and that such condition results
in part from respirators that were negligently designed or manufactured. The
defendants in these lawsuits are often numerous, and include, in addition to
respirator manufacturers, employers of the plaintiffs and manufacturers of sand
(used in sand blasting) and asbestos. Responsibility for legal costs, as well as
for settlements and judgments, is shared contractually by the Company, American
Optical Corporation and a prior owner of American Optical Corporation. The
Company and Cabot have entered into an arrangement relating to certain
respirator claims asserted after July 11, 1995 (the date of the Company's
formation) whereby, so long as the Company pays to Cabot an annual fee of
$400,000, which the Company has elected to pay, Cabot will retain responsibility
and liability for, and indemnify the Company against, certain legal claims
alleged to arise out of the use of respirators manufactured prior to July 1995.
The Company has the right to discontinue the payment of such annual fee at any
time, in which case the Company will assume responsibility for and indemnify
Cabot with respect to such claims.
As part of a trademark dispute with Moldex-Metric, Inc. involving the Company's
"Yellow Neon Blasts"(TM) polyurethane earplugs, a federal district court in
Southern California issued a preliminary injunction in October, 2000 that
required the Company to immediately withdraw the current version of "Yellow Neon
Blasts"(TM) polyurethane earplugs from the U.S. market, and to also advise its
distributors to withdraw this product from the market, until the trademark issue
could be resolved. In accordance with this ruling, the Company ceased
manufacturing and distributing "Yellow Neon Blasts"(TM). The Company appealed
the preliminary injunction and the court granted a stay of the injunction
pending appeal to the Ninth Circuit. "Yellow Neon Blasts"(TM) was introduced
approximately one year ago as part of the Company's new line of polyurethane
earplugs called E-A-Rsoft(TM). Over the twelve months prior to October 2000,
"Yellow Neon Blasts"(TM) had accounted for approximately $1 million of the
Company's U.S. sales (the trademark dispute and the preliminary injunction do
not include the E-A-Rsoft(TM) "Yellow Neons"(TM) solidly colored earplugs or any
other Company products). In December, 2000 the Company reached a non-cash
settlement with Moldex-Metric, Inc. whereby the "Yellow Neon Blasts"(TM) would
be taken off the market in the U.S. and Canada. In the opinion of management,
this will not have a material impact on operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
On October 10, 2000, the Company filed a Current Report
on Form 8-K containing its press release regarding
a preliminary injunction issued by the federal district
court involving a trademark dispute.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: February 13, 2001 AEARO CORPORATION
/s/ Jeffrey S. Kulka
-----------------------------------------
Jeffrey S. Kulka
Vice President, Finance, Treasurer, and
Secretary (Principal Financial and
Accounting Officer)
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EXHIBIT INDEX
EXHIBITS DESCRIPTION
- -------- -----------
None.
*Filed herewith.