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 June 30, 1997
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.)
One Washington Mall, Eighth Floor
Boston, Massachusetts 02108-2610
(Address of principal executive offices) (Zip Code)
(617) 371-4200
(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
--- ---
2
AEARO CORPORATION
TABLE OF CONTENTS
FORM 10-Q FOR THE QUARTERLY PERIOD
ENDED JUNE 30, 1997
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- -----------------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF
JUNE 30, 1997 (UNAUDITED) AND SEPTEMBER 30, 1996 3-4
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED) FOR THE THREE MONTH AND NINE MONTH PERIODS ENDED
JUNE 30, 1997 AND 1996 5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) FOR THE NINE MONTHS ENDED JUNE 30, 1997 AND 1996 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) 7-10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ----------------------------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS 11-15
-----------------------------------
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 16
- --------------------------------------
ITEM 2. CHANGES IN SECURITIES 16
- ------------------------------------------
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 16
- ----------------------------------------------------
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS 16
- ------------------------------------------------------------------------
ITEM 5. OTHER INFORMATION 16
- --------------------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 16
- -----------------------------------------------------
SIGNATURE PAGE 17
3
PART I
ITEM 1. FINANCIAL STATEMENTS
AEARO CORPORATION
BALANCE SHEETS--ASSETS
(DOLLARS IN THOUSANDS)
JUNE 30 1997 SEPTEMBER 30, 1996
------------ ------------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 5,428 $ 8,540
Accounts receivable, net 46,579 45,890
Inventories 40,361 41,164
Deferred and prepaid expenses 3,824 2,748
-------- --------
Total current assets 96,192 98,342
-------- --------
PROPERTY, PLANT AND EQUIPMENT, NET 65,551 68,712
INTANGIBLE ASSETS, NET 146,696 161,940
OTHER ASSETS 8,057 9,442
-------- --------
Total assets $316,496 $338,436
======== ========
The accompanying notes are an integral part of these financial statements.
3
4
AEARO CORPORATION
BALANCE SHEETS--LIABILITIES AND STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
JUNE 30, 1997 SEPTEMBER 30, 1996
------------- -------------------
(Unaudited)
CURRENT LIABILITIES:
Current portion of long-term debt $ 10,448 $ 8,767
Accounts payable and accrued liabilities 36,198 40,348
Accrued interest 6,846 3,779
U.S. and foreign income taxes 436 5,713
-------- --------
Total current liabilities 53,928 58,607
-------- --------
LONG-TERM DEBT 239,885 241,520
DEFERRED INCOME TAXES 1,121 697
OTHER LIABILITIES 2,803 2,811
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value-
Authorized--200,000 shares
Issued and outstanding--45,000 shares - -
Common stock, $.01 par value-
Authorized--200,000 shares
Issued and outstanding--96,810 and 99,350 shares at
June 30, 1997 and September 30, 1996, respectively 1 1
Additional paid-in capital 32,736 32,640
Retained earnings (deficit) (5,327) 1,607
Cumulative foreign currency translation adjustments (8,651) 553
-------- --------
Total stockholders' equity 18,759 34,801
-------- --------
Total liabilities and stockholders' equity $316,496 $338,436
======== ========
The accompanying notes are an integral part of these financial statements.
4
5
AEARO CORPORATION
STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(Unaudited)
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- -------------------------
1997 1996 1997 1996
---- ---- ---- ----
NET SALES $74,911 $64,596 $211,096 $177,312
COST OF SALES 41,974 35,518 121,696 97,858
------- ------- -------- --------
Gross profit 32,937 29,078 89,400 79,454
SELLING AND ADMINISTRATIVE 23,067 19,408 64,896 52,762
RESEARCH AND TECHNICAL SERVICES 1,314 678 3,911 2,271
AMORTIZATION EXPENSE 2,066 1,395 6,382 3,351
OTHER CHARGES (INCOME), NET 428 349 2,407 346
------- ------- -------- --------
Operating income 6,062 7,248 11,804 20,724
INTEREST EXPENSE, NET 6,658 5,120 19,904 14,188
------- ------- -------- --------
Income (loss) before provision (benefit) for income taxes (596) 2,128 (8,100) 6,536
PROVISION (BENEFIT) FOR INCOME TAXES 657 1,324 (1,166) 3,262
------- ------- -------- --------
Net income (loss) (1,253) 804 (6,934) 3,274
PREFERRED STOCK DIVIDEND ACCRUED 1,794 1,582 5,218 4,615
------- ------- -------- --------
Earnings (loss) applicable to Common Shareholders (3,047) (778) (12,152) (1,341)
======= ======= ======== ========
EARNINGS (LOSS) PER COMMON SHARE $(31.37) $ (7.78) $(123.53) (13.41)
======= ======= ======== ========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 97,146 100,005 98,373 100,002
======= ======= ======== ========
The accompanying notes are an integral part of these financial statements.
5
6
AEARO CORPORATION
STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(Unaudited)
FOR THE NINE MONTHS ENDED
JUNE 30,
-------------------------
1997 1996
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(6,934) $ 3,274
Adjustments to reconcile net income (loss) to cash provided (used)
by operating activities--
Depreciation 7,132 5,193
Amortization 7,805 4,298
Deferred income taxes 377 --
Other, net 399 26
Changes in assets and liabilities--
Accounts receivable (1,002) (3,470)
Inventory 98 373
Accounts payable and accruals (196) 2,578
Other, net (5,858) (541)
------- --------
Net cash provided (used) by operating activities 1,821 11,731
------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (6,924) (6,510)
Proceeds provided by disposals of property, plant and equipment 815 --
Purchase of Shoplyne assets (242) --
Cash paid for acquisitions:
Peltor A.B. -- $(83,555)
Eastern Safety -- (6,636)
Eastern Safety escrow deposit -- 3,000
------- --------
Net cash used by investing activities (6,351) (93,701)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from revolving credit facility, net 7,200 (3,800)
Increase (decrease) in term loans (5,799) 96,216
Repayment of external long-term debt (677) (5,254)
Decrease in shareholder notes, net 203 130
Sale (repurchase) of common stock, net (107) 60
------- --------
Net cash provided by financing activities 820 87,352
------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH 598 675
------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (3,112) 6,057
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 8,540 4,707
------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 5,428 $ 10,764
======= ========
CASH PAID FOR:
Interest $12,871 $ 10,471
======= ========
Income taxes $ 2,007 $ 746
======= ========
The accompanying notes are an integral part of these financial statements.
6
7
AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1997
(UNAUDITED)
(1) 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 generally accepted accounting
principles, the Company's financial position, results of operations and
cash flows for the interim periods presented. Such adjustments consisted of
only normal recurring items. 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 was formed by Vestar Equity Partners, L.P. (Vestar) in
June 1995 to effect the acquisition (the Formation Acquisition) of
substantially all of the assets and liabilities of Aearo Company (formerly
Cabot Safety Corporation) and certain affiliates (the Predecessor). The
Predecessor was wholly owned by Cabot Corporation (Cabot) prior to 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 July 13, 1995. Aearo Corporation has no other materials
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 their
estimated fair values as of July 11, 1995, which may be revised at a later
date. The valuation of assets and liabilities acquired reflect carryover
basis for the percentage ownership retained by Cabot.
(3) USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
7
8
AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(4) SIGNIFICANT ACCOUNTING POLICIES
Income Taxes. Deferred tax assets and liabilities are determined based on
the difference between the financial statement and tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse.
Intangible Assets. Intangible assets consist primarily of the costs of
goodwill, patents, and trademarks purchased in business acquisitions.
Intangible assets are amortized on the straight-line basis over either 25
years or an estimated useful life, whichever is shorter.
Net Income (Loss) per Common Share. Net income (loss) per common share has
been computed by dividing earnings applicable to common shareholders for
the period by the weighted average number of common shares outstanding
during the period.
(5) STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123
In December 1995, the Financial Accounting Standards Board issued SFAS No.
123, Accounting for Stock-Based Compensation, which is to become effective
for fiscal years beginning after December 15, 1995. SFAS No. 123 requires
employee stock-based compensation to be either recorded or disclosed at its
fair value. Management intends to continue to account for employee
stock-based compensation under Accounting Principles Board Opinion No. 25
and will not adopt the new accounting provision for employee stock-based
compensation under SFAS No. 123, but will include the additional required
disclosures in the fiscal 1997 Form 10-K financial statements.
(6) INVENTORIES
Inventories consisted of the following (dollars in thousands):
JUNE 30, 1997 SEPTEMBER 30, 1996
------------- ------------------
(unaudited)
Raw materials $10,583 $13,100
Work in process 10,544 11,130
Finished goods 19,234 16,934
------- -------
$40,361 $41,164
======= =======
Inventories are stated at the lower of cost or market, cost being
determined using the first-in, first-out method.
(7) DEBT
In July 1995, Aearo Company entered into a credit agreement (the Agreement)
that provides for secured borrowings from a syndicate of lenders consisting
of (i) a Revolving Credit Facility providing for up to $25.0 million and
(ii) Term Loans denominated in U.S., Canadian, and British currencies
aggregating $45.0 million. In addition, Aearo Company issued $100.0 million
of Senior Subordinated Notes due 2005 (Notes). In May 1996, Aearo Company
and the Syndicated Lenders amended and restated the Senior Bank Facility
8
9
AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) DEBT (CONTINUED)
to provide (i) Term Loans denominated in U.S., Canadian, British, and
German currencies aggregating $140.0 million and (ii) a Revolving Credit
Facility providing for up to $25.0 million. Under the terms of both the
Agreement and the Note indenture, Aearo Company is required to comply with
certain financial covenants and restrictions. In April 1997, the Credit
Agreement was amended with respect to certain covenants applicable to
periods ending on and after June 30, 1997. Aearo Company was in compliance
with the amended Credit Agreement at June 30, 1997. At June 30, 1997, the
amounts outstanding on the Term Loans and the Revolving Credit Facility
were $133.1 million and $12.3 million, respectively.
(8) COMMITMENTS AND CONTINGENCIES
The Company is a defendant in various lawsuits and administrative
proceedings which are being handled in the ordinary course of business. In
the opinion of management of the Company, these suits and claims should not
result in final judgments or settlements which, in the aggregate, would
have a material adverse effect on the Company's financial condition or
results of operations.
During fiscal 1995, the Company became aware that its French subsidiary had
been delinquent in the remittance of value-added tax payments to the French
government. The Company believes that any required tax payments and
attendant penalties will not have a material adverse effect on the
Company's financial condition or results of operations.
(9) ACQUISITIONS
On January 10, 1997, the Company acquired inventory and other selected
assets of Shoplyne Safety Products (a Division of Mack Products, Inc.) for
$241,600. As part of the purchase price, the Company entered into a
non-compete agreement with Mack Products, Inc. for $75,000. The transaction
was accounted for using the purchase method of accounting. The pro forma
impact of the transaction is not material to the results of the periods
presented, and therefore has not been included.
On May 30, 1996, the Company acquired Peltor Holding AB (the "Acquisition")
for approximately $85.6 million. The Acquisition has been accounted for as
a purchase transaction in accordance with Accounting Principles Board
Opinion No. 16, and accordingly, the consolidated financial statements for
the periods subsequent to May 30, 1996, reflect the purchase price,
including transaction costs, allocated to tangible and intangible assets
acquired and liabilities assumed, based on the estimated fair values as of
May 30, 1996. The purchase price allocation is preliminary and may be
revised at a later date, however, the Company does not presently expect
material changes to the allocation of the purchase price.
Unaudited pro forma operating results of the Company for the nine months
ended June 30, 1996, as adjusted for the debt financing and estimated
effects of the Acquisition as if it had occurred on October 1, 1995, are as
follows (dollars in thousands except share amounts):
Net sales $207,576
Earnings (loss) applicable to common shareholders (5,000)
Earnings (loss) per common share (50.00)
Weighted average common shares outstanding 100,002
9
10
AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) ACQUISITIONS (CONTINUED)
On January 3, 1996, the Company acquired the stock of Eastern Safety
Equipment Company, Inc. ("Eastern") for $6.8 million subject to final
closing adjustments, as defined. In addition, the Company entered into
non-compete and consulting agreements that provide an aggregate of $1.0
million in consideration to the former controlling stockholder of Eastern.
The transaction was accounted for using the purchase method of accounting.
The pro forma impact of the transaction is not material to the results of
the periods presented. Amounts allocated to the non-compete and consulting
agreements are being charged to expense over the five year term of the
agreements.
10
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The following discussion should be read in conjunction with the consolidated
Financial Statements and Notes thereto appearing elsewhere in this report. This
report contains forward-looking statements within the meaning of Section 27A of
the Securities Act of 1993 and Section 21E of the Securities Exchange Act of
1934. Such statements involve risks and uncertainties that could cause actual
results to differ materially from those set forth in such forward-looking
statements. Among other things, expectations for upcoming periods are based on
assumptions which management believes to be reasonable at this time, including
assumptions concerning the volume and product mix of sales. Moreover, there can
be no assurances the degree to which initiatives undertaken by the Company to
relieve operational difficulties related to the conversion to a new computer
system and to improve production planning will continue to be successful. Other
significant potential risks and uncertainties include the following: risks
associated with indebtedness; uncertainties of acquisition strategy; high level
of competition in the Company's markets; importance and costs of product
innovation; risks associated with international operations; product liability
exposure; unpredictability of patent protection and other intellectual property
issues; dependence on key personnel; the risk of adverse effect of economic and
regulatory conditions on sales; and risks associated with environmental matters.
RESULTS OF OPERATIONS -- THREE MONTHS ENDED JUNE 30, 1997 COMPARED TO THREE
MONTHS ENDED JUNE 30, 1996
Net Sales. Net sales in the three months ended June 30, 1997 increased 16.0% to
$74.9 million from $64.6 million in the three months ended June 30, 1996. The
increase in net sales was due primarily to the acquisition of Peltor AB during
1996. Safety Products net sales in the three months ended June 30, 1997
increased 18.3% to $65.3 million from $55.2 million in the three months ended
June 30, 1996. The acquisition of Peltor AB contributed approximately $7.4
million to net sales. Internal growth was approximately 5.3% due to growth in
sales of new eyewear products as well as gradual improvements in service levels
as the Company recovers from difficulties associated with its new management
information system and related difficulties in operations. Specialty Composites'
net sales in the three months ended June 30, 1997 increased 2.2% to $9.6 million
from $9.4 million in the three months ended June 30, 1996 as softness in the
Class 8 truck market was offset by growth in precision equipment and health
related markets.
Gross Profit. Gross Profit in the three months ended June 30, 1997 increased
13.3% to $32.9 million from $29.1 million in the three months ended June 30,
1996. The increase was primarily due to the acquisition of Peltor AB which was
partially offset by higher costs at the Southbridge, MA manufacturing facility.
These costs included primarily excess direct labor costs and overtime premiums
and excess material usage. These cost levels had increased in the beginning of
the fiscal year and were reduced during the month of March. Gross Profit as a
percentage of net sales in the three months ended June 30, 1997 was 44.0% as
compared to 45.0% in the three months ended June 30, 1996. Such percentage
decreased primarily due to higher operating and material costs in Southbridge.
Selling and Administrative Expenses. Selling and administrative expenses in the
three months ended June 30, 1997 increased 18.9% to $23.1 million from $19.4
million in the three months ended June 30, 1996. Of this increase, approximately
$1.52 million was due to the acquisition of Peltor AB. Of the remaining
increase, approximately $0.6 million was due to higher distribution expenses.
These expenses include higher freight
11
12
charges as well as labor costs associated with a higher level of backorders
which result in more expensive partial shipments. The remaining increase was due
to increases in the sales force during 1996 as well as increased sales and
marketing spending related to growth initiatives and increased legal expenses.
Selling and administrative expenses as a percentage of net sales in the three
months ended June 30, 1997 increased to 30.8% of sales as compared to 30.1% of
sales in the three months ended June 30, 1996. This was primarily as a result of
the increase in distribution and sales and marketing expenses relative to growth
in sales.
Research and Technical Service Expenses. Research and technical service expenses
in the three months ended June 30, 1997 increased 93.8% to $1.3 million from
$0.7 million in the three months ended June 30, 1996. This increase was
primarily due to the acquisition of Peltor AB which spends proportionally more
on research and technical services because it has more significant technical
components to its products.
Amortization Expense. Amortization expense in the three months ended June 30,
1997 increased to $2.1 million from $1.4 million in the three months ended June
30, 1996 as a result of purchase accounting for the acquisition of Peltor AB.
Other Charges (Income), Net. Other charges increased to $0.4 million in the
three months ended June 30, 1997 from $0.3 million in the three months ended
June 30, 1996. These costs in both periods relate primarily to foreign exchange
losses.
Operating Income. As a result of the increases in selling and administrative
expenses, research and technical expenses, amortization expenses and other
charges which were only partially offset by the increase in gross profit
contribution from Peltor AB, operating income declined 16.4% to $6.1 million in
the three months ended June 30, 1997 from $7.2 million in the three months ended
June 30, 1996.
Interest Expense, Net. As a result of the increased borrowings to finance the
acquisitions of Peltor AB, interest expense, net in the three months ended June
30, 1997 increased 30.0% to $6.7 million from $5.1 million in the three months
ended June 30, 1996.
Net Loss. For the three months ended June 30, 1997 the Company had a net loss of
$1.3 million as compared to net income of $0.8 million for the three months
ended June 30, 1996.
RESULTS OF OPERATIONS -- NINE MONTHS ENDED JUNE 30, 1997 COMPARED TO NINE MONTHS
ENDED JUNE 30, 1996
Net Sales. Net sales in the nine months ended June 30, 1997 increased 19.1% to
$211.1 million from $177.3 million in the nine months ended June 30, 1996. The
increase in net sales was due primarily to the acquisitions of Peltor AB and
Eastern Safety during 1996. Safety Products net sales in the nine months ended
June 30, 1997 increased 24.5% to $184.0 million from $147.7 in the nine months
ended June 30, 1996. The acquisition of Peltor AB and Eastern Safety contributed
$28.6 million and $3.0 million to net sales respectively. Internal growth was
approximately 3.2% as growth in sales in North America was hampered by
difficulties earlier in the period associated with the new management
information system and related backorders. Specialty Composites' net sales in
the nine months ended June 30, 1997 decreased 8.4% to $27.1 million from $29.6
million in the nine months ended June 30, 1996. The decrease was primarily due
to the impact of a $2.3 million shipment related to the Sea Wolf submarine in
the three months ended December 31, 1995, as well as softness in the Class 8
truck market in the current period.
12
13
Gross Profit. Gross Profit in the nine months ended June 30, 1997 increased
12.5% to $89.4 million from $79.5 million in the nine months ended June 30,
1996. The increase was primarily due to the acquisitions of Peltor AB and
Eastern Safety which were partially offset by higher costs in the Southbridge,
MA manufacturing facility and, to a lesser extent, the Indianapolis, IN central
packaging operation in the first quarter. These costs included temporary labor,
overtime and excess material usage and were significantly increased by efforts
to correct difficulties associated with the conversion to the new management
information system. Gross Profit as a percentage of net sales in the nine months
ended June 30, 1997 was 42.4% as compared to 44.8% for the nine months ended
June 30, 1996. Such percentage decreased due to the higher costs in North
American operations as well as the lower sales in Europe in the first quarter.
Selling and Administrative Expenses. Selling and administrative expenses in the
nine months ended June 30, 1997 increased 23.0% to $64.9 million from $52.8
million in the nine months ended June 30, 1996. Of this increase, approximately
$5.0 million was due to the acquisitions of Peltor AB and Eastern Safety. Of the
remaining increase, approximately $2.6 million was due to higher distribution
expenses. These expenses include higher freight charges as well as labor costs
associated with a higher level of backorders and partial shipments as well as
higher product returns. In addition, the Company incurred higher costs in
customer service in order to mitigate operational difficulties relating to its
new management information system. Finally, higher sales and marketing expenses
from the Company's growth initiatives were partially offset by reductions in
management and employee incentive accruals in the first quarter. Selling and
administrative expenses as a percentage of net sales in the nine months ended
June 30, 1997 increased to 30.7% of sales as compared to 29.8% of sales in the
nine months ended June 30, 1996. This was primarily as a result of the higher
distribution expenses as well as increased spending in sales and marketing.
Research and Technical Service Expenses. Research and technical service expenses
in the nine months ended June 30, 1997 increased 72.2% to $3.9 million from $2.3
million in the nine months ended June 30, 1996. This increase was primarily due
to the acquisition of Peltor AB which spends proportionally more on research and
technical services because it has more significant technical components to its
products.
Amortization Expense. Amortization expense in the nine months ended June 30,
1997 increased to $6.4 million from $3.4 million in the nine months ended June
30, 1996 as a result of purchase accounting for the acquisitions of Peltor AB
and Eastern Safety.
Other Charges (Income), Net. Other charges increased to $2.4 million in the nine
months ended June 30, 1997 from $0.3 million in the nine months ended June 30,
1996. Approximately $1.7 million of this increase was due to foreign exchange
losses. The remaining charges relate to the abandonment of two
automation-related capital projects totaling approximately $0.5 million at the
Company's Indianapolis, IN facility.
Operating Income. As a result of the increases in selling and administrative
expenses, research and technical expenses, amortization expenses and other
charges which were only partially offset by the increase in gross profit,
operating income declined 43.0% to $11.8 million in the nine months ended June
30, 1997 from $20.7 million in the nine months ended June 30, 1996.
Interest Expense, Net. As a result of the increased borrowings to finance the
acquisitions of Peltor AB and Eastern Safety, interest expense, net in the nine
months ended June 30, 1997 increased 40.3% to $19.9 million from $14.2 million
in the nine months ended June 30, 1996.
Net Loss. For the nine months ended June 30, 1997 the Company had a net loss of
$6.9 million as compared to net income of $3.3 million for the nine months ended
June 30, 1996.
13
14
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 dollar denominated. As a result, a decline in the value of the
dollar relative to the other currencies can have a favorable impact on the
profitability of the Company and an increase in the value of the 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, AB 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 estimates that these changes had
the effect of decreasing operating profit by $1.7 million in the nine months
ended June 30, 1997 compared to the nine months ended June 30, 1996. Subsequent
to June 30, 1997, the Company has entered into foreign exchange purchase
contracts and may also utilize options to purchase/sell foreign currencies, with
the intention of mitigating some of the future impacts of changes in exchange
rates.
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 and (ii) a Revolving Credit Facility providing for up to $25.0
million.
The required amortization payments under the Company's Senior Bank Facilities
are $2.5 million for the remainder of fiscal 1997, $10.7 million in fiscal 1998,
$13.1 million in fiscal 1999, $16.1 million in fiscal 2000, $20.9 million in
fiscal 2001, $34.6 million in fiscal 2002 and $35.2 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 will also be required to make interest
payments with respect to both the Senior Bank Facilities and the Notes.
The Company typically makes capital expenditures related primarily to the
maintenance and improvement of manufacturing facilities as well as for the
support of new products. The Company's capital spending is of a relatively short
duration, with the complete commitment process involving less than one year.
Included in capital expenditures over the past two years was an aggregate of
$5.4 million for a casting line in the Newark, Delaware facility and $7.5
million for a worldwide management information system. In the nine months ended
June 30, 1997 the Company spent $6.9 million for capital expenditures as
compared to $6.5 million in the nine months ended June 30, 1996. In the current
period, the most significant expenditures were to support the introduction of
the Company's new Fectoids eyewear product. In the nine months ended June 30,
1996 the most significant expenditures were $1.4 million spent on the casting
line at the Newark, Delaware facility and $2.4 million spent on the management
information systems. Offsetting the spending in the nine months ended June 30,
1997 was $0.8 million in proceeds from the sale of the Rhode Island facility of
Peltor, Inc. as those operations were consolidated into the Company's
Southbridge, MA and Indianapolis, IN facilities.
14
15
The Company's principal source of cash to fund debt service and these capital
expenditures is net cash provided by operations. In the nine months ended June
30, 1997 operating activities resulted in net cash provided by operating
activities of $1.8 million as compared to $11.7 million in the nine months ended
June 30, 1996. This change was a result of the net loss of $6.9 million
discussed previously, as well as a reduction in income taxes payable in the
period. The Company continued to build inventory in the earlier part of the
period both as a result of difficulties in production planning as well as a
result of an effort to minimize the risks of backorders with its customers.
Inventories have been reduced since the month of February due to management's
efforts to reduce inventory as well as better utilization of the new information
system.
Net cash provided by financing activities for the nine months ended June 30,
1997 was $0.8 million as increased borrowings under the revolving credit
facility were partially offset by the repayment of term loans and the repayment
of a mortgage note on the Rhode Island facility of Peltor, Inc. upon the sale of
the facility. Net cash used by operating and investing activities was partially
funded by decreases in cash and cash equivalents. These decreases were partially
offset by the effect of exchange rate changes on cash.
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 available under the Senior Bank Facilities, which
provides for borrowings up to $25.0 million, subject to certain customary
drawing conditions, to meet its liquidity needs. At June 30, 1997 the Company
had borrowed $12.3 million under the revolving credit facility. The Company will
continue to borrow under the revolver for at least the balance of the fiscal
year to support higher levels of inventory and receivables. These borrowing
levels will remain high until the difficulties associated with the conversion to
the new computer system are completely resolved and the improvements in
production planning are realized. While there can be no certainty when these
operational difficulties will be overcome, Management believes that improvements
will continue to be realized during the balance of the fiscal year. The Company
anticipates that operating cash flow will be adequate to meet its debt service
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 will be impacted by service levels, continued new product
development, worldwide economic conditions and competitive pressures. 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.
The Company's ability to borrow is limited by covenants in the Senior Bank
Facilities and the Notes. In April, 1997, the Company amended its credit
agreement with its syndicate of lenders with respect to the financial covenants
applicable to periods ending on and after June 30, 1997. The revised covenants
reflect the reduced profitability that the Company has been experiencing
primarily due to the operating difficulties which have been triggered by the new
computer system. The amendment also provides the Company with the ability to
simplify its corporate structure in Europe in order to proceed with the further
integration of Peltor AB.
15
16
PART II
ITEM 1. LEGAL PROCEEDINGS
In November 1996, the Company received a complaint from Gargoyles, Inc. alleging
that one of the Company's recently introduced plano eyewear products (Fectoids)
infringes patents utilized in the plaintiff's sun and sporting glasses.
(Reported in the Company's Annual Report on Form 10-K for the year ended
September 30, 1996.) In April 1997, a federal district court denied the
plaintiff's motion for a preliminary injunction against the Company. The Company
believes the Gargoyles claim to be without merit and continues to defend this
allegation vigorously.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1* -- Financial Data Schedule.
(b) Reports on Form 8-K
None.
* Filed herewith.
16
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 11, 1997 AEARO CORPORATION
/s/ Bryan J. Carey
----------------------------------------
Bryan J. Carey
Vice President, Chief Financial Officer,
Treasurer and Assistant Secretary
17
18
EXHIBIT INDEX
EXHIBITS DESCRIPTION
-------- -----------
27.1* -- Financial Data Schedule.
*Filed herewith.
18