UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number 333-116676
AEARO COMPANY I
(Exact name of registrant as specified in its charter)
Delaware 13-3840456
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
5457 West 79th Street 46268
Indianapolis, Indiana (Zip Code)
(Address of principal executive offices)
(317) 692-6666
(Registrant's telephone number, including area code)
______________________________________
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 __ No 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
The number of shares of the registrant's common stock, par value $.01
per share, outstanding as of August 14, 2004 was 100.
Aearo Company I
TABLE OF CONTENTS
Form 10-Q for the Quarterly Period Ended June 30, 2004
PART I-FINANCIAL INFORMATION..................................................3
Item 1.Financial Statements...................................................3
Condensed Consolidated Balance Sheets - Assets................................3
Condensed Consolidated Balance Sheets - Liabilities
and Stockholder's Equity....................................................4
Consolidated Statement of Stockholder's Equity................................5
Condensed Consolidated Statements of Operations...............................6
Condensed Consolidated Statements of Cash Flows...............................7
Notes To Condensed Consolidated Financial Statements..........................8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................................23
Item 3. Quantitative and Qualitative Disclosures About Market Risk...........34
Item 4. Controls and Procedures..............................................36
PART II - OTHER INFORMATION..................................................37
Item 6.Exhibits and Reports on Form 8-K......................................37
SIGNATURES...................................................................38
EXHIBIT INDEX................................................................39
PART I-FINANCIAL INFORMATION
Item 1.Financial Statements
AEARO COMPANY I AND SUBSIDIARIES
Condensed Consolidated Balance Sheets - Assets
(In Thousands)
Successor Predecessor
------------ ----------
June 30, September 30,
2004 2003
------------ ----------
(Unaudited) |
CURRENT ASSETS: |
Cash and cash equivalents $ 11,854 | $ 7,301
Accounts receivable (net of allowance |
for doubtful accounts of |
$1,464 and $1,358, respectively) 53,650 | 49,146
Inventories 41,343 | 37,269
Deferred and prepaid expenses 4,212 | 7,321
----------- | ---------
Total current assets 111,059 | 101,037
----------- | ---------
|
LONG TERM ASSETS: |
Property, plant and equipment, net 47,398 | 48,869
Goodwill, net 209,240 | 81,770
Other intangible assets, net 57,665 | 57,887
Other assets 13,139 | 3,953
----------- | ---------
|
Total assets $ 438,501 | $ 293,516
=========== | =========
-3-
AEARO COMPANY I AND SUBSIDIARIES
Condensed Consolidated Balance Sheets - Liabilities and Stockholder's Equity
(In Thousands, Except Share Amounts)
Successor Predecessor
---------- --------------
June 30, September 30,
2004 2003
---------- | --------------
(Unaudited) |
|
CURRENT LIABILITIES: |
Current portion of long-term debt $ 1,621 | $ 17,767
Accounts payable and |
accrued liabilities 44,033 | 44,043
Accrued interest 3,336 | 2,566
U.S. and foreign income taxes 1,088 | 1,746
--------- | ------------
Total current liabilities 50,078 | 66,122
--------- | ------------
|
LONG TERM LIABILITIES: |
Long-term debt 302,281 | 180,786
Deferred income taxes 1,674 | 1,609
Due to parent | 207
Other liabilities 12,864 | 11,334
--------- | ------------
Total liabilities 366,897 | 260,058
--------- | ------------
|
|
STOCKHOLDER'S EQUITY: |
Common stock, $.01 par value- |
Authorized--100 shares |
Issued and outstanding--100 shares - | -
Paid in capital 101,300 | 32,531
Retained earnings (deficit) (28,552) | 7,713
Accumulated other comprehensive loss (1,144) | (6,786)
----------- | ------------
Total stockholder's equity 71,604 | 33,458
----------- | ------------
Total liabilities |
and stockholder's equity $ 438,501 | $ 293,516
=========== =============
-4-
AEARO COMPANY I AND SUBSIDIARIES
Consolidated Statement of Stockholder's Equity
(In Thousands, Except Share Amounts)
Additional Accumulated
Paid Retained Other Comprehensive
Common In Earnings Comprehensive Income
Shares Amount Capital (Deficit) Loss Total (Loss)
------- -------- ---------- ----------- ------------- -------- -------------
Balance, October 1, 2002 100 $ - $ 32,531 $ 6,532 $ (17,536) $21,527
Foreign currency translation
adjustment - - - - 9,080 9,080 $ 9,080
Unrealized loss on derivative
instruments - - - - (390) (390) (390)
Net minimum pension liability
adjustment 2,060 2,060 2,060
Dividend to parent (19,506) (19,506)
Net income - - - 20,687 - 20,687 20,687
-------------
Comprehensive income - - - - - $ 31,437
------- -------- ---------- ----------- ------------- -------- =============
Balance, September 30, 2003 100 - 32,531 7,713 (6,786) 33,458
------- -------- ---------- ----------- ------------- --------
Net income - - - 8,564 - 8,564 8,564
Foreign currency translation
adjustment 1,688 1,688 1,688
Net minimum pension liability
adjustment 4 4 4
-------------
Comprehensive income $ 10,256
=============
------- -------- ---------- ----------- ------------- --------
Balance, March 31, 2004 100 - 32,531 16,294 (5,094) 43,714
------- -------- ---------- ----------- ------------- --------
Capital contribution 100 - 101,300 101,300
Unrealized loss on derivative
instruments - - - - (112) (112) $ (112)
Foreign currency translation
adjustment - - - - (1,032) (1,032) (1,032)
Dividend to parent (14,305) (14,305)
Net loss - - - (14,247) - (14,247) (14,247)
-------------
Comprehensive loss - - - - - - $ (15,391)
=============
------- -------- ---------- ----------- ------------- --------
Balance, June 30, 2004 100 $ - $ 101,300 $(28,552) $ (1,144) $71,604
======= ======== ========== =========== ============= ========
-5-
AEARO COMPANY I AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(In Thousands)
(Unaudited)
Three Six Nine
Months Months Months
Three Months Ended Ended Ended Ended
June 30, June 30, March 31, June 30,
-------------------------------------------------------------
Successor Predecessor Successor Predecessor
-------------------------------------------------------------
2004 | 2003 2004 | 2004 2003
---- | ---- ---- | ---- ----
Net Sales $ 97,126 | $ 86,723 $ 97,126 | $ 169,579 $ 232,126
Cost of sales 68,144 | 45,768 68,144 | 89,056 121,325
-------- | -------- -------- | --------- ---------
Gross profit 28,982 | 40,955 28,982 | 80,523 110,801
| |
Selling and administrative 28,149 | 26,218 28,149 | 56,835 75,406
Research and technical services 1,966 | 1,462 1,966 | 3,623 4,671
Amortization 101 | 62 101 | 242 194
Other charges 1,690 | 734 1,609 | (506) 1,691
Restructuring -- | -- -- | (1,091) -
-------- | -------- -------- | ---------- ---------
Operating income (loss) (2,924)| 12,479 (2,924) | 21,420 28,839
Interest expense 10,292 | 4,737 10,292 | 10,836 14,701
-------- | -------- -------- | --------- ---------
Income (loss) before | |
provision for income taxes (13,216)| 7,742 (13,216) | 10,584 14,138
Provision for income taxes 1,031 | 1,364 1,031 | 2,020 4,039
-------- | -------- -------- | --------- ---------
Net income (loss)............. $(14,247)| $ 6,378 $(14,247) | $ 8,564 $ 10,099
=========| ======== ========= | ========= =========
-6-
AEARO COMPANY I AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)
Three Six Nine
Months Months Months
Ended Ended Ended
June 30, March 31, June 30,
-------------------------------------
Successor Predecessor
-------------------------------------
2004 | 2004 2003
---- | ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES: |
Net income (loss) $(14,247) | $ 8,564 $ 10,099
Adjustments to reconcile net income (loss) to cash provided by |
operating activities- |
Depreciation 3,006 | 5,931 8,175
Amortization of intangible assets and deferred financing costs 4,335 | 2,283 1,422
Inventory purchase accounting adjustment 17,067 | -- --
Restructuring adjustment -- | (1,091) --
Deferred income taxes (7) | (15) (14)
Other, net 139 | 682 386
Changes in assets and liabilities-(net of effects of |
acquisitions) |
Accounts receivable (2,242) | (1,113) 2,015
Inventories 2 | (3,464) (1,083)
Income taxes payable 522 | (1,168) 3,001
Accounts payable and accrued liabilities 4,513 | (3,221) 5,261
Other, net 706 | 1,647 (1,223)
-------- | -------- ---------
Net cash provided by operating activities 13,794 | 9,035 28,029
-------- | -------- --------
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
Additions to property, plant and equipment (2,810) | (5,006) (7,525)
Acquisitions, net of cash -- | -- (11,062)
Proceeds provided by disposals of property, plant and equipment -- | 12 22
-------- | -------- --------
Net cash used by investing activities (2,810) | (4,994) (18,565)
--------- | --------- ---------
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
Distribution to shareholders of parent (86,852) | -- --
Repayment of revolving credit facility (15,600) | 3,950 --
Repayment of old credit facility (78,333) | (8,949) (9,580)
Proceeds from new credit facility 125,000 | -- --
Repayment of 12.50% senior subordinated notes (98,000) | -- --
Proceeds from 8.25% senior subordinated notes 175,000 | -- --
Debt issue costs (10,408) | -- --
Dividend to parent (14,305) | -- --
Repayment of capital lease obligations (61) | (122) (164)
Repayment of long term debt (26) | (119) (57)
--------- | --------- ---------
Net cash used for financing activities (3,585) | (5,240) (9,801)
--------- | --------- ---------
|
EFFECT OF EXCHANGE RATE ON CASH (858) | (789) 914
--------- | --------- --------
|
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 6,541 | (1,990) 577
|
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 5,313 | 7,301 14,480
-------- | -------- --------
|
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 11,854 | $ 5,313 $ 15,057
======== | ======== ========
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Capital Lease Obligations $ -- $ $ 430
======== ======== ========
CASH PAID FOR:
Interest $ 4,787 $ 8,862 $ 10,538
======== ======== ========
Income Taxes $ 552 $ 3,254 $ 1,332
======== ======== ========
-7-
AEARO COMPANY I AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
JUNE 30, 2004
(Unaudited)
1) CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements of Aearo Company I (the "Company") contain all
adjustments necessary to present fairly, in accordance with accounting
principles generally accepted in the United States of America, the 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 included in the registration statement filed on June 18, 2004. The
periods prior to April 7, 2004, are referred to as predecessor financial
statements and the periods after April 7, 2004, are referred to as successor
financial statements.
2) COMPANY BACKGROUND, MERGER AND BASIS OF PRESENTATION
The Company manufactures and sells products under the brand names:
AOSafety(R), E-A-R(R), Peltor(R) and SafeWaze(TM). These products are sold
through three reportable segments, which are Safety Products, Safety
Prescription Eyewear and Specialty Composites.
On March 10, 2004, Aearo Corporation, the Company's parent, entered into a
merger agreement with AC Safety Holding Corp. and its subsidiary, AC Safety
Acquisition Corp. Pursuant to the terms of the Merger Agreement, on April 7,
2004 ("Acquisition Date"), AC Safety Acquisition Corp. merged with and into
Aearo Corporation with Aearo Corporation surviving the merger as a wholly-owned
subsidiary of AC Safety Holding Corp. The aggregate purchase price was
approximately $408.4 million, including fees and expenses. The merger was
financed with approximately $303.4 million of new debt as discussed in Note 6,
$3.7 million of assumed debt and $101.3 million of equity. The Company continues
to be wholly-owned by Aearo Corporation after the merger.
Approximately $86.9 million of proceeds from the merger was used to pay the
shareholders of the parent to effect the merger transaction. An additional $14.3
million was used to pay the outstanding debt of the parent as of April 7, 2004
The merger was a business combination under SFAS No. 141, "Business
Combinations," and the purchase price paid for our parent was pushed down to the
Company. Accordingly, the unaudited balance sheet as of June 30, 2004 and the
results of operations (unaudited) subsequent to the Acquisition Date are
presented on a different basis of accounting than the balance sheet as of
September 30, 2003 and the results of operations (unaudited) prior to the
Acquisition Date, and therefore are not directly comparable. The sale was
accounted for as if it had occurred on March 31, 2004, as management determined
that results of operations were not significant and no material transactions
occurred during the period from April 1, 2004 to April 7, 2004.
-8-
The purchase price is allocated to the Company's net tangible and
intangible assets based upon estimated fair values as of the date of the merger.
The preliminary allocation included a $17.1 million adjustment to inventory as
of March 31, 2004 which was charged to cost of goods sold during the three month
period ended June 30, 2004. The purchase price allocation is based on
preliminary estimates and valuations and may be revised at a later date when
additional information concerning assets and liability valuations are finalized.
The preliminary purchase price allocation is as follows (dollars in thousands):
Current assets and other tangibles assets $ 306,125
Liabilities assumed (161,629)
Identifiable intangible assets 57,725
Goodwill 206,165
------------
Purchase Price $ 408,386
------------
3) SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates. The preparation of the condensed consolidated financial
statements in conformity with accounting principles generally accepted in the
United States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates.
Reclassifications. Certain amounts included in the prior period financial
statements may have been reclassified to conform to the current period
presentation. The reclassifications have no impact on net income (loss)
previously reported.
Revenue Recognition and Allowance for Doubtful Accounts. 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. 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 customer's credit worthiness, historical bad debt
experience, changes in payment history and general economic and market trends.
-9-
Foreign Currency Translation. Assets and liabilities of the Company's
foreign subsidiaries are translated at period-end exchange rates. Income and
expenses are translated at the approximate average exchange rate during the
period. Foreign currency translation adjustments are recorded as a separate
component of stockholder's 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).
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 currently enacted tax rates. The effective tax rate in the
three and nine months ended June 30, 2004 and 2003 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
losses have been fully offset by a valuation allowance. The Company is included
in the consolidated tax return filed by Aearo Corporation. All taxes are
recorded as if separate, stand alone returns were filed. Deferred taxes are
based on preliminary purchase price allocations and may be subsequently
adjusted.
Goodwill and Other Intangibles. Effective October 1, 2002, the Company
adopted 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.
Intangible assets that have finite useful lives will continue to be amortized
over their useful lives and reviewed for impairment at each reporting date. The
following presents a summary of intangibles assets as of June 30, 2004 before
final allocations resulting from the April 7, 2004 merger:
Gross Accumulated Carrying
Amount Amortization Additions Amount
------- --------- --------- ---------
Trademarks $ 54,313 $ - $ 54,313
Customer
Relationship List 1,758 (47) 1,711
Patents 1,271 (18) 41 1,294
Other 383 (36) 347
-------- --------- --------- --------
Total Intangibles $ 57,725 $ (101) $ 41 $ 57,665
======== ========= ========= ========
Aggregate Estimate of Amortization Expense:
Six months ending September 30, 2004 $240
Year ending September 30, 2005 401
Year ending September 30, 2006 405
Year ending September 30, 2007 417
Year ending September 30, 2008 328
Year ending September 30, 2009 340
-10-
The following presents the changes in the carrying amount of goodwill for
the period ended June 30, 2004:
Goodwill pushed down in merger transaction $ 206,165
Translation adjustment 3,075
----------
Balance June 30, 2004 $ 209,240
==========
Stock-based Compensation. All stock option activity represent awards under
Aearo Corporation's stock option plan and all options were cancelled effective
April 7, 2004. As such, this disclosure relates only to the predecessor company.
The Company currently accounts for stock-based compensation under the intrinsic
method of Accounting Principles Board ("APB") Opinion No. 25. The following
table illustrates the effect on net income (loss) as if the fair value based
method had been applied to all outstanding awards (dollars in thousands):
Three Six Nine
Months Months Months
Ended Ended Ended
June 30, March 31, June 30,
2004 2004 2004
---- ---- ----
Net Income (loss) as reported $ 6,378 $ 8,564 $ 10,099
Deduct: Total stock-based
employee compensation expense
determined under the fair value
method for all awards, net of
tax 37 67 111
-------- ------- ---------
Proforma net income (loss) $ 6,341 $ 8,497 $ 9,988
--------- ------- ---------
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" requires that
every derivative instrument be recorded in the balance sheet as either an asset
or a liability measured at its fair value.
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 forward foreign currency
contracts and interest rate swap, cap and collar 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 and collar 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 to
results of operations when the related product sales affect earnings for forward
foreign currency contracts. As a result of the forward foreign currency
contracts, the Company has recorded a derivative payable of $0.1 million at June
30, 2004 and $0.4 million at September 30, 2003. All forward foreign currency
contracts will expire over the next three months.
During the three month period ended June 30, 2004, the Company's earnings
were unaffected by the exercise of forward foreign currency contracts. During
the six month period ended March 31, 2004, the Company reclassified into results
of operations a loss of approximately $0.5 million resulting from the exercise
of forward foreign currency contracts compared to a loss of approximately $1.0
million for the three month and $1.7 million for the nine month periods ended
June 30, 2003, respectively. All forward foreign currency contracts were
determined to be highly effective; therefore, no ineffectiveness was recorded in
results of operations.
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
-11-
are recorded as transaction adjustments in results of operations. The
impact on results of operations was a gain of approximately $0.3 million and a
loss $0.9 million for the three and six month periods ended June 30, 2004,
respectively, compared to a gain of approximately $0.2 million for the three and
nine month periods ended June 30, 2003, respectively.
The Company has approximately $30.5 million of variable rate debt protected
under an interest rate cap arrangement through December 31, 2004. The
approximate fair value of the interest rate cap at June 30, 2004 and September
30, 2003 was $0.1 million. The Company has not elected hedge accounting
treatment for the interest rate cap as defined under SFAS No. 133 and, as a
result, any fair value adjustment is charged directly to other income (expense).
During the three months ended June 30, 2004, the fair value of the interest rate
cap increased by approximately $0.1 million.
4) COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) consisted of the following (dollars in
thousands):
Three Six Nine
Months Months Months
Three Months Ended Ended Ended Ended
June 30, June 30, March 31, June 30,
------------------------------------------------------------
Successor Predecessor Successor Predecessor
------------------------------------------------------------
2004 | 2003 2004 | 2004 2003
---- | ---- ---- | ---- ----
Net Income (loss) $(14,247)| $ 6,378 $(14,247)| $ 8,564 $ 10,099
| |
Foreign currency translation adjustment (1,032)| 2,996 (1,032)| 1,688 7,181
Unrealized gain (loss) on derivative | |
instruments (112)| 116 (112)| 4 (538)
---------| -------- ---------| --------- ----------
Comprehensive income (loss) $(15,391)| $ 9,490 $(15,391)| $ 10,256 $ 16,742
---------| ---------- ---------| --------- ---------
5) INVENTORIES
Inventories consisted of the following (dollars in thousands):
June 30, September 30,
2004 2003
--------------- | ------------
(Unaudited) |
|
Raw materials $ 9,400 | $ 8,301
Work in process 10,983 | 11,976
Finished goods 20,960 | 16,992
--------------- | ------------
$ 41,343 | $ 37,269
=============== | ============
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
At September 30, 2003, the Company's debt structure included: (a) $98.0
million of 12.50% Senior Subordinated Notes due 2005 (the "12.50% Notes") issued
under an indenture dated as of July 11, 1995 (the "Notes Indenture") and (b) up
to an aggregate of $130.0 million under a credit agreement with various banks
comprised of (i) a secured term loan facility consisting of loans providing for
-12-
up to $100.0 million of term loans (collectively the "Term Loans") with a
portion of the Term Loans denominated in foreign currencies and (ii) the
Revolving Credit Facility providing for up to $30.0 million of revolving loans
for general corporate purposes (collectively the "Senior Bank Facilities"). The
amounts outstanding under the Term Loans, Revolving Credit Facility and the
12.50% Notes at September 30, 2003, were approximately $85.1 million, $11.7
million and $98.0 million, respectively. The Company elected to call the 12.50%
Notes effective May 6, 2004.
As noted in Note 2, on March 10, 2004, Aearo Corporation, the Company's
parent, entered into a merger agreement with AC Safety Holding Corp. and its
subsidiary, AC Safety Acquisition Corp. Pursuant to the terms of the Merger
Agreement, on April 7, 2004, AC Safety Acquisition Corp. merged with and into
Aearo Corporation with Aearo Corporation surviving the merger as a wholly owned
subsidiary of AC Safety Holding Corp. In connection with this transaction, (i)
the Company repaid all outstanding amounts under the Senior Bank Facilities,
terminated all commitments under that facility and redeemed the 12.50% Notes and
(ii) entered into a new senior credit facility, consisting of a $125.0 million
term loan facility due 2011 at a variable interest rate based on the London
Interbank Offering Rate ("LIBOR") (1.54%) plus 275 basis points and a $50.0
million revolving credit facility (collectively the "New Credit Facility") and
issued $175.0 million aggregate principal amount of 8.25% senior subordinated
notes due 2012 (the "8.25% Notes") in a private placement pursuant to Rule 144A
and Regulation S under the Securities Act of 1933. The 8.25% Notes have call
provisions that apply in certain circumstances. The amounts outstanding under
the New Credit Facility and 8.25% Notes at June 30, 2004, were approximately
$125.4 million and $175.0 million, respectively. The Company makes semi-annual
interest payments on the 8.25% Notes and quarterly payments of approximately
$0.3 million of principal plus interest on the New Credit Facility. Under the
terms of the New Credit Facility and the indenture governing the 8.25% Notes,
the Company is required to comply with certain financial covenants and
restrictions. The Company was in compliance with all financial covenants and
restrictions as of June 30, 2004.
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 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 Corporation, 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 Aearo Corporation makes an annual
payment of $400,000 to Cabot, the Sellers agreed to retain, and Cabot and the
Sellers agreed to defend and indemnify Aearo Corporation and its subsidiaries
against, any liability or obligation relating to or otherwise arising under any
proceeding or other claim against Aearo Corporation and its subsidiaries 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
-13-
respirators or similar devices sold by Sellers or their predecessors (including
American Optical Corporation and its predecessors) prior to July 11, 1995. To
date, Aearo Corporation has elected to pay the annual fee and intends to
continue to do so. In addition, under the terms of the Merger Agreement, Aearo
Corporation agreed to make the annual payment to Cabot for a minimum of seven
years from the Acquisition Date. Aearo Corporation and its subsidiaries could
potentially be liable for claims currently retained by Sellers if Aearo
Corporation 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 Aearo
Corporation entered into on June 27, 2003 (providing for the sale by Cabot to
Aearo Corporation of all of the common and preferred stock of Aearo Corporation
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 June 30, 2004 and September 30, 2003, the Company has recorded
liabilities of approximately $4.8 million and $4.5 million, respectively, 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
results of 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 Aearo Corporation and
its subsidiaries, including 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.
8) SEGMENT REPORTING
The Company manufactures and sells products under the brand names:
AOSafety(R), E-A-R(R), Peltor(R) and SafeWaze(TM). 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, communication headsets,
non-prescription safety eyewear, face shields, reusable and disposable
respirators, hard hats, fall protection 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
-14-
of its frames) from various suppliers, grinds, shapes and applies coatings to
the lenses in accordance with the customer's prescription, and then assembles
the glasses using the customer's choice of frame. The Specialty Composites
segment manufactures a wide array of energy-absorbing materials that are
incorporated into other manufacturers' products to control noise, vibration and
shock.
Net Sales by Business Segment (dollars in thousands):
Three Six Nine
Months Months Months
Three Months Ended Ended Ended Ended
June 30, June 30, March 31, June 30,
------------------------------------------------------------
Successor Predecessor Successor Predecessor
------------------------------------------------------------
2004 | 2003 2004 | 2004 2003
---- | ---- ---- | ---- ----
Safety Products $ 73,966 | $ 68,269 $ 73,966| $ 127,964 $ 176,953
Safety Prescription Eyewear 10,126 | 10,165 10,126| 20,337 30,463
Specialty Composites 13,034 | 8,289 13,034| 21,278 24,710
-------- | -------- --------| --------- ---------
Total $ 97,126 | $ 86,723 $ 97,126| $ 169,579 $ 232,126
-------- | ---------- --------| --------- ---------
Inter-segment sales from the Specialty Composites segment to the Safety
Products segment totaled $0.6 million and $0.8 million for the three months
ended June 30, 2004 and 2003, respectively. Inter-segment sales from the
Specialty Composites segment to the Safety Products segment totaled $1.6 million
and $2.3 million for the six and nine months ended March 31, 2004 and June 30,
2003, respectively. The inter-segment sales value is determined at fully
absorbed inventory cost at standard rates plus 25%.
Profit (loss) by business segment and reconciliation to income (loss)
before provision for income taxes (dollars in thousands):
Three Six Nine
Months Months Months
Three Months Ended Ended Ended Ended
June 30, June 30, March 31, June 30,
------------------------------------------------------------
Successor Predecessor Successor Predecessor
------------------------------------------------------------
2004 | 2003 2004 | 2004 2003
---- | ---- ---- | ---- ----
Safety Products $ 16,122 | $ 14,473 $ 16,122 | $ 23,704 $ 35,678
Safety Prescription Eyewear 37 | 249 37 | (57) 612
Specialty Composites 2,623 | 631 2,623 | 2,855 918
-------- | -------- -------- | --------- --------
Segment profit 18,782 | 15,353 18,782 | 26,502 37,208
Depreciation 3,006 | 2,812 3,006 | 5,931 8,175
Amortization of intangibles 101 | 62 101 | 242 194
Inventory purchase accounting 17,067 | -- 17,067 | -- --
Bond call premium 1,532 | -- 1,532 | -- --
Restructuring -- | -- -- | (1,091) --
Interest 10,292 | 4,737 10,292 | 10,836 14,701
-------- | -------- -------- | --------- --------
Income (loss) before provision for income |
taxes $(13,216)| $ 7,742 $(13,216) | $ 10,584 $ 14,138
=========| ======== ========= | ========= =========
Segment profit is defined as operating income (loss) before depreciation,
amortization, interest expense, inventory purchase accounting adjustment, bond
call premium expense and income taxes and represents the measure used by the
chief operating decision maker to assess segment performance and make decisions
about the allocation of resources to business segments.
9) PENSION
The following table presents the components of net periodic pension cost
for the three and nine month periods ended June 30, 2004 and 2003, respectively
(dollars in thousands):
Three Six Nine
Months Months Months
Three Months Ended Ended Ended Ended
June 30, June 30, March 31, June 30,
------------------------------------------------------
Successor Predecessor Successor Predecessor
---------------------------------------------------------
2004 | 2003 2004 | 2004 2003
---- | ---- ---- | ---- ----
Service cost $ 335 | $ 378 $ 335 | $ 669 $ 1,133
Interest cost 186 | 208 186 | 371 625
Expected return on plan assets (167)| (168) (167)| (332) (504)
Amortization of: | |
Prior service cost 2 | 2 2 | 5 7
Loss -- | 16 -- | -- 47
-------- | -------- -------- | --------- ---------
Total $ 356 | $ 436 $ 356 | $ 713 $ 1,308
======== | ======== ======== | ========= =========
10) RESTRUCTURING CHARGE
During fiscal 2001, the Company recorded a restructuring charge of $11.4
million relating 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.
During the six month period ended March 31, 2004, the Company reversed $1.1
million of reserves related to the September 30, 2001 restructuring provision.
The adjustment represents a change in estimate related to amounts for
non-cancelable lease obligations due to the renegotiation of the subject lease
that was completed during the second quarter. The balance of the restructuring
accrual as of June 30, 2004 was zero.
11) SUMMARIZED FINANCIAL INFORMATION
The Company's 8.25% Senior Subordinated Notes due 2012 are fully and
unconditionally guaranteed, on a joint and several basis, by substantially all
of the Company's wholly owned domestic subsidiaries ("Subsidiary Guarantors").
The non-guarantor subsidiaries are the Company's foreign subsidiaries.
The following condensed financial information illustrates the composition
of the combined Subsidiary Guarantors based on the preliminary allocation of
purchase price. The Company believes that the separate, complete financial
statements of the respective guarantors would not provide additional material
information which would be useful in assessing the financial composition of the
Subsidiary Guarantors (dollars in thousands).
Condensed Consolidated Statement of Operations
Three Months Ended June 30, 2004
Successor
-------------------------------------------------------------
Non-
Guarantor Guarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
Net Sales......................... $ 72,522 $ -- $ 35,388 $ (10,784) $ 97,126
Cost of sales..................... 52,065 -- 26,893 (10,814) 68,144
-------- -------- -------- ---------- ---------
Gross profit.................... 20,457 -- 8,495 30 28,982
Selling and administrative........ 20,797 344 7,008 -- 28,149
Research and technical services... 1,251 -- 715 -- 1,966
Amortization...................... 83 18 -- -- 101
Other charges (income), net....... 5,582 (6,743) 2,851 -- 1,690
Restructuring income.............. -- -- -- -- --
-------- -------- -------- --------- ---------
Operating income (loss)........ (7,256) 6,381 (2,079) 30 (2,924)
Interest expense (income)......... 10,152 (399) 539 -- 10,292
-------- --------- -------- --------- ---------
Income (loss) before taxes........ (17,408) 6,780 (2,618) 30 (13,216)
Income tax provision (benefit).... (2,875) 2,700 1,206 -- 1,031
Equity in subsidiaries............ 256 (3,824) -- 3,568 --
-------- --------- -------- --------- ---------
Net income (loss).............. $(14,277) $ 256 $ (3,824) $ 3,598 $ (14,247)
========= ======== ========= ========= ==========
Condensed Consolidated Statement of Operations
Six Months Ended March 31, 2004
Predecessor
-------------------------------------------------------------
Non-
Guarantor Guarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
Net Sales................................. $122,913 $ -- $ 65,030 $ (18,364) $ 169,579
Cost of Sales............................. 71,142 -- 36,348 (18,434) 89,056
-------- -------- -------- ---------- ---------
Gross profit............................ 51,771 -- 28,682 70 80,523
Selling and administrative................ 42,612 674 13,549 -- 56,835
Research and technical services........... 2,351 -- 1,272 -- 3,623
Amortization.............................. 168 74 -- -- 242
Other charges (income), net............... 6,815 (12,283) 4,962 -- (506)
Restructuring charges (income)............ (1,091) -- -- -- (1,091)
--------- -------- -------- --------- ----------
Operating income....................... 916 11,535 8,899 70 21,420
Interest, net............................. 10,117 (983) 1,702 -- 10,836
-------- --------- -------- --------- ---------
Income (loss) before taxes................ (9,201) 12,518 7,197 70 10,584
Income tax provision (benefit)............ (4,642) 5,022 1,640 -- 2,020
Equity in subsidiaries.................... 13,053 5,557 (18,610) --
-------- -------- -------- ---------- ---------
Net income (loss)...................... $ 8,494 $ 13,053 $ 5,557 $ (18,540) $ 8,564
======== ======== ======== ========== =========
Condensed Consolidated Statement of Operations
Nine Months Ended June 30,2003
Predecessor
-------------------------------------------------------------
Non-
Guarantor Guarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
Net Sales................................. $168,143 $ -- $ 90,379 $ (26,396) $ 232,126
Cost of sales............................. 97,850 -- 49,975 (26,500) 121,325
-------- -------- -------- ---------- ---------
Gross profit............................ 70,293 -- 40,404 104 110,801
Selling and administrative................ 57,416 847 17,143 -- 75,406
Research and technical services........... 3,364 -- 1,307 -- 4,671
Amortization.............................. 113 81 -- -- 194
Other charges (income), net............... 10,229 (15,534) 6,996 -- 1,691
-------- --------- -------- --------- ---------
Operating income (loss)................ (829) 14,606 14,958 104 28,839
Interest expense (income), net............ 13,585 (2,354) 3,470 -- 14,701
-------- --------- -------- --------- ---------
Income (loss) before taxes................ (14,414) 16,960 11,488 104 14,138
Income tax provision (benefit)............ (6,682) 6,774 3,947 -- 4,039
Equity in subsidiaries.................... 17,727 7,541 -- (25,268) --
-------- -------- -------- ---------- ---------
Net income (loss)...................... $ 9,995 $ 17,727 $ 7,541 $ (25,164) $ 10,099
======== ======== ======== ========== =========
Condensed Consolidated Balance Sheet
Period Ended June 30, 2004
Successor
-------------------------------------------------------------
Non-
Guarantor Guarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
Current Assets:
Cash and cash equivalents.............. $ 3,030 $ 97 $ 8,727 $ -- $ 11,854
Receivables, net....................... 33,865 -- 19,785 -- 53,650
Inventories............................ 29,767 -- 11,913 (337) 41,343
Deferred and prepaid expenses.......... 2,880 -- 1,332 -- 4,212
-------- -------- -------- --------- ---------
Total current assets...................... 69,542 97 41,757 (337) 111,059
-------- -------- -------- ---------- ---------
Long term assets:
Property plan and equipment............ 35,616 -- 11,782 -- 47,398
Goodwill and other intangibles, net.... 188,276 24,756 53,873 -- 266,905
Inter-company receivables (payables) (40,950) 95,008 (54,058) -- --
Investment in subsidiaries ............ 158,429 40,981 (690) (198,720) --
Other assets........................... 13,128 -- 11 -- 13,139
-------- -------- -------- --------- ---------
Total assets.............................. 424,041 160,842 52,675 (199,057) 438,501
======== ======== ======== ========== =========
Current Liabilities:
Current portion of long term debt...... 1,601 -- 20 1,621
Accounts payable and accrued
liabilities............................ 29,593 581 13,859 -- 44,033
Accrued interest....................... 3,336 -- -- -- 3,336
Income tax payables (receivables)...... 2,049 (2,038) 1,077 1,088
-------- --------- -------- --------- ---------
Total current liabilities................. 36,579 (1,457) 14,956 -- 50,078
-------- --------- -------- --------- ---------
Long Term Liabilities:
Long term debt......................... 302,102 -- 179 -- 302,281
Deferred income taxes.................. 227 -- 1,447 -- 1,674
Other liabilities...................... 12,864 -- -- -- 12,864
-------- -------- -------- --------- ---------
Total Liabilities......................... 351,772 (1,457) 16,582 -- 366,897
-------- --------- ------ --------- ---------
Stockholder's Equity:
Common................................. -- -- 7,396 (7,396) --
Paid in capital........................ 101,300 167,519 15,454 (182,973) 101,300
Retained earnings...................... (28,469) (8,513) 20,173 (11,743) (28,552)
Accumulated other comprehensive income
(loss)................................. (562) 3,293 (6,930) 3,055 (1,144)
--------- -------- --------- --------- ----------
Total Stockholder's Equity................ 72,269 162,299 36,093 (199,057) 71,604
-------- -------- -------- ---------- ---------
Total Liabilities and Stockholder's Equity $424,041 $160,842 $ 52,675 $(199,057) $ 438,501
======== ======== ======== ========== =========
Condensed Consolidated Balance Sheet
Year Ended September 30, 2003
Predecessor
-------------------------------------------------------------
Non-
Guarantor Guarantor
Parent Subsidiaries Subsidiaries Eliminations Consolidated
Current Assets:
Cash and cash equivalents.............. $ 1,545 $ 206 $ 5,550 $ -- $ 7,301
Receivables, net....................... 29,139 96 19,911 -- 49,146
Inventories............................ 24,678 -- 13,029 (438) 37,269
Deferred and prepaid expenses.......... 5,806 -- 1,515 -- 7,321
-------- -------- -------- --------- ---------
Total current assets...................... 61,168 302 40,005 (438) 101,037
-------- -------- -------- ---------- ---------
Long term Assets:
Property plan and equipment............ 37,097 -- 11,772 -- 48,869
Goodwill and other intangibles, net.... 26,717 54,452 58,488 -- 139,657
Inter-company receivables (payables) (50,485) 93,411 (42,926) -- --
Investment in subsidiaries ............ 54,145 11,255 (670) (64,730) --
Other assets........................... 3,942 -- 11 -- 3,953
-------- -------- -------- --------- ---------
Total assets.............................. 132,584 159,420 66,680 (65,168) 293,516
======== ======== ======== ========== =========
Current Liabilities:
Current portion of long term debt...... 14,752 -- 3,015 17,767
Accounts payable and accrued
liabilities............................ 31,434 803 11,806 -- 44,043
Accrued interest....................... 2,562 -- 4 -- 2,566
Income tax payables.................... 2,556 (2,378) 1,568 1,746
-------- --------- -------- --------- ---------
Total current liabilities................. 51,304 (1,575) 16,393 -- 66,122
-------- --------- -------- --------- ---------
Long Term Liabilities:
Long term debt......................... 165,305 -- 15,481 -- 180,786
Due to parent.......................... 207 -- -- -- 207
Deferred income taxes.................. 228 -- 1,381 -- 1,609
Other liabilities...................... 11,334 -- -- -- 11,334
-------- -------- -------- --------- ---------
Total Liabilities......................... 228,378 (1,575) 33,255 -- 260,058
-------- --------- ------ --------- ---------
Stockholder's Equity:
Common................................. - -- -- -- -
Paid in capital........................ 32,531 167,519 20,773 (188,292) 32,531
Retained earnings...................... (126,149) (9,049) 20,646 122,265 7,713
Accumulated other comprehensive income. (2,176) 2,525 (7,994) 859 (6,786)
--------- -------- --------- --------- ----------
Total Stockholder's Equity................ (95,794) 160,995 33,425 (65,168) 33,458
--------- -------- -------- ---------- ---------
Total Liabilities and Stockholder's Equity $132,584 $159,420 $ 66,680 $ (65,168) $ 293,516
======== ======== ======== ========== =========
Condensed Consolidating Statement of Cash Flows
Three Months Ended June 30, 2004
Successor
-------------------------------------------------
Non-
Guarantor Guarantor
Parent Subsidiaries Subsidiaries Consolidated
Net cash provided by operating activities. $ 5,096 $ 5,352 $ 3,346 $ 13,794
Net cash used for investing activities.... (2,196) -- (614) (2,810)
Net cash provided by (used for) financing
activities............................. (2,814) (5,796) 5,025 (3,585)
Effect of exchange rate on cash........... 2,051 (210) (2,699) (858)
-------- --------- --------- ----------
Increase (decrease) in cash and cash
equivalents............................ 2,137 (654) 5,058 6,541
======== ========= ======== =========
Cash and cash equivalents at the
beginning of the period................ 893 751 3,669 5,313
Cash and cash equivalents at the end of
the period............................. $ 3,030 $ 97 $ 8,727 $ 11,854
Condensed Consolidating Statement of Cash Flows
Six Months Ended March 31, 2004
Predecessor
-------------------------------------------------
Non-
Guarantor Guarantor
Parent Subsidiaries Subsidiaries Consolidated
Net cash provided by operating activities. $ (1,359) $ 6,407 $ 3,987 $ 9,035
Net cash used for investing activities.... (3,326) -- (1,668) (4,994)
Net cash used for financing activities.... 3,255 (6,840) (1,655) (5,240)
Effect of exchange rate on cash........... 779 978 (2,546) (789)
-------- -------- --------- ----------
Increase (decrease) in cash and cash
equivalents............................ (651) 545 (1,882) (1,988)
Cash and cash equivalents at the
beginning of the period................ 1,544 206 5,551 7,301
-------- -------- -------- ---------
Cash and cash equivalents at the end of
the period............................. $ 893 $ 751 $ 3,669 $ 5,313
======= ======= ======= ========
Condensed Consolidating Statement of Cash Flows
Nine Months Ended June 30, 2003
Predecessor
-------------------------------------------------
Non-
Guarantor Guarantor
Parent Subsidiaries Subsidiaries Consolidated
Net cash provided by operating activities. $ 15,911 $ 7,216 $ 4,902 $ 28,029
Net cash used for investing activities.... (16,138) -- (2,427) (18,565)
Net cash provided by (used for) financing
activities............................. 1,470 (9,655) (1,616) (9,801)
Effect of exchange rate on cash........... (318) 2,158 (926) 914
--------- -------- --------- ---------
Increase (decrease) in cash and cash
equivalents............................ 925 (281) (67) 577
======== ========= ========= =========
Cash and cash equivalents at the
beginning of the period................ 7,322 475 6,683 14,480
Cash and cash equivalents at the end of
the period............................. $ 8,247 $ 194 $ 6,616 $ 15,057
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
included in its registration statement filed June 18, 2004. This Report contains
forward-looking statements within the meaning of the federal securities laws.
Statements that are not historical facts, including statements about the
Company's beliefs and expectations, are forward-looking statements.
Forward-looking statements included statements preceded by, followed by or that
include the words "may," "could," "would," "should," "believe," "expect,"
"anticipate," "plan," "estimate," "target," "project," "intend," or similar
expressions. These statements include, among others, statements regarding the
Company's expected business outlook, anticipated financial and operating
results, the Company's business strategy and means to implement the strategy,
the Company's objectives, the amount and timing of future capital expenditures,
future acquisitions, the likelihood of the Company's success in developing and
introducing new products and expanding its business, the timing of the
introduction of new and modified products or services, financing plans, working
capital needs and sources of liquidity.
Forward-looking statements are only predictions and are not guarantees of
performance. These statements are based on management's beliefs and assumptions,
which in turn are based on currently available information. Important
assumptions relating to the forward-looking statements include, among others,
assumptions regarding demand for our products, the cost, timing and success of
product upgrades and new product introductions, expected pricing levels, the
timing and cost of planned capital expenditures and expected synergies relating
to acquisitions. These assumptions could prove inaccurate. Forward-looking
statements also involve risks and uncertainties, which could cause actual
results to differ materially from those contained in any forward-looking
statements. Many of these factors are beyond the Company's ability to control or
predict. Such factors include, but are not limited to: 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.
The Company believes these forward-looking statements are reasonable;
however, undue reliance should not be placed on any forward-looking statements,
which are based on current expectations. Further, forward-looking statements
speak only as of the date they are made, and except as otherwise required by the
federal securities laws, the Company undertakes no obligation to update any of
them publicly in light of new information or future events.
Merger Agreement
On March 10, 2004, Aearo Corporation, the Company's parent, entered into a
merger agreement with AC Safety Holding Corp. and its subsidiary, AC Safety
Acquisition Corp. that closed on April 7, 2004. Pursuant to the terms of the
Merger Agreement, AC Safety Acquisition Corp. merged with and into Aearo
Corporation with Aearo Corporation surviving the merger as a wholly-owned
subsidiary of AC Safety Holding Corp. The aggregate purchase price was
approximately $408.4 million, including estimated fees and expenses. The merger
was financed with approximately $303.4 million of new debt consisting of $175.0
million of 8.25% senior subordinated notes and $125.0 million of senior credit
facility, $3.7 million of assumed debt and $101.3 million of equity.
The merger was a business combination under SFAS No. 141,
"Business Combinations," and the purchase price paid for our parent
was pushed down to the Company. Accordingly, the unaudited balance
sheet as of June 30, 2004 and the results of operations (unaudited)
subsequent to the Acquisition Date are presented on a different basis
of accounting than the balance sheet as of September 30, 2003 and the
results of operations (unaudited) prior to the Acquisition Date, and
therefore are not directly comparable. The sale was accounted for as
if it had occurred on March 31, 2004, as management determined that
results of operations were not significant and no material
transactions occurred during the period from April 1, 2004 to April 7,
2004.
Critical Accounting Policies
The Company's discussion and analysis of its financial condition
and results of operations are based upon the Company's condensed
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, assumptions and subjective interpretations
of accounting principles 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. The Company revises its
estimates and assumptions as new information becomes available.
The Company believes that of its significant accounting policies
the following policies involve a higher degree of judgment and/or
complexity.
Income Taxes - The Company is included in the consolidated tax returns
filed by Aearo Corporation. All taxes are recorded as if separate,
standalone returns are filed. The Company accounts for income taxes in
accordance with 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.
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.
Pension Plan - The valuation of the Company's pension plan requires the use
of assumptions and estimates that are used to develop actuarial valuations of
expenses and assets/liabilities. These assumptions include discount rates,
investment returns, projected salary increases and mortality rates. The
actuarial assumptions used in the Company's pension reporting are reviewed
annually and compared with external benchmarks and internal operating trends to
assure that they accurately account for future pension obligations. Changes in
assumptions and future investment returns could potentially have a material
impact on the Company's pension expense and funding requirements. The Company
adopted the provisions SFAS No. 132R effective January 1, 2004.
Impairment of Long-Lived Assets - The Company evaluates long-lived assets,
including other intangibles and 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 and Allowance for Doubtful Accounts - 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. 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 customer's credit worthiness, historical bad debt
experience, changes in payment history and general economic and market trends.
Goodwill - SFAS No. 142, "Goodwill and Other Intangible Assets," requires
that goodwill no longer be amortized, and instead, be tested for impairment on a
periodic basis. In testing for a potential impairment of goodwill, SFAS No. 142
requires the Company to individually allocate and assign the carrying value of
assets and liabilities (including goodwill) to specific reporting units or
business segments, estimate the fair value of the reporting units or business
segments, and determine goodwill impairment by comparing the estimated fair
value to the assigned carrying value. The process of evaluating the potential
impairment is highly subjective and requires significant judgment at many points
during the analysis.
Results of Operations -- Three Months Ended June 30, 2004 Compared to Three
Months Ended June 30, 2003.
Management has based its narrative analysis of the results of operations
for the three and nine month period ended June 30, 2004 and June 30, 2003 on the
combined results of operations for the entire period. Material variances are
caused by the different basis of accounting have been disclosed where
applicable.
Results of Operations
(Dollars in Thousands)
(Unaudited)
Three months ended June 30,
------------------------------------------------------
2004 (1) % 2003 %
-------- ---------- ---------- ---------
Net sales:
Safety Products $ 73,966 76.2 $ 8,269 78.7
Safety Prescription Eyewear 10,126 10.4 10,165 11.7
Specialty Composites 13,034 13.4 8,289 9.6
--------- -------- ---------- -------
Total net sales 97,126 100.0 86,723 100.0
Cost of sales 68,144 70.2 45,768 52.8
--------- -------- ---------- -------
Gross profit 28,982 29.8 40,955 47.2
Operating expenses:
Selling and administration 28,149 29.0 26,218 30.2
Research and technical services 1,966 2.0 1,462 1.7
Amortization 101 0.1 62 0.1
Other charges (income), net 1,690 1.7 734 0.8
--------- -------- ---------- -------
Total operating expenses 31,906 32.9 28,476 32.8
Operating income (loss) (2,924) (3.0) 12,479 14.4
Interest expense 10,292 10.6 4,737 5.5
--------- -------- ---------- -------
Income (loss) before provision for
income taxes (13,216) (13.6) 7,742 8.9
Provision for income taxes 1,031 1.1 1,364 1.6
--------- -------- ---------- -------
Net income (loss) $ (14,247) (14.7) $ 6,378 7.4
========== ========= ========== =======
(1) Reflects a new basis of accounting subsequent to April 7, 2004 due to the
merger.
Net sales in the three months ended June 30, 2004 increased 12.0% to $97.1
million from $86.7 million in the three months ended June 30, 2003. The
increase in net sales was primarily driven by organic growth in the Safety
Products and Speciality Composites segments and foreign currency translation.
The weakness of the U.S. dollar favorably impacted net sales by $2.2 million.
The safety Products segment net sales in the three months ended June 30, 2004
increased 8.3% to $74.0 million from $68.3 million in the three months ended
June 30, 2003. The increase in net sales resulted from organic growth of 5.2%
and a 3.1% increase due to foreign currency translation. Organic sales growth
for the Safety Products segment, defined as net sales less the impact of
foreign currency translation and acquisitions, has increased for eight
consecutive quarters. The Company attributes this growth to its ability to
successfully introduce new products into the markets it serves. The Safety
Prescription Eyewear segment net sales in the three months ended June 30, 2004
were essentially flat at $10.1 million as compared to $10.2 million in the
three months ended June 30, 2003. Specialty Composites' net sales in the three
months ended June 30, 2004 increased 57.2% to $13.0 million from $8.3 million
in the three months ended June 30, 2003. The increase was primarily driven by
volume increases in the precision electronics, truck, aircraft and industrial
markets. The Company tracks measures such as computer and electronic
production data and truck build rates to gauge the momentum in the Specialty
Composites segment which has been experiencing positive sales trends in the
last four quarters.
Gross profit in the three months ended June 30, 2004 decreased 29.2% to
$29.0 million from $41.0 million in the three months ended June 30, 2003. The
decrease in gross profit is primarily due to the non-recurring charge of $17.1
million resulting from the write-up in inventory required by SFAS No. 141 on the
merger date and subsequent sale of such inventory. Excluding the effects of the
SFAS No. 141 adjustment, gross profit as a percentage of net sales in the three
months ended June 30, 2004 improved to 47.4% as compared to 47.2% in the three
months ended June 30, 2003. The improvement in the gross profit percentage,
exclusive of the non-recurring charge, is primarily due to continued
productivity improvements and the impact of foreign currency translation,
partially offset by movements in product mix.
Operating expenses in the three months ended June 30, 2004 increased 12.0%
to $31.9 million from $28.5 million in the three months ended June 30, 2003. The
increase in operating expenses was primarily driven by an increase in selling
and administrative expense, research and technical services and other charges
(income), net. Selling and administrative expenses included approximately $0.6
million of expenses due to foreign currency translation, $0.9 of expenses due to
variable selling and marketing expenses. Selling and administrative expenses as
a percentage of net sales improved to 29.0% in the three months ended June 30,
2004 as compared to 30.2% in the three months ended June 30, 2003. Research and
technical services expense increased $0.5 million primarily due to increased
product development. Other charges (income), net was expense of $1.7 million for
the three months ended June 30, 2004 as compared to expense of $0.7 million in
the three months ended June 30, 2003. The expense of $1.7 million in the three
months ended June 30, 2004 was primarily due to a $1.5 million call premium to
redeem the Company's 12.50% Senior Subordinated Notes due 2005 (the "12.50%
Notes") in connection with the merger.
Interest expense, net, in the three months ended June 30, 2004 increased to
$10.3 million from $4.7 million in the three months ended June 30, 2003.
Interest expense for the three months ended June 30, 2004 included the write-off
of approximately $4.0 million for deferred financing fees related to the
redemption of the 12.50% Notes and the repayment of the Company's senior bank
facilities. In addition, the Company incurred an incremental 30 days of interest
on the 12.50% Notes between the call date for the 12.50% Notes and the
redemption date. The balance of the increase is due to the higher level of
borrowings under the Company's new credit facility and its Senior Subordinated
Notes due 2012 (the "8.25% Notes").
The provision for income taxes in the three months ended June 30, 2004 was
$1.0 million as compared to $1.4 million in the three months ended June 30,
2003. The effective tax rate in the three months ended June 30, 2004 and 2003
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 losses have been fully offset by a valuation allowance.
Results of Operations -- Nine Months Ended June 30, 2004 Compared to Nine
Months Ended June 30, 2003.
Management has based its narrative analysis of the results of operations
for the three and nine month period ended June 30, 2004 and June 30, 2003 on the
combined results of operations for the entire period. Material variances are
caused by the different basis of accounting have been disclosed where
applicable.
Results of Operations
(Dollars in Thousands)
(Unaudited)
Nine months ended June 30,
----------------------------------------------------------
2004 (1) % 2003 %
----------- ---------- ---------- ----------
Net sales:
Safety Products $ 201,930 75.7 $ 176,953 76.2
Safety Prescription Eyewear 30,463 11.4 30,463 13.1
Specialty Composites 34,312 12.9 24,710 10.7
---------- ------ --------- --------
Total net sales 266,705 100.0 232,126 100.0
Cost of sales 157,200 58.9 121,325 52.3
---------- ------ --------- --------
Gross profit 109,505 41.1 110,801 47.7
Operating expenses:
Selling and administration 84,984 31.9 75,406 32.5
Research and technical services 5,589 2.1 4,671 2.0
Amortization 343 0.1 194 0.1
Other charges (income), net 1,184 0.4 1,691 0.7
Restructuring (1,091) 0.4) -- --
---------- ------- ---------- ---------
Total operating expenses 91,009 34.1 81,962 35.3
Operating income 18,496 6.9 28,839 12.4
Interest expense 21,128 7.9 14,701 6.3
---------- -------- ---------- -------
Income (loss) before provision for
income taxes (2,632) (1.0) 14,138 6.1
Provision for income taxes 3,051 1.1 4,039 1.7
---------- -------- ---------- -------
Net income (loss) $ (5,683) (2.1) $ 10,099 4.4
=========== ========== ========== =======
(1) Reflects a new basis of accounting subsequent to April 7, 2004 due to the
merger.
Net sales in the nine months ended June 30, 2004 increased 14.9% to $266.7
million from $232.1 million in the nine months ended June 30, 2003. The increase
in net sales was primarily driven by organic growth in the Safety Products and
Specialty Composites segments, the impact of the SafeWaze acquisition on March
14, 2003 and foreign currency translation. The weakness of the U.S. dollar and
the SafeWaze acquisition favorably impacted net sales by $9.6 million and $5.0
million, respectively. The Safety Products segment net sales in the nine months
ended June 30, 2004 increased 14.1% to $201.9 million from $177.0 million in the
nine months ended June 30, 2003. The increase in net sales resulted from a 6.2%
increase in organic growth, a 5.1% increase due to foreign currency translation
and a 2.8% increase due to the acquisition of SafeWaze. Organic sales growth for
the Safety Products segment, defined as net sales less the impact of foreign
currency translation and acquisitions, has increased for eight consecutive
quarters. The Company attributes this growth to its ability to successfully
introduce new products into the markets it serves. The Safety Prescription
Eyewear segment net sales in the nine months ended June 30, 2004 were unchanged
at $30.5 million. Specialty Composites' net sales in the nine months ended June
30, 2004 increased 38.9% to $34.3 million from $24.7 million in the nine months
ended June 30, 2003. The increase was primarily driven by volume increases in
the precision electronics, truck, aircraft and industrial markets. The Company
tracks measures such as computer and electronic production data and truck build
rates to gauge the momentum in the Specialty Composites segment which has been
experiencing positive sales trends in the last four quarters.
Gross profit in the nine months ended June 30, 2004 decreased 1.2% to
$109.5 million from $110.8 million in the nine months ended June 30, 2003. The
decrease in gross profit is primarily due to the non-recurring charge of $17.1
million resulting from the write-up of inventory required by SFAS No. 141 on the
merger date and subsequent sale of such inventory. Excluding the effects of the
purchase accounting adjustment, gross profit as a percentage of net sales in the
three months ended June 30, 2004 was 47.5% as compared to 47.7% in the three
months ended June 30, 2003. The slight decline in the gross profit percentage,
exclusive of the non-recurring charge, is primarily due to unfavorable product
mix partially offset by productivity improvements and the impact of foreign
currency translation.
Operating expenses in the nine months ended June 30, 2004 increased 11.0%
to $91.0 million from $82.0 million in the nine months ended June 30, 2003. The
increase in operating expenses was primarily driven by an increase in selling
and administrative, research and technical services expenses and amortization
expense, partially offset by the restructuring provision adjustment and other
charges, net. Selling and administrative expenses included approximately $1.1
million of expenses due to the acquisition of SafeWaze, $2.6 million due to
foreign currency translation, $1.1 million due to variable selling expenses, as
well as increased marketing expenses to support new product launches and build
brand support. Selling and administrative expenses as a percentage of net sales
improved to 31.9% in the nine months ended June 30, 2004 as compared to 32.5% in
the nine months ended June 30, 2003. The restructuring provision adjustment of
$1.1 million of income was the result of a change in estimate relating to
non-cancelable leases.
Interest expense, net, in the nine months ended June 30, 2004 increased to
$21.1 million from $14.7 million in the nine months ended June 30, 2003.
Interest expense for the nine months ended June 30, 2004 included the wrote-off
of approximately $4.0 million for deferred financing fees related to the
redemption of the 12.50% Notes and the repayment of the Company's senior bank
facilities. In addition, the Company incurred an incremental 30 days of interest
on the 12.50% Notes between the call date for the 12.50% Notes and the
redemptions date. The balance of the increase is due to the higher level of
borrowings under the Company's new credit facility and the 8.25% Notes.
The provision for income taxes in the nine months ended June 30, 2004 was
$3.1 million as compared to $4.0 million in the nine months ended June 30, 2003.
The effective tax rate in the nine months ended June 30, 2004 and 2003 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 losses have been fully offset by a valuation allowance.
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. The Company's Swedish operations are also affected
by changes in exchange rates relative to the Swedish Krona. In contrast to the
above, 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, 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.
At September 30, 2003, the Company's debt structure included: (a) $98.0
million of 12.50% Senior Subordinated Notes due 2005 (the "12.50% Notes") issued
under an indenture dated as of July 11, 1995 (the "Notes Indenture") and (b) up
to an aggregate of $130.0 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 and (ii) the
Revolving Credit Facility providing for up to $30.0 million of revolving loans
for general corporate purposes (collectively the "Senior Bank Facilities"). The
amounts outstanding under the Term Loans, Revolving Credit Facility and the
12.50% Notes at September 30, 2003, were approximately $85.1 million, $11.7
million and $98.0 million, respectively. Under the terms of the Senior Credit
Facility and the Notes Indenture, the Company was in compliance with all
financial covenants and restrictions as of September 30, 2003.
As noted in Note 2, on March 10, 2004, Aearo Corporation, the Company's
parent, entered into a merger agreement with AC Safety Holding Corp. and its
subsidiary, AC Safety Acquisition Corp. Pursuant to the terms of the Merger
Agreement, on April 7, 2004, AC Safety Acquisition Corp. merged with and into
Aearo Corporation with Aearo Corporation surviving the merger as a wholly owned
subsidiary of AC Safety Holding Corp. In connection with this transaction, (i)
the Company repaid all outstanding amounts under the Senior Bank Facilities,
terminated all commitments under that facility and redeemed the 12.50% Notes and
(ii) entered into a new senior credit facility, consisting of a $125.0 million
term loan facility due 2011 at a variable interest rate based on the London
Interbank Offering Rate ("LIBOR") (1.54%) plus 275 basis points and a $50.0
million revolving credit facility (collectively the "New Credit Facility") and
issued $175.0 million aggregate principal amount of 8.25% senior subordinated
notes due 2012 (the "8.25% Notes") in a private placement pursuant to Rule 144A
and Regulation S under the Securities Act of 1933. The amounts outstanding under
the New Credit Facility and 8.25% Notes at June 30, 2004, were approximately
$125.4 million and $175.0 million, respectively. Under the terms of the New
Credit Facility and the indenture governing the 8.25% Notes, the Company is
required to comply with certain financial covenants and restrictions. The
Company was in compliance with all financial covenants and restrictions as of
June 30, 2004.
The Company typically makes capital expenditures related primarily to the
maintenance and improvement of manufacturing facilities. The Company's principal
source of cash to fund these capital requirements is cash from operations. The
Company spent $7.8 million and $7.5 million, respectively for capital
expenditures for the nine months ended June 30, 2004 and 2003, respectively. The
Company anticipates it will a spend approximately $11.0 million for capital
expenditures in its fiscal year ended September 30, 2004.
The Company's net cash provided by operating activities for the nine months
ended June 30, 2004 totaled $22.8 million as compared to $28.0 million for the
nine months ended June 30, 2003. The decrease of $5.2 million was due primarily
to an $12.9 million decrease related to the net changes in assets and
liabilities, partially offset by a $7.7 million improvement in net income
adjusted for cash and non-cash charges (depreciation, inventory purchase
accounting adjustment, amortization, deferred taxes and other). The Company's
net changes in assets and liabilities was primarily driven by a decrease in cash
from receivables, inventory and accounts payable and accrued liabilities and
income taxes, partially offset by an increase in cash from other, net.
Net cash used by investing activities was $7.8 million for the nine months
ended June 30, 2004 as compared to $18.6 million for the nine months ended June
30, 2003. The decrease in net cash used by investing activities is primarily
attributed to acquisitions in the nine months ended June 30, 2003.
Net cash provided by financing activities for the nine months ended June
30, 2004 was $8.8 million compared with net cash used by financing activities
for the nine months ended June 30, 2003 of $9.8 million. The change is primarily
due to the financing of the merger agreement on April 7, 2004.
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 asset 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 annual pension
expense. The discount rate was also 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 annual 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 2004. 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.
Contractual Obligations
The Company has the following minimum commitments under contractual
obligations including purchase obligations, as defined by the U.S. Securities
and Exchange Commission as of June 30, 2004:
2004 2005-2006 2007-2008 2009 and after Total
Capital lease obligations $ 69 $ 552 $ 552 $ 126 $ 1,299
Operating lease obligations 1,241 6,937 7,864 6,347 22,389
Mortgage obligations 43 112 2,052 16 2,223
Purchase obligations 976 6,402 6,402 3,201 16,981
Respiratory commitment 100 800 800 1,100 2,800
Long term debt 313 2,500 2,500 295,067 300,380
----------- ------------ --------------- ---------------- -----------
Total $ 2,742 $ 17,303 $ 20,170 $ 305,857 $ 346,072
=========== ======== =============== ================ ===========
Off-Balance Sheet Arrangements
The Company has no financing arrangements involving variable interest
entities.
Item 3. 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, as amended. 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. The Company's Swedish 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 nine months ended June 30, 2004 and 2003, net
transaction exposures were a loss of $0.5 million and a gain of $2.0 million,
respectively. Cash flow exposures for the same period were a loss of $0.5
million and $1.7 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 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 the forward foreign currency contracts, the Company has recorded a
derivative payable of $0.1 million at June 30, 2004 and $0.4 million at
September 30, 2003. All forward foreign currency contracts will expire over the
next nine months.
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 results of operations. The impact on
results of operations was a loss of approximately $1.1 million and a gain of
$0.2 million for the nine months ended June 30, 2004 and 2003, respectively.
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.
The Company has approximately $30.5 million of variable rate debt protected
under an interest rate cap arrangement through December 31, 2004. The
approximate fair value of the cap at June 30, 2004 and September 30, 2003 was
$0.1 million. The Company has not elected to take hedge accounting treatment for
the interest rate cap as defined under SFAS No, 133 and, as a result, any fair
value adjustment is charge directly to other income/(expense). During the nine
months ended June 30, 2004 there was no change in the value of the interest rate
cap.
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.
Item 4. 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 as of
June 30, 2004, and have determined that such disclosure controls and procedures
are effective.
There has been no change in the Company's internal control over financial
reporting during the quarter ended June 30, 2004, that has materially affected,
or is reasonably likely to materially affect, the Company's internal control
over financial reporting.
<
PART II - OTHER INFORMATION
Item 6...Exhibits and Reports on Form 8-K
(a)......Exhibits
See Index of Exhibits on page 36 hereof.
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 16, 2004 AEARO COMPANY I
/s/ Michael A. McLain
---------------------------------------
Michael A. McLain
Chairman, President and
Chief Executive Officer
(Principal Executive Officer)
/s/ Jeffrey S. Kulka
---------------------------------------
Jeffrey S. Kulka
Senior Vice President, Chief Financial
Officer, Treasurer, and Secretary
Principal Financial and Accounting Officer)
EXHIBIT INDEX
EXHIBITS DESCRIPTION
31.1 Certification of Chief Executive Officer pursuant to Rule 15d-14(a) of the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Rule 15d-14(a) of the
Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.