February 25, 2005
Page 11 of 11
Securities and Exchange Commission
Division of Corporation Finance
Mail Stop 0510
Washington, DC 20549-0510
Via EDGAR
Attn: Rufus Decker
Accounting Branch Chief
Re: Aearo Company I
Form 10-K for the fiscal year ended September 30, 2004
Form 10-Q for the period ended December 31, 2004
File No. 333-116676
Dear Mr. Decker:
Aearo Company I (the "Company") has received the Staff's comments on the
Company's Form 10-K for the fiscal year ended September 30, 2004 and its Form
10-Q for the period ending December 31, 2004. Set forth below are the Staff's
comments as well as the Company's responses to each of the Staff's comments.
FORM 10-K FOR THE YEAR ENDED SEPTEMBER 30, 2004
Comment applicable to your overall filing
Comment 1: Where a comment below requests additional disclosures or other
revisions to be made, please show us in your supplemental response what the
revisions will look like. These revisions should be included in your future
filings.
Response: Where a comment has requested additional disclosures or other
revisions, we have provided additional disclosures that will be
incorporated into future filings.
Item 7 Management's Discussion and Analysis of Financial Condition and Results
of Operation
Critical Accounting Policies
Revenue Recognition and Allowance for Doubtful Accounts, page 20
Comment 2: Your disclosure on page 7 indicates that you offer your distributors
certain programs, including sales rebate and reward programs, as well as,
cooperative advertising and marketing incentives to customers. You
disclosed certain provisions may be recorded, including pricing discounts
and incentives related to these programs. Please expand your disclosure
here and in your significant accounting policy footnote to include your
accounting policy for each of these types of arrangements, including the
statement of income line item that each type of arrangement is included in.
For each expense line item that includes these types of arrangements,
please disclose in your footnotes the related amount included in that line
item. For each type of arrangement treated as an expense rather than as a
reduction of revenues, please tell us how this type of arrangement meets
the requirements in EITF 01-9. Please also discuss in MD&A any significant
estimates resulting from these arrangements.
Response: The Company will add the following information related to sales
rebates and incentives in the critical accounting policies section of the
MD&A and the significant accounting policy footnote to the financial
statements under revenue recognition in future 10-K filings:
The Company offers its customers three types of incentive programs: A sales
rebate/volume discount program, a marketing incentive program and a
co-operative advertising program. The sales rebate/volume discount program
is based on achieved volume levels along with growth incentives over the
prior year's sales dollars. Rebate obligations are estimated based on
current sales levels and are recorded as a reduction of revenue when sales
to the customer make progress towards the required sales level. The
marketing incentive program provides qualifying customers with funds to
assist the customers with marketing the Company's products. The funds
provided to the qualifying customers are recorded as a reduction of revenue
when sales to the customer make progress towards the required sales level.
The co-operative advertising program provides funds to specific customers
to advertise the Company's products. The qualifying customers provide
specific documentation of the advertising to the Company to assure that the
benefit received is comparable to other arms length advertising
expenditures undertaken by the Company. The amount of co-operative
advertising charged to selling and administrative expenses for the years
ended September 30, 2002, 2003 and 2004 were $1.1 million, $1.7 million and
$1.9 million, respectively.
The computation of the liability for these incentive programs is based upon
known information as of year end and does not result in a significant
estimate.
Results of Operations
Fiscal 2004 Compared to Fiscal 2003, page 21
Comment 3: You have disclosed components that have contributed to the change in
gross profits on a consolidated basis, as well as on a segment basis.
Please expand your disclosure to quantify the incremental impact each of
these components have had on the overall change in gross profits.
Response: The Company will revise its disclosure of gross profit in future 10-K
filings as follows:
Excluding the effects of the purchase accounting adjustment, gross profit
as a percentage of net sales for the year ended September 30, 2004 was
47.5% as compared to 48.2% for the year ended September 30, 2003. The
slight decline in the gross profit percentage, exclusive of the
non-recurring purchase accounting adjustment, is primarily due to
unfavorable product mix of 1.0% partially offset by the impact of foreign
currency translation of 0.3%. The Safety Products segment gross profit in
the year ended September 30, 2004, excluding the effects of the purchase
accounting adjustment, increased 9.8% to $133.4 million from $120.0 million
in the year ended September 30, 2003. The increase in gross profit is
primarily due to an improvement in sales volume of $8.7 million due to an
improved economy, the favorable impact of foreign currency translation of
$6.5 million partially offset by $2.0 million of product mix. The Safety
Prescription Eyewear segment gross profit in the year ended September 30,
2004, excluding the effects of the purchase accounting adjustment,
decreased slightly to $18.5 million from $18.9 million in the year ended
September 30, 2003, primarily a result of the slight decline in sales
volume of $0.6 million partially offset by foreign currency translation of
$0.1 million. Specialty Composites' gross profit in the year ended
September 30, 2004, excluding the effects of the purchase accounting
adjustment, increased 61.5% to $18.8 million from $11.7 million in the year
ended September 30, 2003. The increase in gross profit was primarily driven
by sales volume increases.
Comment 4: You have disclosed in your notes to the financial statements in
your significant accounting policies that costs related to shipping and
handling are included in selling and administrative expenses in your
statement of operations. Please expand your disclosure to indicate that
your gross margins may not be comparable to those of other entities, since
some entities include all of these costs in cost of sales and others, like
you exclude a portion of them from gross margin, instead including them in
selling and administrative expenses.
Response: The Company will add the following information to the MD&A and
the Shipping and Handling section of its accounting policy footnote in
future 10-K filings:
The Company's gross profit may not be comparable to the gross profit of
other entities who record shipping and handling expenses as a component of
cost of sales.
Liquidity and Capital Resources, page 24
Comment 5: Please expand your disclosure to provide additional details
relating to the following:
Change and trends in product mix or volume, including any offsetting
results these changes may have with one another.
Status of new products, your outlook on how these new products will
likely impact, or have impacted your future growth, liquidity, and
capital commitments.
Response: The following will be added to the Liquidity and Capital
Resources disclosure of future 10-K filings:
The Company's business is affected by macroeconomic activity, mainly
manufacturing output in developed nations. In addition, significant changes
in product mix and volume can impact the Company's liquidity and capital
resources in both the short and long term. As such, the Company's liquidity
and capital resources are more likely to be impacted by macroeconomic
factors. The Company believes that its disciplined approach to cost
control, its diversification into Consumer and other channels and the
available capacity on its revolving credit facility will enable the Company
to maintain adequate liquidity and capital resources in an economic
downturn. The introduction of new products is likely to continue to
favorably impact liquidity and capital resources in periods of economic
growth although there are no guarantees that these trends will continue in
the future.
Contractual Obligations, page 26
Comment 6: Please revise your table of contractual cash obligations to
include planned funding of pension and other postretirement benefit
obligations. Because the table is aimed at increasing transparency of cash
flow, we believe these payments should be included in the table. Please
also disclose any assumptions you made to derive these amounts.
Response: The following will be added to the paragraph below the
contractual obligations table in future 10-K filings:
The Company plans to fund approximately $1.5-$2.2 million per year for
pension obligations over the next 5 years. The above contribution level was
determined by the consideration of many factors such as the funded status
of the plan, the long term rate of return on plan assets of 8%, the
duration of plan liabilities, workforce characteristics and changes to plan
features. The goal of the funding strategy is to achieve full funding while
minimizing the year to year volatility of contributions payments.
Item 8. Financial Statements and Supplementary Data
Consolidated Statements of Cash Flows, page 39
Comment 7: Please present cash flows related to the change in other assets
separately from those related to the change in other liabilities. Please
also present these cash flows on a gross basis, rather than a net basis.
Refer to paragraphs 11 to 13 of SFAS 95.
Response: The cash flow statement will include the addition of the
following lines to present the changes other, net on a gross basis in
future 10-K filings:
Years Ended Six Months Ended
September 30, September 30, March 31, September 30,
2002 2003 2004 2004
Prepaid and deferred assets $ (548) $ (3,707) $1,065 $ 780
Other assets (936) (2,983) (432) (3,440)
Other liabilities 3,037 4,756 1,014 (698)
Consolidated Statements of Stockholder's Equity, page 38
Comment 8: Please revise your statement of stockholder's equity to display
the gross change in other comprehensive income or expand your disclosures
to include the gross change in a note to the financial statements. Refer to
paragraph 20 of SFAS 130.
Response: The statement of stockholder's equity will include the following
disclosure of reclassification amounts in future 10-K filings:
Years Ended Six Months Ended
September 30, September 30, March 31, September 30,
2002 2003 2004 2004
Unrealized holding losses on
derivatives during the period $(593) $ (2,395) $ (522) $ 248)
Less: reclassification
adjustment for gains (losses)
included in the statement of
operations (615) (2,005) (522) (248)
Total $ 22 $ (390) $ - $ --
Notes to Consolidated Financial Statements
1. Basis of Presentation, page 40
Comment 9: Please expand your disclosure to discuss the facts and
circumstances that caused the $17.1 million adjustment to inventory.
Response: The fifth paragraph of Note 1 "Basis of Presentation" to the
consolidated financial statements will be expanded as follows in future
10-K filings:
The purchase price is allocated to the Company's net tangible and
intangible assets and liabilities based upon the estimated fair value as of
the date of the Merger. The allocation included a $17.1 million fair value
adjustment to inventory as of March 31, 2004. As the inventory was sold,
this amount was charged to cost of goods sold during the three month period
ended June 30, 2004. The inventory adjustment above was based on the
guidance for assigning amounts to inventory in accordance with paragraph
37(c) of SFAS No. 141, "Business Combinations", which requires inventory to
be valued at estimated selling prices less a reasonable profit allowance
for the selling effort.
Comment 10: Did the Merger, as described on page 40, result in any
purchased research and development? If so, please describe to us in detail
how this was accounted for. Refer to paragraphs 42 and 51(g) of SFAS 141.
Response: The Merger did not result in any purchased research and
development, therefore, no disclosure is considered necessary.
Comment 11:Please expand your disclosure to include the disclosures
required by paragraphs 52(a) to (c) of SFAS 141.
Response: Please refer to Note 2 for the information required by paragraph
52(a) and Note 13 for information required by paragraph 52(c). In addition,
we indicated that the goodwill as a result of the Merger was not deductible
for tax purposes in the paragraph below the statement of changes in
goodwill in Note 2.
Comment 12: Please expand your disclosure to include the reason why the
purchase price allocation has not been finalized. Refer to paragraph 51(h)
of SFAS 141.
Response: We will add the following to the Basis of Presentation footnote
in future 10-K filings:
Significant time was needed to evaluate identifiable intangibles. Because
of the complexities in evaluating the different categories and types of
such assets, the Company considered various scenarios and many factors in
determining the fair value of the intangible assets.
2. Significant Accounting Policies, page 41
Comment 13: Please disclose the types of expenses that you include in the
cost of sales line item and the types of expenses that you include in the
selling and administrative expenses line item. Please also disclose whether
you include inbound freight charges, purchasing and receiving costs,
inspection costs, warehousing costs, internal transfer costs, and the other
costs of your distribution network in the cost of sales line item. With the
exception of warehousing costs, if you currently exclude a portion of these
cost from cost of sales, please disclose:
in a footnote the line items that these excluded costs are included in
and the amounts included in each line item for each period presented,
and
in MD&A that your gross margins may not be comparable to those of
other entities, since some entities include all of the costs related
to their distribution network in cost of sales and others like you
exclude a portion of them from gross margin, including them instead in
a line item, such as selling and administrative expenses.
Response: The Company will include the following information in the critical
accounting policies section of the MD&A and the significant accounting
policy footnote to the financial statements in future 10-K filings:
Cost of goods sold includes all costs to manufacture the Company's products
including raw materials, which include inbound freight and import duties,
direct labor, plant supervision, maintenance labor and parts, quality
control, receiving, purchasing, production planning, manufacturing
supplies, scrap, rework, utilities, depreciation, property taxes, sales and
use taxes and insurance.
Selling and administrative expenses include salaries and benefits for
selling, marketing, customer service, finance and human resources
personnel, direct marketing expenses, trade show expenses, commissions,
selling expenses, bad debts, advertising, travel and entertainment, office
supplies, recruiting, relocation, legal expenses, accounting fees,
consulting and warehousing and logistics expenses incurred after the point
of manufacture.
Comment 14: Please disclose your policy regarding product warranties.
If product warranties exist, please include in your disclosure how you
determined the liability and a reconciliation for the changes in the
product warranties for the reporting period. Refer to paragraph 14 of FIN
45.
Response: Product warranties are not considered material for disclosure
purposes. The Company's product warranty accrual was approximately $0.2
million at September 30, 2003 and 2004, respectively.
Fair Value of Financial Instruments, page 45
Comment 15: Please expand your disclosure to include the amounts charged to
income/(expense) relating to your interest rate cap arrangement and the
derivative asset relating to the embedded call caption.
Response: Based on the following amounts, which we consider immaterial, we do
not believe that disclosure is necessary:
The amount charged to income (expense) related to the interest rate cap
arrangement was $0.01 million, $0.2 million, ($0.1) million and $0.07
million for the periods ended September 30, 2002 and 2003, March 31, 2004
and September 30, 2004, respectively. The amount recorded for the embedded
call option was $0.01 million of expense for the six month period ended
September 30, 2004.
7. Debt
Employee Benefit Plans, page 53
Comment 16: Please expand the portion of your disclosure relating to employee
benefit plans to include the effects, if any, the Merger had on these
plans. If you conclude that the Merger did have an effect on these plans,
please revise your disclosures to include a separate line for any effects
the Merger had on the plans. Refer to paragraphs 5 and 11 of FAS 132(R).
Response: The Merger did not have a material impact (approximately $0.035
million of periodic pension expense) on the Company's benefit plans,
therefore further disclosure is not considered necessary.
Note 11. Commitments and Contingencies
Contingencies, page 61
Comment 17: You have probable product liabilities related primarily to asbestos
and silica-related claims. Please disclose separately for each of these
types of claims the following:
A rollforward for each period presented of your claims activity that
shows the number of claims at the beginning of the period, increases
in the number of claims, the number of claims settled, and the ending
number of claims.
The average settlement amount for cases closed in each period.
Response: We note to the Staff, the Company has historically attempted to
collect relevant and precise claims data in order to improve upon the
methods that are used to determine what the ultimate exposure may be in
this area. In accessing this data, we rely on other parties with whom we
share responsibility for these claims. The data generally is substantially
over-inclusive as to the number of claims for which the Company may be
responsible. Due to indemnity agreements between the Company and the former
owners of the respiratory business, the claims that may ultimately be
attributed to the Company have been only a small proportion of the total
claims pool. Even those claims that initially appear to be claims for which
the Company is responsible may ultimately end up being assigned to years of
responsibility not attributed to us. Also, pleadings that are vague with
respect to products usage and dates used further complicate the Company's
ability to determine which claims are in fact potential liabilities. In
addition, we have been concerned about providing what could later be
determined to be misleading claims data and for these reasons the Company
has been unable to get comfortable with providing this information.
12. Acquisitions, page 62
Comment 18: Your disclosure regarding the acquisition of VH Industries, Inc.,
indicates that the purchase price of $11.6 million included costs to
restructure operations. Please expand your disclosure to include the
following, if material:
The total cost require to restructure operations,
The accounting treatment and related guidance used in concluding these
amounts should be included in the purchase price, and
A reconciliation of beginning and ending balances by each major
type of cost.
Response: The restructuring costs for VH Industries related to exit activities
under EITF 95-3 of less than $50,000, which we believe is not material, and
therefore, further disclosure is not considered necessary.
13. Segment Data, page 63
Comment 19: Please expand your disclosure to include the factors used to
identify that the business operates under three reportable segments. Refer
to paragraph 26(a) of SFAS 131.
Response: The following sentence will be inserted as the second sentence of the
first paragraph of Note 13 in future 10-K filings:
The factors used for determining the Company's reportable segments were
predominantly based on the nature and type of product sold.
Comment 20: Please expand your disclosure to include the information required by
paragraph 39 of SFAS 131 regarding revenue transactions of ten percent or
more generated from a single external customer.
Response: The following sentence will be inserted as the second sentence of the
first paragraph of Note 13 in future 10-K filings:
The Company does not have a single customer in any of its three reportable
segments that accounts for more than 10% of segment revenues in any of the
periods presented.
Item 12. Security Ownership of Certain Beneficial Owners and Management, page 85
Comment 21: Please expand your disclosure to include information relating to
securities authorized for issuance under equity compensation plans. See
Item 201(d) of Regulation S-K.
Response: The following disclosure will be included in future 10-K filings:
There are no authorized shares above the amounts listed as issued and
outstanding.
FORM 10-Q FOR THE PERIOD ENDED DECEMBER 31, 2004
Comment applicable to your overall filing
Comment 22: Please address the comments above in your interim Forms 10-Q as
well.
Response: To the extent applicable, we will address the above comments in future
10-Q filings.
Item 1. Financial Statements
Notes to Consolidated Financial Statements
2. Company Background, Merger and Basis of Presentation
Comment 23: Please expand your disclosure regarding the Merger to describe the
nature and amounts of the adjustments made to deferred tax liabilities and
goodwill relating to the initial allocation of the purchase price. Please
include this explanation in your significant accounting policies as well.
Refer to paragraph 51(h) of SFAS 141.
Response: The following will be included in the notes to the financial
statements in future 10-Q filings:
The adjustments made to deferred tax liabilities and goodwill during the
quarter ended December 31, 2004, reflect the adjustment of the purchase
price allocation to identifiable intangible assets and the related deferred
tax liabilities for differences between book and tax basis of those assets
as a result of finalizing the tax basis of certain assets.
3. Significant Accounting Policies
Comment 24: You have disclosed that your tax benefits have been partially offset
by a valuation allowance. Please expand your disclosure to include the
total valuation allowance you have recorded for each of the periods
presented.
Response: The following will be added to the significant accounting policies
footnote in future 10-Q filings:
Due to the uncertainty of realizing these tax benefits, deferred tax assets
resulting from net operating losses have been partially offset by a
valuation allowance of $7.5 million as of September 30, 2004 and December
31, 2004.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Comment 25: Your segment footnote in your Form 10-K filed for the year ended
September 30, 2004 indicates a decline in segment profit for the safety
prescription eyewear segment from Fiscal 2002 through Fiscal 2004. Your
segment footnote in your Form 10-Q for the period ended December 31, 2004
continues to show a decline in segment profit for this segment. Please
expand your disclosure to address this trend. Please address items such as,
but not limited to the following:
Whether or not you expect this trend to continue, and if so what your
projections are relating to this segment,
How this decline in segment profits will likely affect future cash
flows and the results of operations, and
Whether or not this decline coupled with your future expectations of
growth and profitability in this segment will be enough to prevent the
need for an impairment charge.
Response: The following will be added to the MD&A in future 10-Q filings:
The Company does not expect the negative trend in profits to continue but
can make no assurances that this trend will not continue in the future. The
Company is committed to implement cost reduction initiatives to adjust its
expenses in line with its revenues to stabilize the business. Additionally,
although the profit trend is negative, the profits reported in the
Company's segment disclosure include the allocation of corporate overhead
charges. These overhead charges are allocated to each segment on a
consistent systematic basis. Excluding the corporate allocations, this
segment generates more than adequate cash flow to prevent the likelihood of
an impairment charge.
Liquidity and Capital Resources
Comment 26: Please expand your disclosure to discuss the $3.3 million increase
in deferred and prepaid expenses from September 30, 2004 to December 31,
2004.
Response: The following will be included in the cash flow from operations
paragraph in the Liquidity and Capital Resources section of the MD&A in
future 10-Q filings:
Approximately $1.0 million of the increase is for prepaid insurance through
September 30, 2005. The remaining increase relates to deferred compensation
benefits that were earned on December 31, 2004 and will be paid throughout
the calendar year 2005.
Comment 27: You have disclosed here and in your debt footnote that since the
acquisition date your debt has been negatively impacted by $6.3 million
relating to fluctuations in the relationship between the euro and the U.S.
dollar. Please expand your disclosure to discuss any measures you are
taking to minimize this risk going forward.
Response: The following will be added to the debt footnote to the financial
statements in future 10-Q filings:
The Company does not currently plan to take any measure to minimize this
risk going forward. Since the Company's foreign operational cash flows are
ultimately converted back to US dollars, the Company views the euro
denominated debt as a natural hedge whose cash flow impacts are inversely
related to the operational cash flows.
We trust the foregoing is responsive to the Staff's comments.
Very truly yours,
Aearo Company I
______________________________________
Jeffrey S. Kulka
Senior Vice President, Chief Financial
Officer and Secretary
(Principal Financial Officer)