UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
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 13-3840356
(State or other jurisdiction of incorporation (IRS Employer Identification No.)
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 X No
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 15, 2005 was 100.
AEARO COMPANY I
TABLE OF CONTENTS
Form 10-Q for the Quarterly Period Ended June 30, 2005
PART I-FINANCIAL INFORMATION...................................................3
Item 1 Financial Statements....................................................3
Consolidated Balance Sheets - Assets...........................................3
Consolidated Balance Sheets - Liabilities and Stockholder's Equity.............4
Consolidated Statements of Operations..........................................5
Consolidated Statement of Stockholder's Equity.................................6
Consolidated Statements of Cash Flows..........................................7
Notes to Consolidated Financial Statements.....................................8
Item 2Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................................26
Item 3 Quantitative and Qualitative Disclosures About Market Risk ............37
Item 4 Controls and Procedures................................................38
PART II - OTHER INFORMATION...................................................39
Item 6 Exhibits and Reports on Form 8-K ......................................39
SIGNATURES....................................................................40
EXHIBIT INDEX.................................................................41
PART I-FINANCIAL INFORMATION
Item 1. Financial Statements
AEARO COMPANY I AND SUBSIDIARIES
Condensed Consolidated Balance Sheets - Assets
(In Thousands)
June 30, September 30,
2005 2004
--------------- ---------------
(Unaudited)
CURRENT ASSETS:
Cash and cash equivalents $ 16,019 $ 27,724
Accounts receivable (net of allowance
for doubtful accounts of $1,463 and
$1,358 respectively) 60,553 54,159
Inventories 44,424 40,849
Deferred and prepaid expenses 5,602 4,146
--------------- ---------------
Total current assets 126,598 126,878
--------------- ---------------
LONG TERM ASSETS:
Property, plant and equipment, net 51,317 54,750
Other intangible assets, net 182,050 185,855
Other assets 13,403 15,144
Goodwill 116,596 133,745
---------------- ---------------
Total assets $ 489,964 $ 516,372
================= ===============
The accompanying notes are an integral part of these condensed consolidated
financial statements
3
AEARO COMPANY I AND SUBSIDIARIES
Condensed Consolidated Balance Sheets - Liabilities and Stockholder's Equity
(In Thousands, Except for Per Share and Share Amounts)
June 30, September 30,
2005 2004
------------ ---------------
(Unaudited)
CURRENT LIABILITIES:
Current portion of long-term debt $ 3,455 $ 1,639
Accounts payable and accrued liabilities 55,684 46,730
Accrued interest 3,067 6,996
Accrued income taxes 1,947 1,648
------------ -----------------
Total current liabilities 64,153 57,013
------------- ----------------
LONG TERM LIABILITIES: 298,299 302,842
Deferred income taxes 40,587 59,699
Other liabilities 14,169 14,726
-------------- -----------------
Total liabilities 417,208 434,280
-------------- -----------------
STOCKHOLDER'S EQUITY:
Common stock, $.01 par value-
Authorized--100 shares
Issued and outstanding--100 shares - -
Paid in capital 101,640 101,610
Accumulated deficit (26,848) (19,415)
Accumulated other comprehensive loss (2,036) (103)
-------------- -----------------
Total stockholder's equity 72,756 82,092
-------------- -----------------
Total liabilities and stockholder's equity $ 489,964 $ 516,372
============== =================
The accompanying notes are an integral part of these condensed consolidated
financial statements
4
Condensed Consolidated Statements of Operations
(In Thousands)
(Unaudited)
Nine Three Six
Months Months Months
Three Months Ended Ended Ended Ended
June 30, June 30, June 30, March 31,
2005 2004 2005 2004 2004
Successor Successor Predecessor
Net sales $ 113,198 $ 97,126 $ 313,437 $ 97,126 | $ 169,579
|
Cost of sales 58,124 68,144 159,757 68,144 | 89,056
------------------ ------------------ --------------- ------------------|-----------------
|
Gross profit 55,074 28,982 153,680 28,982 | 80,523
|
Selling and administrative 34,172 28,149 98,583 28,149 | 56,835
|
Research and technical services 2,234 1,966 6,665 1,966 | 3,623
|
Amortization 1,313 101 3,928 101 | 242
|
Other (income) charges, net (512) 1,690 (200) 1,690 | (506)
|
Restructuring -- -- -- -- | (1,091)
------------------ ------------------ --------------- ------------------|-----------------
|
Operating income (loss) 17,867 (2,924) 44,704 (2,924) | 21,420
|
Interest expense, net 5,856 10,292 16,785 10,292 | 10,836
------------------ ------------------ --------------- ------------------|-----------------
|
Income (loss) before provision |
for income taxes 12,011 (13,216) 27,919 (13,216) | 10,584
|
Provision for income taxes 1,569 1,031 358 1,031 | 2,020
------------------ ------------------ --------------- ------------------|-----------------
|
Net income (loss) $ 10,442 $ (14,247) $ 27,561 $ (14,247) | $ 8,564
------------------ ------------------ --------------- ------------------------------------
The accompanying notes are an integral part of these condensed consolidated
financial statements
5
Condensed Consolidated Statement of Stockholder's Equity
(In Thousands, Except Share Amounts)
Accumulated
Paid Other Comprehensive
Common Stock In Accumulated Comprehensive Income
Successor Shares Amount Capital Deficit Loss Total (Loss)
Balance, October 1, 2004 100 $ - $ 101,610 $ (19,415) $ (103) $ 82,092
Net income - - - 27,561 - 27,561 $ 27,561
Dividend to parent (34,994) (34,994) -
Foreign currency translation
adjustment - - - - (1,689) (1,689) (1,689)
Unrealized loss on derivative
instruments - - - - (244) (244) (244)
Vesting of restricted stock - - 30 - 30 -
------------
Comprehensive income - - - - - - $ 25,628
============
------- -------- ---------- ----------- ------------- --------
Balance, June 30, 2005 100 $ - $ 101,640 $ $ (2,036) $ 72,756
(26,848)
======= ======== ========== =========== ============= ========
The accompanying notes are an integral part of these condensed consolidated
financial statements
6
Condensed Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)
Nine Three Six
Months Months Months
Ended Ended Ended
June 30, June 30 March 31,
--------------------------------------------
2005 2004 | 2004
-----------------------------|--------------
Cash Flows from Operating Activities: Successor | Predecessor
Net income (loss) $ 27,561 $ (14,247) | $ 8,564
Adjustments to reconcile net income (loss) to cash |
provided by operating activities- |
Depreciation 8,131 3,006 | 5,931
Amortization of intangible assets 3,928 101 | 242
Amortization of deferred financing costs 1,068 4,234 | 2,026
Inventory purchase accounting adjustment -- 17,067 | --
Deferred income taxes (3,310) (7) | --
Stock based compensation 30 10 |
Restructuring -- -- | (1,091)
Loss on disposal of assets 3 | 682
Changes in assets and liabilities- |
Accounts receivable (6,755) (2,242)| (1,113)
Inventories (4,166) 2 | (3,464)
Accrued income taxes 432 522 | (1,453)
Accrued interest (3,928) 767 | 3
Accounts payable and accrued liabilities 7,107 2,667 | (3,224)
Prepaid expenses and other assets 427 986 | 633
Other liabilities 1,012 928 | 1,299
--------- ---------- | ---------
Net cash provided by operating activities 31,540 13,794 | 9,035
--------- ---------- | ---------
CASH FLOWS FROM INVESTING ACTIVITIES: |
Additions to property, plant and equipment (5,404) (2,810)| (5,006)
Proceeds provided by disposals of property, plant and |
equipment 64 -- | 12
--------- ---------- | ---------
Net cash used by investing activities (5,340) (2,810)| (4,994)
--------- ----------| ---------
CASH FLOWS FROM FINANCING ACTIVITIES: |
Distribution to shareholder to effect the merger -- (86,852)| --
Repayment of old credit facility -- (78,333)| --
Repayment of 12.5% senior subordinated notes -- (98,000)| --
Proceeds from 8.25 senior subordinated notes -- 175,000 | --
Debt issue costs -- (10,408)|
Dividend to parent (34,994) (14,305)| --
Proceeds from (repayment of) revolving credit facility, net -- (15,600)| 3,950
Proceeds from (repayment of) term loans (961) 125,000 | (8,949)
Repayment of capital lease obligations (200) (61)| (122)
Repayment of long term debt (273) (26)| (119)
--------- ----------| ---------
Net cash used for financing activities (36,428) (3,585)| (5,240)
--------- ----------| ---------
EFFECT OF EXCHANGE RATE ON CASH (1,477) (858)| (789)
--------- ----------| ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (11,705) 6,541 | (1,988)
|
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 27,724 5,313 | 7,301
--------- ----------| ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 16,019 $ 11,854 | $ 5,313
========= ==========| =========
CASH PAID FOR: |
Interest $ 19,977 $ 4,787 | $ 8,862
========= ==========| =========
Income taxes $ 3,674 $ 552 | $ 3,254
========= ==========| =========
The accompanying notes are an integral part of these condensed consolidated
financial statements
<
7
AEARO COMPANY I AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
JUNE 30, 2005
(Unaudited)
1) Consolidated Financial Statements
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements of Aearo Company I (the "Company")
contain all normal, recurring 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
consolidated financial statements do not include all disclosures associated
with annual financial statements, and accordingly, should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K.
2) 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 ("Parent"), the Company's parent,
entered into a merger agreement ("Merger Agreement") with AC Safety Holding
Corp. and its subsidiary, AC Safety Acquisition Corp. that closed on April
7, 2004 (the "Merger"). 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 $409.3 million, including fees and expenses. The
Merger was financed with approximately $303.7 million of debt as discussed
in Note 6, $3.7 million of which was assumed, $4.3 million of cash and
$101.3 million of equity. The Company continues to be wholly-owned by Aearo
Corporation after the Merger. The purpose of the Merger was to effect a
change of control from Aearo Corporation to the Company's ultimate parent
AC Safety Holding Corp.
Approximately $87.0 million of proceeds from the Merger was distributed to
our Parent and used to pay the shareholders of the Parent to effect the
merger transaction. An additional $14.3 million distributed to our Parent
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 reflects the push
down of 100% of the purchase price resulting from the Merger. Accordingly,
the results of operations subsequent to the Acquisition Date are presented
on a different basis of accounting than the results of operations 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. 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.
The purchase price is allocated to the Company's tangible and intangible
assets and liabilities based upon estimated fair values as of the date of
the Merger. The adjustment made to deferred tax liabilities and goodwill in
fiscal 2005 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. The purchase price has been
allocated as follows (dollars in thousands):
Working capital $ 77,357
Fixed assets 55,139
Other assets and liabilities 16,073
Deferred tax liabilities (45,258)
Finite lived intangible asset 74,104
Indefinite lived intangible assets 114,300
Goodwill 117,629
Purchase price $ 409,344
=======
Goodwill resulting from the Merger is not deductible for income tax
purposes.
8
3) Significant Accounting Policies
Use of Estimates. The preparation of the consolidated financial statements
in conformity with accounting principles generally accepted in the United
States 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.
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. 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 three months ended June 30, 2005 and 2004 were $0.9 million and $0.4
million, respectively. The amount of co-operative advertising charged to
selling and administrative expenses for the nine months ended June 30, 2005
and six months ended March 31, 2004 were $2.0 million and $0.9 million,
respectively.
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.
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.
Cost of Goods Sold. 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. 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.
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. At September 30, 2004, the
Company's deferred tax asset for domestic net operating losses was
partially offset by a valuation allowance of $7.5 million. During the three
month period ended March 31, 2005, management determined that based on
current domestic operating results, it is more likely than not that
domestic net operating losses will be realized and consequently reversed
the $7.5 million valuation allowance.
The Company is included in the consolidated tax return filed by AC Safety
Holding Corp. All taxes are recorded as if separate, stand alone returns
were filed.
Goodwill and Other Intangibles. Under the provisions of SFAS No. 142,
"Goodwill and Other Intangibles", goodwill and intangible assets that have
indefinite useful lives are not amortized but are tested at least annually
for impairment. The Company will test its goodwill and indefinite lived
intangible assets as of September 30, 2005. Intangible assets that have
finite useful lives are amortized over their useful lives and reviewed for
impairment at each reporting date.
9
The following presents a summary of other intangibles assets as of
September 30, 2004 and June 30, 2005, resulting from the Merger (dollars in
thousands):
Gross Accumulated
September 30, 2004 Amount Amortization Additions Carrying Amount
Trademarks $ 114,300 $ -- $ -- $ 114,300
Customer relationship list 73,000 (2,433) -- 70,567
Patents 719 (122) 82 679
Other 385 (76) -- 309
------- ------- ---- -------
Total Intangibles $ 188,404 $ (2,631) $ 82 $ 185,855
======= ======= ==== =======
Gross Accumulated
June 30, 2005 (Unaudited) Amount Amortization Additions Carrying Amount
Trademarks $ 114,300 $ -- $ -- $ 114,300
Customer Relationship List 73,000 (6,083) -- 66,917
Patents 802 (316) 122 608
Other 385 (160) -- 225
------- ------- ------ -------
Total Intangibles $ 188,487 $ (6,559) $ 122 $ 182,050
======= ======= ======= =======
Estimate of Aggregate Amortization Expense (dollars in thousands):
Year ending September 30, 2005 $ 5,241
Year ending September 30, 2006 5,225
Year ending September 30, 2007 5,114
Year ending September 30, 2008 4,904
Year ending September 30, 2009 4,913
The following presents the allocation of goodwill resulting from the Merger
and the changes in the carrying amount of goodwill for the nine months
ended June 30, 2005 (dollars in thousands):
Nine Months
Ended
June 30,
2005
Beginning balance $ 133,745
Allocation adjustment (15,491)
Translation adjustment (1,658)
-------
Ending balance $ 116,596
=======
10
The allocation adjustment in fiscal 2005 reflects the adjustment of the
purchase price allocation to identifiable intangible assets and the related
deferred tax liabilities for differences between book and tax bases of
those assets as a result of finalizing the tax basis of certain assets.
Stock-based Compensation. The Company accounts for stock-based compensation
under the recognition and measurement principles of Accounting Principals
Board ("APB") No. 25, "Accounting for Stock Issued to Employees".
Accordingly, no compensation expense for stock options has been recognized
as all options granted had an exercise price equal to or above the price of
the underlying common stock on the grant date. The Company recognizes
compensation expense related to restricted stock awards and amortizes the
expense over the vesting period based on the estimated fair value of the
stock at the date of grant.
11
The following table illustrates the effect on net income if the Company had
applied the fair value recognition provisions of SFAS No. 123, "Accounting
for Stock-Based Compensation" as amended by SFAS No. 148 "Accounting for
Stock-Based Compensation - Transition and Disclosure," to stock-based
employee compensation (dollars in thousands):
Nine Three Six
Months Months Months
Three Months Ended Ended Ended Ended
June 30, June 30 June 30, March 31,
2005 2004 2005 2004 2004
Successor Successor Predecessor
Net income (loss) as reported $ 10,442 $ (14,247) $ 27,561 $ (14,247) $ 8,564
Stock based compensation expense
recorded under APB No. 25, net
of tax 10 -- 30 10 --
Stock-based compensation expense
determined under the fair value
method, net of tax (44) -- (127) (10) (67)
------- ------- ------ ------- -------
Proforma net income (loss) $ 10,408 $ (14,247) $ 27,464 $ (14,247) $ 8,497
======= ======= ====== ======= =======
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 foreign currency
exchange contracts and interest rate swap agreements, which are derivatives
as defined by SFAS No. 133. The Company enters into forward foreign
currency contracts to mitigate the effects of changes in foreign currency
rates on profitability and enters into interest rate swap agreements to
hedge its variable interest rate risk. These derivatives are cash flow
hedges. For all qualifying and highly effective cash flow hedges, the
changes in the fair value of the derivatives are recorded in other
comprehensive income. Amounts accumulated in other comprehensive income
will be reclassified to earnings when the related product sales affect
earnings for forward foreign currency contracts or when related interest
payments affect earnings for interest rate swaps. During the three month
period ended June 30, 2005, the Company entered into three new forward
foreign currency contracts that will protect the Company against exchange
rate movement during fiscal year 2006. As result of the new forward
currency contracts, the Company has recorded a derivative payable of $0.4
million at June 30, 2005. For the three month periods ended June 30, 2005
and 2004, the Company had no gains or losses resulting from the exercise of
forward foreign currency contracts. For the nine and six month periods
ended June 30, 2005 and March 31, 2004, the Company reclassified into
earnings net losses of $0 million and $0.5 million, respectively resulting
from the exercise of forward foreign currency contracts. All forward
foreign currency contracts were determined to be highly effective whereby
no ineffectiveness was recorded in earnings.
The Company had approximately $30.5 million of variable rate debt protected
under an interest rate cap arrangement, which expired December 31, 2004.
The Company did not elect hedge accounting treatment for the interest rate
cap as defined under SFAS No. 133, and, as a result, any fair value
adjustment was charged directly to other charges (income), net. There was
$0.1 million of expense charges to earnings for the period ended, June 30,
2004 for the change in the fair value of the interest rate cap.
12
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 other charges
(income), net. The impact on earnings was a gain of approximately $ 0.3
million and $ 0.1 million for the three and nine month periods ended June
30, 2005, respectively, compared to net loss of $ 0.3 million and $0.4
million, respectively for the three and six month periods ended June 30,
2004 and March 31, 2004, respectively.
On June 30, 2005, the FASB issued Derivatives Implementation Group ("DIG")
B39, "Application of Paragraph 13(b) to Call Options That are Exercisable
Only by the Debtor", which provides an explicit scope exception to the
provisions of paragraph 13(b) of SFAS No. 133 when the right to accelerate
a repayment can only be exercise by the debtor (issuer/borrower). The
Company has adopted DIG B39 as of April 1, 2005. Prior to the adoption of
DIG B39, the Company determined under the provisions of DIG B16, "Calls and
Puts in Debt Instruments", that the embedded call option in the Company's
Senior Subordinated Notes was not clearly and closely related to the debt
host contract and therefore required bifurcation. The carrying values of
the derivative asset and liability were $2.0 million at September 30, 2004.
Prior to the adoption of DIG B39, the Company had recorded $0.2 million
loss in other (income) charges, net for the mark to market revaluation of
the embedded call option and $0.2 million for the reduction of interest due
to the amortization of the corresponding liability during 2005. Upon the
adoption of DIG B39, the Company reversed a derivative asset of
approximately $1.8 million and the corresponding liability that was
previously recorded.
4) Other Comprehensive Income
The following table presents the reclassification amounts related to
unrealized holding gains and losses presented in the statement of
stockholder's equity for the three month periods ended June 30, 2005 and
2004 and the nine and six month periods ended June 30, 2005 and March 31,
2004, respectively (dollars in thousands):
Nine Three Six
Months Months Months
Three Months Ended Ended Ended Ended
June 30, June 30 June 30, March 31,
2005 2004 2005 2004 2004
Successor Successor Predecessor
Unrealized holding losses on $ (138)
derivatives during the period $ (244) $ (138) $ (244) $ (133)
Less: reclassification
adjustment for gains (losses)
included in the statements of
operations -- 25 -- 25 523
------- ------- ------- ------- -------
Total $ (244) $ (113) $ (244) $ (113) $ 390
======= ======= ======= ======= =======
13
5) Inventories
Inventories consist of the following (dollars in thousands):
June 30, September 30,
2005 2004
------------------- -------------------
(Unaudited)
Raw materials $ 11,029 $ 9,302
Work in process 9,415 12,087
Finished goods 23,980 19,460
------------------- -------------------
$ 44,424 $ 40,849
=================== ===================
Inventories, which include materials, labor and manufacturing overhead, are
stated at the lower of cost or market, cost being determined using the
first-in, first-out method.
6) Debt
The Company's debt structure includes: (a) $175.0 million of 8.25% Senior
Subordinated Notes ("8.25% Notes") due 2012, which are publicly held and
redeemable at the option of the Company, in whole or in part at various
redemption prices, (b) up to an aggregate of $175.0 million under its
Credit Agreement with various banks comprised of (i) a secured term loan
facility consisting of loans providing for up to $125.0 million of term
loans (collectively the "Term Loans") with a portion of the Term Loans
denominated in Euros, (ii) a secured revolving credit facility ("Revolving
Credit Facility") providing for up to $50.0 million of revolving loans for
general corporate purposes, and (iii) an uncommitted incremental term loan
facility of up to $75.0 million for acquisitions (collectively, the "Senior
Bank Facilities"). Since the Acquisition Date, the Company's debt has been
negatively impacted by $0.3 million related to the fluctuation of the Euro
relative to the U.S dollar as of June 30, 2005. The Company does not plan
to take any measure to minimize the foreign exchange impact of its Euro
denominated debt. The amounts outstanding on the Term Loans were
approximately $123.8 million and $126.0 million at June 30, 2005 and
September 30, 2004, respectively. There were no amounts outstanding under
the Revolving Credit Facility at June 30, 2005 and September 30, 2004
respectively. The Revolving Credit Facility provides for the issuance of
letters of credit in an aggregate face amount of up to $15.0 million. The
Company had approximately $1.4 million and $1.6 million of letters of
credit outstanding at September 30, 2004 and June 30, 2005, respectively.
The Term Loans amortize quarterly over a seven-year period. Amounts repaid
or prepaid in respect of the Term Loans may not be re-borrowed. Loans and
letters of credit under the Revolving Credit Facility will be available
until the Revolving Loan Maturity Date, which is April 7, 2010. The Term
Loans mature on April 7, 2011. Effective December 31, 2004, the Company
received a 0.25% reduction in the interest rate paid on its Term Loans for
meeting certain financial covenants. The Company was in compliance with all
financial covenants and restrictions as of June 30, 2005.
On April 28, 2005, the Company amended its credit agreement to allow the
Company to make, prior to September 30, 2005, up to $35 million of cash
distributions to Aearo Corporation, its parent corporation for the purpose
of paying cash dividends to AC Safety Holding Corp., its parent, to be used
by AC Safety Holding Corp. primarily to redeem, pro rata, its outstanding
preferred shares and to pay accrued dividends on the preferred shares. In
addition, the amendment (i) modified the amount of the incremental Term
14
Loan commitment from $60.0 million to $75.0 million (ii) eliminated the
termination date for the incremental Term Loan commitment and (iii) allowed
for incremental Term Loans in Euros.
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.
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.
Many 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 Corporation 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 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 with AC Safety
Acquisition Corp., 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 a 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.
In fiscal 2003 and 2004, the Company settled 259 claims in which it
was named as a defendant for an average settlement amount of $24.36 in
silica claims and $83.24 in asbestos claims, while an additional 200 claims
were dismissed without any payment (43.6% of cases closed), because the
Company was not a proper defendant or did not make the product in question.
As of September 30, 2004, the number of open claims where the Company was
named as a defendant in silica and asbestos related matters was 11,087 and
4,282, respectively. For the nine months ended June 30, 2005, the increases
in number of claims where the Company was named as a defendant in silica
and asbestos related matters was 2,122 and 1,010 respectively. The 1,010
new asbestos claims include 114
15
claims that allege exposure from clothing, which the Company never
manufactured. One claim was settled for $17.85 where the Company was named
as a defendant in silica related matters during the nine months ended June
30, 2005. No claims were settled where the Company was named as a defendant
in asbestos related matters during the nine months ended June 30, 2005. As
of June 30, 2005, the number of open claims where the Company was named as
a defendant in silica and asbestos related matters was 12,739 and 4,095,
respectively.
In addition to the above claims, the Company may agree to pay a share
of the settlement and defense costs in particular cases even though the
Company is not named as a defendant because of agreements with prior owners
of the brand and/or because of allegations that Aearo has some risk of
legal liability as a successor ("Additional Claims"). During the nine
months ended June 30, 2005, Aearo paid a total of $1.67 million for
settlement, administrative and defense costs resulting in the settlement of
4,325 silica and asbestos claims that were settled between October 1, 2002
and September 30, 2004 involving both claims in which Aearo was named as a
defendant and Additional Claims. During the period October 1, 2004 to June
30, 2005 Aearo paid a total of $164.72 for three additional claims that
were settled during that time period and paid a total of $0.4 million for
administrative and defense costs involving both claims in which Aearo was
named as a defendant and Additional Claims. In addition, Aearo may receive
the benefit of releases in some additional cases settled by the AO Defense
Group regardless of whether or not any claim was made against Aearo.
The above information was based on data provided by Simon Peragine
Smith, an outside law firm which tracks numbers of cases and settlements on
behalf of the "AO Defense Group", and is believed to be materially
accurate. This information may be subject to future adjustment in light of
new information becoming available. The AO Defense Group is a voluntary
association of current and former manufacturers of the "AO Safety" brand of
respirators and certain of their insurers in which Aearo participates and
through which all of its settlements have been handled in the relevant
years. Also, between October 1, 2004 and June 30, 2005, there may have been
claims settled by and fully funded by the insurers of Eastern Safety
Equipment Co., Inc., a dissolved former subsidiary of Aearo.
At June 30, 2005 and September 30, 2004, the Company has recorded
liabilities of approximately $4.6 million and $5.4 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. The $0.8 million reduction in the reserve, net of new accruals
which added to the reserve, since September 30, 2004 is primarily
attributed to the payment of $1.67 million, as referenced above, to pay
costs attributed to settlement, administrative and defense costs that had
been reached over the prior two year time period. This reserve is
re-evaluated periodically and additional charges or credits to results of
operations may result as additional information becomes available. 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 2009 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.
16
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 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. The factors used for determining the
Company's reportable segments were predominantly based on the nature and
type of product sold.
Net Sales by Business Segment (dollars in thousands):
Nine Three Six
Months Months Months
Three Months Ended Ended Ended Ended
June 30, June 30 June 30, March 31,
2005 2004 2005 2004 2004
Successor Successor Predecessor
Safety Products $ 86,161 $ 73,966 $ 235,926 $ 73,966 $ 127,964
Safety Prescription Eyewear 10,493 10,126 29,706 10,126 20,337
Specialty Composites 16,544 13,034 47,805 13,034 21,278
------- ------- ------ ------- -------
Total $113,198 $ 97,126 $ 313,437 $ 97,126 $ 169,579
======= ======= ======= ======= =======
Inter-segment sales from the Specialty Composites segment to the Safety
Products segment totaled $1.1 million and $0.7 million for the three months
ended June 30, 2005 and 2004, respectively. Inter-segment sales from the
Specialty Composites segment to the Safety Products segment totaled $3.1
million and $1.5 million for the nine and six months ended June 30, 2005
and March 31, 2004, respectively. The inter-segment sales value is
determined at fully absorbed inventory cost at standard rates plus 25%. 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.
17
Profit (loss) by business segment and reconciliation to income (loss)
before income taxes (dollars in thousands):
Nine Three Six
Months Months Months
Three Months Ended Ended Ended Ended
June 30, June 30 June 30, March 31,
2005 2004 2005 2004 2004
Successor Successor Predecessor
Safety Products $ 18,526 $ 16,122 $ 46,374 $ 16,122 | $ 23,704
Safety Prescription Eyewear 275 37 (66) 37 | (57)
Specialty Composites 3,504 2,623 10,455 2,623 | 2,855
------ ------- ------ ------ -------
Segment profit 22,305 18,782 56,763 18,782 | 26,502
|
Depreciation 3,125 3,006 8,131 3,006 | 5,931
Amortization of intangibles 1,313 101 3,928 101 | 242
Inventory purchase accounting -- 17,067 -- 17,067 | --
Bond call premium -- 1,532 -- 1,532 | --
Restructuring -- -- -- -- | (1,091)
Interest 5,856 10,292 16,785 10,292 | 10,836
------- ------- ------ ------- | -------
Income (loss) before income taxes 12,011 $ (13,216) $ 27,919 $ (13,216) | $ 10,584
====== ======== ====== ======== ========
Segment profit is defined as operating income (loss) before
depreciation, amortization, interest 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 month periods ended June 30, 2004 and 2005, and the nine and
six month periods ended June 30, 2005 and March 31, 2004, respectively
(dollars in thousands):
Nine Three Six
Months Months Months
Three Months Ended Ended Ended Ended
June 30, June 30 June 30, March 31,
2005 2004 2005 2004 2004
Successor Successor Predecessor
Service cost $ 364 $ 335 $ 1,089 $ 335 | $ 669
Interest cost 206 186 618 186 | 371
Expected return on plan assets (184) (167) (552) (167) | (332)
Amortization of prior service cost -- 2 -- 2 | 5
------ ------ ----- ----- | -----
Total $ 386 $ 356 $ 1,155 $ 356 | $ 713
====== ====== ===== ===== =====
The Company previously disclosed in its Annual Report on Form 10-K for the
year ended September 30, 2004, that it expected to contribute $1.2 million
to its pension plan in 2005. As of June 30, 2005, the Company has not made
any contributions to its pension plan and plans to contribute a revised
amount of $1.8 million in the fourth quarter of fiscal 2005.
18
10) Dividend
On May 5, 2005, the Company's Board of Directors declared and paid a cash
dividend to the Company's parent, Aearo Corporation, the sole holder of
common stock, of approximately $35 million. Aearo Corporation then paid a
cash dividend to AC Safety Holding Corp., the Company's ultimate parent,
who used the proceeds to make a partial redemption of its preferred stock.
The Company used available cash to fund the dividend.
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 financial information illustrates the composition of the
combined Subsidiary Guarantors. 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).
Consolidated Statement of Operations (Unaudited)
Nine Months Ended June 30, 2005
Successor
-------------------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I SubsidiariesSubsidiariesEliminationsConsolidated
Net sales................................. $234,381 $ -- $114,004 $ (34,948) $ 313,437
Cost of sales............................. 132,127 -- 62,454 (34,824) 159,757
------- ------ ------ ------- -------
Gross profit............................ 102,254 -- 51,550 (124) 153,680
Selling and administrative................ 71,843 2,871 23,869 -- 98,583
Research and technical services........... 4,186 -- 2,479 -- 6,665
Amortization.............................. 2,774 194 960 -- 3,928
Other charges (income), net............... 13,686 (20,911) 7,025 -- (200)
------ ------- ------ ------ -------
Operating income (loss)................ 9,765 17,846 17,217 (124) 44,704
Interest expense (income)................. 16,374 (2,172) 2,583 -- 16,785
------- ------- ------ ------ -------
Income (loss) before income taxes......... (6,609) 20,018 14,634 (124) 27,919
Income tax provision (benefit)............ (11,984) 8,232 4,110 -- 358
Equity in subsidiaries' earnings.......... 22,310 10,524 (32,834) --
------- ------- ------ ------- ------
Net income............................. $ 27,685 $ 22,310 $ 10,524 $ (32,958) $ 27,561
====== ======= ======= ======= ======
19
Consolidated Statement of Operations (Unaudited)
Three Months Ended June 30, 2004
Successor
------------------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I SubsidiariesSubsidiariesEliminationsConsolidated
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
------- ------ ----- ---- ------
Operating income....................... (7,256) 6,381 (2,079) 30 (2,924)
Interest expense (income), net............ 10,152 (399) 539 -- 10,292
------- ------ ------ ---- -------
Income (loss) before income 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' earnings.......... 256 (3,824) 3,568 --
-------- ------- ------- ------- --------
Net income (loss)...................... $(14,277) $ 256 $ (3,824) $ 3,598 $ (14,247)
======== ======= ======= ======= ========
Consolidated Statement of Operations (Unaudited)
Six Months Ended March 31, 2004
Predecessor
-------------------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I SubsidiariesSubsidiariesEliminationsConsolidated
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 expense (income), net............ 10,117 (983) 1,702 -- 10,836
------- ------- ------ ------- -------
Income (loss) before income 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' earnings.......... 13,053 5,557 (18,610) --
------- ------ ------ ------- ------
Net income............................. $ 8,494 $ 13,053 $ 5,557 $ (18,540) $ 8,564
====== ====== ====== ======== ======
20
Consolidated Statement of Operations (Unaudited)
Three Months Ended June 30, 2005
Successor
-------------------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I Subsidiaries Subsidiaries Eliminations Consolidated
Net sales................................. $ 86,049 $ -- $ 40,402 $ (13,253) $ 113,198
Cost of Sales............................. 48,648 -- 22,657 (13,181) 58,124
------ ----- ------ ------- -------
Gross profit........................... 37,401 -- 7,745 (72) 55,074
Selling and administrative................ 25,628 344 8,200 -- 34,172
Research and technical services........... 1,401 -- 833 -- 2,234
Amortization.............................. 923 70 320 -- 1,313
Other charges (income), net............... 5,134 (7,547) 1,901 -- (512)
------ ------ ------ ------- -------
Operating income....................... 4,315 7,133 6,491 (72) 17,867
Interest expense (income)................. 5,687 (531) 700 -- 5,856
------ ------ ------ ------- -------
Income (loss) before income taxes......... (1,372) 7,664 5,791 (72) 12,011
Income tax provision (benefit)............ (2,313) 3,140 742 -- 1,569
Equity in subsidiaries' earnings.......... 9,573 5,049 -- (14,622) --
------ ------- ------ ------- -------
Net income............................. $ 10,514 $ 9,573 $ 5,049 $ (14,694) $ 10,442
====== ===== ===== ======== ======
21
Consolidated Balance Sheet (Unaudited)
June 30, 2005
Non-
Aearo Guarantor Guarantor
Company I Subsidiaries Subsidiaries Eliminations Consolidated
Current Assets:
Cash and cash equivalents.............. $ 6,169 $ 397 $ 9,453 $ -- $ 16,019
Receivables, net....................... 39,813 229 20,511 -- 60,553
Inventories............................ 33,091 -- 11,766 (433) 44,424
Deferred and prepaid expenses.......... 4,533 -- 1,069 -- 5,602
------ ----- ------ ------- -------
Total current assets...................... 83,606 626 42,799 (433) 126,598
------ ----- ------ ------- -------
Long Term Assets:
Property plant and equipment........... 37,349 -- 13,968 -- 51,317
Goodwill and other intangibles, net.... 90,228 122,243 86,175 -- 298,646
Inter-company receivables (payables)... (54,417) 94,199 (39,782) -- --
Investment in subsidiaries ............ 242,966 67,292 (664) (309,594) --
Other assets........................... 13,392 -- 11 -- 13,403
------- ------- ------- -------- -------
Total assets.............................. $413,124 $284,360 $102,507 $(310,027) $ 489,964
======= ======= ======= ========= =======
Current Liabilities:
Current portion of long term debt...... $ 3,455 $ -- $ -- $ -- $ 3,455
Accounts payable and accrued
liabilities............................ 40,675 435 14,574 -- 55,684
Accrued interest....................... 3,067 -- -- -- 3,067
Income tax payables (receivables)...... 2,012 (2,150) 2,085 1,947
------- ------- ------- -------- -------
Total current liabilities................. 49,209 (1,715) 16,659 -- 64,153
Long Term Liabilities:
Long term debt......................... 298,299 -- -- -- 298,299
Deferred income taxes.................. 3,719 23,860 13,008 -- 40,587
Other liabilities...................... 14,169 -- -- -- 14,169
------- ------- ------- -------- -------
Total liabilities......................... 365,396 22,145 29,667 -- 417,208
Stockholder's Equity:
Common................................. -- -- 4,222 (4,222) --
Paid in capital........................ 101,640 267,796 41,865 (309,661) 101,640
Accumulated deficit.................... (54,445) (8,638) 36,695 (460) (26,848)
Accumulated other comprehensive income
(loss)................................. 533 3,057 (9,942) 4,316 (2,036)
------- ------- ------- -------- -------
Total stockholder's equity................ 47,728 262,215 72,840 (310,027) 72,756
------- ------- ------- -------- -------
Total liabilities and stockholder's equity $413,124 $284,360 $102,507 $(310,027) $ 489,964
======= ======= ======= ======== =======
22
Consolidated Balance Sheet
September 30, 2004
Non-
Aearo Guarantor Guarantor
Company I Subsidiaries Subsidiaries Eliminations Consolidated
Current Assets:
Cash and cash equivalents.............. $ 18,309 $ 140 $ 9,275 $ -- $ 27,724
Receivables, net....................... 34,823 -- 19,336 -- 54,159
Inventories............................ 29,956 -- 11,202 (309) 40,849
Deferred and prepaid expenses.......... 3,014 -- 1,132 -- 4,146
------- ------- ------- -------- -------
Total current assets...................... 86,102 140 40,945 (309) 126,878
------- ------- ------- -------- -------
Long Term Assets:
Property plant and equipment........... 40,040 -- 14,710 -- 54,750
Goodwill and other intangibles, net.... 134,567 131,786 53,247 -- 319,600
Inter-company receivables (payables)... 64,478 (12,147) (52,331) -- --
Investment in subsidiaries ............ 154,350 40,981 (713) (194,618) --
Other assets........................... 15,133 -- 11 -- 15,144
------- ------- ------- -------- -------
Total Assets.............................. $494,670 $160,760 $ 55,869 $(194,927) $ 516,372
======= ======= ====== ========= =======
Current Liabilities:
Current portion of long term debt...... $ 1,618 $ -- $ 21 $ -- $ 1,639
Accounts payable and accrued
liabilities............................ 32,623 577 13,530 -- 46,730
Accrued interest....................... 6,996 -- -- -- 6,996
Income tax payables (receivables)...... 2,324 (2,317) 1,641 -- 1,648
------- ------- ------- -------- -------
Total current liabilities................. 43,561 (1,740) 15,192 -- 57,013
Long Term Liabilities:
Long term debt......................... 302,662 -- 180 -- 302,842
Deferred income taxes.................. 58,073 -- 1,626 -- 59,699
Other liabilities...................... 14,726 -- -- -- 14,726
------- ------- ------- -------- -------
Total liabilities......................... 419,022 (1,740) 16,998 -- 434,280
Stockholder's Equity:
Common................................. -- -- 7,396 (7,396) --
Paid in capital........................ 101,610 167,519 12,280 (179,799) 101,610
Accumulated deficit.................... (24,824) (8,664) 26,168 (12,095) (19,415)
Accumulated other comprehensive income
(loss)................................. (1,138) 3,645 (6,973) 4,363 (103)
------- ------- ------- -------- -------
Total stockholder's equity................ 75,648 162,500 38,871 (194,927) 82,092
------- ------- ------- -------- -------
Total liabilities and stockholder's equity $494,670 $160,760 $ 55,869 $(194,927) $ 516,372
======== ======= ====== ========= =======
23
Consolidating Statement of Cash Flows (Unaudited)
Nine Months Ended June 30, 2005
Successor
-------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I Subsidiaries Subsidiaries Consolidated
Net cash provided by operating activities. $ 16,140 $ 12,605 $ 2,795 $ 31,540
Net cash used for investing activities.... (3,508) -- (1,832) (5,340)
Net cash provided by (used for) financing
activities............................. (24,768) (11,660) - (36,428)
Effect of exchange rate on cash........... (4) (688) (785) (1,477)
------- ------- ------ ------
Increase (decrease) in cash and cash
equivalents............................ (12,140) 257 178 (11,705)
Cash and cash equivalents at the
beginning of the period................ 18,309 140 9,275 27,724
------ ------- ------ ------
Cash and cash equivalents at the end of
the period............................. $ 6,169 $ 397 $ 9,453 $ 16,019
====== ======= ====== ======
Consolidating Statement of Cash Flows (Unaudited)
Three Months Ended June 30, 2004
Predecessor
-------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I SubsidiariesSubsidiariesConsolidated
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
====== ====== ======= ======
24
Consolidating Statement of Cash Flows (Unaudited)
Six Months Ended March 31, 2004
Predecessor
-------------------------------------------------
Non-
Aearo Guarantor Guarantor
Company I Subsidiaries Subsidiaries Consolidated
Net cash provided by (used for) operating
activities............................. $ (1,359) $ 6,407 $ 3,987 $ 9,035
Net cash used for investing activities.... (3,326) -- (1,668) (4,994)
Net cash provided by (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
===== ====== ===== =======
25
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
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. You should read this report in conjunction with the more detailed risks
included in the Company's Annual Report on Form 10-K for the fiscal year ended
September 30,2004.
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 ("Parent"), the Company's parent, entered
into a merger agreement ("Merger Agreement") with AC Safety Holding Corp. and
its subsidiary, AC Safety Acquisition Corp. that closed on April 7, 2004 (the
"Merger"). 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 $409.3 million, including fees and expenses. The Merger was
financed with approximately $303.7 million of debt as discussed in Note 6, $3.7
million of which was assumed, $4.3 million of cash and $101.3 million of equity.
The Company continues to be wholly-owned by Aearo Corporation after the Merger.
The purpose of the Merger was to effect a change of control from Aearo
Corporation to the Company's ultimate parent AC Safety Holding Corp.
Approximately $87.0 million of proceeds from the Merger was distributed to our
Parent and used to pay the shareholders of the Parent to effect the merger
transaction. An additional $14.3 million distributed to our Parent was used to
pay the outstanding debt of the Parent as of April 7, 2004.
26
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 results of operations subsequent to the Acquisition
Date are presented on a different basis of accounting than the results of
operations 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.
Results of Operations -- Three Months Ended June 30, 2005 Compared to Three
Months Ended June 30, 2004.
The following table sets forth the major components of the Company's
consolidated statements of operations expressed as a percentage of net sales.
Results of Operations
(Dollars in Thousands)
Three Months Ended June 30,
2005 % 2004 %
Net sales:
Safety Products $ 86,161 76.1 $ 73,966 76.2
Safety Prescription Eyewear 10,493 9.3 10,126 10.4
Specialty Composites 16,544 14.6 13,034 13.4
------- ------- ------- -----
Total net sales 113,198 100.0 97,126 100.0
Cost of sales 58,124 51.3 68,144 70.2
------- ------- ------- -----
Gross profit 55,074 48.7 28,982 29.8
Operating expenses:
Selling and administrative 34,172 30.1 28,149 29.0
Research and technical services 2,234 2.0 1,966 2.0
Amortization 1,313 1.2 101 0.1
Other charges (income), net (512) (0.4) 1,690 1.7
------- ------- ------- -----
Total operating expense 37,207 32.9 31,906 32.8
Operating income (loss) 17,867 15.8 (2,924) (3.0)
Interest expense, net 5,856 5.2 10,292 10.6
------- ------- ------- -----
Income (loss) before income taxes 12,011 10.6 (13,216) (13.6)
Provision for income taxes 1,569 1.4 1,031 1.1
------- ------- ------- -----
Net income (loss) $ 10,442 9.2 $ (14,247) (14.7)
======== ====== ======== ======
Net sales for the three months ended June 30, 2005 increased 16.6% to $113.2
million from $97.1 million in the three months ended June 30, 2004. The increase
in net sales was primarily driven by organic growth in the Safety Products and
Specialty Composites segments and foreign currency translation. The weakness of
the U.S. dollar favorably impacted net sales by $1.8 million. The Safety
Products segment net sales for the three months ended June 30, 2005 increased
16.5% to $86.2 million from $74.0 million in the three months ended June 30,
2004. The increase in net sales resulted from a 14.2% increase in organic growth
and a 2.3% increase due to foreign currency translation. Organic sales
27
for the Safety Products segment, defined as net sales less the impact of foreign
currency translation and acquisitions, have increased for thirteen consecutive
quarters, when compared to the same quarter of the prior year. The Company
attributes this growth to an improved economy and its ability to successfully
introduce new products into the markets it serves. The Safety Prescription
Eyewear segment net sales for the three months ended June 30, 2005 increased
3.6% to $10.5 million from $10.1 million for the three months ended June 30,
2004. The increase in net sales resulted from a 2.8% increase in organic growth
and a 0.8% increase from foreign currency translation. Specialty
Composites' net sales for the three months ended June 30, 2005 increased 26.9%
to $16.5 million from $13.0 million in three months ended June 30, 2004. The
increase was primarily driven by market share gains and an improving economy
driving 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 eight quarters.
Gross profit for the three months ended June 30, 2005 increased to $55.1 million
from $29.0 million for the three months ended June 30, 2004. Gross profit in the
three months ended June 30, 2004 was negatively impacted by 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 for the three months ended June 30, 2005 was 48.7% as compared to 47.4%
for the three months ended June 30, 2004. The 130 basis point improvement in the
gross profit percentage is primarily due to product mix and productivity,
accounting for approximately 100 basis points, with the remainder due primarily
to the impact of foreign currency translation. 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. The Safety Products segment
gross profit in the three months ended June 30, 2005 increased 20.0% to $43.3
million from $36.1 million in the three months ended June 30, 2004. The increase
in gross profit is primarily due to an improvement in sales volume due to an
improved economy and the Company's ability to successfully introduce new
products into the markets it serves, productivity improvements and the favorable
impact of foreign currency translation. Volume and productivity improvements
contributed approximately 16.9% of the increase in gross profit with foreign
currency translation contributing the remaining 3.1% of the increase. The Safety
Prescription Eyewear segment gross profit in the three months ended June 30,
2005 increased 0.4% to $4.6 million from $4.5 million in the three months ended
June 30, 2004. The increase was primarily the result of a 3.6% improvement due
to sales volume and a 3.2% reduction due to product mix. Specialty Composites'
gross profit in the three months ended June 30, 2005 increased 33.3% to $7.2
million from $5.4 million in the three months ended June 30, 2004. The increase
was primarily driven by market share gains and an improving economy driving
volume increases in the precision electronics, truck, aircraft and industrial
markets, aided by productivity and improved manufacturing absorption.
Approximately 26.9% of the increase in the Specialty Composites gross profit was
due to volume increases with the remaining 6.4% of the increase due to product
mix.
Operating expenses for the three months ended June 30, 2005 increased 16.6% to
$37.2 million from $31.9 million for the three months ended June 30, 2004. The
increase in operating expenses was primarily driven by an increase in selling
and administrative, amortization expense, restructuring and research and
technical partially offset by other charges, net. Selling and administrative
expenses included approximately $2.1 million due to variable selling expenses
such as freight, commissions, travel and marketing, $1.5 million of legal and
consulting fees related to strategic alternatives such as acquisitions and debt
financing and a $0.4 million increase due to foreign currency translation. In
addition, in the three months ended June 30, 2004, the Company adjusted
28
approximately $1.0 million of expenses incurred as a result of the merger due to
the allocation of purchase price as required by SFAS No. 141. Selling and
administrative expenses as a percentage of net sales increased to 30.1% for the
three months ended June 30, 2005 as compared to 29.0% for the three months ended
June 30, 2004. Amortization expense increased approximately $1.2 million due to
the allocation of purchase price to finite lived intangible assets required by
SFAS No. 141 due to the Merger Agreement. Other charges (income), net included
approximately $0.5 million favorable impact of foreign currency transaction
expenses in the three months ended June 30, 2005 as compared to $1.7 million of
expense in the three months ended June 30, 2004, which included approximately
$1.5 million of expense to call the Company's 12.5% senior subordinated notes to
effect the Merger.
Interest expense, net, for the three months ended June 30, 2005 decreased to
$5.9 million from $10.3 million for the three months ended June 30, 2004.
Interest expense in the three months ended June 30, 2004 included approximately
$4.0 million of expense related to the write off of deferred financing fees and
approximately $1.0 million of incremental interest expense related to the
redemption of the 12.5% senior subordinated notes as a result of the Merger.
The provision for income taxes for the three months ended June 30, 2005
increased to $1.6 million from $1.0 million for the three months ended June 30,
2004. The 2005 estimated annual effective income tax rate was lowered to 29.5%
in the three months ended June 30, 2005, which reduced the provision for income
taxes by $1.6 million.
The following discussion provides a comparison of the results of operations for
the successor company and that of the predecessor company for the nine months
ended June 30, 2005 and 2004, respectively. The discussion is provided for
comparative purposes only, but the value of such comparison may be limited.
Material variances that are caused by the different basis of accounting have
been disclosed where applicable.
29
Results of Operations
(Dollars in Thousands)
Nine Months Ended June 30,
2005 (1) % 2004 (1) %
Net sales: Successor Predecessor
Safety Products $ 235,926 75.3 | $ 201,930 75.7
Safety Prescription Eyewear 29,706 9.5 | 30,463 11.4
Specialty Composites 47,805 15.2 | 34,312 12.9
------- ------- | ------- -----
Total net sales 313,437 100.0 | 266,705 100.0
Cost of sales 159,757 51.0 | 157,200 58.9
------- ------- | ------- -----
Gross profit 153,680 49.0 | 109,505 41.1
------- ------- | ------- -----
Operating expenses: |
Selling and administrative 98,583 31.5 | 84,984 31.9
Research and technical services 6,665 2.1 | 5,589 2.1
Amortization 3,928 1.3 | 343 0.1
Other charges (income), net (200) (0.1) | 1,184 0.4
Restructuring -- -- | (1,091) (0.4)
------- ------- | ------- -----
Total operating expense 108,976 34.8 | 91,009 34.1
Operating income 44,704 14.2 | 18,496 6.9
Interest expense, net 16,785 5.3 | 21,128 7.9
------- ------- | ------- -----
Income (loss) before income taxes 27,919 8.9 | (2,632) (1.0)
Provision for income taxes 358 0.1 | 3,051 1.1
------- ------- | ------- -----
Net income (loss) $ 27,561 8.8 | $ (5,683) (2.1)
======= ===== ======= ======
(1) Reflects a new basis of accounting subsequent to April 7, 2004 due to
the Merger.
Net sales for the nine months ended June 30, 2005 increased 17.5% to $313.4
million from $266.7 million in the nine months ended June 30, 2004. The
increase in net sales was primarily driven by organic growth in the Safety
Products and Specialty Composites segments and foreign currency
translation. The weakness of the U.S. dollar favorably impacted net sales
by $7.0 million. The Safety Products segment net sales for the nine months
ended June 30, 2005 increased 16.8% to $235.9 million from $201.9 million
in the nine months ended June 30, 2004. The increase in net sales resulted
from a 13.5% increase in organic growth and a 3.3% increase due to foreign
currency translation. Organic sales for the Safety Products segment,
defined as net sales less the impact of foreign currency translation and
acquisitions, have increased for thirteen consecutive quarters, when
compared to the same quarter of the prior year. The Company attributes this
growth to an improved economy and its ability to successfully introduce new
products into the markets it serves. The Safety Prescription Eyewear
segment net sales for the nine months ended June 30, 2005 decreased 2.5% to
$29.7 million from $30.5 million for the nine months ended June 30, 2004.
The decrease in net sales resulted from a 3.3% reduction in volume
partially offset by 0.8% increase from foreign currency translation.
Specialty Composites' net sales for the nine months ended June 30, 2005
increased 39.3% to $47.8 million from $34.3 million in nine months ended
June 30, 2004. The increase was primarily driven by market share gains and
an
30
improving economy driving 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 eight quarters.
Gross profit for the nine months ended June 30, 2005 increased 40.3%
to $153.7 million from $109.5 million for the nine months ended June 30,
2004. Gross profit in the nine months ended June 30, 2004 was negatively
impacted by 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 for the nine
months ended June 30, 2005 was 49.0% as compared to 47.5% for the nine
months ended June 30, 2004. The 150 basis point improvement in the gross
profit percentage is primarily due to product mix and productivity,
accounting for approximately 120 basis points, with the remainder due
primarily to the impact of foreign currency translation. 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.
The Safety Products segment gross profit in the nine months ended June 30,
2005 increased 20.9% to $119.5 million from $98.9 million in the nine
months ended June 30, 2004. The increase in gross profit is primarily due
to an improvement in sales volume due to an improved economy and the
Company's ability to successfully introduce new products into the markets
it serves, productivity improvements and the favorable impact of foreign
currency translation. Volume and productivity improvements contributed
approximately 19.8% of the increase in gross profit with foreign currency
translation contributing the remaining 1.0% of the increase. The Safety
Prescription Eyewear segment gross profit in the nine months ended June 30
2005 decreased 6.3% to $13.3 million from $14.2 million in the nine months
ended June 30, 2004. The decrease was primarily the result of a 2.5%
reduction due to a decrease in sales volume and a 3.9% reduction due to
product mix. Specialty Composites' gross profit in the nine months ended
June 30, 2005 increased 52.9% to $20.8 million from $13.6 million in the
nine months ended June 30, 2004. The increase was primarily driven by
market share gains and an improving economy driving volume increases in the
precision electronics, truck, aircraft and industrial markets, aided by
productivity and improved manufacturing absorption. Approximately 39.3% of
the increase in the Specialty Composites gross profit was due to volume
increases with the remaining 14.3% of the increase due to product mix.
Operating expenses for the nine months ended June 30, 2005 increased
19.7% to $109.0 million from $91.0 million for the nine months ended June
30, 2004. The increase in operating expenses was primarily driven by an
increase in selling and administrative, amortization expense, restructuring
and research and technical partially offset by other charges, net. Selling
and administrative expenses included approximately $2.2 million due to
performance based incentives related to the increase in sales volume, $2.0
million related to variable marketing programs and travel, $1.6 million due
to foreign currency translation, $1.8 million related to freight and
distribution with the remaining increase consistent with the increase in
sales volume. Selling and administrative expenses as a percentage of net
sales improved to 31.5% for the nine months ended June 30, 2005 as compared
to 31.9% for the nine months ended June 30, 2004. Amortization expense
increased approximately $3.6 million due to the allocation of purchase
price to finite lived intangible assets required by SFAS No. 141 due to the
Merger Agreement. The decrease in other charges, net was attributed to
foreign currency transaction expenses in the nine months ended June 30,
2005 as compared to $1.2 million of expense in the nine months ended June
30, 2004, which included approximately $1.5 million of expense to call the
Company's 12.5% senior subordinated notes to effect the merger. The
restructuring provision adjustment of $1.1 million of income in the nine
months ended June 30, 2004 was the result of a change in estimate relating
to non-cancelable leases.
31
Interest expense, net, for the nine months ended June 30, 2005
decreased to $16.8 million from $21.1 million for the nine months ended
June 30, 2004. Interest expense in the nine months ended June 30, 2004
included approximately $4.0 million of expense related to the write off of
deferred financing fees and approximately $1.0 million of incremental
interest expense related to the redemption of the 12.5% senior subordinated
notes as a result of the Merger.
The provision for income taxes for the nine months ended June 30, 2005
decreased to $0.4 million from $3.1 million for the nine months ended June
30, 2004. At September 30, 2004, the Company's net operating losses were
partially offset by a valuation allowance of $7.5 million. During the six
month period ended March 31, 2005, management determined that based on
current domestic operating results, it is more likely than not that
domestic net operating losses will be realized and consequently reversed
the $7.5 million valuation allowance. The reversal of the valuation
allowance reduced the expected annual effective tax rate.
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, from time to time, will utilize
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, dividends and
acquisitions.
The Company's debt structure includes: (a) $175.0 million of 8.25%
Senior Subordinated Notes ("8.25% Notes") due 2012, which are publicly held
and redeemable at the option of the Company, in whole or in part at various
redemption prices, (b) up to an aggregate of $175.0 million under its
Credit Agreement with various banks comprised of (i) a secured term loan
facility consisting of loans providing for up to $125.0 million of term
loans (collectively the "Term Loans") with a portion of the Term Loans
denominated in Euros, (ii) a secured revolving credit facility ("Revolving
Credit Facility") providing for up to $50.0 million of revolving loans for
general corporate purposes, and (iii) an uncommitted incremental term loan
facility of up to $75.0 million for acquisitions (collectively, the "Senior
Bank Facilities"). Since the Acquisition Date, the Company's debt has been
negatively impacted by $ 0.3 million related to the fluctuation of the Euro
relative to the U.S dollar as of June 30, 2005. The Company does not plan
32
to take any measure to minimize the foreign exchange impact of its Euro
denominated debt. The amounts outstanding on the Term Loans were
approximately $123.8 million and $126.0 million at June 30, 2005 and
September 30, 2004, respectively. There were no amounts outstanding under
the Revolving Credit Facility at June 30, 2005 and September 30, 2004,
respectively. The Revolving Credit Facility provides for the issuance of
letters of credit in an aggregate face amount of up to $15.0 million. The
Company had approximately $1.4 million and $1.6 million of letters of
credit outstanding at September 30, 2004 and June 30, 2005, respectively.
The Term Loans amortize quarterly over a seven-year period. Amounts repaid
or prepaid in respect of the Term Loans may not be re-borrowed. Loans and
letters of credit under the Revolving Credit Facility will be available
until the Revolving Loan Maturity Date, which is April 7, 2010. The Term
Loans mature on April 7, 2011. Effective December 31, 2004, the Company
received a 0.25% reduction in the interest rate paid on its Term Loans for
meeting certain financial covenants. The Company was in compliance with all
financial covenants and restrictions as of June 30, 2005.
On April 28, 2005, the Company amended its credit agreement to allow
the Company to make, prior to September 30, 2005, up to $35 million of cash
distributions to Aearo Corporation, its parent corporation for the purpose
of paying cash dividends to AC Safety Holding Corp., its parent, to be used
by AC Safety Holding Corp. primarily to redeem, pro rata, its outstanding
preferred shares and to pay accrued dividends on the preferred shares. In
addition, the amendment (i) modified the amount of the incremental Term
Loan commitment from $60.0 million to $75.0 million (ii) eliminated the
termination date for the incremental Term Loan commitment and (iii) allowed
for incremental Term Loans in Euros.
On May 5, 2005, the Company's Board of Directors declared a cash dividend
of approximately $35 million to be paid to the Company's parent, Aearo
Corporation, the sole holder of common stock. On May 7, 2005 Aearo
Corporation paid a cash dividend to AC Safety Holding Corp., the Company's
ultimate parent, who used the proceeds to make a partial redemption of its
preferred stock. The Company used available cash to fund the dividend.
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 $5.4 million and $7.8 million, respectively,
for capital expenditures for the nine months ended June 30, 2005 and 2004,
respectively. The Company anticipates it will spend approximately $9.5
million for capital expenditures in its fiscal year ending September 30,
2005.
The Company's net cash provided by operating activities for the nine months
ended June 30, 2005 totaled $31.5 million as compared to $22.8 million for
the nine months ended June 30, 2004. The increase of $8.7 million was
primarily due to a $10.9 million improvement in net income adjusted for
non-cash charges (depreciation, amortization, deferred taxes and other),
partially offset by a $2.2 million reduction from the net changes in assets
and liabilities.
Net cash used for investing activities was $5.3 million for the nine months
ended June 30, 2005 as compared to $7.8 million for the nine months ended
June 30, 2004. The decrease in net cash used by investing activities is
primarily attributed to reduced spending for property, plant and equipment.
Net cash used for financing activities for the nine months ended June 30,
2005 was $36.4 million compared with $8.8 million for the nine months ended
June 30, 2004. The change is primarily due to the cash dividend paid to our
Parent as mentioned above.
33
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. To
develop the expected long-term rate of return on assets assumption, the
Company considered historical returns and future expectations for returns
for each asset class, as well as the target asset allocation of the pension
portfolio. Over the 11 year period ended September 30, 2004, the returns on
the portfolio, assuming it was invested at the current target asset
allocation in prior periods, would have been a compound annual average
return of 9.3%. Considering this information and the potential for lower
future returns, the Company selected an 8.0% rate of return on plan asset
assumption. Actual asset returns for the Company's pension plan improved in
the last two fiscal years after two years of negative returns. 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 unchanged at 6.0% for the year ended September 30,
2004. 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 $0.1
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.
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid (in thousands of dollars):
Fiscal year 2005 $ 1,121
Fiscal year 2006 466
Fiscal year 2007 618
Fiscal year 2008 830
Fiscal year 2009 1,214
Fiscal year 2010 - 2014 6,784
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 assurances that these trends will continue 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, capital
expenditures and debt service 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.
34
Product Liability Claims
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.
Many 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 Corporation 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 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 with AC Safety
Acquisition Corp., 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 a 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.
In fiscal 2003 and 2004, the Company settled 259 claims in which it
was named as a defendant for an average settlement amount of $24.36 in
silica claims and $83.24 in asbestos claims, while an additional 200 claims
were dismissed without any payment (43.6% of cases closed), because the
Company was not a proper defendant or did not make the product in question.
As of September 30, 2004, the number of open claims where the Company was
named as a defendant in silica and asbestos related matters was 11,087 and
4,282, respectively. For the nine months ended June 30, 2005, the increases
in number of claims where the Company was named as a defendant in silica
and asbestos related matters was 2,122 and 1,010 respectively. The 1,010
new asbestos claims include 114 claims that allege exposure from clothing,
which the Company never manufactured. One claim was settled for $17.85
where the Company was named as a defendant in silica related matters during
the nine months ended June 30, 2005. No claims were settled where the
Company was named as a defendant in asbestos related matters during the
nine months ended June 30, 2005. As of June 30, 2005, the number of open
claims where the Company was named as a defendant in silica and asbestos
related matters was 12,739 and 4,095, respectively.
In addition to the above claims, the Company may agree to pay a share
of the settlement and defense costs in particular cases even though the
Company is not named as a defendant because of agreements with prior owners
of the brand and/or because of allegations that Aearo has some risk of
legal liability as a successor ("Additional Claims"). During the nine
months ended June 30, 2005, Aearo paid a total of $1.67 million for
settlement, administrative and defense costs resulting in the settlement of
4,325 silica and asbestos claims that were settled between October 1, 2002
and September 30, 2004 involving both claims in which Aearo was named as a
defendant and Additional Claims. During the period October 1, 2004 to June
30, 2005 Aearo paid a total of $164.72 for three additional claims that
were settled during that time period and paid a total of $0.4 million for
administrative and defense costs involving both claims in which Aearo was
named as a defendant and Additional Claims. In addition, Aearo may receive
the benefit of releases in some additional cases settled by the AO Defense
Group regardless of whether or not any claim was made against Aearo.
35
The above information was based on data provided by Simon Peragine
Smith, an outside law firm which tracks numbers of cases and settlements on
behalf of the "AO Defense Group", and is believed to be materially
accurate. This information may be subject to future adjustment in light of
new information becoming available. The AO Defense Group is a voluntary
association of current and former manufacturers of the "AO Safety" brand of
respirators and certain of their insurers in which Aearo participates and
through which all of its settlements have been handled in the relevant
years. Also, between October 1, 2004 and June 30, 2005, there may have been
claims settled by and fully funded by the insurers of Eastern Safety
Equipment Co., Inc., a dissolved former subsidiary of Aearo.
At June 30, 2005 and September 30, 2004, the Company has recorded
liabilities of approximately $4.6 million and $5.4 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. The $0.8 million reduction in the reserve, net of new accruals
which added to the reserve, since September 30, 2004 is primarily
attributed to the payment of $1.67 million, as referenced above, to pay
costs attributed to settlement, administrative and defense costs that had
been reached over the prior two year time period. This reserve is
re-evaluated periodically and additional charges or credits to results of
operations may result as additional information becomes available. 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 2009 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.
Contractual Obligations
The Company has the following minimum commitments under contractual
obligations including purchase obligations by fiscal year, as defined by
the U.S. Securities and Exchange Commission as of June 30, 2005:
(1) 2010 and
2005 2006-2007 2008-2009 after Total
Capital lease obligations $ 88 $ 705 $ 368 $ 32 $ 1,193
Operating lease obligations 905 5,711 4,972 5,434 17,022
Mortgage obligations 90 2,048 -- -- 2,138
Purchase obligations 1,021 6,680 6,402 -- 14,103
Respiratory commitment 100 800 800 800 2,500
Long term debt 5,626 43,403 43,173 320,028 412,230
------ ------- ------ ------- -------
Total $ 7,830 $ 59,347 $ 55,715 $ 326,294 $ 449,186
====== ====== ====== ======= =======
1) Amounts presented in the current fiscal year represent remaining
payments for the fiscal year.
The amounts for long term debt above include both interest and principal
payments. The Company paid approximately $4.7 million for taxes worldwide
in fiscal 2004 and does not anticipate significant changes to its tax
obligations in the future. The Company has approximately $1.6 million of
letters of credit outstanding as of June 30, 2005 and does not anticipate
significant changes to its outstanding letters of credit in the future.
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 after 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 contribution payments.
36
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements or 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 accounts for derivatives pursuant to SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities", 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 results of
operations and cash flows, the Company executes two hedging programs, one
for transaction exposures, and the other for cash flow exposures in foreign
operations. In order to implement the transaction hedging program, the
Company utilizes 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 gain of approximately
$ 0.3 million and $ 0.1 million for the three and nine month periods ended
June 30, 2005, respectively, compared to net loss of $ 0.3 million and $
0.6 million, respectively for the three and nine month periods ended June
30, 2004. In regard to its cash flow hedging program, the Company complies
with SFAS No. 133 which requires that derivative instruments be recorded in
the balance sheet as either an asset or liability measured at its fair
value. During the three month period ended June 30, 2005, the Company
entered into three new forward foreign currency contract derivatives that
protect the Company against exchange rate movement during fiscal 2006. As
result of the new forward currency contracts, the Company has recorded a
derivative payable of $0.4 million at June 30, 2005. For the three and nine
month periods ended June 30, 2004, the Company reclassified into earnings
net losses of $0 million and $0.5 million, respectively, resulting from the
exercise of forward foreign currency contracts. All forward foreign
currency contracts were determined to be highly effective whereby no
ineffectiveness was recorded in earnings. In addition, the Company limits
the foreign exchange impact on the balance sheet with debt denominated in
Euros.
37
Interest Rates
The Company is exposed to market risk from changes in interest rates. The
Company, from time to time, will utilize interest rate instruments to
reduce the impact of either increases or decreases in interest rates on its
floating rate debt.
The Company had approximately $30.5 million of variable rate debt protected
under an interest rate cap arrangement, which expired December 31, 2004.
The Company had not elected hedge accounting treatment for the interest
rate cap as defined under SFAS No, 133 and, as a result, fair value
adjustments were charged directly to other charges (income), net. There was
a $0.1 million impact on earnings for the nine-month period ending June 30,
2004.
The Company is of the opinion that it is well positioned to manage interest
rate 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, 2005, 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, 2005, that has materially
affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
38
PART II - OTHER INFORMATION
Item 6. Exhibits
(a) Exhibits
See Index of Exhibits on page 41 hereof.
39
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 15, 2005 AEARO COMPANY I
/s/ Michael A. McLain
_______________________________________
Michael A. McLain
Chairman and Chief Executive Officer
(Principal Executive Officer)
/s/ Jeffrey S. Kulka
_______________________________________
Jeffrey S. Kulka
Senior Vice President, Chief Financial Officer
and Secretary
(Principal Financial and Accounting Officer)
40
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.
41