Item 1. Business
General Aearo Corporation, a Delaware corporation ("Aearo"), and its direct wholly owned subsidiary, Aearo Company I, doing business as Aearo Company, a Delaware corporation (the "Subsidiary"), are collectively referred to herein as the "Company". The Company is one of the leaders in the hearing, eye, face, head and respiratory protection segments of the personal protection equipment ("PPE") market worldwide. PPE encompasses all articles of equipment and clothing worn for the purpose of protecting against bodily injury, including safety eyewear and goggles, earmuffs and earplugs, respirators, hard hats, fall protection, gloves, safety clothing and safety shoes. The Company manufactures and sells hearing protection devices, communication headsets, prescription and non-prescription safety eyewear, face shields, reusable and disposable respirators, fall protection, hard hats and first aid kits in more than 70 countries under its well-known brand names: AOSafety(R), E-A-R(R), Peltor(R) and SafeWaze(TM). The Company attributes its leading market positions to:
- Strong, well-recognized brand names - A reputation for providing innovative, quality products - Intensive coverage of multiple distribution channels targeting a wide array of end-users - One of the industry's broadest product offerings, and - A commitment to providing the highest level of customer service.
The Company also manufactures a wide array of energy-absorbing materials that are incorporated into other manufacturers' products to control noise, vibration and shock. These products are marketed under its brand name E-A-R(R) Specialty Composites. Aearo derives all of its operating income and cash flow from the Subsidiary, and its only material assets are the shares of common stock of the Subsidiary that Aearo owns. Other than its ownership of the Subsidiary and its guarantee of the indebtedness of the Subsidiary, Aearo has no business or operations. Aearo was incorporated in the State of Delaware in June 1995. Detailed information with respect to the Company's segment reporting is presented in Note 14 of Notes to Consolidated Financial Statements of Aearo Corporation contained in Item 8 hereof.
Segments The Company operates three business segments. 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 equipment and first aid kits in more than 70 countries under its well-known brand names: AOSafety(R), E-A-R(R), Peltor(R) and SafeWaze(TM). The Safety Products segment accounted for approximately 77% of the Company's net sales in fiscal 2003 and approximately 73% in fiscal 2002 and fiscal 2001, respectively.
The Safety Prescription Eyewear segment manufactures and sells products under the AOSafety(R) brand name that are designed to protect the eyes from the typical hazards encountered in the industrial work environment. The Company purchases component parts (lenses and the majority of its frames) from various suppliers, grinds and shapes the lenses to the end-user's prescription, and then assembles the glasses using the end-user's choice of frame. The Safety Prescription Eyewear segment accounted for approximately 13% of the Company's net sales in fiscal 2003 and approximately 14% in fiscal 2002 and fiscal 2001, respectively.
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 problems in other manufacturers' products. Specific product applications for Specialty Composites' materials, technology and engineering expertise include thermal acoustic systems in business and regional jet aircraft; protective and performance-enhancing components in precision electronic equipment; thermal and acoustic treatments for heavy-duty trucks; and treatments to control noise, vibration and shock in a wide range of industrial and commercial equipment. Specialty Composites also produces specially formulated foam used in the manufacture of the Safety Products segment's polyvinyl chloride ("PVC") and polyurethane ("PU") earplugs. Specialty Composites accounted for approximately 10% of the Company's net sales in fiscal 2003 and approximately 13% in fiscal 2002 and fiscal 2001, respectively.
Products - Safety Products Segment Within Safety Products, the Company classifies its products in five main categories: hearing protection and communication headsets; eye protection; face and head protection; respiratory protection; fall protection and other protection products. These products serve a variety of end users, such as in the construction, heavy machinery, airport, forestry, textile, mining, military, motor sports, health care and two-way radio markets.
Hearing Protection and Communication Headsets: The Company's hearing protection products primarily consist of disposable earplugs, reusable earplugs, earmuffs, and communication headsets. The Company has been a leader in hearing conservation research and development since 1972, when it first introduced the PVC disposable earplug. Today, this product is known as the "Classic(R)" and its color yellow is a registered trademark in the United States of America, Canada, Belgium, Netherlands and Luxembourg, and is recognized throughout the world. This product, and the recently introduced and patented SuperFit(R) product, is designed to be "rolled down" or compressed before being inserted into the ear, and, as a result of its unique slow recovery characteristics, the plug slowly expands (or "recovers") to fill the ear canal and provide the desired protection. In addition, the Company manufactures a full line of disposable polyurethane earplugs, including its E-Z-Fit(R), TaperFit(R), and E-A-Rsoft(R) products. The Company's disposable earplugs are available corded and uncorded and in a variety of packaging options.
In the reusable earplug segment of the market, the Company offers its patented UltraFit(R) and E-A-R(R) Express(R) products. The E-A-R(R) Express(R) product features a polyurethane pod and a short plastic stem to facilitate sanitary and easy insertion of the plug into the ear. The Company also offers the "Flex"(TM) line of "semi-aural" banded products. These products feature articulating arms that allow for use in multiple positions and for easy storage around the neck. The Company manufactures, assembles and sells a broad line of earmuffs and communication headsets under its Peltor brand. The Company is a leader in providing noise attenuating headsets and wireless and hardwire communication headsets. These products provide protection from harmful high and low frequency noise and also allow for easy communication in noisy or remote environments. The Company also offers auditory systems products, which are sold to audiologists and are used in the testing of hearing.
In 2003 E-A-R Push-Ins(TM) were introduced, offering all the performance and convenience of a reusable earplug for the price of a disposable earplug. The product's flexible stem allows for easy insertion and removal with no rolling down, and the patented foam tip is sized to mold comfortably to fit virtually every size of ear canal. The quick and easy fit and sure seal combine to provide high noise attenuation.
Eye Protection: Non-prescription eye protection is used in work environments where a number of hazards present a danger to the eyes including dust, flying particles, metal fragments, chemicals, extreme glare and optical radiation. The Company offers a large number of task-specific non-prescription safety eyewear products under the AOSafety(R) brand. The basic categories of non-prescription eyewear protection products are non-prescription (or "plano") eyewear and goggles:
Plano (Non-prescription) Eyewear. Plano eyewear accounts for the majority of the Company's sales in this category and encompasses a full range of protective needs including visitor spectacles, over-the-glass, single lens and dual lens products. Within these categories are a variety of styles, frame colors and lens options in addition to a number of adjustability and comfort options. Many of these AOSafety(R) products feature our DX(R) coating, combining the benefits of chemical and scratch resistance with anti-fog. Flywear(TM), Maxim(TM), X-SeriesTM, MetaliksTM and X.SportTM eyewear offer modern sport styling with numerous comfort features. NuvoTM eyewear has the classic dual lens look reinterpreted for today's worker. Lexa(R) eyewear blends a wrapping, single lens with a lightweight, frameless design. Virtua(TM) offers stylish eyewear at an economical price. Visitor spectacles and over-the-glass products are represented by Seepro(R) and Tourguard(R) eyewear.
Goggles. The Company manufactures and sells a broad line of goggles, which are typically required in work environments where a higher degree of impact protection is required, where increased protection against dust, mist or chemical splash is needed and/or for use in welding operations. To meet these requirements, the Company offers a variety of vented and non-vented goggles with varying fields of view including Dust GoggleGearTM for Lexa(R), Splash GoggleGearTM for Lexa(R) and Centurion(R), all under the AOSafety(R) brand.
Face and Head Protection: Face and head protection is used in work environments where a number of hazards present a danger to the face and head, including dust, flying particles, metal fragments, chemicals, extreme glare, optical radiation and items dropped from above. The basic categories of face and head protection are faceshields and hard hats:
Faceshields. Faceshields are designed to protect against heat, splash and flying particles and are worn in conjunction with other protective equipment, such as Plano eyewear and respirators. The Company offers a wide variety use specific faceshield windows under both AOSafety(R) and Peltor(R) brands. The patented AO TuffMaster(R) line of faceshields is one of the leading brands in the market.
Hard Hats. The Company manufactures and sells a broad line of hard hats, including "bump" caps, full-brim hats and traditional hard hats, featuring four or six point suspension, ratchet adjustment, and a wide selection of colors and custom imprinting. The XLR8(R) line of hard hats represents the latest design and functionality under the AOSafety(R) brand.
Respiratory Protection: Respiratory protection products are used to protect against the harmful effects of contamination and pollution caused by dust, gases, fumes, sprays and other contaminants. The Company offers a broad line of disposable dust and mist masks, cartridge-equipped quarter, half and full-face respirators, and "escape" respirators (a single-use respirator for emergencies) under the AOSafety(R) brand. Pleats PlusTM offers the latest design in particulate respirators. QuickLatch(R) half mask respirators offer an innovative, patented on-and-off latching system that can be accomplished with just one hand.
Fall Protection: The Company offers a line of fall protection equipment under the SafeWaze(TM) brand name as a result of the acquisition of VH Industries, Inc. in March of 2003.
Other Protection Products: The Company also offers first aid kits predominantly through the Consumer/Do-It-Yourself (DIY) market. First aid kits are either for general use or for industrial or commercial uses. Additional products in this group include safety vests, flagging tape, and safety cones.
Products - Safety Prescription Eyewear Segment
The Company's Safety Prescription Eyewear ("SRx") products are designed to protect the eyes from the typical hazards encountered in the industrial work environment. The Company purchases component parts (lenses and the majority of its frames) from various suppliers, grinds and shapes the lenses to the end user's prescription, and then assembles the glasses using the end user's choice of frame. The Company views its ability to provide individual attention to each patient through Company-employed, as well as independently contracted eyecare professionals as an essential part of its SRx business. These products serve a wide variety of end user markets such as utilities, transportation, industrial manufacturing and federal, state and local governments.
Products - Specialty Composites Segment
The Company's Specialty Composites segment manufactures a wide array of energy-absorbing materials that are incorporated into other manufacturers' products to control noise, vibration and shock. Specialty Composites' products fall into three broad categories: (i) barriers and absorbers for airborne noise control, (ii) damping and isolation products for vibration and shock control, and (iii) energy control products for vibration, shock control and comfort management. Some examples of end user applications for such materials include noise- and vibration-damping materials used in under-hood and cab treatments for transportation equipment such as Class 8 heavy trucks, as well as shock protection parts for electronic devices such as computer hard disk drives, servers and highly damped proprietary materials for the interior cabins of business and regional jet aircraft. The Company's products include Tufcote(R) polyurethane foams for acoustical applications, Confor(R) heavily damped viscoelastic foams for ergonomic cushioning applications and shock protection and Isodamp(R) foams for the reduction of mechanical vibration, noise and shock. Specialty Composites also produces the specially formulated foams used in the manufacture of Safety Products' earplugs. The principal strengths of Specialty Composites are its specialized polyurethane formulations, its thin-sheet casting capability, its composite technologies and its applications and materials engineering. These strengths allow the Company to manufacture in a single process, high value-added composites using casting, extrusion and molding processes.
Sales and Marketing
The Company divides its sales and marketing force into its three business segments, as follows:
Sales and Marketing - Safety Products Segment
Within Safety Products, sales are managed through five channels: North American Industrial Distribution; Consumer/Do-It-Yourself ("DIY"); Europe, construction and International. Each of these channels has its own sales force and its own distinct yet synergistic sales strategies. In addition, through the acquisitions of Peltor(R) and Norhammer, the Company significantly expanded its sales coverage, including a dedicated effort to serve the specialty communications earmuff market. The Company also produces versions of the PVC plug for many international airlines for inclusion in their amenity kits.
North American Industrial Distribution (NAI). This is the largest sales channel for Safety Products and includes approximately 1,041 North American distributors and dealers of which, approximately 213 qualify for the Dialog(TM) rebate program. Participation in the Dialog(TM) program requires minimum annual purchase levels while encouraging support across the full product line. Dialog distributors qualify for annual volume and growth rebates, and cooperative advertising. The Company also offers Dialog(TM) distributors financial incentives for establishing electronic order entry/invoicing interfaces with the Company, and for developing marketing programs that promote the Company's products.
Consumer. Under the AOSafety(R) brand name, the Company is North America's leading supplier of personal safety products. The AOSafety(R) brand offers a wide variety of quality products to meet existing and emerging consumer personal safety needs in many marketplaces. Within the Hardware/Do-it-Yourself marketplace, AOSafety(R) is the primary brand carried by The Home Depot, Ace Hardware, TruServ Corporation, Lowe's Home Improvement Warehouse and other retailers. AOSafety(R) also has the leading position in the sporting goods safety marketplace and AOSafety(R) products are marketed in the lawn and garden, paint, drug and mass merchandise channels.
Europe. The Company has a significant presence in Europe with manufacturing facilities in England, Sweden, and France, and sales offices in the U.K., Sweden, Norway, Germany, France, Italy and Spain. The Company's historical strength in this market has been in passive hearing protection products (E-A-R(R)) sold through over 1000 industrial distributors, and Peltor Communications products sold to the military, sport shooting, and rally sports market segments. AOSafety is the number one prescription eyewear brand in France.
International. The Company exports its products around the world, and this channel is managed through independent sales representatives located in Singapore, Miami (covering the Caribbean and Central America), Brazil, Australia, New Zealand and South Africa (covering the Middle East).
Sales and Marketing - Safety Prescription Eyewear Segment (SRx)
The SRx segment employs its own sales force to sell its products throughout North America. Approximately 85% of the Company's safety prescription eyewear are sold directly to more than 15,000 industrial locations, including a majority of the industrial companies in the Fortune 500. The remainder of the Company's SRx products are sold through the industrial distribution channel and directly to eyecare professionals.
Sales and Marketing - Specialty Composites Segment
The Company utilizes an inside sales and marketing team, independent manufacturers representatives and select distributors to identify global sales opportunities in target markets for Specialty Composites' products and technologies. Once such applications have been identified, the Company's marketing, sales and technical staffs work closely with customer product development teams to provide the customer with cost-effective, integrated solutions for noise, vibration, shock, cushioning and/or comfort management problems. Currently, Specialty Composites' marketing efforts are aimed at four key, strategic segments worldwide: aircraft, precision electronic equipment, heavy-duty trucks and original equipment manufacturing (OEM).
Aircraft Market. Specialty Composites provides integrated thermal acoustic systems for aircraft manufacturers and refurbishers worldwide. Designed primarily for business and regional jets, the systems include high performance, weight-efficient, multi-function composites that the Company has developed specifically to meet the requirements of aircraft applications and meet FAA regulations.
Precision Equipment Market. This global market has increasingly focused on compact designs and highly portable devices. Specialty Composites' engineering expertise and advanced energy-control materials and technology are critical to customers' product development, helping in the design of quieter, more rugged, more accurate and faster devices. Key applications include portable and desk top computers, hand held devices, disk drives, data servers and data storage units.
Heavy-duty Truck Market. Focusing mainly on Class 5 through Class 8 vehicles, Specialty Composites' strategy in the truck market has been to assist manufacturers in meeting regulatory pass-by noise standards and thermal underhood and in-cab requirements in differentiating vehicles. Incorporating acoustical foams, barriers and multi-function composite products, thermal and acoustic treatment packages are designed for maximum performance and minimum installation labor.
Industrial and OEM Market. Specialty Composites' energy-control technology base, broad product line and depth of engineering experience enable the Company to provide highly effective, targeted solutions to manufacturers in a wide range of industries, ranging from noise control treatments for pumps, generators and compressors, to vibration damping and shock isolation in garage door openers, laboratory centrifuges and high-speed printers.
Research and Development
The Company has a strong emphasis on new product development, innovation and protection of intellectual property in each of its three business segments.
Research and Development - Safety Products Segment
The Company believes that its Research and Development facilities, personnel and programs are among the best in the PPE industry. Since its inception in 1972, the Company's ultimate predecessor, the former E-A-R(R) (Energy Absorbing Resins) Division of Cabot Corporation ("Cabot"), has been a leader in the development of technology for understanding noise, measuring noise and hearing loss, and in developing products and programs to encourage hearing protection and conservation. In order to test the efficacy of its hearing protection products, the Company owns and operates a National Voluntary Laboratory Accreditation Program ("NVLAP") laboratory in the United States. The Company also operates sound chambers and testing facilities in the United States and Sweden that measure the performance of its materials and designs. With these and other capabilities, the Company believes it is a leader in the development of both passive and active hearing protection products. Similarly, the Company believes that it has been a pioneer and leader in the development and testing of safety eyewear as extensive facilities are operated for the design and testing of these products. The Company also has facilities for the design and testing of respiratory safety equipment. Many of the Research and Development personnel of the Company are recognized experts in the safety products industry and are members of various committees of standard setting organizations.
Research and Development - Safety Prescription Eyewear Segment
This segment shares resources with the Safety Products Segment in the areas of coating technology, automation and manufacturing process improvements. This segment works extensively with outside suppliers for development of frames, lenses and coatings.
Research and Development - Specialty Composites Segment
Specialty Composites' research and development efforts focus on developing proprietary materials and enhancing existing products in order to meet market and customer needs identified by the Company's marketing, sales and technical staffs. Products such as VersaDamp(TM) thermoplastic elastomers and Confor(R) environmentally friendly, energy-absorbing foams are being introduced in a growing number of applications across all markets served by Specialty Composites.
Raw Materials and Suppliers
The Company buys and consumes a wide variety of raw materials, component parts, office supplies, and maintenance and repair parts. Significant categories purchased include corrugated paper products, poly packaging films, chemicals, eyewear frames and optical lenses. The chemical category includes plastic resins such as polycarbonates, propionates, polyols, plasticizers, substrates, pre-polymers, isocyanates and adhesives. The eyewear frames are for both the non-prescription and SRx products.
The Company has a diverse base of material suppliers and is subject to market risks with respect to industry pricing in paper and crude oil as it relates to various commodity items. Items with potential risk of price volatility include paperboard, packaging films, nylons, resins, propylene, ethylene, plasticizer and freight. With reference to supplier agreements that allow for price changes based upon an index, the Company builds anticipated commodity price movements into each year's planning cycle. The Company manages pricing pressure exposure on large volume commodities such as polycarbonate, polyols and polyvinyl chloride via price negotiations utilizing alternative supplier competitive pricing. However, where appropriate, the Company will use a single source for supply of certain items. In addition, based on the material, availability of supply, level of quality and the technical difficulty to produce, the Company will use a major and minor source to insure continued best pricing and a ready back up supply. The Company does not enter into derivative instruments to manage commodity risk.
The Company's commodity pricing and negotiating strategy is to consolidate suppliers where applicable, leverage competitive pricing, identify alternate lower cost materials and work with existing suppliers to reduce costs through engineering and innovation.
Although the Company outsources the production of less than 25% of its assembled parts and products to various manufacturers, the Company has found resource availability, abundant supplier competition and infrastructure stability in the Far East to provide favorable supply opportunities.
Manufacturing and Distribution Operations
The Company maintains a high degree of vertical integration, allowing it to manufacture over 75% of the products that it sells. The Company's strengths include the manufacture of foams (casting, molding and fabricating) for Specialty Composites' products (including the foam used in the manufacture of PVC and PU earplugs); high speed assembly and packaging of earplugs; plastic injection molding, coating and assembly of non-prescription eyewear; and assembly, grinding, polishing and coating of prescription eyewear. The Company also utilizes a limited number of contract manufacturers in the United States of America, Mexico, and Europe to supplement internal operations and to assemble and/or manufacture products where the Company does not have world class processing capabilities. The Company uses selected Asian suppliers for some product lines to complement Company manufactured products and fill in product families, where it is advantageous to minimize capital expenditures and accelerate new product introductions. The Company will continue to use contract manufacturers where appropriate to remain competitive and maximize profit margins. Consistent across all of the Company's manufacturing operations is an emphasis on producing high quality products. Currently, all of the Company's manufacturing facilities have been awarded ISO 9002 or ISO 9001 certification, indicating that the Company has achieved and sustained a high degree of quality and consistency with respect to its products. The Company has also attained QS 9000 certification for the Specialty Composites operations in Indianapolis and Newark. The Company believes that ISO certification is an increasingly important selling feature both domestically and internationally, and certain customers require ISO certification from all their vendors.
The Company's products are generally shipped within several days from the receipt of a purchase order. As a result, backlog is not material to the Company's business.
Manufacturing and Distribution Operations - Safety Products Segment
The Company's Indianapolis, Indiana plant is the largest earplug manufacturing facility in the world. It fabricates, molds, assembles and packages hundreds of millions of pairs of earplugs annually, utilizing automated, high-speed assembly and packaging equipment. The economies of scale present in this operation are unique in the hearing protection products industry and management believes that they offer the Company a competitive advantage in lowering costs. The plant's high-speed robotic fabrication, assembly and packaging of earplugs facilitate cost-savings, high-volume production and improved cycle times and inventory management. The Southbridge, Massachusetts facility is the Company's largest manufacturing site and manufactures a wide variety of Personal Protection Equipment. These manufactured safety products include respiratory, plug and muff type hearing, head and face, and a broad offering of safety eyewear protection. All Company manufacturing sites have implemented a number of initiatives including lean manufacturing concepts and an extensive KAIZEN event schedule, resulting in significant improvements in the areas of safety, quality, cost, and customer service.
The Company's principal international manufacturing operations are located in Poynton, England and Varnamo, Sweden. The Poynton facility serves customers in Western Europe, producing and packaging earplugs and other hearing and eyewear products. The Varnamo, Sweden plant is the principal Peltor manufacturing location supplying finished goods and components to customers and other subsidiaries from this location.
The Company fills virtually all of its domestic and certain of its international orders through its distribution center located in Indianapolis, Indiana which has bar-code scanning capabilities to assure rapid turn-around time and service levels for customer orders. Recent freight studies, having taken into consideration Aearo Company manufacturing locations in conjunction with domestic customer locations, have shown Indianapolis to be the ideal single warehouse and distribution location for our safety business. Over the road carriers are readily available in Indianapolis, which contributes to competitive pricing for both our inbound and outbound business. European orders are filled from distribution facilities near Manchester, U.K. and in Varnamo, Sweden.
Manufacturing and Distribution Operations - Safety Prescription Eyewear Segment
The SRx production operations are comprised of two facilities located in the U.S., one in Canada and two in Europe. The U.S. locations are in Indiana and Oklahoma. In Canada, the Mississauga, Ontario plant fabricates prescription eyewear and, together with a small customer service operation in Montreal, produces SRx products for the Canadian market. In both Poynton, England and Joinville, France, the Company has small SRx laboratories that perform edging and assembly operations and serve primarily the U.K. and French market, respectively. The remaining facilities possess lens surfacing, edging, grinding and coating machinery capable of handling glass, plastic and polycarbonate lenses. The lenses are then fitted into frames and the finished product is shipped to customers. These facilities currently manufacture and distribute approximately 500,000 pairs of safety prescription glasses annually. Prescription eyewear fulfillment is predominantly by US Postal Service.
Manufacturing and Distribution Operations - Specialty Composites Segment
Specialty Composites' products are manufactured in Indianapolis, Indiana, and Newark, Delaware. The Indianapolis plant supplies specially formulated foam for the Company's earplugs, manufactures and fabricates sheet and roll PVC and polyurethane materials and molds polyurethanes. This facility also houses technical support functions, including research and development, applications engineering, sales and marketing administration, quality assurance and customer service support. The Newark, Delaware, facility manufactures polyurethane foams and houses the Company's proprietary, thin sheet foam casting line, which permits the casting of both sheet and composite materials, including facings and substrates, in a single pass through the line. Product development for this facility is onsite.
Competition and the Personal Protection Equipment Market
The PPE market is highly fragmented as a large number of relatively small, independent manufacturers with limited product lines serve the PPE market. The Company estimates that there are several hundred manufacturers of PPE (other than safety clothing, gloves and shoes) in the United States of America, Europe and Southeast Asia. Participants in the industry range in size from small, independent, single-product companies with annual sales of less than $15 million, to a small number of multinational corporations with annual sales in excess of $100 million. The Company believes that participants in the PPE market compete primarily on the basis of product characteristics (such as design, style and functional performance), product quality, service, brand name recognition and, to a lesser extent, price. From a positive competitive standpoint, the Company believes it is currently well situated, primarily because of its large size and its broad product offerings, to compete in this fragmented industry. The Company enjoys certain economies of scale that are not available to smaller competitors. The Company's advanced distribution center further facilitates timely and accurate deliveries. However, the industry has undergone some degree of consolidation that could potentially increase long-term competitive pressures on the Company.
Several manufacturers compete in noise and vibration control, but few if any competitors offer the complete range of technology and energy-control materials as Specialty Composites. Thus the Company is able to differentiate itself by bundling its technology, engineering and wide ranges of proprietary products into energy control solutions or systems that add value to customers' products and supply chain management. In markets where technology is of particular value, Specialty Composites is able to command better margins, but price is a significant factor in other highly competitive markets sectors in which the Company participates.
Employees
As of September 30, 2003, the Company had 1,603 employees, of whom 989 were primarily engaged in manufacturing, 429 in sales, marketing and distribution, 55 in research and development and 130 in general and administrative. The Company believes its employee relations are good. The Company has one domestic U.S. facility that employs union members. This facility, located in Plymouth, Indiana, employs 72 members of the International Union of Electronic, Electrical, Salaried, Maritime and Furniture Workers (out of a total of 79 employees), and the Company's relations with these union members are fully satisfactory. The union contract expires on June 26, 2004.
Patents and Trademarks
The Company owns and has obtained licenses to various domestic and foreign patents, patent applications and trademarks related to its products, processes and business. The Company places significant value on its trademark for the color yellow for earplugs in the United States and Canada and on its overall patent portfolio. However, no single patent or patent application is material to the Company. The Company's patents expire at various times in the future not exceeding 20 years.
Government Regulation
As a manufacturer of safety products, the Company is subject to regulation by numerous governmental bodies. Principal among the federal regulatory agencies in the United States of America are: the Occupational Safety and Health Administration ("OSHA"), which regulates the occupational usage of all PPE, the Environmental Protection Agency ("EPA"), which regulates labeling of hearing protection devices; the Mine Safety and Health Administration ("MSHA") and the National Institute of Occupational Safety and Health ("NIOSH"), both of which certify respirators. These agencies generally mandate that the Company's products meet standards established by private groups, such as American National Standards Institute ("ANSI"). The Company's products are also subject to foreign laws and regulations. In particular, they must comply with the Canadian Standards Association, European Committee for Normalization and Standards Australia. The Company believes it is in compliance in all material respects with the regulations and standards of these governmental bodies.
Environmental Matters
The Company is subject to various evolving federal, state and local environmental laws and regulations governing, among other things, emissions to air, discharge to waters and the generation, handling, storage, transportation, treatment and disposal of hazardous substances and wastes. The Company believes that it is in substantial compliance with all such laws and regulations. The Company has an active program to ensure environmental compliance and achievement of environmental goals and objectives. The Company will continue to implement Environmental Management Systems at its manufacturing facilities. In October 2003, the Company's Varnamo, Sweden facility achieved ISO 14001 certification.
Item 2.
Item 2. Properties
The Company owns and/or leases facilities in the United States of America, Canada, and Europe. The following table sets forth the location of each, its square footage and the principal function as of December 23, 2003.
Approx Location Square Ft Function
SAFETY PRODUCTS Southbridge, Massachusetts 198,984 Manufacturing/Administration Indianapolis, Indiana (1) 226,794 Distribution/Customer Service Indianapolis, Indiana 81,540 Manufacturing/Corporate Headquarters Poynton, England (2) 74,331 Manufacturing/Distribution/Customer Service Varnamo, Sweden 124,130 Manufacturing/Distribution/Customer Service Ettlingen, Germany 14,661 Manufacturing/Distribution/Customer Service Concord, North Carolina 17,500 Manufacturing/Distribution/Customer Service Paris, France 1,894 Sales Office Barcelona, Spain (*) Sales Office Milan, Italy (*) Sales Office Barrie, Ontario, Canada 4,768 Manufacturing/Distribution/Customer Service Oslo, Norway 6,300 Sales/Distribution/Customer Service Joinville-le-Pont, France 10,200 Sales/Distribution/Customer Service
SAFETY PRESCRIPTION EYEWEAR Chickasha, Oklahoma 35,000 Manufacturing/Customer Service Plymouth, Indiana 9,500 Manufacturing/Customer Service Mississauga, Ontario, Canada 12,300 Manufacturing/Customer Service Montreal, Quebec, Canada 1,800 Customer Service Brooklyn Park, Maryland 1,200 Customer Service Dundalk, Maryland 1,050 Customer Service Newport News, Virginia 1,400 Customer Service Richmond, Virginia 1,800 Customer Service
SPECIALTY COMPOSITES Indianapolis, Indiana 155,800 Manufacturing/Distribution/Customer Service Newark, Delaware 79,650 Manufacturing/Distribution Newark, Delaware 61,642 Warehouse/Distribution - --------------------- (1) This facility also serves as an international distribution center.
(2) This facility's primary function is manufacturing safety products.
(*) Less than 1,000 square feet.
The Company believes that its facilities are suitable for its operations and provide sufficient capacity to meet the Company's requirements for the foreseeable future. All of the Company's facilities are leased except for the following facilities owned by the Company: (i) the Safety Products manufacturing facility in Indianapolis, (ii) the Specialty Composites manufacturing/distribution facility in Indianapolis, (iii) the Specialty Composites manufacturing facility in Newark, (iv) the Peltor manufacturing/distribution facility in Varnamo, Sweden and (v) the Safety Products manufacturing facility in Ettlingen, Germany. The Company believes that it will be able to renew each of its leases upon their respective expiration dates on commercially reasonable terms. In addition, the Company believes that it would be able to lease suitable additional or replacement space on commercially reasonable terms.
Item 3.
Item 3. Legal Proceedings
Various lawsuits and claims arise against the Company in the ordinary course of its business. Most of these lawsuits and claims are products liability matters that arise out of the use of safety eyewear and respiratory product lines manufactured by the Company as well as products purchased for resale.
In addition, the Company is a defendant in lawsuits by plaintiffs alleging that they suffer from respiratory medical conditions, such as asbestosis or silicosis, relating to exposure to asbestos and silica, and that such conditions result, in part, from the use of respirators that, allegedly, were negligently designed or manufactured. The defendants in these lawsuits are often numerous, and include, in addition to manufacturers and distributors of respirators, manufacturers, distributors and installers of sand (used in sand blasting), asbestos and asbestos-containing products. Most of these claims are covered by the Asset Transfer Agreement entered into on June 13, 1995 by the Company and Aearo Company, on the one hand, and Cabot and certain of its subsidiaries (the "Sellers"), on the other hand (the "1995 Asset Transfer Agreement"). In the 1995 Asset Transfer Agreement, so long as the Company makes an annual payment of $400,000 to Cabot, the Sellers agreed to retain, and Cabot and the Sellers agreed to defend and indemnify the Company against, any liability or obligation relating to or otherwise arising under any proceeding or other claim against the Company 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, the Company has elected to pay the annual fee and intends to continue to do so. The Company could potentially be liable for claims currently retained by Sellers if the Company elects to cease paying the annual fee or if Cabot and the Sellers no longer are able to perform their obligations under the 1995 Asset Transfer Agreement. Cabot acknowledged in the Stock Purchase Agreement that it and the Company entered into on June 27, 2003 (providing for the sale by Cabot to the Company of all of the common and preferred stock of the Company owned by Cabot) that the foregoing provisions of the 1995 Asset Transfer Agreement remain in effect. The 1995 Asset Transfer Agreement does not apply to claims relating to the business of Eastern Safety Equipment, the stock of which the Company acquired in 1996.
At September 30, 2003, the Company has recorded liabilities of approximately $4.5 million, which represents reasonable estimates of its probable liabilities for product liabilities substantially related to asbestos and silica-related claims as determined by the Company in consultation with an independent consultant. This reserve is re-evaluated periodically and additional charges or credits to operations may result as additional information becomes available. Consistent with the current environment being experienced by companies involved in asbestos and silica-related litigation, there has been an increase in the number of asserted claims that could potentially involve the Company. Various factors increase the difficulty in determining the Company's potential liability, if any, in such claims, including the fact that the defendants in these lawsuits are often numerous and the claims generally do not specify the amount of damages sought. Additionally, the bankruptcy filings of other companies with asbestos and silica-related litigation could increase the Company's cost over time. In light of these and other uncertainties inherent in making long-term projections, the Company has determined that the five-year period through fiscal 2008 is the most reasonable time period for projecting asbestos and silica-related claims and defense costs. It is possible that the Company may incur liabilities in an amount in excess of amounts currently reserved. However, taking into account currently available information, historical experience, and the 1995 Asset Transfer Agreement, but recognizing the inherent uncertainties in the projection of any future events, it is management's opinion that these suits or claims should not result in final judgments or settlements in excess of the Company's reserve that, in the aggregate, would have a material effect on the Company's financial condition, liquidity or results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
On October 7, 2003, the Company held a special meeting of stockholders. The stockholders approved the selection of Deloitte & Touche LLP as the Company's independent public accountants for the year ending September 30, 2004 with a total of 56,971.5 votes in favor, 50 votes in opposition and 2,391 abstention votes. The stockholders voted to elect the following directors for the ensuing year with a total of 57,021.5 votes in favor of each director and 2,391 abstention votes for each director: Norman W. Alpert, Bryan P. Marsal, John D. Curtin, Jr., William E. Kassling, Michael A. McLain, Arthur J. Nagle, Daniel S. O'Connell.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
As of December 1, 2003 there were outstanding 59,412.5 shares of common stock, par value $0.01 per share, of Aearo ("Aearo Common Stock"). All of the Aearo Common Stock is held, collectively, by Vestar Equity Partners, L.P. (together with certain related persons, "Vestar") and management. As of December 1, 2003 there were 34 shareholders of record of Aearo Common Stock. In July 1995, Vestar, Cabot and management effected through the Company the acquisition of substantially all of the assets and certain liabilities of Cabot CSC Corporation ("Old Cabot Safety Corporation"), a wholly-owned subsidiary of Cabot, and certain of its affiliates (the "Formation Acquisition") for $206.1 million. To effectuate the Formation Acquisition, the Company sold $100 million of 12 1/2% senior subordinated notes due 2005 (the "Senior Subordinated Notes"), issued pursuant to the Indenture dated July 11, 1995 among Aearo Company, the Company and U.S. Bank, N.A. (the "Note Indenture"), issued to Vestar and Cabot an aggregate of $45 million of 12 1/2% redeemable preferred stock (the "Aearo Preferred Stock"), and issued to Vestar, Cabot and certain members of management and key employees of the Company an aggregate of 100,000 shares of Aearo Common Stock. In August 2003, the Company redeemed the Aearo Common Stock and Aearo Preferred Stock held by Cabot ("Cabot Stock Redemption") for a total cost of $38.5 million, including $4.0 million for fees. The Company financed this transaction with $8.0 million in cash, $15.5 million from its revolver facility for up to $30.0 million for general purposes ("Revolving Credit Facility") and $15.0 million of new senior subordinated notes due July 15, 2005 ("Holding Company Notes") issued pursuant to the Note Purchase Agreement dated August 18, 2003 ("Note Purchase Agreement"). See Item 12, "Security Ownership of Certain Beneficial Owners and Management." All of the common stock of the Subsidiary is owned by Aearo, and thus no trading market exists for such stock. Accordingly, no trading market exists for any capital stock of the Company.
The Company has never paid cash dividends on the Aearo Common Stock. Payment of dividends on the Aearo Common Stock is limited by the terms of the Company's Credit Agreement, Senior Subordinated Notes and Holding Company Notes and is subordinated to payment of dividends on the Aearo Preferred Stock. See Note 7 to the Consolidated Financial Statements.
Item 6.
Item 6. Selected Financial Data
The selected historical financial data as of and for the periods ended September 30, 1999, 2000, 2001, 2002, and 2003 are derived from the consolidated financial statements of Aearo Corporation and subsidiaries. The data should be read in conjunction with the consolidated financial statements and related notes, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other financial information included herein.
Notes to Selected Financial Data:
1. Ratio of earnings to fixed charges is defined as pretax income from continuing operations plus fixed charges divided by fixed charges. Fixed charges include interest expense (including amortization of debt issuance costs). Earnings for the period ended September 30, 2001 were inadequate to cover fixed charges by $3.8 million.
2. On September 30, 2001, the Company recorded a restructuring charge of $11.4 million related to a restructuring plan announced by the Company to improve its competitive position and long-term profitability. The plan includes the closure of its Ettlingen, Germany plant, significantly reorganizing operations at the Company's Varnamo, Sweden plant, rationalizing the manufacturing assets and product mix of its Specialty Composites business unit and a reduction of products and product lines (See Note 16 of Notes to Consolidated Financial Statements).
3. During fiscal 2002, the Company reversed $0.6 million of reserves related to the September 30, 2001 restructuring provision. The adjustment represents a change in estimate of the plan for the disposal of certain items of inventory and the closure of its Ettlingen, Germany plant. The inventory provision of $0.5 million was classified as cost of sales with the remaining $0.1 million classified as operating expenses.
4. During fiscal 2003, the Company reversed $0.3 million of reserves related to the September 30, 2001 restructuring provision. The adjustment represents a change in estimate of the plan for the disposal of certain items of inventory. The inventory provision of $0.3 million was classified as cost of sales.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with "Selected Financial Data," and the consolidated financial statements of the Company, including notes thereto, appearing elsewhere in this Report. This Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company's actual results could differ materially from those set forth in such forward-looking statements. The factors that might cause such a difference include, among others, the following: risks associated with indebtedness; risks related to acquisitions; risks associated with the conversion to a new management information system; high level of competition in the Company's markets; importance and costs of product innovation; risks associated with international operations; product liability exposure; unpredictability of patent protection and other intellectual property issues; dependence on key personnel; the risk of adverse effect of economic and regulatory conditions on sales; and risks associated with environmental matters.
General
The following discussion provides a summary of major developments affecting the Company over the past few years.
The Company benefited from new product launches including the Lexa(R) product line first introduced in 1998, which continued with very positive growth during 1999. In addition, new hearing products introduced during 1999 included E-A-Rsoft(TM), Yellow Neons(R), SuperFit(R), and several new Peltor(R) communication products. New eyewear products introduced during 1999 included Nassau Rave(R) and new safety prescription eyewear frames.
During fiscal year 2000, the sales increased 4.9%, despite a stronger US dollar, which had the affect of depressing reported sales by approximately $6.6 million. On a currency adjusted basis sales were 7.7% higher than the previous year. Although sales were higher in all three of the Company's segments, the Specialty Composites trucking market began to soften during the fourth quarter. The continued productivity improvements in purchasing and manufacturing, especially in the manufacture of non-prescription eyewear product lines, drove a strong improvement in gross profit performance, resulting in a 0.8% improvement in the gross profit percentage of sales. The gross profit would have been approximately an additional 0.6% higher had it not been for the weakness of the Euro, which depressed revenue while having a more limited impact on manufacturing costs.
During fiscal year 2001, continued softening of the Specialty Composites' trucking market that began in the fourth quarter of the previous year was followed by overall softness in the North American economy. Order softness began with the consumer marketplace and then the industrial marketplace as consumer confidence and manufacturing employment in North America declined during the year. In addition, the US dollar continued to strengthen against most global currencies, which had the affect of depressing reported sales by approximately $7.8 million. Continued productivity improvements in purchasing and manufacturing enabled the Company to offset much of the negative currency impact as well as the impact on manufacturing overhead absorption due to reduced volume. Selling and administrative expenses decreased $8.3 million primarily due to the Company's proactive measures to reduce expenses in line with the slowdown in the economy. In May 2001 the Company completed an upgrade of its SAP management information system to version 3.1i and it intends to continue to apply information system version upgrades, as it deems appropriate. In July 2001, the Company successfully completed the refinancing of its indebtedness under its prior $165.0 million credit agreement with a new $135.0 million credit agreement and ended the year with undrawn revolver commitments of approximately $30.0 million, an available U.K. overdraft facility of $5.0 million and cash of $18.2 million. On September 30, 2001 the Company recorded a restructuring charge of $11.4 million related to a restructuring plan announced by the Company to improve its competitive position and long-term profitability.
The terrorist events of September 11, 2001, coupled with the previously weak economy, made for a challenging start for fiscal year 2002. Sales for the first quarter were off 9.8% versus the prior year due to the resulting significant slowdown in the manufacturing sectors of the economy in which the Company markets its products. The following three quarters showed comparable improvements with sales down only 4.5% in the second quarter and then up 6.0% and 12.7% in quarters three and four.
Despite the difficult economy in fiscal 2002, the Company was able to improve performance through continued reliance on its strategy of ongoing productivity improvements, global new product development and value-creating acquisitions. Productivity improvements in purchasing and manufacturing as well as the benefits of the restructuring program implemented toward the end of fiscal 2001 allowed the Company to improve gross profits to 47.6% of net sales (up 230 basis
points). The initiatives on global new product development resulted in the Company launching 36 new or improved product lines including the Quick-Latch(R) respiratory line, the X-Factor(TM) eyewear line for the Consumer channel, and PU shaped earplugs under the EARsoft(R) name. In addition, the Company also released new and improved Peltor passive muffs as well as the new and improved Comtac(TM) and PowerCom Plus(TM) communication muffs. In addition, the difficult economy did provide acquisition opportunities and the Company was able to complete four value creating acquisitions during the fiscal year. These acquisitions are in the Company's core product offerings and enhance the Company's global eyewear positions. In prescription eyewear the Company added to SRx's number one global market share position under its single AOSafety(R) brand name, and in non-prescription eyewear the Company acquired an eyewear line that was restaged under the X-Series(TM) line which is being expanded through the International, Consumer, European and North American channels. The overall result was that the Company ended its fiscal year with operating income of $31.2 million, as compared to $19.9 million in the previous fiscal year, with undrawn revolver commitments of approximately $30.0 million, an available U.K. overdraft facility of $5.0 million and cash of $14.5 million.
In fiscal 2003, the Company continued with the momentum gained during the previous fiscal year and increased its sales by $29.6 million, or 10.3%. The impact of a strong new product development program allowed the Company's Safety Segment to register its fifth straight quarter of organic growth ending the year with organic growth of 5.9%. The Company's SRx and Specialty Composite segments were negatively impacted by the weak economy in North America resulting in total Company organic growth of 1.7%.
During the year the Company introduced new eyewear products including Maxim(TM), Metaliks(TM) and X.Sport(TM). In the hearing product line, the Company launched EAR PushIns(TM), and HearPlug products. A major launch in respiratory was the launch of Quick-Latch with Voice Transmission. Acquisitions accounted for $10.9 million of incremental sales led by the acquisition of the SafeWaze branded fall protection product line. SafeWaze sells into the US non-residential construction market and allows the Company access to that channel for its existing personal protection equipment. In addition, the acquired fall protection product line is being introduced to the North American industrial market via the Company's strong presence in that channel. A weaker US dollar added $13.7 million to net sales and gross profit as a percentage of net sales increased 0.6% to 48.2% primarily as a result of productivity improvements in purchasing and manufacturing. Operating income improved $11.5 million, or 36.8% to $42.7 million.
In August 2003, the Company effected the Cabot Stock Redemption for a total cost $38.5 million, including $4.0 million for fees. The Company financed this transaction with $8.0 million in cash, $15.5 million from its Revolving Credit Facility and $15.0 million of Holding Company Notes. The Company ended the year with cash of $7.3 million and a revolver balance of $11.7 million.
Critical Accounting Policies
The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). GAAP requires the use of estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. The Company believes its use of estimates and underlying accounting assumptions adhere to GAAP and are consistently applied except for the change in the method of accounting for goodwill and intangibles. The Company revises its estimates and assumptions as new information becomes available.
The Company believes that of its significant accounting policies (see the accompanying Notes to the Consolidated Financial Statements) the following policies involve a higher degree of judgment and/or complexity.
Income Taxes - The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes", which requires deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between book and tax bases of recorded assets and liabilities. SFAS No. 109 also requires deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. Recognition of a deferred tax asset is dependent on generating sufficient future taxable income in the United States prior to the expiration of the tax loss and credit carryforwards, which expire over various periods ranging from 2010 to 2021. In its evaluation of the adequacy of the valuation allowance, the Company assesses prudent and feasible tax planning strategies. Due to the uncertainties of realizing these tax benefits, the Company has recorded a full valuation allowance against these losses and credit carryforwards. The ultimate amount of deferred tax assets realized could be different from those recorded, as influenced by potential changes in enacted tax laws and the availability of future taxable income.
Product Liabilities -The Company has established reserves for potential product liabilities that arise out of the use of the Company's products. A significant amount of judgment is required to quantify the Company's ultimate exposure in these matters and the valuation of reserves is estimated based on currently available information, historical experience and, from time to time, the Company may seek the assistance of an independent consultant. While the Company believes that the current level of reserves is adequate, changes in the future could impact these determinations.
Restructuring - The Company recorded an unusual charge in fiscal 2001 based on a restructuring plan to improve its competitive position and long-term profitability. The provision recorded was based on estimates of the expected costs associated with site closures, consolidation of products and product lines, disposal of assets, contract terminations or other costs directly related to the restructuring. To the extent that actual costs may differ from amounts recorded, revisions to the estimated reserves would be required. The restructuring provision included a reduction of $0.6 million and $0.3 million in fiscal years 2002 and 2003, respectively, to account for new information made available during the year.
Impairment of Long-Lived Assets - The Company evaluates long-lived assets, including other intangibles and related goodwill, of identifiable reporting units for impairment when events or changes in circumstances indicate, in management's judgment, that the carrying value of such assets may not be recoverable. Cash flows used in the potential impairment evaluation are based on management's estimates and assumptions. Changes in business conditions could potentially require future adjustments to asset valuations.
Revenue Recognition - The Company recognizes revenue when title and risk transfer to the customer, which is generally when the product is shipped to customers (FOB shipping point). At the time revenue is recognized, certain provisions may also be recorded, including pricing discounts, rebates and incentives. In addition, 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 customers credit worthiness, historical bad debt experience, changes in payment history and general economic and market trends.
Results of Operations
The following table sets forth the major components of the Company's consolidated statements of operations expressed as a percentage of net sales.
Years Ended September 30, --------------------------------------------- 2001 2002 2003 ------------- ------------ ------------ Net sales: Safety Products 72.7 % 72.7 % 76.6 % Safety Prescription Eyewear 13.8 14.2 12.6 Specialty Composites 13.5 13.1 10.8 ------------- ------------ ------------ Total net sales 100.0 100.0 100.0 Cost of sales 54.7 52.4 51.8 ------------- ------------ ------------ Gross profit 45.3 47.6 48.2 Selling and administrative 30.8 32.0 32.0 Research and technical services 1.8 2.0 2.1 Amortization expense 2.3 2.2 0.0 Other charges (income), net 0.0 0.5 0.6 Restructuring charge 3.2 0.0 0.0 ------------- ------------ ------------ Operating income 7.2 % 10.9 % 13.5 % ============= ============ ============
Fiscal 2003 Compared to Fiscal 2002
Net Sales. Net sales in the year ended September 30, 2003 increased 10.3% to $316.4 million from $286.9 million in the year ended September 30, 2002. The increase in sales was primarily driven by organic growth in the Safety Products segment, the impact of foreign currency translation, and acquisitions, partially offset by declines in the Safety Prescription Eyewear and Specialty Composites segments. The weakness of the U.S. dollar relative to other currencies and acquisitions favorably impacted net sales by $13.7 million and $10.9 million, respectively. The Safety Products segment net sales in the year ended September 30, 2003 increased 16.2% to $242.3 million from $208.5 million in the year ended September 30, 2002. The increase in net sales resulted from a 5.9% increase due to organic growth, a 6.5% increase due to foreign currency translation and a 3.8% increase due to acquisitions. The Safety Prescription Eyewear segment net sales in the year ended September 30, 2003 decreased 2.0% to $40.0 million from $40.8 million in the year ended September 30, 2002. The decrease in net sales resulted from a 9.9% reduction in volume, partially offset by a 7.3% increase due to acquisitions, with the remainder due to the impact of foreign currency translation. The Specialty Composites segment net sales in the year ended September 30, 2003 decreased 9.0% to $34.1 million from $37.5 million in the year ended September 30, 2002. The decrease was primarily driven by volume declines in the automotive and truck markets.
Gross Profit. Gross profit in the year ended September 30, 2003 increased 11.7% to $152.4 million from $136.5 million in the year ended September 30, 2002. The increase in gross profit is primarily due to productivity improvements, acquisitions, volume and the impact of foreign currency translation,. Gross profit as a percentage of net sales in the year ended September 30, 2003 improved by 0.6% to 48.2% as compared to 47.6% in the year ended September 30, 2002. The increase in gross margin percentage was primarily due to product mix, productivity improvements, volume and the impact of foreign currency translation.
Operating Expenses. Operating expenses in the year ended September 30, 2003 increased 4.1% to $109.7 million from $105.3 million in the year ended September 30, 2002. The increase in operating expenses was primarily driven by an increase in selling and administrative expenses and research and technical services expense, partially offset by a decrease in amortization expense. The 10.2% increase in selling and administrative expenses resulted from a 3.3% increase due to foreign currency translation, a 3.5% increase due to acquisitions, a 2.6% increase due to compensation expense, which includes the costs of increased benefits and variable incentives, and the remaining 0.6% due to product launches and marketing support. Research and technical services expense increased $0.7 million due to product development initiatives. Amortization expense decreased $6.0 million due to the adoption of SFAS No. 142 which requires the Company to discontinue amortizing goodwill and other intangible assets with indefinite useful lives. Amortization expense would have been reduced by approximately $6.0 million had the provisions of SFAS No. 142 been adopted in the year ended September 30, 2002. Selling and administrative expenses as a percentage of net sales were unchanged at 32.0% in the years ended September 30, 2003 and 2002, respectively.
Operating Income. Primarily as a result of the factors discussed above, operating income increased $11.6 million or 37.2% in the year ended September 30, 2003 from $31.1 million in the year ended September 30, 2002. Operating income as a percentage of net sales in the year ended September 30, 2003 was 13.5% as compared to 10.9% in the year ended September 30, 2002.
Interest Expense, Net. Interest expense, net in the year ended September 30, 2003 decreased 2.5% to $19.6 million from $20.1 million in the year ended September 30, 2002. The decrease is attributed to lower interest rates during the year ended September 30, 2003 as compared to the year ended September 30, 2002.
Income (Loss) Before Provision for (Benefit From) Income Taxes. Income before provision for income taxes increased $12.1 million to $23.2 million in the year ended September 30, 2003 compared to $11.1 million in the year ended September 2002.
Provision for (Benefit From) Income Taxes. The provision for income taxes in the year ended September 30, 2003 was $2.6 million compared to $1.8 million in the year ended September 30, 2002. The Company's effective tax rate was different from the statutory rate due to the mix of income between the Company's foreign and domestic subsidiaries. The Company's foreign subsidiaries had taxable income in their foreign jurisdictions while the Company's domestic subsidiaries have net operating loss carry-forwards for income tax purposes. Due to the uncertainty of realizing these tax benefits, the tax benefits generated by the net operating loss carry-forwards have been fully offset by a valuation allowance.
Net Income. For the year ended September 30, 2003, the Company recorded net income of $20.6 million as compared to $9.3 million for the year ended September 30, 2002.
Fiscal 2002 Compared to Fiscal 2001
Net Sales. Net sales in the year ended September 30, 2002 increased 1.1% to $286.9 million from $283.9 million in the year ended September 30, 2001. The increase in sales was primarily driven by new product launches and acquisitions. The Safety Products segment net sales in the year ended September 30, 2002 increased 1.1% to $208.5 million from $206.3 million in the year ended September 30, 2001. The Safety Products segment included approximately $5.0 million of sales from the acquisition of Leader Industries in January 2002. The Safety Prescription Eyewear segment net sales in the year ended September 30, 2002 increased 4.3% to $40.8 million from $39.1 million in the year ended September 30, 2001. The Safety Prescription Eyewear segment included approximately $2.7 million of sales from the acquisition of Iron Age Vision in December 2001 and Chesapeake Optical in May 2002. The Specialty Composites segment net sales in the year ended September 30, 2002 decreased 2.3% to $37.6 million from $38.5 million in the year ended September 30, 2001. The decrease was primarily driven by volume declines in the industrial equipment market segment.
Gross Profit. Gross profit in the year ended September 30, 2002 increased 6.1% to $136.5 million from $128.7 million in the year ended September 30, 2001. Gross profit as a percentage of net sales in the year ended September 30, 2002 improved by 2.3% to 47.6% as compared to 45.3% in the year ended September 30, 2001. The increase in gross margin was primarily due to productivity improvements and the impact of the restructuring plan that was charged during the year ended September 30, 2001.
Selling and Administrative Expenses. Selling and administrative expenses in the year ended September 30, 2002 increased 5.3% to $91.9 million from $87.3 million in the year ended September 30, 2001. The increase is primarily due to the impact of the acquisitions in addition to increased spending in sales and marketing to support new product launches and build brand recognition. Selling and administrative expenses as a percentage of net sales in the year ended September 30, 2002 were 32.0%, compared to 30.8% in the year ended September 30, 2001.
Research and Technical Services. Research and technical services expense in the year ended September 30, 2002 increased 9.6% to $5.7 million from $5.2 million in the year ended September 30, 2001. The increase is primarily due to increased spending for new product development. Research and technical services expenses as a percentage of net sales in the year ended September 30, 2002 were 2.0% compared to 1.8% in the year ended September 30, 2001.
Other Charges (Income), Net. Other charges (income), net was expense of $1.5 million for the year ended September 30, 2002 as compared to expense of $0.7 million for the year ended September 30, 2001. The $1.5 million expense for the year ended September 30, 2002 was primarily attributed to foreign currency transaction and hedge losses of approximately $0.8 million and $0.5 million of asset write-offs. The $0.7 million expense for the year ended September 30, 2001 was primarily attributed to foreign currency transaction and hedge losses of approximately $0.8 million. The foreign currency transaction and hedge losses were largely due to a weakening U.S. dollar, mainly in the second half of the fiscal year, as compared to European currencies. This currency shift, although unfavorable to other charges (income), net, was favorable to overall operating income.
Restructuring Charge. On September 30, 2001 the Company recorded a restructuring charge of $11.4 million related to a restructuring plan announced by the Company to improve its competitive position and long-term profitability. The plan included the closure of its Ettlingen, Germany plant, significantly reorganizing operations at the Company's Varnamo, Sweden plant, rationalizing the manufacturing assets and product mix of its Specialty Composites business unit and a reduction of products and product lines. On September 30, 2002, the Company revised its estimate relating to the disposal of certain items of inventory and to the closure of its Ettlingen, Germany operation and adjusted the restructuring provision by $0.6 million, of which $0.5 million was classified as cost of sales relating to inventory. As of September 30, 2002, there is approximately $4.2 million accrued relating to the restructuring.
Operating Income. Primarily as a result of the factors discussed above, operating income increased $11.3 million or 56.8% in the year ended September 30, 2002 from $19.9 million in the year ended September 30, 2001. Operating income as a percentage of net sales in the year ended September 30, 2002 was 10.9% as compared to 7.0% in the year ended September 30, 2001.
Interest Expense, Net. Interest expense, net in the year ended September 30, 2002 decreased 15.3% to $20.1 million from $23.7 million in the year ended September 30, 2001. The decrease is attributed to lower weighted average borrowings and lower interest rates during the year ended September 30, 2002 as compared to the year ended September 30, 2001.
Income (Loss) Before Provision for (Benefit From) Income Taxes. Income before provision for income taxes increased $14.9 million to $11.1 million in the year ended September 30, 2002 compared to a loss of $3.8 million in the year ended September 2001. Income before provision for income taxes excluding restructuring charges increased $2.8 million to $10.5 million in the year ended September 30, 2002 compared to $7.6 million in the year ended September 30, 2001.
Provision for (Benefit From) Income Taxes. The provision for income taxes in the year ended September 30, 2002 was $1.8 million compared to a benefit of $1.9 million in the year ended September 30, 2001. The Company's effective tax rate was lower than the statutory rate due to a decrease in the valuation allowance. The valuation allowance at September 30, 2002 and 2001 relates to the uncertainty of realizing the tax benefits of reversing temporary differences and net operating loss carryforwards.
Net Income (Loss). For the year ended September 30, 2002, the Company recorded net income of $9.3 million as compared to a net loss of $1.9 million for the year ended September 30, 2001.
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 currencies. While many of the Company's selling and distribution costs are also denominated in these currencies, a large portion of product costs is U.S. dollar denominated. As a result, a decline in the value of the U.S. Dollar relative to other currencies can have a favorable impact on the profitability of the Company and an increase in the value of the U.S. Dollar relative to these other currencies can have a negative effect on the profitability of the Company. As a result of the acquisition of Peltor(R), the Company's operations are also affected by changes in exchange rates relative to the Swedish Krona. A decline in the value of the Krona relative to other currencies can have a favorable impact on the profitability of the Company and an increase in the value of the Krona relative to other currencies can have a negative impact on the profitability of the Company. The Company utilizes forward foreign currency contracts 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 Company's revenues or results of operations.
Liquidity and Capital Resources
The Company's sources of funds have consisted primarily of operating cash flow and debt financing. The Company's uses of those funds consist principally of debt service, capital expenditures and acquisitions.
On August 18, 2003, the Company authorized the issuance and sale of $15.0 million aggregate principal of Holding Company Notes due July 15, 2005. The proceeds of the Holding Company Notes were used along with $15.5 million from the Revolver Credit Facility and $8.0 million cash to effect the Cabot Stock Redemption.
The Company's debt structure includes: (a) $98.0 million of Senior Subordinated Notes (Notes) due 2005, which are publicly held and are redeemable at the option of the Company, in whole or in part, at various redemption prices, (b) $15.0 million of Holding Company Notes due 2005, and (c) up to an aggregate of $135.0 million under a credit agreement with various banks comprised of (i) a secured term loan facility consisting of loans providing for up to $100.0 million of term loans (collectively the "Term Loans") with a portion of the Term Loans denominated in foreign currencies, (ii) the Revolving Credit Facility providing for up to $30.0 million of revolving loans for general corporate purposes, and (iii) a U.K. overdraft facility of up to an equivalent of $5.0 million in Great Britain Pounds for working capital requirements as needed (collectively the "Senior Bank Facilities"). The amount outstanding on the Term Loans and Revolving Credit Facility at September 30, 2003, were approximately $85.1 and $11.7 million, respectively. No amounts were outstanding under the U.K. overdraft facility. At September 30, 2003, the Company's available lines of credit totaled approximately $22.3 million.
Under the terms of the Senior Bank Facilities, the Note Indenture and the Note Purchase Agreement for the Holding Company Notes, Aearo Company is required to comply with certain financial covenants and restrictions. Aearo Company was in compliance with all financial covenants and restrictions at September 30, 2003.
During the first quarter of fiscal 2002, the Company's Board of Directors authorized management to repurchase, from time to time, a portion of the Company's 12.5% Notes, subject to market conditions and other factors. No assurances can be given as to whether or when or at what price such repurchases will occur. Subsequently, pursuant to a first amendment to the Senior Bank Facilities, the Company purchased and retired $2.0 million of the Notes during the first quarter of fiscal 2002.
Maturities under the Company's Term Loans are: $17.4 million in fiscal 2004 and $67.7 million in fiscal 2005. Other than upon a change of control or as a result of certain asset sales, or in the event that certain excess funds exist at the end of a fiscal year, the Company will not be required to make additional principal payments in respect of the Term Loans until maturity in 2005. The Company is required to make interest payments with respect to the Senior Bank Facilities, the Notes and the Holding Company Notes. The Company's Revolving Credit Facility and Term Loans mature in March 2005.
The Company's net cash provided by operating activities for the year ended September 30, 2003 totaled $36.7 million as compared to $26.6 million for the year ended September 30, 2002. The increase of $10.1 million was primarily due to a $4.7 million increase in net income adjusted for cash and non cash charges (depreciation, amortization, deferred taxes and other) and a $5.4 million net change in assets and liabilities. The Company's net changes in assets and liabilities was primarily driven by an increase in cash from receivables, taxes, and accrued liabilities, partially offset by a reduction of cash for inventories and other, net.
The Company typically makes capital expenditures related primarily to the maintenance and improvement of manufacturing facilities. The Company spent $9.9 million for capital expenditures, plus an additional $0.4 million under capital leases, for the year ended September 30, 2003 as compared to $8.2 million for capital expenditures for the year ended September 30, 2002 and $7.8 million for the year ended September 30, 2001. The Company's capital spending cycle is of a relatively short duration with a typical project completion time of less than one year. The Company plans to spend up to $11.0 million for capital expenditures in fiscal year 2004.
Net cash used by investing activities was $22.5 million for the year ended September 30, 2003 as compared to $17.7 million for the year ended September 30, 2002. The increase of $4.7 million in net cash used by investing activities is primarily attributed to the acquisitions of VH Industries, Inc. and Industrial Protection Products, Inc.
Net cash used by financing activities for the year ended September 30, 2003 was $25.0 million compared with $10.7 million for the year ended September 30, 2002. The change of $13.9 million is primarily due to the Cabot Stock Redemption of $38.5 million, which includes debt issuance costs of $4.0 million. In addition, there was an increased use of cash of $4.6 million for the repayment of Term Loans, partially offset by a lower repayment of Senior Subordinated Notes compared to the prior year, additional borrowing under the Revolving Credit Facility for $11.7 million and the issuance of the Holding Company Notes of $15.0 million.
The Company maintains a non-contributory defined benefit cash balance pension plan. The Company utilizes an outside actuarial firm to estimate pension expense and funding based on various assumptions including the discount rate and the expected long-term rate of return on plan assets. In developing the expected long-term rate of return assumption, the Company's management evaluates input from outside investment advisors and actuaries as of the measurement date. Actual assets returns for the Company's pension plan improved in fiscal 2003 after two years of negative returns. Although recent trends have been positive, the Company lowered the long-term rate of return on plan assets from 8.5% to 8.0% for the year ended September 30, 2003. The Company's management believes that this rate is reasonable based on historical trends over a 20-30 year period. The estimated effect of a 1% change in the expected long-term rate of return on plan assets results in a $0.1 million impact on pension expense. The discount rate has also been lowered from 6.75% to 6.00% for the fiscal year ended September 30, 2003. The Company bases the discount rate on the AA Corporate bond yields. The estimated impact of a 1% change in the discount rate results in a $0.2 million impact on 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 2003. However, contributions may increase in future years. Due to the uncertainty of the future returns of the equity and corporate bond markets, it is difficult to estimate the impact of pension contributions in the future.
The Company has a substantial amount of indebtedness. The Company relies on internally generated funds, and to the extent necessary, on borrowings under the Revolving Credit Facility (subject to certain customary drawing conditions) to meet its liquidity needs. The Company anticipates that operating cash flow will be adequate to meet its operating and capital expenditure requirements for the next several years, although there can be no assurances that existing levels of sales and normalized profitability, and therefore cash flow, will be maintained. In particular, during fiscal 2001 and 2002, the Company was affected by the significant slowdown in the manufacturing sector of the economies in which the Company markets its products that began in earnest during the first fiscal quarter of fiscal 2001, exacerbated by the impact of the terrorist events of September 11, 2001. The Company expects to arrange for new financing of both the Senior Bank Facilities and the Notes before the maturity of the Senior Bank Facilities in March 2005. There can be no assurances that any additional financing or other sources of capital will be available to the Company at acceptable terms, or at all. The inability to obtain additional financing would have a material adverse effect on the Company's business, financial condition and results of operations.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements or financing arrangements involving variable interest entities.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
The Company is exposed to market risks related to changes in foreign currencies, interest rates and commodity pricing. The Company uses derivatives to mitigate the impact of changes in foreign currencies and interest rates. All derivatives are for purposes other than trading. The Company adopted the provisions of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" on October 1, 2000. 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. As a result of the acquisition of Peltor, the Company's operations are also affected by changes in exchange rates relative to the Swedish Krona. A decline in the value of the Krona relative to other currencies can have a favorable impact on the profitability of the Company and an increase in the value of the Krona relative to other currencies can have a negative impact on the profitability of the Company.
To mitigate the effects of changes in foreign currency rates on profitability the Company executes two hedging programs, one for transaction exposures, and the other for cash flow exposures in foreign operations. The Company utilizes forward foreign currency contracts for transaction as well as cash flow exposures. For the year ended September 30, 2003, 2002 and 2001, transaction exposures were a gain of $0.3 million and losses of $0.2 million and $0.4 million, respectively. For the year ended September 30, 2003, 2002 and 2001, cash flow exposures were losses of $2.0 million, $0.6 million and $0.2 million, respectively. In addition, the Company limits the foreign exchange impact on the balance sheet with foreign denominated debt in Great Britain Pound Sterling, Euros, Swedish Krona and Canadian dollars.
SFAS No. 133 requires that every derivative instrument be recorded in the balance sheet as either an asset or liability measured at its fair value. As a result of foreign currency contracts the Company has recorded a derivative payable of $0.4 million as of September 30, 2003. The forward foreign currency contracts will expire over the next twelve months.
Interest Rates
The Company is exposed to market risk changes in interest rates through its debt. The Company utilizes interest rate instruments to reduce the impact of either increases or decreases in interest rates on its floating rate debt.
As a result of the current economic slowdown and corresponding interest rate reductions, the Company entered into an interest rate collar arrangement in October 2001 to protect $25.0 million of the outstanding variable rate term loan debt from future interest rate volatility through September 30, 2003. The collar floor was set at 2% LIBOR (London Interbank Offering Rate) and cap at 6.25% LIBOR. The collar was not designated as a hedge under SFAS No. 133 and accordingly, the fair value gains or losses were charged to earnings. Approximately $0.2 million was expensed during the fiscal year ended September 30, 2003. No amounts were recorded to income or expense related to the interest collar for the years ended September 30, 2001 and 2002, respectively.
As part of the August 2003 financing incurred to redeem the common and preferred Aearo stock owned by Cabot, the Company entered into an interest rate cap arrangement to protect its $30.5 million of variable debt from LIBOR rates above 1.13% through December 31, 2004. The cap was not designed as a hedge under SFAS No. 133 and accordingly, the fair value of gains or losses will be charged to earnings. Approximately $0.1 million was recorded as income as of September 30, 2003.
The Company is of the opinion that it is well positioned to manage interest exposures in the short term. The Company continues to monitor interest rate movements and has mitigated the risks of potential interest rate fluctuations through the use of the aforementioned interest rate instruments.
Commodity Risk
The Company is subject to market risks with respect to industry pricing in paper and crude oil as it relates to various commodity items. The Company is also exposed to market risks for electricity, fuel oil and natural gas consumed in its operations. Items with potential risk of price volatility are paperboard, packaging films, nylons, resins, propylene, ethylene, plasticizer and freight. The Company manages pricing exposures on larger volume commodities such as polycarbonate, polyols and polyvinyl chloride via price negotiations utilizing alternative supplier competitive pricing. The Company sources some products and parts from Far East sources where resource availability, competition, and infrastructure stability has provided a favorable purchasing environment. The Company does not enter into derivative instruments to manage commodity risks.
Item 8.
Item 8. Financial Statements and Supplementary Data
INDEPENDENT AUDITORS' REPORT.................................................27 CONSOLIDATED BALANCE SHEETS..................................................28 CONSOLIDATED STATEMENTS OF OPERATIONS........................................29 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY..............................30 CONSOLIDATED STATEMENTS OF CASH FLOWS........................................31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS...................................32
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of Aearo Corporation:
We have audited the accompanying consolidated balance sheets of Aearo Corporation and subsidiaries as of September 30, 2003 and 2002, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended September 30, 2003. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of the Corporation's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Aearo Corporation and subsidiaries as of September 30, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2003, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, in 2003, the Corporation changed its method of accounting for goodwill and other intangible assets.
DELOITTE & TOUCHE LLP Indianapolis, Indiana December 12, 2003
AEARO CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in Thousands, Except Share Amounts)
September 30, September 30, 2002 2003 ------------- --------------
ASSETS Current Assets: Cash and cash equivalents $ 14,480 $ 7,301 Accounts receivable (net of reserve for doubtful accounts of $1,524 and $1,358, respectively) 46,478 49,146 Inventories 33,161 37,269 Deferred and prepaid expenses 3,449 7,321 ------------- -------------- Total current assets 97,568 101,037 ------------- --------------
Long Term Assets: Property, plant and equipment, net 48,096 48,869 Goodwill, net 67,821 81,770 Other intangible assets, net 54,158 57,887 Other assets 2,526 3,953 ------------- ------------- Total Assets $ 270,169 $ 293,516 ============= ============= LIABILITIES Current Liabilities: Current portion of long-term debt $ 12,847 $ 17,767 Accounts payable and accrued liabilities 36,410 44,043 Accrued interest 2,568 2,736 U.S. and foreign income taxes 1,156 1,885 ------------- ------------- Total current liabilities 52,981 66,431 ------------- ------------- Long-term debt 182,715 195,786 Deferred income taxes 800 1,609 Other liabilities 12,129 11,334 ------------- ------------- Total Liabilities 248,625 275,160 ------------- ------------- COMMITMENTS AND CONTINGENCIES Preferred stock, $.01 par value- (Redemption value of $109,480 and $61,910, respectively) Authorized - 200,000 shares Issued and outstanding - 45,000 and 22,500, - - respectively) Stockholders' Equity: Common stock $.01 par value- Authorized -- 200,000 shares Issued and outstanding -- 101,913 and 1 1 59,413, respectively Additional paid-in-capital 33,614 - Stock subscription receivables (1,360) (1,399) Retained earnings 6,825 26,541 Accumulated other comprehensive loss (17,536) (6,787) ------------- ------------- Total Stockholders' Equity 21,544 18,356 ------------- ------------- Total Liabilities and Stockholders' Equity $ 270,169 $ 293,516 ============= =============
The accompanying notes are an integral part of these consolidated financial statements.
AEARO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in Thousands)
Years Ended September 30, 2001 2002 2003 ----------- ----------- -----------
Net sales $ 283,862 $ 286,867 $ 316,428 Cost of sales 152,849 150,897 164,289 Restructuring charges (income) 2,364 (500) (270) ----------- ----------- ----------- Gross profit 128,649 136,470 152,409
Selling and administrative 87,286 91,903 101,257 Research and technical services 5,162 5,740 6,402 Amortization expense 6,530 6,293 267 Other charges (income), net 680 1,475 1,737 Restructuring charges (income) 9,077 (100) - ----------- ----------- -----------
Operating income 19,914 31,159 42,746 Interest income (203) (211) (146) Interest expense 23,869 20,266 19,733 ----------- ----------- -----------
Income (loss) before provision (3,752) 11,104 23,159 for (benefit from) income taxes Provision for (benefit from) (1,872) 1,785 2,551 income taxes ----------- ----------- -----------
Net income (loss) $ (1,880) $ 9,319 $ 20,608 =========== =========== ===========
AEARO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in Thousands)
AEARO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation Aearo Corporation, a Delaware corporation ("Aearo"), and its direct wholly owned subsidiary, Aearo Company I, doing business as Aearo Company, a Delaware corporation (the "Subsidiary") (collectively referred to herein as the Company) manufactures and sells products through three reportable segments. The Company's segments are Safety Products, Safety Prescription Eyewear and Specialty Composites. The Safety Products segment manufactures and sells hearing protection devices, non-prescription safety eyewear, face shields, reusable and disposable respirators, hard hats and first aid kits under the brand names: AOSafety(R), E-A-R(R), and Peltor(R). 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 and shapes the lenses to the customer's prescription, and then assembles the glasses using the customer's choice of frame. The Specialty Composites segment manufactures and sells a wide array of energy-absorbing materials that are incorporated into other manufacturers' products to control noise, vibration and shock.
Aearo Corporation was formed by Vestar Equity Partners, L.P. ("Vestar") and Cabot Corporation ("Cabot") in June 1995 to effect the acquisition of substantially all of the assets and liabilities of Cabot Safety Corporation and certain affiliates, all of which were wholly owned by Cabot, (the "Formation Acquisition"). Separate financial statements of Aearo Company are not presented because they do not provide any additional information from what is presented in the consolidated financial statements of Aearo Corporation that would be meaningful to the holders of the senior subordinated notes (the Senior Subordinated Notes) (see Note 7).
2. Significant Accounting Policies The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. All significant intercompany balances and transactions have been eliminated in consolidation. The significant accounting policies of the Company are described below.
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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Reclassifications
Certain amounts included in the prior year's consolidated financial statements have been reclassified to conform to the current year presentation. The reclassifications have no impact on stockholders' equity or net income (loss) previously reported.
Revenue Recognition
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. In addition, 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 customers credit worthiness, historical bad debt experience, changes in payment history and general economic and market trends.
Advertising
The Company expenses the costs of advertising as incurred. These expenses were approximately $5.9 million, $6.1 million, and $7.3 million for the years ended September 30, 2001, 2002 and 2003, respectively.
Cash Equivalents
The Company considers all time deposits and short-term investments with an original maturity of three months or less to be cash equivalents.
Foreign Currency Translation and Transactions
Foreign Currency Translation:
Assets and liabilities of the Company's foreign subsidiaries are translated at the exchange rate as of the end of the year. Income and expenses are translated at the approximate average exchange rates during the year. Foreign currency translation adjustments are recorded as a separate component of stockholders' equity.
Foreign Currency Transactions:
Foreign currency gains and losses arising from transactions by any of the Company's subsidiaries are reflected in net income (loss). For the years ended September 30, 2001, 2002 and 2003 the accompanying consolidated statements of operations include approximately $0.4 million, $0.2 million, and ($0.3) million, respectively, of transaction (gains)/losses included in other (income) charges, net.
To mitigate the effects of changes in foreign currency rates on profitability related to trade accounts receivable and trade accounts payable denominated in foreign currencies, the Company enters into forward foreign currency contracts. Gains and losses related to contracts designated as hedges of trade accounts receivable and trade accounts payable denominated in foreign currencies are accrued as exchange rates change and are recognized in the accompanying consolidated statements of operations as transaction (gains) and losses and included in other (income) charges, net. As of September 30, 2003, relative to these exposures, the Company had forward foreign currency contracts open in the following amounts:
Currency Amount (000s) Contract Position -------- ------------- ----------------- British Pound 3,981 Buy Canadian Dollar 1,625 Sell Norwegian Krona 2,862 Sell Swedish Krona 158,780 Buy Swiss Franc 80 Sell Euro 9,521 Sell Danish Krona 2,412 Sell
As of September 30, 2003, the Company has recorded an unrealized gain of $1.0 million associated with the above forward foreign currency contract commitments.
In addition, the Company enters into forward foreign currency contracts to hedge a portion of anticipated sales denominated in Great Britain Pound Sterling, Euro, and Canadian Dollar to mitigate the impact of the effects of changes in foreign currency rates on profitability related to cash flows from foreign operations. Gains and losses on these hedge contracts are deferred and recognized as an adjustment to the other charges (income), net. For the year ended September 30, 2002 and 2003, the consolidated statement of operations includes approximately $0.6 million and $2.0 million, respectively, of losses related to these instruments.
The Company has entered into Canadian dollar hedges as of September 30, 2003. The US dollar equivalent notional amount of outstanding Canadian dollar forward foreign currency contracts is approximately $14.2 million at September 30, 2003. Deferred losses related to hedge of future Canadian sales transactions were approximately $0.4 million at September 30, 2003. Contracts will mature at various dates through September 30, 2004. The Company does not enter into forward foreign contracts for trading purposes.
Inventories
Inventories are stated at the lower of cost or market, cost being determined using the first-in, first-out (FIFO) method.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost. Depreciation of property, plant and equipment is calculated using the straight-line method based on estimated economic useful lives. Expenditures for maintenance and repairs and minor renewals are charged to expense. Expenses for maintenance and repairs totaled approximately $2.4 million, $2.6 million and $2.4 million for the years ended September 30, 2001, 2002 and 2003, respectively.
Property, plant, equipment, and the related estimated useful lives are as follows:
Asset Classification Estimated Useful Life Buildings 25-40 years Leasehold improvements Life of the lease or useful life, whichever is shorter Machinery and equipment 3-10 years Furniture and fixtures 3-10 years
Upon the sale or retirement of assets, the cost and related accumulated depreciation are removed from the consolidated financial statements, and any resultant gain or loss is recognized.
Income Taxes
Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using currently enacted tax rates.
Goodwill and Intangible Assets
Effective October 1, 2002, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangibles". Under the provisions of SFAS No. 142, goodwill and intangible assets that have indefinite useful lives are no longer amortized but are tested at least annually for impairment. The Company performed its first annual impairment test as of January 1, 2003 and determined there was no impairment. Intangible assets that have finite useful lives will continue to be amortized over their useful lives. The following presents a summary of the changes in goodwill and intangible assets as of September 30, 2003 (dollars in thousands):
Goodwill Trademarks Other Total ----------- ------------ ----------- ------------ Balance October 1, 2001 $ 61,323 $ 55,678 $ 1,199 $ 118,200 Additions 394 394 Acquisitions 5,534 5,534 Translation adjustment 4,143 4,143 Amortization (3,179) (2,965) (148) (6,292) ----------- ------------ ----------- ------------ Balance September 30, 2002 $ 67,821 $ 52,713 $ 1,445 $ 121,979 Additions 46 46 Acquisitions 6,808 1,600 2,350 10,758 Translation adjustment 7,141 7,141 Amortization (267) (267) ----------- ------------ ----------- ------------ Balance September 30, 2003 $ 81,770 $ 54,313 $ 3,574 $ 139,657 ----------- ------------ ----------- ------------
As a result of the non-amortization provisions of SFAS No. 142, the Company will no longer record approximately $6.1 million of annual amortization relating to goodwill and indefinite lived intangibles. The following presents amortization expense and proforma net income for the years ended September 30, 2001, 2002 and 2003, respectively, as if SFAS No. 142 had been adopted (dollars in thousands):
September 30, ------------------------------------------ 2001 2002 2003 -------------- ------------- ------------- Net income (loss) as reported $ (1,880) $ 9,319 $ 20,608 Goodwill amortization 2,965 2,965 -- Trademark amortization 3,212 3,179 -- -------------- ------------- ------------- Adjusted net income $ 4,297 $ 15,463 $ 20,608 ============== ============= =============
Impairment
The Company accounts for long-lived and certain intangible assets in accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". The Company continually reviews its long-lived assets and finite-lived intangible assets for events or changes in circumstances that might indicate the carrying amount of the assets may not be recoverable. The Company assesses the recoverability of the assets by determining whether the amortization of such assets over their remaining lives can be recovered through projected undiscounted future cash flows. The amount of impairment, if any, is measured based on projected discounted future cash flows using a discount rate reflecting the Company's average cost of funds. During the year ended September 30, 2001, the Company identified certain manufacturing assets in the Newark, Delaware facility that were determined by the Company to be impaired. As a result, the Company wrote off approximately $2.9 million related to those assets (see Note 16) as part of its restructuring plan. During the years ended September 30, 2002 and 2003, as a result of normal product/equipment obsolescence and productivity or capacity enhancement projects, the Company wrote off approximately $0.5 million and $0.3 million of manufacturing assets, respectively.
Deferred Financing Costs
Deferred financing costs are stated at cost as a component of other assets and amortized over the life of the related debt. Amortization of deferred financing costs is included in interest expense and aggregated $2.0 million, $1.3 million and $1.4 million for the years ended September 30, 2001, 2002 and 2003, respectively.
Fair Value of Financial Instruments
In accordance with the requirements of SFAS No. 107, "Disclosures about Fair Value of Financial Instruments", the Company has determined the estimated fair value of its financial instruments using appropriate market information and valuation methodologies. Considerable judgment is required to develop the estimates of fair value; thus, the estimates are not necessarily indicative of the amounts that could be realized in a current market exchange. The Company's financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, Senior Subordinated Notes, Holding Company Notes, bank debt (including Term Loans, the Revolving Credit Facility and other debt) and interest rate instruments. The carrying value of these assets and liabilities is a reasonable estimate of their fair market value at September 30, 2003.
The Company has approximately $30.5 million of variable rate debt protected under an interest rate cap arrangement through December 31, 2004. The fair value of the cap at September 30, 2003 was $0.1 million. The Company has not elected to take hedge accounting treatment for the interest rate collar as defined under SFAS No. 133 and, as a result, any fair value adjustment is charge directly to other income/(expense).
The Company also uses financial instruments in the form of forward foreign currency contracts. Current market prices were used to estimate the fair value of the forward foreign currency contracts.
The future value of the forward foreign currency contracts and the related currency positions are subject to offsetting market risk resulting from foreign currency exchange rate volatility. The counter-parties to these contracts are
substantial and creditworthy financial institutions. Neither the risks of counter-party non-performance nor the economic consequences of counter-party non-performance associated with these contracts are considered by the Company to be material.
Accounting for Stock-based Compensation
SFAS No. 123 "Accounting for Stock-Based Compensation" addresses accounting and reporting requirements for stock options and other equity instruments issued or granted based on their fair market values. The Company intends to continue accounting for its stock-based compensation plans for employees in accordance with Accounting Principals Board ("APB") No. 25, "Accounting for Stock Issued to Employees". Under SFAS No. 123, companies choosing to continue to use APB No. 25 to account for stock-based compensation plans for employees must make footnote disclosure of the pro forma effects on earnings per share, had the principles contained within SFAS No. 123 been applied. The following table illustrates the effect on net income as if the fair value method had been applied to all outstanding and unvested option awards:
2001 2002 2003 ---------- ---------- ---------- Net income (loss) as reported $ (1,880) $ 9,319 $ 20,608 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of tax (94) (188) (147) ---------- ---------- ---------- Adjusted net income (loss) $ (1,974) $ 9,131 $ 20,461 ========== ========== ==========
The fair value of each option grant was estimated on the grant date using the Black-Scholes pricing model with the following weighted average assumptions:
2001 2002 2003 ---------- ---------- ---------- Risk-free interest rate 5.22% 4.52% 4.71% Expected life of options granted 10 years 10 years 10 years Expected volatility of underlying stock 0% 0% 0% Dividend yield 0% 0% 0%
Shipping and Handling Fees and Costs
Shipping and handling costs include payments to third parties for the delivery of products to customers, as well as internal salaries and overhead costs incurred to store, move and prepare finished products for shipment. Shipping and handling costs are included with selling and administrative expenses in the accompanying consolidated statement of operations and totaled $17.1 million, $17.2 million and $18.3 million in fiscal 2001, 2002 and 2003, respectively. The Company recovers a portion of its shipping and handling costs from its customers and records this recovery in net sales.
Accounting for Derivative Instruments and Hedging Activities
The Company adopted the provisions of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" on October 1, 2000. SFAS No. 133 requires that every derivative instrument be recorded in the balance sheet as either an asset or a liability measured at its fair value. The adoption of SFAS No. 133 on October 1, 2000 resulted in a $0.4 million transition adjustment charge to accumulated other comprehensive income to recognize the fair value of all derivatives that are designated as cash flow hedges.
The Company has formally documented its hedging relationships, including identification of the hedging instruments and the hedge items, as well as its risk management objectives and strategies for undertaking each hedge transaction. 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 (loss). Amounts accumulated in other comprehensive income (loss) will be reclassified as earnings when the related
product sales affect earnings for forward foreign currency contracts or when related interest payments affect earnings for interest rate swaps. There were no forward foreign currency contracts or interest rate derivatives at September 30, 2002 as defined under SFAS No. 133. For the year ended September 30, 2003, 2002 and 2001, the Company reclassified into earnings net losses of $2.0 million, $0.6 million and $0.2 million, respectively, resulting from the exercise of forward foreign currency contracts for cash flow hedges. All forward foreign currency contracts were determined to be highly effective whereby no ineffectiveness was recorded in earnings.
The Company entered into an interest rate collar arrangement in October 2001 to protect $25.0 million of the outstanding variable rate term loan debt from future interest rate volatility through September 30, 2003. The collar floor was set at 2% LIBOR (London Interbank Offering Rate) and cap at 6.25% LIBOR. The collar was not designated as a hedge under SFAS No. 133 and accordingly, the fair value gains or losses were charged to earnings. Approximately $0.2 million was expensed during the fiscal year ended September 30, 2003. No amounts were recorded to income or expense related to the interest collar for the years ended September 30, 2001 and 2002, respectively.
The Company has approximately $30.5 million of variable rate debt protected under an interest rate cap arrangement through December 31, 2004. The fair value of the cap at September 30, 2003 was $0.1 million. The Company has not elected to take hedge accounting treatment for the interest rate collar as defined under SFAS No. 133 and, as a result, any fair value adjustment is charge directly to other income/(expense). Approximately $0.1 million was recorded as income during the fiscal year ended September 30, 2003.
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 current earnings. For the year ended September 30, 2003, 2002 and 2001, the impact on earnings for trade activities were a net gain of $0.3 million, and net losses of $0.2 million and $0.4 million, respectively.
New Accounting Pronouncements
Effective October 1, 2002, the Company adopted SFAS No. 143, "Accounting for Asset Retirement Obligations". SFAS No. 143 requires the Company to record the fair value of liabilities associated with the retirement of long-lived assets in the period in which they are incurred. The adoption of SFAS No. 143 had no material impact on the Company's results of operations or financial position.
Effective October 1, 2002, the Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and APB No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions". SFAS No. 144 retains the fundamental provisions with respect to the recognition and measurement of long-lived asset impairments but does not apply to goodwill and other intangible assets. The adoption of SFAS No. 144 had no material impact on the Company's results of operations or financial position.
Effective October 1, 2002, the Company adopted SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections". This statement rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishment of Debt", and an amendment of that Statement, SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements". This Statement also rescinds SFAS No. 44, "Accounting for Intangible Assets of Motor Carriers". This Statement amends SFAS No. 13, "Accounting for Leases", to eliminate the inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. The adoption of SFAS No. 145 had no material impact on the Company's results of operations or financial position.
Effective October 1, 2002, the Company adopted SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146 requires that a liability for costs associated with exit or disposal activities be recognized and measured at fair value only when the liability is incurred. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS No. 146 did not material impact on the Company's results of operations or financial position.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123". SFAS No 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock based employee compensation. In addition, this statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock based employee compensation and the effect of the method used on reported results. As permitted under SFAS No. 148, the Company adopted the disclosure only provisions of SFAS No. 148 in the 2nd quarter of fiscal 2003.
In April 2003, the FASB issued Statement of Financial Accounting Standards No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." This Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement is effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. In addition, generally all provisions of this statement should be applied prospectively. The adoption of this statement did not have a material effect on the Company's financial position, results of operations and its cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity". SFAS No. 150 establishes standards for how an issuer classifies and measures three classes of freestanding financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability or an asset in some circumstances. SFAS No. 150 is effective for mandatorily redeemable financial instruments of non-public entities for the first fiscal period beginning after December 15, 2003, and for all other instruments for interim periods beginning after June 15, 2003. The Company has not entered into any financial instruments within the scope of SFAS No. 150 since June 15, 2003 and does not hold any significant financial instruments within its scope.
In November 2002, the FASB issued FASB Interpretation ("FIN") No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". FIN No. 45 expands upon the disclosure requirements to be made by a guarantor in its interim and annual financial statements regarding its obligations under certain guarantees that it has issued. Additionally, FIN No. 45 requires that the guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. Footnote disclosures are required in interim and year-end financial statements ending after December 15, 2002. Liability recognition and measurement provisions apply prospectively to guarantees issued or modified starting January 1, 2003. The adoption of FIN No. 45 had no effect on the Company's results of operations or financial position.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest Entities, an Amendment of ARB No. 51". FIN No. 46 addresses consolidation of business enterprises of certain variable interest entities, and is effective for variable interest entities created after January 31, 2003 and to variable interest entities in which an enterprise obtains an interest after that date. The adoption of FIN No. 46 had no effect on the Company's results of operations or financial position.
3. Inventories Inventories consisted of the following at September 30 (dollars in thousands):
2002 2003 -------------- ----------------- Raw materials $ 7,514 $ 8,301 Work in process 10,196 11,976 Finished goods 15,451 16,992 -------------- ----------------- $ 33,161 $ 37,269 ============== =================
4. Property, Plant and Equipment Property, plant and equipment consisted of the following at September 30 (dollars in thousands):
2002 2003 ----------- ----------- Land $ 2,589 $ 2,658 Building and improvements 20,774 23,391 Machinery and equipment 59,687 65,770 Furniture and fixtures 23,486 25,797 Construction in progress 4,670 5,276 ----------- ----------- 111,206 122,892 Less - accumulated depreciation 63,110 74,023 ----------- ----------- $ 48,096 $ 48,869 =========== ===========
5. Intangible Assets Intangible assets consisted of the following at September 30 (dollars in thousands):
2002 2003 ------------- -------------- Goodwill $ 93,804 $ 114,144 Trademarks and trade names 74,122 74,122 Patents 1,916 2,078 Non-compete agreement 701 1,335 Other 215 215 ------------- -------------- $ 170,758 $ 191,894 Less - accumulated amortization 48,779 52,237 ------------- -------------- $ 121,979 $ 139,657 ------------- --------------
The weighted average life of patents is 17 years. The Company expects amortization expense to be approximately $0.3 million for each of the next five years.
6. Accounts Payable and Accrued Liabilities Accounts payable and accrued liabilities consisted of the following at September 30 (dollars in thousands):
2002 2003 ----------- ----------- Accounts payable - trade $ 15,733 $ 21,205 Accrued liabilities -- Employee compensation and benefits (Note 8) 12,269 11,785 Restructuring reserve 3,497 2,405 Other 4,911 8,648 ----------- ----------- $ 36,410 $ 44,043 =========== ===========
7. Debt The long-term debt consisted of the following at September 30 (dollars in thousands):
2002 2003 ---------- ---------- Term loans, due 2003 $ 12,529 $ -- Term loans, due 2004 16,706 17,357 Term loans, due 2005 64,641 79,349
Senior subordinated notes, due 2005, 12.5% 98,000 98,000 Holding Company subordinated notes, due 2005 - 15,000 Mortgage note, due 1998 - 2006, 10.1% 2,165 2,087 Other 1,521 1,760 ---------- ---------- 195,562 213,553 Less-- Current portion of long-term debt 12,847 17,767 ---------- ---------- Total $ 182,715 $ 195,786 ========== ==========
Senior Bank Facilities
The Company's debt structure includes up to an aggregate of $135.0 million under its Credit Agreement with various banks comprised of (i) a secured term loan facility consisting of loans providing for up to $100.0 million of term loans (collectively the "Term Loans") with a portion of the Term Loans denominated in foreign currencies, (ii) a secured revolving credit facility ("Revolving Credit Facility") providing for up to $30.0 million of revolving loans for general corporate purposes, and (iii) a U.K. overdraft facility of up to an equivalent of $5.0 million in Great Britain Pounds for working capital requirements as needed (collectively, the "Senior Bank Facilities"). The amounts outstanding on the Term Loans and Revolving Credit Facility at September 30, 2003, were approximately $85.1 and $11.7 million, respectively. No amounts were outstanding under the U.K. overdraft facility. The Revolving Credit Facility provides for the issuance of letters of credit in an aggregate face amount of up to $10.0 million. The Term Loans amortize quarterly over a four-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 March 31, 2005.
At the Company's option, the interest rates per annum applicable to the Senior Bank Facilities are either (a) an adjusted rate based on the London Interbank Offered Rate ("LIBOR") plus a margin of 3.25% in the case of Term Loans and 2.75% for revolving loans or (b) the Base Rate, as defined, plus a margin of 2.25% in the case of Term Loans and 1.75% for revolving loans. The Base Rate is the higher of Bankers Trust Company's announced prime lending rate or the
Overnight Federal Funds rate plus 0.50%. The Company must pay certain fees in connection with the Senior Bank Facilities, including a commitment fee ranging from 0.375% to 0.50% on the undrawn portion of the commitments in respect of the Revolving Credit Facility based upon the Company's leverage ratio, and a 0.25% facing fee relating to the issuance of letters of credit.
The Company is entitled to an Interest Reduction Discount of .25% when the Company achieves a leverage ratio of less then 3.50. The discount would apply to all Term Loans and the Revolving Credit Facility.
Under the terms of the Senior Bank Facilities, the Company is required to comply with a number of affirmative and negative covenants. Among other restrictions, Aearo Company must satisfy certain financial covenants and ratios, including interest coverage ratios, leverage ratios, fixed charge coverage ratios and limits on the amount of permitted capital acquisitions. The Senior Bank Facilities also impose limitations on certain business activities of the Company. The Senior Bank Facilities restrict, among other things, the incurrence of additional indebtedness, creation of certain liens, the payment of dividends on the Company's Common Stock, sales of certain assets and limitations on transactions with affiliates. As of September 30, 2003, Aearo Company was in compliance with the covenants of the Senior Bank Facilities. The Senior Bank Facilities are unconditionally guaranteed by Aearo Corporation and secured by first priority security interests in substantially all the capital stock and tangible and intangible assets of the Company.
During the first quarter of fiscal 2002, the Company's Board of Directors authorized management to repurchase, from time to time, a portion of the Company's 12.5% Notes, subject to market conditions and other factors. No assurances can be given as to whether or when or at what price such repurchases will occur. Subsequently, pursuant to a first amendment to the Senior Bank Facilities, the Company purchased and retired $2.0 million of the Notes during the first quarter of fiscal 2002.
Term Loans
At September 30, 2003, the total balance outstanding of the Term Loans was $85.1 million and interest rates were 4.4% for the U.S. Dollar Term Loan ($46.3 million US dollars outstanding at September 30, 2003), 7.0% for the British Pound Term Loan (13.6 million British Pounds outstanding at September 30, 2003), 5.4% for the Euro Term Loan (9.9 million Euro outstanding at September 30, 2003), and 6.0% for the Canadian Term Loan (6.2 million Canadian dollars outstanding at September 30, 2003). For the year ended September 30, 2003, the weighted average interest rates paid were 4.7%, 7.1%, 6.0%, and 6.3% for the U.S. Dollar Term Loan, the British Pounds Term Loan, the Euro Term Loan and the Canadian Term Loan, respectively.
At September 30, 2002, the total balance outstanding on the Term Loans was $93.9 million and interest rates were 5.0% for the U.S. Dollar Term Loan ($53.8 million US dollars outstanding at September 30, 2002), 7.2% for the British Pound Term Loan (15.8 million British Pounds outstanding at September 30, 2002), 6.5% for the Euro Term Loan (11.5 million Euro outstanding at September 30, 2002), and 6.2% for the Canadian Term Loan (6.2 million Canadian dollars outstanding at September 30, 2002). For the year ended September 30, 2002, the weighted average interest rates paid were 5.4%, 7.6% 6.7% and 5.9% for the U.S. Dollar Term Loan, the British Pounds Term Loan, the Euro Term Loan and the Canadian Term Loan, respectively.
Revolving Credit Facility
At September 30, 2003 the balance on the Revolving Credit Facility was $11.7 million, which $5.0 million bore interest at LIBOR (3.89%) and $6.7 million at Base Rate (5.75%). For the year ended September 30, 2003, the maximum amount outstanding was $16.5 million, the average was $1.7 million and the weighted average interest rate paid was 5.7%. At September 30, 2003, approximately $17.3 million was available for additional borrowings and $11.3 million to finance additional permitted acquisitions.
At September 30, 2002, no amounts were outstanding on the Revolving Credit Facility. For the year ended September 30, 2002, the maximum amount outstanding was $1.5 million, the average was approximately zero and the weighted average interest rate paid was 6.5%. At September 30, 2002, approximately $29.0 million was available for additional borrowings and $22.9 million to finance additional permitted acquisitions.
Senior Subordinated Notes
In connection with the Formation Acquisition, Aearo Company issued $100.0 million of Notes due 2005, which are unsecured obligations of the Company. The Notes bear interest at a rate of 12.5% per annum and interest is payable semiannually on each January 15 and July 15.
The Notes are redeemable at the option of the Company, on or after July 15, 2000. From and after July 15, 2000, the Notes will be subject to redemption at the option of the Company, in whole or in part, at various redemption prices, declining from 106.3% of the principal amount to par on and after July 15, 2004. The Company repurchased $2.0 million of Notes in October 2001.
The Notes indenture contains affirmative and negative covenants and restrictions similar to those required under the terms of the Senior Bank Facilities discussed above. As of September 30, 2003, the Company was in compliance with the various covenants of the Notes agreement. The Notes are unconditionally guaranteed on an unsecured senior subordinated basis by Aearo Corporation.
Holding Company Notes
To finance part of the redemption of Aearo's common and preferred stock owned by Cabot, the Company issued $15.0 million of Holding Company Notes due in 2005. The Holding Company Notes are unsecured obligation of the Company. The initial applicable interest rate was 9.5%, with an increase of 50 basis points each subsequent four-month period beginning December 15, 2003. The applicable interest rate shall not exceed 12%. Interest will be paid three times per year on April 15, August 15, and December 15. The first payment was made on December 15, 2003.
The Note Purchase Agreement contains affirmative and negative covenants and restrictions similar to those required under the terms of the Senior Bank Facility and Notes discussed above. As of September 30, 2003 the Company was in compliance with the various covenants of the Notes Purchase Agreement.
Maturities
As of September 30, 2003, the scheduled maturity of indebtedness for each of the next five years and thereafter is as follows (dollars in thousands):
Amount ------------- 2004 $ 17,767 2005 192,742 2006 2,211 2007 329 2008 282 Thereafter 222 ------------- $ 213,553 =============
8. Employee Benefit Plans The Company maintains a noncontributory defined benefit cash balance pension plan. Benefits provided under the plan are primarily based on years of service and the employee's compensation.
The following represents information summarizing the Company's defined benefit cash balance pension plan (dollars in thousands):
Years Ended September 30, Change in benefit obligation 2001 2002 2003 ---------- ----------- ----------- Benefit obligation at beginning of year $ 9,887 $ 11,343 $ 12,995 Service cost 1,336 1,286 1,510 Interest cost 721 790 833 Plan amendments -- 30 -- Benefits paid (993) (1,581) (707) Actuarial gain (loss) 392 1,127 (1,600) ---------- ----------- ----------- Benefit obligation at end of year $ 11,343 $ 12,995 $ 13,031 ---------- ----------- -----------
Change in plan assets Fair value of plan assets at beginning of year $ 10,535 $ 9,259 $ 7,956 Actual return of plan assets (1,491) (945) 1,119 Employer contributions 1,208 1,223 563 Benefits paid (993) (1,581) (707) --------- ---------- ----------- Fair value of plan assets at end of year $ 9,259 $ 7,956 $ 8,931 --------- ---------- -----------
Reconciliation of funded status Funded status $ (2,084) $ (5,039) $ (4,101) Unrecognized prior service cost 96 117 107 Unrecognized actuarial (gain) loss (572) 2,285 176 --------- ---------- ----------- Net pension liability included in accrued liabilities $ (2,560) $ (2,637) $ (3,818) --------- ---------- ----------- Amounts recognized in statement of financial position Prepaid benefit cost $ -- $ -- $ -- Accrued benefit liability (2,560) (4,860) (3,818) Intangible asset -- 116 -- Accumulated other comprehensive income -- 2,107 -- --------- ---------- ----------- Net amount recognized $ (2,560) $ (2,637) $ (3,818) --------- ---------- ----------- Components of net periodic benefit cost Service cost $ 1,336 $ 1,286 $ 1,510 Interest cost 721 790 833 Expected return on plan assets (842) (785) (672) Unrecognized prior service cost 7 9 9 Recognized actuarial gain (loss) (145) -- 63 --------- ---------- ----------- Net periodic benefit cost $ 1,077 $ 1,300 $ 1,743 ========= ========== ===========
The weighted average assumptions used in determining net periodic benefit cost and the projected benefit obligation were as follows:
Years Ended September 30, 2001 2002 2003 --------- --------- --------- Discount rate 7.50% 6.75% 6.00% Expected long-term rate of return of plan assets 8.00% 8.50% 8.00% Rate of compensation increase 4.00% 4.00% 4.00%
In addition, the Company has an unfunded, noncontributory defined benefit pension plan, the Aearo Company Supplemental Executive Retirement Plan (the SERP Plan), which is also a cash balance plan. The SERP Plan, effective January 1, 1994, covers certain employees in the United States. The costs to the Company for the SERP Plan were $148,000, $111,000 and $113,000 for the years ended September 30, 2001, 2002 and 2003, respectively. The aggregate liability for the SERP Plan was $524,000, $486,000 and $540,000 for the years ended September 30, 2001, 2002 and 2003, respectively.
A 401(k) plan, the Aearo Company Employees' 401(k) Savings Plan, was established as of May 1, 1990. Employees normally scheduled to work a minimum of 1,000 hours per year can join the plan immediately and may contribute up to 60% of their compensation. The Company contributes amounts equal to 50% of the employee's contribution to a maximum of 3% of the employee's pay. The costs to the Company for this Plan were $903,000, $866,000 and $891,000 for the years ended September 30, 2001, 2002 and 2003, respectively.
The Company has a defined contribution savings plan for U.K. employees, under which eligible employees are allowed to contribute up to 15% of their compensation. The Company contributes 5% of pay for all eligible employees and additional amounts equal to 40% of the employee's contribution to a maximum of 2% of the employee's pay. For the years ended September 30, 2001, 2002 and 2003, the Company contributed approximately $212,000, $197,000, and $228,000, respectively.
9. Related Party Transactions
Pursuant to an agreement with Cabot and Vestar, dated as of July 11, 1995, an annual management fee is payable by the Company equal to the greater of (i) $400,000 or (ii) 1.25% of the consolidated net income of the Company and its subsidiaries before cash interest, taxes, depreciation and amortization for such fiscal year. Payments totaled approximately $728,000, $519,000 and $611,000 during the years ended September 30, 2001, 2002 and 2003, respectively. Until August 18, 2003, this annual management fee was shared by Cabot and Vestar based on their relative equity ownership of the Company. On August 18, 2003, the Company redeemed all of the shares of common and preferred stock of Aearo owned by Cabot in the Cabot Stock Redemption, which had no effect on the calculation of the management fee. All payments subsequent August 18, 2003 have been and will be paid to Vestar. Of the $611,00 in management fees paid by the Company during the year ended September 30, 2003, the Company paid Vestar $167,000 in management fees for the interim period from August 18, 2003 through September 30, 2003.
See Note 12 for a description of certain ongoing liability retention and indemnity agreements between the Company and Cabot relating to respiratory medical conditions. The Company paid Cabot $400,000 for each of the years ended September 30, 2001, 2002 and 2003.
The Company has made available to certain members of management ("Management Investors") loans in order to provide such Management Investors with funds to be applied to a portion of the purchase price of the Common Stock purchased by such Management Investors under the Stock Purchase Plan. Each such loans (i) is secured by Common Stock purchased with the proceeds thereof, (ii) bears interest at an annual rate of 2.73%, and (iii) is subject to mandatory prepayment in the event the employment of the Management Investor terminates or of maturity. Maturity, at the earliest, is at the option of the note-holder, or at the latest, at the time of the Vestar realization event as defined in the Stockholder's Agreement. The aggregate amount of these loans was approximately $1,363,000 and $1,399,000 at September 30, 2002 and 2003, respectively.
10. Income Taxes Income (loss) before provision for income taxes was as follows (dollars in thousands):
Years Ended September 30, 2001 2002 2003 ---------- --------- ----------- Domestic $ 10,865) $ 4,762 $ 12,128 Foreign 7,113 6,342 11,031 ---------- --------- ----------- Total $ (3,752) $ 11,104 $ 23,159 ========== ========= ===========
A summary of provision (benefit) for income taxes was as follows (dollars in thousands): Years Ended September 30, U.S. Federal and State: 2001 2002 2003 ---------- --------- ----------- Current $ (3,525) $ 125 $ 620 Deferred -- 203 -- ---------- --------- ----------- $ (3,525) $ 328 $ 620 ========== ========= =========== Foreign:
Current 1,957 1,226 1,148 Deferred (304) 231 783 ---------- --------- ----------- 1,653 1,457 1,932 ---------- --------- ----------- Total $ (1,872) $ 1,785 $ 2,551 ========== ========= ===========
The provision (benefit) for income taxes at the Company's effective tax rate differed from the provision (benefit) for income taxes at the statutory rate as follows (dollars in thousands):
Years Ended September 30, 2001 2002 2003 --------- --------- --------- Computed tax expense (benefit) at the $ (1,277) $ 3,740 $ 7,875 expected statutory rate State taxes, net of federal effect (51) 82 85 Foreign income taxed at different rates (1,172) (166) (1,174) Foreign dividends -- 324 -- Non-deductible goodwill amortization 308 309 -- Non-deductible expenses 267 99 125 Increase (decrease) in valuation allowance 110 (2,302) (4,710) Other, net (57) (301) 350 --------- --------- --------- Provision (benefit) for income taxes $ (1,872) $ 1,785 $ 2,551 ========= ========= =========
Significant components of deferred income taxes are as follows at September 30 (dollars in thousands):
As of September 30, Deferred tax assets 2002 2003 --------- --------- Pension and other benefits $ 1,862 $ 1,673 Property, plant and equipment (3,158) (2,422) Intangible assets 459 (4,940) Restructuring charges 1,349 530 Inventory 1,147 1,759 Unrealized foreign currency exchange -- 1,254 Net operating loss and credit carryforwards - Domestic 11,298 8,096 Accrued expenses and other 345 1,705 --------- --------- Subtotal 13,302 7,655 Valuation allowances (14,102) (9,263) ========= ========= Total deferred tax liability $ (800) $ (1,608) ========= =========
The valuation allowance at September 30, 2002 and 2003 relates to the uncertainty of realizing the tax benefits of reversing temporary differences and net operating loss carryforwards. The gross amount of domestic net operating loss carryforwards, before the tax effect, is approximately $22.6 million as of September 30, 2003. The net operating loss carryforwards expire at various periods ranging from 2010 to 2021. Of the valuation allowance recorded as of September 30, 2003, approximately $6.9 million will be used to reduce goodwill if the benefits are realized.
11. Stockholders' Equity
Stock Ownership and Stockholders' Agreement
As of September 30, 2003, Vestar, and its affiliates, owns 71.5% of the outstanding shares of Aearo Common Stock (42,500 shares) and 100% of the outstanding shares of Aearo Preferred Stock (22,500 shares) and Management Investors and certain other employees of the Company own 28.5% of the outstanding shares of Aearo Common Stock (16,912.5 shares). At September 30, 2002, Vestar, and its affiliates, owned 41.7% of the outstanding shares of Aearo Common Stock (42,500 shares) and 50% of the outstanding shares of Aearo Preferred Stock (22,500 shares), Cabot owned 41.7% of the outstanding shares of Aearo Common Stock (42,500 shares) and 50% of the outstanding shares of Aearo Preferred Stock (22,500 shares) and the Management Investors and certain other employees of the Company owned 16.6% of outstanding shares of Aearo Common Stock (16,912.5 shares). Vestar and the Management Investors are parties to a stockholders' agreement (the "Stockholders' Agreement"). The Stockholders' Agreement contains stock transfer restrictions, as well as provisions granting certain tag-along rights, drag-along rights, registration rights and participation rights.
The Aearo Preferred Stock is cumulative redeemable $.01 par value stock. Dividends accrue whether or not dividends are declared or funds are available at an annual rate of 12.5%, compounded quarterly. To date, no dividends have been declared. Accrued dividends may be paid in cash or in additional shares of preferred stock. Shares are redeemable for cash at any time, subject to certain exceptions, at the option of the Company at a redemption price equal to the actual or implied purchase price ($22.5 million) plus a redemption payment based on the dividend rate. As of September 30, 2002 and 2003, the redemption value of the preferred stock was $109.5 million and $61.9 million, respectively.
Aearo Company is permitted to pay cash dividends to Aearo Corporation for taxes and expenses in the ordinary course of business. The maximum amount of cash dividends paid to Aearo Corporation for ordinary business expenses may not exceed $1,000,000 in any fiscal year. As long as no event of default would result, Aearo Corporation and Aearo Company are permitted to pay dividends consisting of shares of qualified capital stock, as defined in the Senior Bank Facilities, and Aearo Corporation may redeem or purchase shares of its capital stock held by former employees of Aearo Corporation or any of its subsidiaries following the termination of their employment, provided that the aggregate amount paid by Aearo Corporation with respect to such purchases or redemptions does not exceed $5.0 million in any fiscal year and $7.5 million in the aggregate. Aearo Company may pay cash dividends to Aearo Corporation for the latter purpose. Additionally, Aearo Corporation may pay dividends on its preferred stock in additional shares of Aearo Preferred Stock. To date, Aearo Corporation has not paid dividends on either Aearo Common or Aearo Preferred Stock.
Stock Option Plans
On June 27, 1996, Aearo's Board of Directors adopted the Executive Stock Option Plan (the "Executive Plan") under which non-qualified options to purchase up to 5,000 shares of Aearo Common Stock may be granted to certain officers and key employees of Aearo and its subsidiaries. In July 1997, the Company's Board of Directors adopted and the stockholders subsequently approved the 1997 Stock Option Plan (the "1997 Option Plan") under which 10,000 shares of Aearo Common Stock were reserved for issuance. During the year ended September 30, 2002, an additional 1,800 shares were reserved for issuance under the 1997 Option Plan. Under the 1997 Option Plan, non-qualified and qualified options may be granted to employees, directors and consultants of Aearo and its subsidiaries. Options granted under the Executive Plan and the 1997 Option Plan will vest and become exercisable upon the earlier of the date on which a stipulated return (as defined) is achieved by Vestar on its investment in the Company or the tenth anniversary of the date of grant. The option term will be 10 years, except that options shall expire in certain instances of termination of employment and upon the sale of the Company. As of September 30, 2003, options to purchase a total of 3,993 shares were outstanding under the Executive Plan and options to purchase a total of 7,930 shares were outstanding under the 1997 Option Plan. A total of 1,077 options are available for grant under the Executive Plan and 3,800 options are available for grant under the 1997 Option Plan.
Pro Forma Stock-Based Compensation Expense
SFAS No. 123, "Accounting for Stock-Based Compensation", sets forth a fair-value-based method of recognizing stock-based compensation expense. As permitted by SFAS No. 123, the Company has elected to continue to apply APB No. 25 to account for its stock-based compensation plans.
Stock Option Activity
Stock option data for the Executive Plan and the 1997 Option Plan for the years ended September 30, 2001, 2002 and 2003, respectively, was as follows:
Number Weighted Average of Shares Exercise Price
Outstanding, October 1, 2000 9,883 $ 630 Granted 2,500 800 Forfeited (218) 600 Forfeited (94) 800 Outstanding, September 30, 2001 12,071 664 Granted 4,274 600 Granted 31 800 Forfeited (456) 600
Outstanding, September 30, 2002 15,920 649 Forfeited (3,997) 800 ------- --------- Outstanding, September 30, 2003 11,923 $ 600 ======= =========
The following table sets forth information regarding options outstanding at September 30, 2003: Weighted Weighted Average Number Weighted Average Exercise of Shares Number Average Remaining Price for Covered by Exercise Currently Exercise Contractual Currently Options Price Exercisable Price Life Exercisable - --------- --------- ----------- --------- ---------- ----------- 11,923 $ 600.00 -- $ 600.00 5.74 years N/A
12. Commitments and Contingencies
Lease Commitments
The Company leases certain transportation vehicles, warehouse facilities, office space, and machinery and equipment under cancelable and non-cancelable operating leases. Rent expense under such arrangements totaled $5.8 million, $6.0 million and $6.4 million for the years ended September 30, 2001, 2002 and 2003, respectively. Future minimum rental commitments under non-cancelable leases in effect at September 30, 2003 are as follows (dollars in thousands):
2004 $ 4,336 2005 3,702 2006 2,341 2007 1,053 2008 1,053 Thereafter 2,070 -------------- Total $ 14,555 ==============
Contingencies
Various lawsuits and claims arise against the Company in the ordinary course of its business. Most of these lawsuits and claims are products liability matters that arise out of the use of safety eyewear and respiratory product lines manufactured by the Company as well as products purchased for resale.
In addition, the Company is a defendant in lawsuits by plaintiffs alleging that they suffer from respiratory medical conditions, such as asbestosis or silicosis, relating to exposure to asbestos and silica, and that such conditions result, in part, from the use of respirators that, allegedly, were negligently designed or manufactured. The defendants in these lawsuits are often numerous, and include, in addition to manufacturers and distributors of respirators, manufacturers, distributors and installers of sand (used in sand blasting), asbestos and asbestos-containing products. Most of these claims are covered by the Asset Transfer Agreement entered into on June 13, 1995 by the Company and Aearo Company, on the one hand, and Cabot and certain of its subsidiaries (the "Sellers"), on the other hand (the "1995 Asset Transfer Agreement"). In the 1995 Asset Transfer Agreement, so long as the Company makes an annual payment of $400,000 to Cabot, the Sellers agreed to retain, and Cabot and the Sellers agreed to defend and indemnify the Company against, any liability or obligation relating to or otherwise arising under any proceeding or other claim against the Company 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, the Company has elected to pay the annual fee and intends to continue to do so. The Company could potentially be liable for claims currently retained by Sellers if the Company elects to cease paying the annual fee or if Cabot and the Sellers no longer are able to perform their obligations under the 1995 Asset Transfer Agreement. Cabot acknowledged in the Stock Purchase Agreement that it and the Company entered into on June 27, 2003 (providing for the sale by Cabot to the Company of all of the common and preferred stock of the Company owned by Cabot) that the foregoing provisions of the 1995 Asset Transfer Agreement remain in effect. The 1995 Asset Transfer Agreement does not apply to claims relating to the business of Eastern Safety Equipment, the stock of which the Company acquired in 1996.
At September 30, 2003, the Company has recorded liabilities of approximately $4.5 million, which represents reasonable estimates of its probable liabilities, for product liabilities substantially related to asbestos and silica-related claims as determined by the Company in consultation with an independent consultant. This reserve is re-evaluated periodically and additional charges or credits to operations may result as additional information becomes available. Consistent with the current environment being experienced by companies involved in asbestos and silica-related litigation, there has been an increase in the number of asserted claims that could potentially involve the Company. Various factors increase the difficulty in determining the Company's potential liability, if any, in such claims, including the fact that the defendants in these lawsuits are often numerous and the claims generally do not specify the amount of damages sought. Additionally, the bankruptcy filings of other companies with asbestos and silica-related litigation could increase the Company's cost over time. In light of these and other uncertainties inherent in making long-term projections, the Company has determined that the five-year period through fiscal 2008 is the most reasonable time period for projecting asbestos and silica-related claims and defense costs. It is possible that the Company may incur liabilities in an amount in excess of amounts currently reserved. However, taking into account currently available information, historical experience, and the 1995 Asset Transfer Agreement, but recognizing the inherent uncertainties in the projection of any future events, it is management's opinion that these suits or claims should not result in final judgments or settlements in excess of the Company's reserve that, in the aggregate, would have a material effect on the Company's financial condition, liquidity or results of operations.
13. Acquisitions
On December 14, 2001, the Company acquired Iron Age Vision from Iron Age Corporation of Pittsburgh, Pennsylvania. The acquisition has been accounted for as a purchase transaction in accordance with SFAS No. 141, and, accordingly, the consolidated financial statements for the periods subsequent to December 14, 2001 reflect the purchase price, including transaction costs, allocated to tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values as of December 14, 2001. The purchase price of $0.9 million, inclusive of acquisition fees and costs to restructure operations, was allocated based on the fair value of assets acquired, which consisted primarily of receivables and fixed assets. The excess of purchase price over the fair market value of assets acquired of $0.5 million was allocated to goodwill.
On January 21, 2002, the Company acquired the industrial safety business of Montreal, Canada based Leader Industries, Inc. The acquisition has been accounted for as a purchase transaction in accordance with SFAS No. 141, and, accordingly, the consolidated financial statements for the periods subsequent to January 21, 2002 reflect the purchase price, including transaction costs, allocated to tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values as of January 21, 2002. The purchase price of $5.1 million, inclusive of acquisition fees and costs to restructure operations, was allocated based on the fair value of assets acquired, which consisted primarily of inventory, receivables, fixed assets and accrued liabilities. The excess of purchase price over the fair market value of assets acquired of $2.2 million was allocated to goodwill.
On May 7, 2002, the Company acquired Chesapeake Optical Company of Baltimore, Maryland. The acquisition has been accounted for as a purchase transaction in accordance with SFAS No. 141, and, accordingly, the consolidated financial statements for the periods subsequent to May 7, 2002 reflect the purchase price, including transaction costs, allocated to tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values as of May 7, 2002. The purchase price of $3.6 million, inclusive of acquisition fees and costs to restructure operations, was allocated based on the fair value of assets acquired, which consisted primarily of inventory, receivables, fixed assets and accrued liabilities. The excess of purchase price over the fair market value of assets acquired of $2.9 million was allocated to goodwill.
On October 7, 2002, the Company acquired the Safety Prescription Eyewear assets Industrial Protection Products, Inc. ("IPP") of Wilmington, Massachusetts for $1.5 million. The acquisition has been accounted for as a purchase transaction in accordance with SFAS No. 141, and, accordingly, the consolidated financial statements for the periods subsequent to October 7, 2002 reflect the purchase price, including transaction costs, allocated to tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values as of October 7, 2002. The purchase price of $1.5 million, inclusive of acquisition fees and costs to restructure operations, was allocated based on the fair value of assets acquired, which consisted primarily of inventory, receivables, fixed assets and accrued liabilities. The excess of purchase price over the fair market value of assets acquired of $1.4 million consisted of $0.9 million of goodwill and $0.5 million of other intangibles.
These operations have been included in the consolidated results from the dates of acquisition. Had the acquisitions been consolidated at the beginning of the year prior to the acquisitions, they would not have materially affected results.
On March 14, 2003, the Company acquired VH Industries, Inc. ("VH") of Concord, North Carolina for $11.6 million. The acquisition has been accounted for as a purchase transaction in accordance with SFAS No. 141, and, accordingly, the consolidated financial statements for the periods subsequent to March 14, 2003 reflect the purchase price, including transaction costs, allocated to tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values as of March 14, 2003. The purchase price of $11.6 million, inclusive of acquisition fees and costs to restructure operations, was allocated on a preliminary basis based on the fair value of assets acquired, which consisted primarily of inventory, receivables, fixed assets and accrued liabilities. The excess of purchase price over the fair market value of assets acquired of $9.4 million consisted of $5.9 million of goodwill and $1.6 million of trademarks and $1.9 million of other intangibles. The following unaudited proforma information presents results as if the acquisition had occurred at the beginning of the respective periods (dollars in thousands):
2001 2002 2003 ----------- ----------- ---------- Sales as reported $ 283,862 $ 286,867 $ 316,428 Proforma sales 292,456 297,223 320,918
Net income (loss)as reported (1,880) 9,319 20,608 Proforma net income (loss) (1,212) 9,803 21,296
14. Segment Data
As defined by SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", the Company's three reportable segments 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 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 Safety Prescription Eyewear segment purchases component parts (lenses and the majority of its frames) from various suppliers, grinds and shapes the lenses to the customer's prescription, and then assembles the glasses using the customer's choice of frame. The Specialty Composites segment manufactures a wide array of energy-absorbing materials that are incorporated into other manufacturers' products to control noise, vibration and shock.
Net sales to external customers by business segment (dollars in thousands):
2001 2002 2003 ---------- ---------- ---------- Safety Products $ 206,311 $ 208,538 $ 242,263 Safety Prescription Eyewear 39,076 40,834 40,028 Specialty Composites 38,475 37,495 34,137 ----------- ----------- ---------- Total $ 283,862 $ 286,867 $ 316,428 =========== =========== ==========
Profit by business segment and reconciliation to income before (benefit from) provision for income taxes (dollars in thousands):
2001 2002 2003 ---------- ---------- ---------- Safety Products $ 43,102 $ 42,608 $ 50,670 Safety Prescription Eyewear 2,922 1,714 462 Specialty Composites 1,984 3,488 2,713 ---------- ----------- ----------- Segment profit $ 48,008 $ 47,810 $ 53,845 ========== ========== ==========
Depreciation 10,123 10,958 11,102 Amortization of intangibles 6,530 6,293 267 Restructuring charges 11,441 (600) (270) Interest, net 23,666 20,055 19,587 ---------- ---------- ----------- Income (loss) before provision for/(benefit from) income taxes $ (3,752) $ 11,104 $ 23,159 ========== ========== ==========
Segment profit is defined as earnings before depreciation, amortization, interest expense and income taxes and presents the measure used by the chief operating decision maker to assess segment performance and make decisions about the allocation of resources to business segments.
Intersegment sales of the Specialty Composites segment to the Safety Products segment totaled $4.2 million, $3.5 million and $3.2 million for the years ended September 30, 2001, 2002 and 2003, respectively. The intersegment sales value is generally determined at fully absorbed inventory cost at standard rates plus 25%.
Depreciation by business segment (dollars in thousands):
2001 2002 2003 ----------- ----------- ----------- Safety Products $ 7,966 $ 8,657 $ 8,978 Safety Prescription Eyewear 378 717 707 Specialty Composites 1,779 1,584 1,417 ----------- ----------- ----------- Total $ 10,123 $ 10,958 $ 11,102 =========== =========== ===========
Identifiable assets by business segment (dollars in thousands):
2002 2003 ----------- ----------- Safety Products $ 217,091 $ 249,553 Safety Prescription Eyewear 18,088 17,748 Specialty Composites 20,510 18,914 Cash 14,480 7,301 ----------- ----------- Total $ 270,169 $ 293,516 =========== =========== Cash is not allocated to segments.
Capital expenditures including capital leases by business segment (dollars in thousands):
2001 2002 2003 ---------- ---------- ----------- Safety Products $ 5,788 $ 7,921 $ 8,888 Safety Prescription Eyewear 425 499 379 Specialty Composites 1,075 791 619 Reconciling items 511 442 430 ----------- ----------- ----------- Total $ 7,799 $ 9,653 $ 10,316 =========== =========== ===========
Reconciling items include corporate expenditures such as information technology and other shared systems.
Net sales by principal geographic areas (dollars in thousands):
2001 2002 2003 ----------- ----------- ----------- United States of America $ 179,398 $ 175,358 $ 187,106 Canada 20,370 20,997 22,965 United Kingdom 13,501 13,115 15,562 Germany 11,447 10,984 11,859 Sweden 10,981 10,710 15,392 France 6,975 10,097 9,967 Italy 5,156 4,933 7,044 All others 36,034 40,673 46,533 ----------- ----------- ----------- Total $ 283,862 $ 286,867 $ 316,428 =========== =========== ===========
The sales as shown above represent the value of shipments into the customer's country of residence. For the years ended September 30, 2001, 2002 and 2003, no single customer accounted for more than 10% of sales.
Net identifiable assets by principal geographic areas (dollars in thousands):
2001 2002 2003 ----------- ----------- ----------- United States of America $ 173,076 $ 173,068 $ 183,910 Canada 9,584 10,252 10,293 United Kingdom 19,304 18,426 21,870 Germany 2,138 144 299 Sweden 56,673 61,860 70,744 France 43 5,869 5,773 All others 484 550 627 ----------- ----------- ----------- Total $ 261,302 $ 270,169 $ 293,516 =========== =========== ===========
15. Quarterly Financial Data (Unaudited)
The following table contains selected unaudited quarterly financial data for fiscal years 2002 and 2003.
16. Restructuring
On September 30, 2001 the Company recorded an unusual charge of $11.4 million related to a restructuring plan announced by the Company to improve its competitive position and long-term profitability. The plan includes the closure of its Ettlingen, Germany plant, significantly reorganizing operations at the Company's Varnamo, Sweden plant, rationalizing the manufacturing assets and product mix of its Specialty Composites business unit and a reduction of products and product lines.
The restructuring charge included cash charges totaling $2.3 million consisting of $1.8 million for severance and related costs to cover the reduction of 5% of the Company's work force and $0.5 million for other costs associated with this plan. The restructuring also included non-cash charges totaling $9.1 million consisting of $3.2 million for non-cancelable long term lease obligations, asset impairment charges of $2.9 million, $2.4 million for the write-off of inventory and $0.6 million related to the sale of the Company's Ettlingen, Germany location.
During 2003, the Company reversed $0.3 million of reserves related to the September 30, 2001 restructuring provision. The adjustment represents a change in estimate of the plan for the disposal of certain items of inventory and was classified as a reduction in cost of sales.
The following table displays the activity and balances of the restructuring reserve account as of and for the year ended September 30, 2003 (in thousands):
September 30, September 30, 2002 Charges 2003 ------------- --------- ------------- Employee termination costs $ 730 $ (506) $ 224 Lease agreements 2,352 (896) 1,456 Loss on disposal of assets 700 (9) 691 Other 47 (30) 17 ------------- --------- ------------- Total $ 3,829 $ (1,541) $ 2,388 ------------ --------- -------------
The Company expects that all charges related to the restructuring provision will be settled in fiscal 2004 except for the lease agreement which will end in March 2005.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. 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 within 90 days prior to the filing of this Annual Report on Form 10-K405 and have determined that such disclosure controls and procedures are effective.
Subsequent to the Company's evaluation, there were no significant changes in internal controls or other factors during the fourth fiscal quarter that could materially affect internal controls, including any corrective actions with regard to significant deficiencies and material weaknesses.
PART III
Item 10.
Item 10. Directors and Executive Officers
The following table sets forth certain information with respect to the directors and executive officers of the Company as of December 22, 2003.
Name Age Position - ---------------------------- ---- ---------- -------- ---------------------- Michael A. McLain (1) 53 Chief Executive Officer, President, and Chairman of the Board of Directors
Jeffrey S. Kulka 46 Senior Vice President, Chief Financial Officer, Treasurer, and Secretary
James H. Bernhardt 59 Senior Vice President and Chief Marketing Officer
James H. Floyd 48 President, Aearo Europe, Managing Director, International
Joseph C. Marlette 60 Senior Vice President, Operations and Research and Development
M. Rand Mallitz 61 Senior Vice President, Specialty Composites
D. Garrad (Gary) Warren, III 51 President, North American Safety Products Group
James M. Phillips 51 Senior Vice President, Human Resources
Rahul Kapur 52 Senior Vice President, Corporate Development and Chief Strategy Officer
Norman W. Alpert (1) 44 Director
Daniel S. O'Connell 48 Director
Arthur J. Nagle 67 Director
Bryan P. Marsal (2) 52 Director
William E. Kassling (2) 58 Director
John D. Curtin, Jr. 70 Director
1. Member of Compensation Committee 2. Member of Audit Committee
Michael A. McLain has been President, Chief Executive Officer and Director of the Company since February 1998. Effective May 30, 2001, he was named Chairman of the Board of Directors. Prior to joining the Company, he was President and Chief Executive Officer of DowBrands, Inc., a large manufacturer of household consumer products. Mr. McLain is a Director of Cluett American Corporation, and Little Rapids Corporation.
Jeffrey S. Kulka, Senior Vice President, Chief Financial Officer, Treasurer and Secretary joined the Company in March 1997 as Corporate Controller. Prior to joining Aearo, he spent ten years with Augat Inc. in a variety of assignments including Divisional Controllerships and Business Development in domestic and international settings.
James H. Bernhardt, Senior Vice President and Chief Marketing Officer, joined the Company in February 2001. Prior to joining Aearo, he was Senior Vice President/General Manager of the Miracle-Gro Division of the Scotts Company. Altogether, he has 30 years of experience in packaged goods marketing.
James H. Floyd, President, Aearo Europe, Managing Director, International, joined Aearo in April 1998. Prior to 1998, he was responsible for global logistics and packaging functions at DowBrands. He began his career at Procter and Gamble where he worked for seven years.
Joseph C. Marlette, Senior Vice President, Operations and Research and Development, joined the Company in April 1998. Prior to joining Aearo, he spent 33 years in various manufacturing positions with the Dow Chemical Company.
M. Rand Mallitz, Senior Vice President and General Manager, E-A-R(R) Specialty Composites, joined the Company in January 1992 as. In December 1999, he was promoted to Vice President Aearo, Senior Vice President Specialty Composites. Prior to joining the Company, Mr. Mallitz was CEO/President of Roth Office Products until 1992.
D. Garrad (Gary) Warren, III joined the Company in November 1999 and currently serves as President - North American Safety Products Group. Prior to that, Mr. Warren was Senior Vice President, Sales and Customer Development for International Home Foods in Parsippany, New Jersey.
James M. Phillips, Senior Vice President, Human Resources joined the Company in May 1998. He worked for Dow Chemical Company for more than 20 years and has worked in recruiting, training and compensation for many diverse divisions of Dow.
Rahul Kapur joined the Company in April 1998 as Vice President of Corporate Development. He currently is Senior Vice President of Corporate Development and chief Strategy Officer. Mr. Kapur joined DowBrands in 1985 in New Product Development and held various positions in Marketing and Strategic Development, including Director of Marketing for Europe. He began his career with Richardson Vicks and Unilever.
Norman W. Alpert is a Managing Director of Vestar Capital Partners and was a founding partner of Vestar at its inception in 1988. In addition to Aearo, Mr. Alpert is a director of MCG Capital Corporation and Cluett American Group, all companies in which Vestar or its affiliates have a significant equity interest. He became a director of the Company in July 1995.
Daniel S. O'Connell is the Chief Executive Officer and founder of Vestar Capital Partners. In addition to Aearo, Mr. O'Connell is a director of Cluett American Corporation, Insight Communications Company, Inc., Sunrise Medical, Inc., St. John Knits Co., Inc. and Agrilink Foods, Inc. All are companies in which Vestar or its affiliates have a significant equity interest. He became a director of the Company in July 1995.
Arthur J. Nagle is a Managing Director of Vestar Capital Partners and was a founding partner of Vestar at its inception in 1988. In addition to Aearo, Mr. Nagle is a director of Advanced Organics, Inc., Gleason Corporation and Sheridan Healthcare, Inc., all companies in which Vestar or its affiliates have a significant equity interest. He became a director of the Company in July 1995.
Bryan P. Marsal, is co-founder of Alvarez & Marsal, Inc. ("A&M"), a global professional services firm specializing in providing corporate advisory and management services to distressed and underperforming companies. Previously, he served as Director of Republic Health Corporation, Anthony Manufacturing, and Gitano. He was also Chief Operating Officer of Alexander's Department Stores. Mr. Marsal holds both a B.B.A. and a M.B.A from the University of Michigan. He currently serves on the boards of Timex Corporation, and Cluett American Corporation (Gold Toe Socks). He became a director of the Company in October 1998.
William E. Kassling was named Chairman of the Board of Wabtec Corporation in February 2001, after having served as Chairman and Chief Executive Officer since 1990. Between 1984 and 1990, Mr. Kassling served as Vice President, Group Executive for the Railway Products Group of American Standard Incorporated. Prior to 1984, he held various operating and strategic planning assignments with American Standard, Clark Equipment Company and Boston Consulting Group. Mr. Kassling earned an MBA from the University of Chicago and a BS in industrial management from Purdue University. In addition to Aearo, Mr. Kassling is a board member of the Pittsburgh Penguins and Scientific Atlanta. He became a director of the Company in July 1998.
John D. Curtin, Jr. retired as Chairman and Chief Executive Officer of the Company in February 1998. Mr. Curtin was named Chief Executive Officer of the Company in April 1994 and became a director of the Company in July 1995. Mr. Curtin joined Cabot in 1989 as Chief Financial Officer and Executive Vice President. Prior to joining Cabot he was President, Chief Executive Officer and Director of Curtin & Co., Inc., a private investment-banking firm. Mr. Curtin is also a director of Harbor Global Company, LTD, Hamilton Thorne Biosciences, Inc., and Nano-C, LLC.
Prior to the Cabot Stock Redemption on August 18, 2003, the number of directors of the Company was fixed at nine. Since that time, the number of directors has been fixed at seven. Under the Stockholders' Agreement, Vestar has the right to designate five directors and the Management Investors have the right to designate two directors. Prior to the Cabot Stock Redemption, Cabot had the right to designate two directors. Messrs. Alpert, O'Connell, Nagle, Kassling and Marsal are the directors designated by Vestar and Mr. McLain and Mr. Curtin are currently the directors designated by the Management Investors. See Item 13, "Certain Relationships and Related Transactions -- Stock Ownership and Stockholders' Agreement -- Election and Removal of Directors." The term of office for each director ends when his or her successor elected at the annual meeting of stockholders or upon his or her removal or resignation.
The Board of Directors has established an audit committee consisting of William E. Kassling and Bryan P. Marsal (the "Audit Committee"). The Audit Committee recommends the firm to be appointed as independent accountants to audit financial statements and to perform services related to the audit, reviews the scope and results of the audit with the independent accountants, reviews with management and the independent accountants the Company's annual operating results, considers the adequacy of the internal accounting procedures, considers the effect of such procedures on the accountants' independence and establishes policies for business values, ethics and employee relations. Mr. Marsal has been designated as the audit committee financial expert and is independent of management.
The Company has adopted a code of ethics that applies to, among others, its Chief Executive Officer, Chief Financial Officer, and Controller. The Code of Ethics is available upon request by contacting the Corporate Counsel at (508) 764-5500. If the Company makes substantive amendments to the Code of Ethics or grant any waiver, including any implicit waiver, from a provision of the Code applicable to our Chief Executive Officer, Chief Financial Officer or Controller, the Company will make a public disclosure of the nature of such amendment or waiver.
Officers and directors of Aearo and the Subsidiary are not subject to Section 16 of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
Item 11.
Item 11. Executive Compensation
The compensation of executive officers of the Company is determined by the Board of Directors. The following table sets forth certain information concerning compensation received by the Chief Executive Officer and the other four most highly-compensated executive officers of the Company serving at the end of fiscal 2003 (the "Named Executive Officers") for services rendered to the Company in all capacities (including service as an officer or director) in fiscal 2003.
Summary Compensation Table Annual Compensation Fiscal All Other Annual Year Salary Bonus Compensation Michael A. McLain Chief Executive Officer, 2003 $ 515,007 $ 398,125 $ 81,855 (1) President, and Chairman 2002 $ 500,004 $ 225,069 $ 86,797 of the Board of Directors 2001 $ 496,667 $ 56,250 $ 84,977
D. Garrad Warren, III 2003 $ 250,281 $ 155,284 $ 44,496 (2) President, North American 2002 $ 243,000 $ 87,507 $ 64,250 Safety Products Group 2001 $ 240,833 $ 21,870 $ 43,316
James H. Floyd 2003 $ 216,300 $ 133,988 $ 34,934 (3) President, Aearo Europe, 2002 $ 207,934 $ 75,623 $ 52,721 Managing Director, 2001 $ 195,066 $ 17,784 $ 42,122 International
M. Rand Mallitz 2003 $ 212,832 $ 131,626 $ 27,882 (4) Senior Vice President and 2002 $ 206,604 $ 74,399 $ 22,907 General Manager, 2001 $ 205,267 $ 18,594 $ 25,180 Specialty Composites
Rahul Kapur 2003 $ 202,152 $ 125,458 $ 33,394 (5) Senior Vice President, 2002 $ 192,108 $ 69,177 $ 40,495 Corporate Development 2001 $ 190,873 $ 17,289 $ 34,336 and Chief Strategy Officer
1. Includes contributions made on behalf of Mr. McLain to the Company's 401(k) Savings Plan ($5,800) and to the Company's Cash Balance Plan ($12,541). Also includes expenses recognized by the Company for unfunded accruals made on Mr. McLain's behalf to the Company's Supplemental Executive Retirement Plan ($43,206) as well as Company match and interest credits to the Company's Deferred Compensation Plan ($20,308).
2. Includes contributions made on behalf of Mr. Warren to the Company's 401(k) Savings Plan ($5,800) and to the Company's Cash Balance Plan ($12,541). Also includes expenses recognized by the Company for unfunded accruals made on Mr. Warren's behalf to the Company's Supplemental Executive Retirement Plan ($11,023) as well as Company match and interest credits to the Company's Deferred Compensation Plan ($15,132).
3. Includes contributions made on behalf of Mr. Floyd to the Company's 401(k) Savings Plan ($5,700); to the Company's Cash Balance Plan ($12,541). Also includes expenses recognized by the Company for unfunded accruals made on Mr. Floyd's behalf to the Company's Supplemental Executive Retirement Plan ($7,354) as well as Company match and interest credits to the Company's Deferred Compensation Plan ($9,339).
4. Includes contributions made on behalf of Mr. Mallitz to the Company's 401(k) Savings Plan ($5,945) and to the Company's Cash Balance Plan ($12,541). Also includes expenses recognized by the Company for unfunded accruals made on Mr. Mallitz's behalf to the Company's Supplemental Executive Retirement Plan ($6,978) as well as Company match and interest credits to the Company's Deferred Compensation Plan ($2,418).
5. Includes contributions made on behalf of Mr. Kapur to the Company's 401(k) Savings Plan ($6,522) and to the Company's Cash Balance Plan ($12,541). Also includes expenses recognized by the Company for unfunded accruals made of Mr. Kapur's behalf to the Company's Supplemental Executive Retirement Plan ($5,706) as well as Company match and interest credits to the Company's Deferred Compensation Plan ($8,625).
The following table sets forth information concerning the number and value of unexercised options to purchase Aearo Common Stock held by the Named Executive Officers at the end of fiscal 2003. None of the Named Executive Officers exercised any options during fiscal 2003.
1. There was no public market for the Aearo Common Stock as of September 30, 2003. Accordingly, these values have been calculated on the basis of an assumed fair market value of $600 per share as established by the Company's Board of Directors.
Director Compensation
Directors (other than two Directors unaffiliated with Vestar (the "Outside Directors")) serve without compensation (other than reimbursement of expenses) in connection with rendering services as such. The Outside Directors receive $10,000 annually for their service as Directors and an additional $2,500 per meeting, plus reimbursement of expenses. In connection with their appointment, Outside Directors appointed in prior fiscal years have been given the opportunity to purchase a limited number of shares of Aearo Common Stock. No Outside Directors were appointed to the Board during fiscal 2003. Outside Directors may also elect to participate in the Deferred Compensation Plan.
Employee Stock and Other Benefit Plans
Stock Purchase Plan. In connection with the Formation Acquisition, the Company adopted the Cabot Safety Holdings Corporation 1995 Stock Purchase Plan, as amended and restated (the "Stock Purchase Plan"), in order to encourage ownership of Aearo Common Stock by selected officers and employees and independent directors of the Company. Under the Stock Purchase Plan, 15,000 shares of Aearo Common Stock have been reserved for purchase by the Company's executive officers and other senior members of management as determined by the Board of Directors. As of December 1, 2003, 13,200 of such shares were issued and outstanding.
Aearo Common Stock acquired under the Stock Purchase Plan is subject to forfeiture through various puts and calls. In the event of death, permanent disability or retirement, which retirement occurs at age 65 or older with at least 3 years of service, such stock may be put to the Company by the holder at fair market value and the Company has a call on such stock at the same price. In the event of termination for cause, the Company has a call at the lesser of initial cost and fair market value. In the event of termination by the Company other than for cause and in the case of voluntary resignation, the Company has a call (i) with respect to a percentage of such stock equal to the number of years elapsed since the Formation Acquisition multiplied by 20% at fair market value, and (ii) with respect to the remainder of such stock at the lesser of initial cost and fair market value. Shares repurchased by the Company are held in reserve, and may be issued to existing and future employees or non-employee directors. These puts and calls expire (i) on the date on which certain financial performance benchmarks (which, following an initial public offering of the Aearo Common Stock, depend in part on the future market value of the Aearo Common Stock) are achieved by the Company or (ii) on various dates, none exceeding five years from the date of purchase. Each Management Investor is also required to be a party to the Stockholders' Agreement. See Item 13, "Certain Relationships and Related Transactions -- Stockholders' Agreement."
Stock Option Plans. In June 1996, Aearo's Board of Directors adopted and the stockholders subsequently approved the Executive Stock Option Plan (the "Executive Plan") under which 5,000 shares of Aearo Common Stock have been reserved for issuance. Under the Executive Plan, non-qualified options may be granted to officers and key employees of the Company and its subsidiaries. In July 1997, Aearo's Board of Directors adopted and the stockholders subsequently approved the 1997 Stock Option Plan (the "1997 Option Plan") under which 11,800 shares of Aearo Common Stock have been reserved for issuance. Under the 1997 Option Plan non-qualified and qualified options may be granted to employees, directors and consultants of the Company.
Each of the Executive Plan and the 1997 Option Plan is administered by a committee of the Board of Directors consisting of all non-employee directors. As of September 30, 2003, non-qualified options to acquire 11,923 shares at a price of $600 per share have been granted to officers and key employees of the Company and its subsidiaries under the Company's stock option plans and 4,877 options remain available for issuance. Of outstanding options, 3,181 in the aggregate have been granted to Named Executive Officers, including Mr. McLain (options to purchase 1,100 shares), Mr. Warren (options to purchase 1,250 shares), Mr. Floyd (options to purchase 300 shares), Mr. Kapur (options to purchase 275 shares) and Mr. Mallitz (options to purchase 256 shares). Each option will vest and become exercisable upon the earlier of: (i) the date on which certain financial performance benchmarks (which depend in part on the future market value of the Aearo Common Stock) are achieved by the Company and (ii) the tenth anniversary of the date of grant. The option term is 10 years; provided, however, that unexercised options expire earlier in certain instances of termination of employment of the option holder and may expire in the event of a merger or liquidation of the Company or a sale of substantially all the assets of the Company. Aearo Common Stock acquired upon exercise of options granted under the Executive Plan or 1997 Option Plan is subject to the same restrictions, including puts and calls and drag-along rights as Aearo Common Stock acquired under the Stock Purchase Plan. See "Stock Purchase Plan."
There were no option grants for Named Executive Officers pursuant to the Executive Plan and the 1997 Option Plan during the year ended September 30, 2003.
Management Incentive Plan. The Company provides performance-based compensation awards to executive officers and key employees for achievement during each year as part of a management incentive plan. Such compensation awards are a function of individual performance and consolidated corporate results. Business unit performance also is a factor in determining compensation awards with respect to key employees who are not executive officers. The specified qualitative and quantitative criteria employed by the Board of Directors of the Company in determining bonus awards varies for each individual and from year to year.
Phantom Equity Plan. Aearo maintains a management phantom equity program, pursuant to which specified members of management may be entitled to receive proceeds upon Aearo's achievement of specified financial goals relating to the value of the common equity. In general, subject to a participant's continued employment, the participant's right to receive such proceeds will vest immediately upon an outright sale of the majority of Aearo by existing shareholders or a recapitalization which results in a significant distribution to the common equity (each, a "realization event"). However, the Board of Directors of Aearo has the right to accelerate vesting for individual participants. The proceeds under the management phantom equity program generally will be distributed upon a realization event.
Supplemental Severance Pay Policy. The Company has adopted a severance pay policy providing executive officers and key employees with salary continuation in the event of a termination. Termination resulting from cause, retirement, death and disability are not eligible. Subject to the Company's discretion, the policy generally provides for one month's base pay for each full year of service with a minimum amount payable of three month and a maximum amount payable of twelve months.
Deferred Compensation Plan. The Company has adopted a Deferred Compensation Plan which is a non-qualified savings plan under the IRS code and which provides executive officers and paid directors the opportunity to defer the receipt of base salary and/or bonus. The plan is effective for fiscal years beginning with fiscal year 2000 and provides unfunded deferred compensation payments upon a participant's retirement or termination from the Company. Participant deferrals are credited annually with amounts based upon the prime rate (plus 450 basis points) and with amounts replicating the Company match in the 401(k) for savings from income above the qualified plan limits.
401(k) Plan. The Company has adopted a savings plan (the "Savings Plan"), which is qualified under Section 401(a) and 401(k) of the Code. All regular employees of the Company in the United States of America normally scheduled to work a
minimum of 1,000 hours per year are eligible to participate in the Savings Plan immediately. For each employee who elects to participate in the Savings Plan and makes a contribution thereto, the Company will make a matching contribution. The Company matches 50.0% of the first 6.0% of compensation contributed. The maximum contribution for any participant for any year is 60.0% of such participant's eligible compensation, not to exceed the 401(k) plan elective deferral limit set forth by the IRS. Contributions to the Savings Plan will be invested, as the employee directs, in any combination of investment options.
Employment Contracts and Termination of Employment and Change-In-Control Arrangements. Effective January 23, 1998, the Company entered into an agreement with Michael A. McLain which covers the terms and conditions of his employment. It contains a provision for separation benefits in the event of a change of control or other termination not related to performance.
Pension Plans. The Company has adopted a Cash Balance Pension Plan. Under such plan, the Company will provide participants with annual credits of 4.0% of eligible compensation up to the Social Security Wage Base as set forth annually by the Social Security Administration and Department of Health and Human Services. An additional annual credit of 4.0% of eligible compensation from the Social Security Wage Base up to the Qualified Plan Compensation Limit set forth by the Internal Revenue Service (IRS) is provided. All balances in the accounts of participants will be credited with interest based on the prior year's U.S. Treasury bill rate. At retirement, participants eligible for benefits may receive the balance standing in their account in a lump sum or as a monthly pension having equivalent actuarial value.
Additionally, the Company has adopted a Supplemental Executive Retirement Plan, which is a non-qualified plan under the Internal Revenue Code, and which provides unfunded deferred compensation benefits to certain individuals whose salary exceeds the Qualified Plan Compensation Limit set forth by the IRS. Pursuant to the plan, participants are credited annually with amounts representing 8% of compensation in excess of the Qualified Plan Compensation Limit.
The following table sets forth, for the Named Executive Officers, the estimated annual benefits payable upon retirement at normal retirement age, from both the qualified and non-qualified pension plans assuming in each case that such officer elects payment over time rather that in a lump sum:
Name and Principal Position Annual Benefits Payable - ------------------------------------------------- ------------
Michael A. McLain $ 82,672 Chief Executive Officer, President, and Chairman of the Board of Directors
D. Garrad Warren, III $ 34,785 President, North American Safety Products Group
M. Rand Mallitz $ 25,158 Senior Vice President and General Manager, Specialty Composites
Rahul Kapur $ 29,045 Senior Vice President, Corporate Development and Chief Strategy Officer
James H. Floyd $ 41,119 President, Aearo Europe, Managing Director, International
Compensation Committee Interlocks and Insider Participation
The Company has a Compensation Committee of the Board of Directors. As of December 1, 2003, the committee consists of Messrs. Alpert and McLain, two directors of the Company. Mr. McLain is also the Chief Executive Officer and President of the Company as well as Chairman of the Board of Directors. This committee makes all executive officer compensation decisions, with Mr. McLain abstaining with respect to decisions affecting his own compensation, and submits them to the full Board of Directors of the Company for final review and approval.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The following table sets forth certain information with respect to the beneficial ownership of Aearo Common Stock, including beneficial ownership by each person or entity known by the Company to own beneficially 5% or more of the Company's voting capital stock, by the Directors, the Named Executive Officers and all of the Company's Directors and executive officers as a group as of December 1, 2003. All of the Subsidiary's issued and outstanding capital stock is owned by Aearo.
Name and Address of Beneficial Owner Number of Shares of Percentage of Aearo Common Stock Outstanding Shares Vestar Equity Partners, L.P. (1) 42,500 71.5% 245 Park Avenue New York, New York 10167
Norman W. Alpert (2) 42,500 71.5%
Daniel S. O'Connell (2) 42,500 71.5%
Arthur J. Nagle (2) 42,500 71.5%
Michael A. McLain 4,050 6.82%
John D. Curtin, Jr. 3,713 6.25%
Rahul Kapur 1,000 1.68%
James H. Floyd 1,000 1.68%
M. Rand Mallitz 950 1.68%
D. Garrad Warren, III 600 1.01%
Bryan P. Marsal 250 *
William E. Kassling 250 *
Directors and executive officers as a group (15 persons)(3) 55,863 94.0%
- ------------------------------------- * Less than 1%.
1. The general partner of Vestar is Vestar Associates L.P., a limited partnership whose general partner is Vestar Associates Corporation ("V.A.C."). In such capacity, V.A.C. exercises sole voting and investment power with respect to all of the shares held of record by Vestar. Messrs. Alpert, O'Connell and Nagle, who are directors of the Company, are affiliated with Vestar in the capacities described under "Management -- Directors and Executive Officers" and are stockholders of V.A.C.
2. Messrs. Alpert, O'Connell and Nagle are affiliated with Vestar in the capacities described under "Directors and Executive Officers." Ownership of Aearo Common Stock for these individuals includes 42,500 shares of Aearo Common Stock included in the above table beneficially owned by Vestar, although such persons believe that they do not have such beneficial ownership. Each such person's business address is c/o Vestar Equity Partners, L.P. at the address set forth above.
3. Vestar and the Management Investors have entered into a Stockholders' Agreement, the terms of which are described more fully under Item 13, "Certain Relationships and Related Transactions -- Stock Ownership and Stockholders' Agreement." Does not include 3,550 shares of Aearo Common Stock held by Management Investors who are not executive officers.
Item 13.
Item 13. Certain Relationships and Related Transactions
The Asset Transfer Agreement
The Company is a party to the 1995 Asset Transfer Agreement dated as of June 13, 1995 with Cabot and certain of its subsidiaries (including Old Cabot Safety Corporation) (the "Asset Transfer Agreement") entered into in connection with the Formation Acquisition. The 1995 Asset Transfer Agreement contains customary representations, warranties and covenants. Cabot and certain of its subsidiaries, on the one hand, and Aearo and the Subsidiary on the other, have also agreed to indemnify and hold each other and their affiliates harmless against certain breaches of representations or covenants and certain other liabilities.
The Company has the right to pay an annual fee of $400,000 to Cabot , and has elected to make this payment, with the result that Cabot and the other subsidiaries retain responsibility and liability for, and indemnify the Company against, certain legal claims alleged to arise out of the use of respirators sold prior to July 11, 1995. See Item 3, Legal Proceedings, for a more detailed discussion of the respective rights and obligations of the parties under this arrangement.
Stock Ownership and Stockholders' Agreement
As of September 30, 2003, Vestar and its affiliates own 71.5% of the outstanding shares of Aearo Common Stock (42,500 shares) and 100% of the outstanding shares of Aearo Preferred Stock (22,500 shares). Management Investors and certain other employees of the Company own 28.5% of Aearo Common Stock (16,912.5 shares).
Under a Stockholders' Agreement originally among Aearo, Vestar, Cabot and the Management Investors, the parties agreed to various stock transfer restrictions, as well as provisions granting certain tag-along rights, drag-along rights, registration rights and participation rights, which are described below. Vestar and Cabot had identical or similar rights until Cabot's rights terminated as a result of the Cabot Stock Redemption on August 18, 2003.
Election and Removal of Directors. Prior to the Cabot Stock Redemption, the number of directors of the Company was fixed at nine. Since that time, the number of directors has been fixed at seven. Under the Stockholders' Agreement, the parties agreed to vote all shares of Aearo Common Stock owned or controlled by them so as to elect as members of the Board of Directors persons designated as follows: (i) Vestar designates three directors so long as Vestar and its affiliates beneficially own on a fully diluted basis at least 21,250 shares of Aearo Common Stock (50% of the shares of Aearo Common Stock acquired by them in the Formation Acquisition), (ii) Vestar may designate two additional directors who are not partners, officers or employees of any of Vestar or its affiliates so long as Vestar and its affiliates beneficially own at least 31,875 shares of Aearo Common Stock (75% of the shares of Aearo Common Stock acquired by them in the Formation Acquisition, and (iii) the Management Investors may designate two directors so long as the Management Investors together own beneficially on a fully diluted basis at least 3,750 shares of Aearo Common Stock (25% of the shares of Aearo Common Stock acquired by all Management Investors in the Formation Acquisition), provided that the two designees of the Management Investors must be initial designees as of the closing date, and in the case of subsequent designees other than the initial designees, shall be officers serving in similar capacities. The foregoing provisions relating to the election of directors terminate in the event that Vestar and its affiliates own on a fully diluted basis fewer than 4,250 shares of Aearo Common Stock (10% of the shares of Aearo Common Stock acquired by them in the Formation Acquisition). Messrs. Alpert, O'Connell and Nagle were designated by Vestar as described in clause (i) above, Messrs. Kassling and Marsal were designated by Vestar as described in clause (ii) above and Mr. McLain and Mr. Curtin were designated by the Management Investors as described in clause (iii) above. All directors can be removed, with or without cause, and replaced by the stockholders who have the right to designate them.
Tag-along Rights. So long as a public offering of Aearo Common Stock shall not have occurred and subject to certain exceptions, with respect to any proposed transfer of Aearo Common Stock or Aearo Preferred Stock by Vestar, other than transfers to affiliates, each other stockholder will have the right to require that the proposed transferee purchase a certain percentage of the shares owned by such stockholder at the same price and upon the same terms and conditions.
Drag-along Rights. The Stockholders' Agreement provides that, so long as Vestar and its affiliates beneficially own at least 21,250 shares of Aearo Common Stock (50% of the shares of Aearo Common Stock acquired by them in the Formation Acquisition), if Vestar receives an offer from a third party to purchase all but not less than all outstanding shares of Aearo Common Stock and Aearo Preferred Stock and such offer is accepted by Vestar, then each party to the Stockholders' Agreement will transfer all shares of Aearo Common Stock and Aearo Preferred Stock owned or controlled by such party on the terms of the offer so accepted by Vestar, provided that all such transfers occur on substantially identical terms and the number of shares to be acquired by the third party after giving effect to all such transfers would be sufficient under the certificate of incorporation and by-laws of the Company, any applicable agreements and applicable law to permit such third party to eliminate all remaining minority interests through a merger opposed by such minority interests. These so-called "drag-along" rights do not apply to sales in a public offering or to stock that has been sold by a party to the Stockholders' Agreement in a public offering or pursuant to Rule 144.
Other Voting Matters. So long as the drag-along rights are in effect, the parties to the Stockholders' Agreement are obligated to vote all shares of Aearo Common Stock owned or controlled by them to ratify, approve and adopt the following actions to the extent that they are adopted and approved by the Board of Directors: (i) any merger or consolidation involving the Company that is, in substance, an acquisition of another Company by the Company or a sale of the Company and in either case does not affect in any way the relative rights of Vestar or result in any benefit to Vestar other than the benefits to it as a stockholder of the Company equal to the benefits received by other stockholders, share for share, and (ii) any amendment to the certificate of incorporation of the Company whereby such amendment does not adversely affect such stockholder in a manner different from that in which any other stockholder is affected. In addition, so long as the voting agreements providing for the election of directors remain in effect, the parties to the Stockholders' Agreement agreed not to vote to approve, ratify or adopt any amendment to the by-laws of the Company unless such amendment is expressly authorized by the Stockholders' Agreement or recommended by the Board of Directors.
Transfers of Common Stock. Subject to certain limitations, transfers of Aearo Common Stock and Aearo Preferred Stock by parties to the Stockholders' Agreement are restricted unless the transferee agrees to become a party to, and be bound by, the Stockholders' Agreement, provided that such restrictions do not apply to sales in a public offering or pursuant to Rule 144. In addition, subject to certain limitations, the Management Investors agreed not to transfer their shares of Aearo Common Stock or Aearo Preferred Stock without the prior written consent of Vestar. Under certain circumstances, the transfer of Aearo Common Stock or Aearo Preferred Stock by Vestar and its affiliates is permitted.
Participation Rights. Under certain circumstances, if Aearo proposes to issue any capital stock to Vestar or any of their respective affiliates, each other stockholder shall have the opportunity to purchase such capital stock on a pro rata basis.
Approval of Affiliate Transactions. The Stockholders' Agreement provides that the Company shall not, and shall cause its subsidiaries not to, enter into any transaction with any affiliate of the Company unless such transaction (i) is on fair and reasonable terms no less favorable to the Company or such subsidiary than it could obtain in a comparable arm's length transaction, (ii) is contemplated by the Stockholders' Agreement, the Asset Transfer Agreement or the Management Advisory Agreement among the Company and Vestar or (iii) is for the payment of reasonable and customary regular fees to outside directors. In no event will the Company issue Aearo Common Stock or other equity securities to Vestar or any affiliate of the Company, subject to certain limitations, below the fair market value of such shares of Aearo Common Stock or equity securities.
Registration Rights. The Stockholders' Agreement provides that, subject to certain limitations, upon a written request by Vestar, the Company will use its best efforts to effect the registration of all or part of the Aearo Common Stock owned by such requesting stockholder, provided that (i) the Company will not be required to effect more than one registration within any 360 day period and (ii) Vestar will be entitled to request more than two registrations. Under certain circumstances, if the Company proposes to register shares of Aearo Common Stock, it will, upon the written request of any stockholder, use all reasonable efforts to effect the registration of such stockholders' Aearo Common Stock.
Termination. The Stockholders' Agreement will terminate as to any Aearo Common Stock or Aearo Preferred Stock, subject to certain limitations, on the date, such Aearo Common Stock is sold in a public offering or pursuant to Rule 144. The rights of Vestar will terminate under the Stockholders' Agreement when Vestar and its affiliates own no Aearo Common Stock, common stock equivalents or Aearo Preferred Stock.
Management Advisory Agreement.
In connection with the Formation Acquisition, the Company became a party to a Management Advisory Agreement with Vestar and Cabot (the "Management Advisory Agreement"), pursuant to which the Company is obligated to pay an annual management fee in an aggregate amount with respect to each fiscal year equal to the greater of (i) $400,000 and (ii) 1.25% of the consolidated net income of the Company before cash interest, taxes, depreciation and amortization for such fiscal year. Until the Cabot Stock Redemption on August 18, 2003, the fee was shared by Cabot and Vestar based on their relative equity ownership of the Company. Thereafter, the fee has been and will be paid solely to Vestar. These payments totaled approximately $728,000, $519,000 and $611,000 during the years ended September 30, 2001, 2002 and 2003, respectively. Of the $611,000 in manegment fees paid by the Company in the year ended September 30, 2003, the Company paid Vestar $167,000 in management fees for the interim period from August 18, 2003 through September 30, 2003. Messrs. Alpert, O'Connell and Nagle, three of the directors of the Company, are affiliated with Vestar in the capacities described under Item 10, "Directors and Executive Officers" and, accordingly, benefit from any payments received by Vestar.
Management and Director Loans.
The Company has made available to certain Management Investors loans in order to provide such Management Investors with funds to be applied to a portion of the purchase price of the Aearo Common Stock purchased by such Management Investors under the Stock Purchase Plan. Such loans (i) are secured by the Aearo Common Stock purchased with the proceeds thereof, (ii) bear interest at an annual rate of 2.73% and (iii) are subject to mandatory prepayment in the event the employment of such Management Investor terminates or event of maturity. At December 1, 2003, amounts outstanding in thousands of dollars were:
Aggregate Amount Amount Outstanding Outstanding at Interest Management Investors December 1, 2003 September 30, 2003 Rate - ---------------------------- ---------------- ------------------ --------- Michael A. McLain $ 665 $ 661 2.73% D. Garrad (Gary) Warren, III 248 246 2.73% Rahul Kapur 72 72 2.73% Joseph C. Marlette 72 72 2.73% James H. Floyd 72 72 2.73% M. Rand Mallitz 82 81 2.73%
Item 14.
Item 14. Principal Accountant Fees and Services
Audit Fees
The firm of Deloitte and Touche, LLP (Deloitte) has served as the Company's independent public accountants for each of the last three fiscal years ended September 30, 2001, 2002 and 2003. The aggregate fees billed by Deloitte for the audit of our financial statements included in the Annual Report on Form 10-K405 and for the review of our financial statements included in our Quarterly Reports on Form 10-Q for the fiscal years ended September 30, 2001, 2002 and 2003 were $221,000, $256,000 and $275,000, respectively.
Tax Fees
The aggregate fees billed by Deloitte for the tax compliance for the fiscal years ended September 30, 2001, 2002 and 2003 were $80,000, $76,000 and $84,000, respectively.
Other Fees
The aggregate fees billed by Deloitte for additional professional services for the fiscal years ended September 30, 2001, 2002 and 2003 were $60,000, $132,000 and $312,000, respectively.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
The following documents are filed as part of this Annual Report on Form 10-K405:
a) 1. Financial Statements: See Index to financial statements under Item 8 on page 26 of this report.
2. Financial Statement Schedules: See Schedule II on page 70 of this report.
3. Exhibits: See Index of Exhibits on pages 72 to 75 hereof.
b) Current Reports on Form 8-K On July 24, 2003, the Company filed a Current Report on Form 8-K to announce its third quarter results of operations.
On August 18, 2003, the Company filed a Current Report on Form 8-K to announce the Cabot Stock Redemption.
c) Exhibits See Index of Exhibits on pages 72 to 75 hereof.
d) Financial Statement Schedule See Schedule II on page 70 of this report.
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.
Aearo Corporation Date: December 22, 2003 By: /s/ Michael A. McLain --------------------- Michael A. McLain Chief Executive Officer, President, and Chairman of the Board of Directors
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Date: December 22, 2003 /s/ Michael A. McLain --------------------- Michael A. McLain President, Chief Executive Officer and Chairman (Principal Executive Officer)
Date: December 22, 2003 /s/ Jeffrey S. Kulka -------------------- Jeffrey S. Kulka Senior Vice President, Chief Financial Officer, Treasurer and Secretary
/s/ John D. Curtin, Jr.* ------------------------ John D. Curtin, Jr., Director
/s/ Norman W. Alpert* --------------------- Norman W. Alpert, Director
/s/ Arthur J. Nagle* -------------------- Arthur J. Nagle, Director
/s/ Daniel S. O'Connell* ------------------------ Daniel S. O'Connell, Director
/s/ William Kassling* --------------------- William Kassling, Director
/s/ Bryan Marsal* ----------------- Bryan Marsal, Director
*By Michael A. McLain, as attorney-in-fact under a Power of Attorney executed by the Directors listed above, which Power of Attorney is being filed with the Securities and Exchange Commission as an exhibit hereto.
Date: December 22, 2003 /s/ Michael A. McLain ---------------------- Michael A. McLain Attorney-In-Fact
INDEX OF EXHIBITS
Exhibit Number Description
2.1 Asset Transfer Agreement, dated as of June 13, 1995, among Aearo Company (formerly, Cabot Safety Corporation), Cabot Canada Ltd., Cabot Safety Limited, Cabot Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation), and Cabot Safety Acquisition Corporation. (Incorporated by reference to Exhibit No. 2.1 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.)
2.2 Trademark Coexistence Agreement, dated July 11, 1995, between Cabot Corporation and Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.2 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).)
2.4 Stockholders' Agreement, dated as of July 11, 1995, among Vestar Equity Partners, L.P., Cabot CSC Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Corporation, and the Management Investors. (Incorporated by reference to Exhibit No. 2.4 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.)
2.7 Assignment and Assumption Agreement, dated as of July 11, 1995, by and between Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation and Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.7 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.)
2.8 Assignment and Assumption Agreement, dated as of July 11, 1995, by and between Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation and Cabot Safety Acquisition Limited (UK). (Incorporated by reference to Exhibit No. 2.8 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.)
2.9 Assignment and Assumption Agreement, dated as of July 11, 1995, by and between Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation and Cabot Safety Canada Acquisition Ltd. (Canada). (Incorporated by reference to Exhibit No. 2.9 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.)
2.10 Bill of Sale and Assignment, dated as of July 11, 1995, made by Aearo Company (formerly, Cabot Safety Corporation), Cabot Canada Ltd., and Cabot Safety Limited in favor of Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation, Cabot Safety Intermediate Corporation, Cabot Safety Acquisition Limited and Cabot Safety Canada Acquisition Ltd. (Incorporated by reference to Exhibit No. 2.10 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.)
2.11 Assumption Agreement dated as of July 11, 1995, by Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation, Cabot Intermediate Corporation, Cabot Safety Acquisition Limited and Cabot Safety Canada Acquisition Ltd. in favor of Cabot Corporation, Aearo Company (formerly, Cabot Safety Corporation), Cabot Canada Ltd. and Cabot Safety Limited. (Incorporated by reference to Exhibit No. 2.11 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.)
2.12 Worldwide Trademark Assignment dated July 11, 1995, by Aearo Company (formerly, Cabot Safety Corporation) to Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.12 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).)
2.13 Worldwide Copyright Assignment dated July 11, 1995, by Aearo Company (formerly, Cabot Safety Corporation) to Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.13 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).)
2.14 Worldwide Patent Assignment dated July 11, 1995, by Aearo Company (formerly, Cabot Safety Corporation) to Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.14 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).)
2.15 Management Advisory Agreement made as of July 11, 1995, among Aearo Company (formerly, Cabot Safety Corporation), Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Certain Subsidiaries of Aearo Corporation, Vestar Capital Partners and Cabot Corporation. (Incorporated by reference to Exhibit No. 2.15 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.)
2.21* Amendment to Stockholder's Agreement dated as of July 3, 1996, by and among Vestar Equity Partners, L.P., Cabot CSC Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation) Cabot Corporation, and certain other stockholders of Aearo Corporation.
3.3** Certificate of Amendment of Amended and Restated Certificate of Incorporation of Cabot Safety Holdings Corporation dated May 29, 1996
3.4** Certificate of Incorporation of Aearo Corporation as Amended through May 29, 1996
3.5** Aearo Corporation By-Laws as Amended through May 29, 1996
4.1 Indenture dated as of July 11, 1995 between Aearo Company (formerly, Cabot Safety Corporation), Aearo Corporation (formerly, Cabot Safety Holdings Corporation), and Fleet National Bank of Connecticut (formerly, Shawmut Bank Connecticut, National Association), as Trustee. (Incorporated by reference to Exhibit No. 4.1 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.)
4.3 Form of Exchange Note. (Incorporated by reference to Exhibit No. 4.3 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).)
4.5 First Supplemental Indenture dated December 6, 1995. (Incorporated by reference to Exhibit No. 4.5 to the Annual Report on Form 10-K of Aearo Corporation (formerly, Cabot Safety Holdings Corporation) for the fiscal year ended September 30, 1995.)
10.2* Amended and Restated US Pledge Agreement dated as of July 11, 1995, as made by Cabot Safety Acquisition Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Intermediate Corporation and CSC FSC, Inc., in favor of Bankers Trust Company as Collateral Agent for the Benefit of the Secured Creditors.
10.3* Amended and Restated Foreign Pledge Agreement as of July 11, 1995, amended and restated as of May 30, 1996, made by Cabot Safety Canada Acquisition Limited and Cabot Safety Acquisition Limited in favor of Bankers Trust Company as Collateral Agent for the Benefit of the Secured Creditors.
10.5* Amended and Restated US Security Agreement dated as of July 11, 1995, as amended and restated as of May 30, 1996, among Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation, Cabot Safety Intermediate Corporation, CSC FSC, Inc., and Bankers Trust Company as Collateral Agent for the Benefit of the Secured Creditors.
10.6* Amended and Restated Canadian Security Agreement dated as of July 11, 1995, as amended and restated as of May 30, 1996, granted by Cabot Safety Canada Acquisition Limited in favor of Bankers Trust Company as Collateral Agent for the Benefit of the Secured Creditors.
10.16* Aearo Corporation (formerly, Cabot Safety Holdings Corporation) Amended and Restated 1995 Employee and Non-Employee Director Stock Purchase Plan. (M)
10.17* Form of Executive Security Purchase Agreement. (M)
10.18* Aearo Corporation (formerly, Cabot Safety Holdings Corporation) Executive Stock Option Plan, adopted June 26, 1996. (M)
10.19* Amended and Restated US Subsidiary Guaranty dated July 11, 1995 delivered by Cabot Safety Intermediate Corporation, CSC FSC, Inc. and Eastern Safety Equipment Co., Inc. in favor of Bankers Trust Company.
10.25* Amended and Restated US Subsidiary Guaranty dated July 11, 1995 as amended and restated as of May 30, 1996, delivered by Cabot Safety Intermediate Corporation, CSC FSC, Inc. and Eastern Safety Equipment Co., Inc. in favor of Bankers Trust Company.
10.27 Aearo Corporation 1997 Stock Option Plan (incorporated by reference to the same numbered exhibit of the Company's Annual Report on 1998 10-K for the year ended September 30, 1998), adopted June 3, 1997. (M)
10.29 Credit Agreement dated July 11, 1995, and Amended and Restated as of July 13, 2001 (incorporated by reference to the same numbered exhibit of the Company's Quarterly Report on Form 10-Q for the quarterly period ending June 30, 2001).
10.30 First Amendment to the Amended and Restated Credit Agreement as of July 13, 2001, dated October 17, 2001 (incorporated by reference to the same numbered exhibit of the Company's Quarterly Report on Form 10-Q for the quarterly period ending December 31, 2001).
10.31 Employment Agreement between the Company and Michael A. McLain (incorporated by reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q for the Quarterly period ending March 31, 1998). (M)
10.32** Form of Executive Security Purchase Agreement Investor Note. (M)
10.33** Form of Pledge and Security Agreement related to Executive Security Purchase Agreement Investor Note. (M)
10.34** Form of Amendment No. 1 to Executive Security Purchase Agreement Investor Note, effective 2002. (M)
10.35** Summary of Management Incentive Plan for Executives other than the CEO. (M)
10.36** Summary of Management Incentive Plan for the CEO. (M)
10.37** Nonqualified Deferred Compensation Plan, effective August 5, 1999. (M)
10.38** Summary of Executive Supplemental Severance Pay Policy, as in effect December 1, 2002. (M)
10.39** Supplemental Executive Retirement Plan, revised January 1, 1999. (M)
10.40 Stock Purchase Agreement, dated June 27, 2003, between Aearo Corporation, Cabot Corporation and Cabot CSC Corporation, a wholly owned subsidiary of Cabot Corporation (incorporated by reference to the same numbered exhibit of the Company's Current Report on Foam 8-K dated August 18, 2003).
10.41 Second Amendment to the Amended and Restated Credit Agreement as of July 13, 2001, dated August 15, 2003 (incorporated by reference to the same numbered exhibit of the Company's Current Report on Foam 8-K dated August 18, 2003).
10.42 Note Purchase Agreement, dated August 18, 2003, for $15,000,000 of Senior Subordinated Notes due July 15, 2005 (incorporated by reference to the same numbered exhibit of the Company's Current Report on Foam 8-K dated August 18, 2003).
10.43+ Promissory Note, Indenture of Mortgage and Assignment of Rents and Leases, each dated April 16, 1991, pertaining to a loan to Cabot Safety Corporation by American United Life Insurance Company
10.44+ Assignment and Assumption Agreement, dated April 11, 1995, between Cabot Safety Corporation and Cabot Safety Acquisition Corporation (currently Aearo Company) for Assignment of Rents and Leases to American United Life Insurance Company
10.45+ Assignment and Assumption Agreement, dated April 11, 1995, between Cabot Safety Corporation and Cabot Safety Acquisition Corporation (currently Aearo Company) for Indenture of Mortgage to American United Life Insurance Company
10.46+ Summary of Phantom Equity Program (M)
12.1+ Statements re: Computation of Ratios.
14.1+ Code of Ethics
21.1+ List of Subsidiaries.
24.1+ Powers of Attorney (see page 71 of this report).
31.1+ Certification of Principal Executive Officer
31.2+ Certification of Principal Financial Officer
* Incorporated by reference to the same numbered exhibit to the registration statement on Form S-l, No. 333-05047, of Aearo Corporation (formerly, Cabot Safety Holdings Corporation).
** Incorporated by reference to the same numbered exhibit of the Company's Annual Report on Form 10-K dated September 30, 2002.
+ Filed herewith.
(M) Identifies management contract or compensatory plan.