<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1998
Commission file number 33-96190
AEARO CORPORATION
(Exact name of registrant as specified in its charter)
--------------------
Delaware 13-3840450
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5457 West 79th Street
Indianapolis, Indiana 46268
(Address of principal executive offices) (Zip Code)
(317) 692-6666
(Registrant's telephone number, including area code)
--------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
<PAGE> 2
AEARO CORPORATION
TABLE OF CONTENTS
FORM 10-Q FOR THE QUARTERLY PERIOD
ENDED DECEMBER 31, 1998
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
- ---------------------------------------
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF
DECEMBER 31, 1998 (UNAUDITED) AND SEPTEMBER 30, 1998 3-4
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED) FOR THE THREE MONTHS ENDED
DECEMBER 31, 1998 AND 1997 5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) FOR THE THREE MONTHS ENDED
DECEMBER 31, 1998 AND 1997 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED) 7-10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
- ----------------------------------------------------------
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11-16
---------------------------------------------
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 17
- ------------------------------------
ITEM 2. CHANGES IN SECURITIES 17
- ----------------------------------------
ITEM 3. DEFAULTS UPON SENIOR SECURITIES 17
- --------------------------------------------------
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS 17
- ----------------------------------------------------------------------
ITEM 5. OTHER INFORMATION 17
- ------------------------------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 17
- ---------------------------------------------------
SIGNATURE PAGE 18
<PAGE> 3
5
PART I
ITEM 1. FINANCIAL STATEMENTS
AEARO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS--ASSETs
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
December 31, September 30,
1998 1998
----------- -------------
(Unaudited)
CURRENT ASSETS:
<S> <C> <C>
Cash and cash equivalents $ 3,943 $ 6,737
Accounts receivable (net of reserve for doubtful
accounts of $1,203 and $1,239, respectively) 38,854 44,486
Inventories 31,220 30,466
Deferred and prepaid expenses 3,626 3,572
-------- --------
Total current assets 77,643 85,261
-------- --------
PROPERTY, PLANT AND EQUIPMENT, NET 56,945 57,729
INTANGIBLE ASSETS, NET 134,320 137,848
OTHER ASSETS 5,509 5,909
-------- --------
Total assets $274,417 $286,747
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 4
AEARO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS--LIABILITIES AND STOCKHOLDERS' EQUITy
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
December 31, September 30,
1998 1998
------------- -------------
(Unaudited)
CURRENT LIABILITIES:
<S> <C> <C>
Current portion of long-term debt $ 13,544 $ 14,573
Accounts payable and accrued liabilities 33,165 37,957
Accrued interest 6,615 3,732
U.S. and foreign income taxes 3,450 3,506
-------- --------
Total current liabilities 56,774 59,768
-------- --------
LONG-TERM DEBT 212,212 218,592
DEFERRED INCOME TAXES 930 959
OTHER LIABILITIES 2,603 2,586
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value-
Authorized--200,000 shares
Issued and outstanding--45,000 shares -- --
Common stock, $.01 par value-
Authorized--200,000 shares
Issued and outstanding--102,338 shares at
December 31, and September 30, 1998 1 1
Additional paid-in capital 32,367 32,383
Accumulated deficit (17,613) (16,715)
Cumulative foreign currency translation adjustments (12,857) (10,827)
--------- ---------
Total stockholders' equity 1,898 4,842
-------- --------
Total liabilities and stockholders' equity $274,417 $286,747
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 5
AEARO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months Ended
December 31,
-------------------------------
1998 1997
--------- --------
<S> <C> <C>
NET SALES $ 69,113 $69,712
COST OF SALES 38,584 39,062
--------- --------
Gross profit 30,529 30,650
SELLING AND ADMINISTRATIVE 21,623 21,515
RESEARCH AND TECHNICAL SERVICES 1,137 1,271
AMORTIZATION OF INTANGIBLES 1,713 1,724
OTHER CHARGES (INCOME), NET 236 (438)
--------- --------
Operating income 5,820 6,578
INTEREST EXPENSE, NET 6,324 6,658
--------- --------
Loss before provision for income taxes (504) (80)
PROVISION FOR INCOME TAXES 394 669
--------- --------
Net loss (898) (749)
PREFERRED STOCK DIVIDEND ACCRUED 2,195 1,934
--------- --------
Loss applicable to Common Shareholders (3,093) (2,683)
========= ========
LOSS PER COMMON SHARE $ (30.22) $(27.62)
========= ========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 102,338 97,136
========= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE> 6
AEARO CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months Ended
December 31,
---------------------------
-------- --------
1998 1997
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net loss $ (898) $ (749)
Adjustments to reconcile net loss to cash provided by operating activities-
Depreciation 2,506 2,921
Amortization of intangible assets and deferred financing costs 2,205 2,202
Deferred income taxes (28) 173
Other, net 5
(2)
Changes in assets and liabilities-
Accounts receivable 5,267 4,805
Inventories (1,033) (2,635)
Accounts payable and accruals (1,727) (1,158)
Other, net (80) 184
-------- --------
Net cash provided by operating activities 6,210 5,748
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment (2,050) (1,348)
Proceeds provided by disposals of property, plant and equipment 3 --
-------- --------
Net cash used by investing activities (2,047) (1,348)
-------- --------
CASH Flows from Financing Activities:
Repayment of revolving credit facility, net (2,600) (3,300)
Repayment of term loans (3,132) (2,491)
Repayment of external long-term debt (1,032) (35)
Sale of common stock, net (17) 248
Increase in shareholder notes, net -- (188)
-------- --------
Net cash used by financing activities (6,781) (5,766)
-------- --------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (176) 1
-------- --------
DECREASE IN CASH AND CASH EQUIVALENTS (2,794) (1,365)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 6,737 5,476
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,943 $ 4,111
======== ========
CASH PAID FOR:
Interest $ 3,005 $ 3,204
======== ========
Income taxes $ 248 $ 98
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
6
<PAGE> 7
AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(UNAUDITED)
(1) CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited condensed
consolidated financial statements contain all adjustments necessary to
present fairly, in accordance with generally accepted accounting
principles, the Company's financial position, results of operations and
cash flows for the interim periods presented. Such adjustments consisted
of only normal recurring items. The results of operations for the interim
periods shown in this report are not necessarily indicative of results
for any future interim period or for the entire year. These condensed
consolidated financial statements do not include all disclosures
associated with annual financial statements and accordingly should be
read in conjunction with the consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10K.
(2) FORMATION ACQUISITION AND FINANCING
Aearo Corporation, a Delaware corporation, and its direct wholly-owned
subsidiary, Aearo Company, a Delaware corporation (collectively referred
to herein as "the Company") manufacture and sell hearing protection
devices (ear plugs and ear muffs), prescription and non-prescription
safety eyewear, face shields, reusable and disposable respirators, hard
hats and first aid kits which are protection segments of the personal
protection equipment market world-wide. Additionally, the Company
manufactures and sells worldwide, a wide array of energy-absorbing
materials that are incorporated into other manufacturer's products to
control noise, vibration and shock.
Aearo Corporation was formed by Vestar Equity Partners, L.P. (Vestar) in
June, 1995 to effect the acquisition (the Formation Acquisition) of
substantially all of the assets and liabilities of Aearo Company
(formerly Cabot Safety Corporation) and certain affiliates (the
Predecessor). The Predecessor was wholly owned by Cabot Corporation
(Cabot) prior to the Formation Acquisition. The Formation Acquisition
closed on July 11, 1995, when Aearo Corporation acquired substantially
all of the assets and certain liabilities of the Predecessor for cash,
preferred stock and a 42.5% common equity interest in Aearo Corporation.
Aearo Corporation immediately contributed the acquired assets and
liabilities to Aearo Company, a wholly owned subsidiary of Aearo
Corporation, pursuant to an asset transfer agreement dated June 13, 1995.
Aearo Corporation has no other materials assets, liabilities or
operations other than those that result from its ownership of the common
stock of Aearo Company.
The Formation Acquisition has been accounted for as a purchase
transaction effective as of July 11, 1995, in accordance with Accounting
Principles Board Opinion No. 16, Business Combinations, and EITF Issue
No. 88-16, Basis in Leveraged Buyout Transactions, and accordingly, the
consolidated financial statements for the periods subsequent to July 11,
1995 reflect the purchase price, including transaction costs, allocated
to tangible and intangible assets acquired and liabilities assumed, based
on a portion of their estimated fair values as of July 11, 1995. The
valuation of assets and liabilities acquired reflect carryover basis for
the percentage ownership retained by Cabot.
7
<PAGE> 8
AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
(UNAUDITED)
(3) SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates.The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
Foreign Currency Translation. Assets and liabilities of the Company's
foreign operations are translated at year-end exchange rates. Revenues
and expenses are translated at the average rate during the year.
Translation gains and losses are reflected as a separate component of
stockholders' equity. Foreign currency gains and losses arising from
transactions by any of the Company's subsidiaries are reflected in net
income.
Income Taxes. Deferred tax assets and liabilities are determined based on
the difference between the financial statement and tax bases of assets
and liabilities using enacted tax rates in effect for the year in which
the differences are expected to reverse.
Intangible Assets. Intangible assets consist primarily of the costs of
goodwill, patents, and trademarks purchased in business acquisitions.
Intangible assets are amortized on the straight-line basis over either 25
years or an estimated useful life, whichever is shorter.
Loss per Common Share. Loss per common share has been computed by
dividing loss applicable to common shareholders for the period by the
weighted average number of common shares outstanding during the period.
In 1998, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 128, Earnings Per Share. Basic earnings per common share is
computed by dividing net income (loss) by the weighted average number of
shares of common stock outstanding during the year. Diluted earnings per
common share is calculated the same as basic except, if not antidilutive,
stock options are included using the treasury stock method to the extent
that the average share trading price exceeds the exercise price. The
implementation of this standard did not have an effect on earnings per
common share for the periods presented and, therefore, did not require
restatement
Effective October 1, 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income. SFAS No. 130 requires the reporting of
comprehensive income in addition to net income from operations. The
Company's only item of comprehensive income relates to foreign currency
translation adjustments, and is presented separately on the balance sheet
as required. If presented on the statement of operations comprehensive
income would be approximately $2.0 million, and $3.3 million less than
reported net income due to foreign currency translation adjustments for
the three months ended December 31, 1998, and December 31, 1997,
respectively.
8
<PAGE> 9
AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(UNAUDITED)
In June 1997, the Financial Accounting Standards board issued SFAS No.
131, Disclosures about Segments of an Enterprise and Related Information.
SFAS No. 131 requires companies to present segment information using the
management approach. The management approach is based upon the way that
management organizes the segments within a Company for making operating
decisions and assessing performance. SFAS No. 131 is effective for the
Company beginning September 30, 1999. Adoption of this standard will not
impact the Company's consolidated financial position, results of
operations or cash flows, and any effect will be limited to the form and
content of its disclosures.
In June 1998, the Financial Accounting Standards board issued SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities. SFAS
No. 133 establishes accounting and reporting standards requiring that
every derivative instrument (including certain derivative instruments
embedded in other contracts) be recorded in the balance sheet as either
an asset or a liability measured at its fair value. SFAS No. 133 requires
that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses
to offset related results on the hedged item in the income statement, and
requires that a company must formally document, designate and assess the
effectiveness of transactions that receive hedge accounting.
SFAS No. 133 is effective for fiscal quarters of all fiscal years
beginning after June 15, 1999. A company may also implement SFAS No. 133
as of the beginning of any fiscal quarter after issuance (that is, fiscal
quarters beginning June 16, 1998 and thereafter). SFAS No. 133 cannot be
applied retroactively. SFAS No. 133 must be applied to (a) derivative
instruments and (b) certain derivative instruments embedded in hybrid
contracts that were issued, acquired or substantially modified after
December 31, 1997 (and, at a company's election, before January 1, 1998).
The Company has not yet quantified the impact of adopting SFAS No. 133 on
the consolidated financial statements and has not determined the timing
of or method of the adoption of SFAS No. 133. However, SFAS No. 133 could
increase volatility in earnings and other comprehensive income.
(4) INVENTORIES
Inventories consisted of the following (dollars in thousands):
<TABLE>
<CAPTION>
December 31, September 30,
1998 1998
------------ -------------
(unaudited)
<S> <C> <C>
Raw materials $10,261 $ 9,113
Work in process 8,437 9,257
Finished goods 12,522 12,096
------- -------
$31,220 $30,466
======= =======
</TABLE>
Inventories, which include materials, labor and manufacturing overhead,
are stated at the lower of cost or market, cost being determined using
the first-in, first-out method.
9
<PAGE> 10
AEARO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
(UNAUDITED)
(5) DEBT
The Company's debt structure includes $100.0 million of Senior
Subordinated Notes (Notes) due 2005, as well as a senior bank facility
comprised of (i) term loans denominated in U.S., Canadian, British, and
German currencies (Term Loans) and (ii) a revolving credit facility
providing for up to $25.0 million (Revolving Credit Facility),
(collectively the Senior Bank Facilities). Under the terms of both the
Senior Bank Facilities and the Notes indenture, Aearo Company is required
to comply with certain financial covenants and restrictions with which
Aearo Company was in compliance at December 31, 1998. At December 31,
1998, the amounts outstanding on the term loans and the revolving credit
facility were $116.8 million and $5.4 million, respectively.
(6) COMMITMENTS AND CONTINGENCIES
Lease Commitments. The Company leases certain transportation vehicles,
warehouse facilities, office space, and machinery and equipment under
cancelable and noncancelable leases, most of which expire within 10 years
and may be renewed by the Company.
Contingencies. The Company is a defendant in various lawsuits and
administrative proceedings that are being handled in the ordinary course
of business. In the opinion of management of the Company, these suits and
claims should not result in final judgments or settlements that, in the
aggregate, would have a material adverse effect on the Company's
financial condition or results of operations.
(7) RESTRUCTURING CHARGE
During fiscal 1998 the Company recorded a restructuring charge of $11.6
million related to the restructuring plans announced by the Company
during the fiscal year. On February 3, 1998, the Company announced the
appointment of Michael A. McLain as President and Chief Executive Officer
and on March 25, 1998 the Company announced plans to close the Boston
headquarters and relocate it to Indianapolis, Indiana, where the Company
has substantial operations. In addition, on September 30, 1998 the
Company announced plans to improve profitability through complexity
reduction and restructuring. The Company is eliminating certain product
offerings in its Eyewear and Respiratory product lines, reducing head
count in North America through restructuring and outsourcing,
consolidating the branding in its Consumer product line and reducing
selling and manufacturing cost in its Prescription eyewear product line.
The $11.6 million charge includes a $6.1 million provision for
inventories and product returns for products that are being discontinued.
The charge also provides $1.1 million for certain property, plant and
equipment for which the Company has determined there is no future use,
and $0.1 million related to intangibles on an abandoned product line. In
addition, the charge provides $4.3 million to cover mainly employee
severance and other contractual obligations.
As of December 31, 1998, there is approximately $2.4 million of remaining
accruals related to cash charges for severance and non-cancelable lease
payments to be substantially paid in fiscal 1999.
10
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Condensed
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.
1999 COMPARED TO 1998 RESULTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Ended Three Months Ended Change - Favorable
------------------------- ------------------------- (Unfavorable)
December 31, Percent of December 31, Percent of -------------------
1998 Net Sales 1997 Net Sales Amount Percent
Net Sales
<S> <C> <C> <C> <C> <C> <C>
Safety Products $ 58,940 85.3 $ 59,925 86.0 $ (985) (1.6)
Specialty Composites 10,173 14.7 9,787 14.0 386 3.9
-------- ----- -------- ----- ------- ------
Total net sales 69,113 100.0 69,712 100.0 (599) (0.9)
Cost of Sales 38,584 55.8 39,062 56.0 478 1.2
-------- ----- -------- ----- ------- ------
Gross Profit 30,529 44.2 30,650 44.0 (121) (0.4)
Operating Expenses-
Selling and administrative 21,623 31.3 21,515 30.9 (108) (0.5)
Research and technical service 1,137 1.7 1,271 1.8 134 10.5
Amortization expense 1,713 2.5 1,724 2.5 11 0.6
Other charges(income),net 236 0.3 (438) (0.6) (674) (153.9)
-------- ----- -------- ----- ------- ------
Operating income 5,820 8.4 6,578 9.4 (758) (11.5)
Interest expense, net 6,324 9.1 6,658 9.5 334 5.0
-------- ----- -------- ----- ------- ------
Loss before provision for income
tax (504) (0.7) (80) (0.1) (424) (530.0)
Provision for income taxes 394 0.6 669 1.0 275 41.1
-------- ----- -------- ----- ------- ------
Net loss (898) (1.3) (749) (1.1) (149) (19.9)
Preferred stock dividend accrued 2,195 3.2 1,934 2.8 (261) (13.5)
-------- ----- -------- ----- ------- ------
Loss applicable to common
shareholders $ (3,093) (4.5) $ (2,683) (3.9) $ (410) (15.3)
======== ===== ======== ===== ======= ======
Loss per common share $ (30.22) $ (27.62) $ (2.60) (9.4)
======== ======== ======= ======
EBITDA $ 10,055 14.5 $ 11,215 16.1 $(1,160) (10.3)
======== ===== ======== ===== ======= ======
</TABLE>
11
<PAGE> 12
RESULTS OF OPERATIONS -- THREE MONTHS ENDED DECEMBER 31, 1998 COMPARED TO THREE
MONTHS ENDED DECEMBER 31, 1997
Net Sales. Net sales in the three months ended December 31, 1998 decreased 0.9%
to $69.1 million from $69.7 million in the three months ended December 31, 1997.
Safety Products net sales in the three months ended December 31, 1998 decreased
1.6% to $58.9 million from $59.9 million in the three months ended December 31,
1997. The sales decrease is primarily due to a decline in the International
business as the economic fallout in Asia began to impact the Company's business
during the second quarter of last year. Specialty Composites' net sales in the
three months ended December 31, 1998 increased 3.9% to $10.2 million from $9.8
million in the three months ended December 31, 1997. The increase was primarily
driven by new product offerings versus the period of a year ago.
Gross Profit. Gross Profit in the three months ended December 31, 1998 decreased
0.4% to $30.5 million from $30.7 million in the three months ended December 31,
1997. Gross Profit as a percentage of net sales in the three months ended
December 31, 1998 increased to 44.2% as compared to 44.0% in the three months
ended December 31, 1997. Reduced spending and productivity in the manufacturing
plants was the primary driver of the Gross Profit percentage of net sales
improvement over a year ago. Offsetting that benefit somewhat is the
amortization of standard cost changes, which had the effect of lowering Gross
Profit by $0.5 million this year while it increased Gross Profit by $0.8 million
in the same period last year, as the Company revalued inventories to reflect the
reduced spending and productivity in the manufacturing plants.
Selling and Administrative Expenses. Selling and administrative expenses in the
three months ended December 31, 1998 increased 0.5% to $21.6 million from $21.5
million in the three months ended December 31, 1997. Within this increase is a
reduction of $0.3 million of distribution and Customer Service expenses while
the Company increased spending in Selling and Marketing by $0.5 million. Selling
and administrative expenses as a percentage of net sales in the three months
ended December 31, 1998 increased to 31.3% of net sales as compared to 30.9% of
net sales in the three months ended December 31, 1997.
Research and Technical Service Expenses. Research and technical service expenses
in the three months ended December 31, 1998 decreased 10.5% to $1.1 million from
$1.3 million in the three months ended December 31, 1997.
Amortization of Intangibles. Amortization expense in the three months ended
December 31, 1998 and 1997 was unchanged at $1.7 million.
Other Charges (Income), Net. Other Charges (Income), Net was an expense of $0.2
million for the three months ended December 31, 1998 as compared to income of
$0.4 million for the three months ended December 31, 1997. This change was a
result of foreign currency transaction losses in the three months ended December
31, 1998 as compared to foreign currency transaction gains in the three months
ended December 31, 1997.
Operating Income. Mainly as a result of the lower volume in the International
business and foreign currency transaction losses, operating income was $5.8
million in the three months ended December 31, 1998 as compared to $6.6 million
in the three months ended December 31, 1997. Operating income as a percentage of
net sales in the three months ended December 31, 1998 was 8.4% as compared to
9.4% in the three months ended December 31, 1997.
Provision For Income Taxes. The provision for income taxes in the three months
ended December 31, 1998 was $0.4 million compared to $0.7 million in the three
months ended December 31, 1997. The Company's foreign subsidiaries have taxable
income in their foreign jurisdictions, but the domestic subsidiaries have a loss
for income
12
<PAGE> 13
tax purposes in the U.S. In the results for the three months ended December 31,
1998 the Company has not recognized any of the tax benefits which will occur in
future periods if there is taxable income in the U.S.
Interest Expense, Net. Interest expense, net in the three months ended December
31, 1998 decreased 5.0% to $6.3 million from $6.7 million in the three months
ended December 31, 1997. Reduction in interest expense was due to a reduction in
average borrowings as well as a reduction in the weighted average interest rates
in effect for the three months ended December 31, 1998 as compared to the three
months ended December 31, 1997.
Net Loss. For the three months ended December 31, 1998 the Company had a net
loss of $0.9 million as compared to a net loss of $0.7 million for the three
months ended December 31, 1997.
EBITDA. EBITDA is defined as earnings before interest, taxes, depreciation,
amortization, and non-operating income or expense. Non-operating income or
expense is further defined as extraordinary gains or losses, or gains or losses
from sales of assets other than in the ordinary course of business. While the
Company believes EBITDA is a useful indicator of its ability to service debt,
EBITDA should not be considered as a substitute for net income determined in
accordance with generally accepted accounting principles as an indicator of
operating performance or as an alternative to cash flow as a measure of
liquidity. Investors should be aware that EBITDA as presented below may not be
comparable to similarly titled measures presented by other companies and
comparisons could be misleading unless all companies and analysts calculate this
measure in the same fashion.
EBITDA CALCULATION
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months Ended Change
December 31, Favorable (Unfavorable)
1998 1997 Amount Percent
------- ------- -------- -------
<S> <C> <C> <C> <C>
Operating Income ....................... $ 5,820 $ 6,578 $ (758) (11.5%)
Add Backs:
Depreciation ...................... 2,506 2,921 (415) (14.2%)
Amortization of Intangibles ....... 1,713 1,724 (11) (0.6%)
Non-operating Costs(Income) (1) ... 16 (8) 24 --
------- ------- ------
EBITDA ................................. $10,055 $11,215 $(1,160) (10.3%)
======= ======= ======= ======
(1) OTHER CHARGES (INCOME), NET SUMMARY:
Non-operating Costs (Income), Net ... $ 16 $ (8) $ (24) --
Foreign Exchange Losses (Gains) ..... 220 (430) (650) (151.2%)
------- ------- ------
Total Other Charges (Income), Net ...... $ 236 $ (438) $ (674) (153.9%)
======= ======= ======= ======
</TABLE>
EBITDA for the three months ended December 31, 1998 was $10.1 million as
compared to $11.2 million for the three months ended December 31, 1997. The
EBITDA decrease is mainly a result of the lower volume in the International
business and foreign currency transaction losses. EBITDA as a percentage of net
sales in the three months ended December 31, 1998 was 14.5% as compared to 16.1%
in the three months ended December 31, 1997.
13
<PAGE> 14
EFFECTS OF CHANGES IN EXCHANGE RATES
In general, the Company's results of operations are affected by changes in
exchange rates. Subject to market conditions, the Company prices its products in
Europe and Canada in local currency. While many of the Company's selling and
distribution costs are also denominated in these currencies, a large portion of
product costs are 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. 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 results of the Company's operations.
YEAR 2000 COMPLIANCE
The "Year 2000 problem" is a flaw existing in many computer hardware and
software programs caused by historical use of dates represented by only two
digits (for example, 98 rather than 1998). This causes computer programs (both
systems and applications) that perform arithmetic operations, comparisons, or
sorting of data fields to yield incorrect results when working with years
outside the range of 1900-1999. To evaluate the impact of this the Company has
assembled a "Y2K" cross functional team which has assessed the impact of year
2000 compliance with respect to Information Technology (IT) and manufacturing
systems as well as the Company's exposure to significant third party risks.
Accordingly, the Company has initiated and substantially completed a plan to
replace or modify existing systems and technology as required and to assure
itself that major customers and critical vendors are also addressing these
issues.
The Company's recent conversion to a new management information system that has
been in use by a majority of the Company's operating units has brought the
advantage of year 2000 compliance to the bulk of the internal systems that could
potentially otherwise have material adverse impacts on the Company's operations.
The prescription eyewear product line is the remaining operating unit that is
not predominantly operated on the new management information system. The
software for this unit will be modified and eventually a new operating system
will be installed. It is anticipated that this project will be completed by the
end of fiscal 1999. It is expected that other remaining conversions will also be
substantially completed by the end of fiscal 1999, and at this time a
contingency plan has not been developed in the event these system conversions
are not completed on a timely basis. The Company's manufacturing systems are
also being subjected to a comprehensive review to determine year 2000 compliance
and the Company has been taking corrective actions as the need arises. As it
relates to internal E-mail and desktop hardware and software systems, the
Company has begun a desktop update and standardization effort which in addition
to providing efficiency tools to the global organization will also address those
remaining year 2000 compliance issues that may exist in that environment.
Including the remaining conversion and desktop standardization initiatives and
the costs of modifying internal software for the prescription eyewear product
line, the cost to achieve Year 2000 compliance is anticipated to be less than
$1.0 million.
14
<PAGE> 15
The Company has contacted and is in the process of surveying its major customers
and vendors. However, there can be no assurance that year 2000 deficiencies in
the systems of other companies on which the Company's systems rely will be
timely corrected or that any such failure by another company to correct its
deficiencies would not have an adverse effect on the Company's systems, business
or results of operations. The Company is continuing its assessment of the
remainder of its internal systems and that of other companies on which the
Company's systems rely.
Since the majority of the Company's products are passive in nature and do not
utilize chip technologies, it is not anticipated that product returns could
materially impact the Company.
LIQUIDITY AND CAPITAL RESOURCES
The Company's sources of funds have consisted primarily of operating cash flow
and debt financing. The Company's uses of those funds consist principally of
debt service, capital expenditures and acquisitions.
The Company's debt structure includes $100.0 million of Senior Subordinated
Notes (Notes) due 2005, as well as a senior bank facility comprised of (i) term
loans denominated in U.S., Canadian, British and German currencies (Term Loans)
and (ii) a revolving credit facility providing for up to $25.0 million
(Revolving Credit Facility), (collectively the Senior Bank Facilities). Under
the terms of both the Senior Bank Facilities and the Notes indenture, Aearo
Company is required to comply with certain financial covenants and restrictions
with which Aearo Company was in compliance at December 31, 1998. At December 31,
1998, the amounts outstanding on the Term Loans and the Revolving Credit
Facility were $116.8 million and $5.4 million, respectively.
Maturities under the Company's Term Loans are: $10.0 million for the remainder
of fiscal 1999, $16.2 million in fiscal 2000, $21.0 million in fiscal 2001,
$34.3 million in fiscal 2002, and $35.3 million in fiscal 2003. Other than upon
a change of control or as a result of certain asset sales, or in the event that
certain excess funds exist at the end of a fiscal year, the Company will not be
required to make any principal payments in respect of the Notes until maturity.
The Company is required to make interest payments with respect to both the
Senior Bank Facilities and the Notes.
The Company's net cash provided by operating activities for the three months
ended December 31, 1998 totaled $6.2 million as compared to $5.7 million for the
three months ended December 31, 1997. The improvement was due primarily to the
Company's net changes in accounts receivable, inventories, and accounts payable
and accruals.
Net cash used by investing activities was $2.0 million for the three months
ended December 31, 1998 as compared to $1.3 million for the three months ended
December 31, 1997. The increase in net cash used by investing activities is
attributed to a higher level of capital expenditures in the three months ended
December 31, 1998 as compared to the three months ended December 31, 1997.
Net cash used by financing activities for the three months ended December 31,
1998 was $6.8 million as the Company reduced the borrowings under the Revolving
Credit Facility by $2.6 million, made scheduled principal repayments on the Term
Loans for $3.1 million, and reduced external long term debt by retiring a higher
interest revenue bond for $1.0 million. Net cash used by financing activities
for the three months ended December 31, 1997 was $5.8 million as the Company
reduced the borrowings under the Revolving Credit Facility by $3.3 million, and
made scheduled principal repayments on the Term Loans for $2.5 million.
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
15
<PAGE> 16
conditions) to meet its liquidity needs. The Company anticipates that operating
cash flow will be adequate to meet its debt service and capital expenditure
requirements for the next several years, although there can be no assurances
that existing levels of sales and normalized profitability, and therefore cash
flow, will be maintained in the future. Levels of sales and profitability may be
impacted by service levels, continued new product development, worldwide
economic conditions and competitive pressures. In addition, the Company may make
additional acquisitions in the future and would rely on internally generated
funds and, to the extent necessary, on borrowings to finance such acquisitions.
16
<PAGE> 17
PART II
ITEM 1. LEGAL PROCEEDINGS
Various lawsuits and claims arise against the Company in the ordinary course of
its business. Most of these lawsuits and claims relate to the Company's safety
eyewear and respiratory product lines and primarily involve accidents and/or
exposures occurring after the Company's predecessor acquired the AOSafety
Division from American Optical Corporation in April 1990. The Company is
contingently liable with respect to numerous lawsuits involving respirators
manufactured by American Optical Corporation prior to the acquisition of the
AOSafety Division in April 1990. These lawsuits typically involve plaintiffs
alleging that they suffer from asbestosis or silicosis, and that such condition
results in part from respirators that were negligently designed or manufactured.
The defendants in these lawsuits are often numerous, and include, in addition to
respirator manufacturers, employers of the plaintiffs and manufacturers of sand
(used in sand blasting) and asbestos. Responsibility for legal costs, as well as
for settlements and judgments, is shared contractually by the Company, American
Optical Corporation and a prior owner of American Optical Corporation. The
Company and Cabot have entered into an arrangement relating to certain
respirator claims asserted after July 11, 1995 (the date of the Company's
formation) whereby, so long as the Company pays to Cabot an annual fee of
$400,000, which the Company has elected to pay, Cabot will retain responsibility
and liability for, and indemnify the Company against, certain legal claims
alleged to arise out of the use of respirators manufactured prior to July 1995.
The Company has the right to discontinue the payment of such annual fee at any
time, in which case the Company will assume responsibility for and indemnify
Cabot with respect to such claims.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 -- Financial Data Schedule
(b) Reports on Form 8-K
On October 2, 1998, the Company filed a Current Report on Form 8-K
containing its press release regarding certain restructuring charges.
On October 22, 1998, the Company filed a Current Report on Form 8-K
containing its press release regarding settlement of the Gargoyles
litigation.
17
<PAGE> 18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: February 12, 1999 AEARO CORPORATION
/s/ Bryan J. Carey
----------------------------------------
Bryan J. Carey
Vice President, Chief Financial Officer,
Treasurer and Assistant Secretary
18
<PAGE> 19
EXHIBIT INDEX
EXHIBITS DESCRIPTION
- -------- -----------
27.1* -- Financial Data Schedule.
*Filed herewith.
19
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONDENSED CONSOLIDATED BALANCE SHEETS OF AEARO CORPORATION AS OF DECEMBER 31,
1998 (UNAUDITED) AND SEPTEMBER 30, 1998 AND THE CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS (UNAUDITED) FOR THE THREE MONTHS ENDED DECEMBER 31,
1998 AND 1997 CONTAINED IN AEARO CORPORATION'S FORM 10-Q FOR THE QUARTER ENDED
DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FORM
10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-START> OCT-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 3,943
<SECURITIES> 0
<RECEIVABLES> 38,854
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<INVENTORY> 31,220
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<PP&E> 87,193
<DEPRECIATION> 30,248
<TOTAL-ASSETS> 274,417
<CURRENT-LIABILITIES> 56,774
<BONDS> 212,212
0
0
<COMMON> 1
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<TOTAL-LIABILITY-AND-EQUITY> 274,417
<SALES> 69,113
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<CGS> 38,584
<TOTAL-COSTS> 38,584
<OTHER-EXPENSES> 24,709
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<INCOME-PRETAX> (504)
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<EPS-PRIMARY> (30.22)
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</TABLE>
