ITEM 1. BUSINESS
GENERAL
Aearo Corporation (formerly Cabot Safety Holdings Corporation), a Delaware corporation ("Aearo"), and its direct wholly-owned subsidiary, Aearo Company I, doing business as Aearo Company (formerly Cabot Safety Corporation), 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 through its safety products operating unit ("Safety Products"), which manufactures and sells hearing protection devices, prescription and non-prescription safety eyewear, face shields, reusable and disposable respirators, hard hats and first aid kits in more than 85 countries under its well-known brand names: AOSafety, E-A-R, Eastern and Peltor. PPE encompasses all articles of equipment and clothing worn for the purpose of protecting against bodily injury, including safety eyewear and goggles, ear muffs and ear plugs, respirators, hard hats, gloves, safety clothing and safety shoes. Safety Products accounted for approximately 86% of the Company's net sales in fiscal 1998. 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
Through its specialty composites operating unit ("Specialty Composites"), the Company manufactures a wide array of energy-absorbing materials which are incorporated into other manufacturers' products to control noise, vibration and shock. Specific product applications for such materials include noise-reducing and vibration-dampening matting used in the lining of transportation equipment such as heavy truck cabs, shock protection parts for electronic devices such as computer disk drives, and durable energy-absorbent and cushioning foams used in footwear. Specialty Composites also produces specially formulated foam used in the manufacture of Safety Products' polyvinylchloride ("PVC") ear plugs. Specialty Composites accounted for approximately 14% of the Company's net sales in fiscal 1998.
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 revenue, operating profit, and identifiable assets by geographic area and amount of export sales is presented in Note 15 of Notes to Consolidated Financial Statements of Aearo Corporation contained in Item 8 hereof.
PERSONAL PROTECTION EQUIPMENT MARKET
A 1998 industry study prepared by Frost & Sullivan estimates that the size of the U.S. segment of the PPE market in which the Company competes (which excludes safety clothing, gloves and shoes) was approximately $1.3 billion in 1997. Management estimates annual sales outside the United States for the segment of the PPE market in which the Company competes were in excess of $1.2 billion in 1997. Historically, a large number of relatively small, independent manufacturers with limited product lines served the PPE market and the industry remains highly fragmented.
PRODUCT OVERVIEW
The Company operates through two separate operating units: Safety Products and Specialty Composites.
SAFETY PRODUCTS
Within Safety Products, the Company classifies its products in five main categories: hearing protection; safety prescription eyewear; eye, face and head protection; respiratory protection; and first aid kits.
HEARING PROTECTION. The Company's hearing protection products primarily consist of disposable ear plugs, reusable ear plugs, and ear muffs. The Company has been a leader in hearing conservation research and development since 1972, when it first introduced the PVC disposable ear plug. Today, this product is known as the "Classic" and its color yellow is a registered trademark of the Company in the United States and Canada. This 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. The Company's PVC ear plugs are available corded and uncorded and in a variety of packaging options. The Company also produces versions of the PVC plug for many of the international airlines for inclusion in their amenity kits. The Company also manufactures a full line of polyurethane ear plugs, including its E-Z-Fit and TaperFit products. These products serve the same disposable ear plug category, but the PVC ear plugs have historically led the market.
In the reusable ear plug segment of the market, the Company offers its patented UltraFit product, and the E-A-R Express, a patented product, which 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" line of "semi-aural" banded products, designed for intermittent use. These products feature articulating arms which allows for use in multiple positions and for easy storage around the neck.
The Company sells a full range of ear muffs. Through its Peltor AB subsidiary ("Peltor"), acquired on May 30, 1996, the Company manufactures, assembles and sells a broad line of ear muffs, hard hats/visors, noise attenuating headsets and wireless and hardwire communication headsets. These products serve a variety of end user markets where protection from harmful high and low frequency noise is sought or the need for easy communication in noisy or remote environment exists, such as in the construction, heavy machinery, airport, forestry, textile and mining industries. The Company also offers auditory systems products, which are sold to audiologists and are used in the testing of hearing.
SAFETY PRESCRIPTION EYEWEAR. 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 employee's prescription, and then assembles the glasses using the employee's choice of frame. The Company views its ability to provide individual attention to each patient through Company-employed, as well as independently contracted, eye professionals, as an essential part of its SRx business.
EYE, FACE AND HEAD PROTECTION. Non-prescription eye and face protection is used in work environments where a number of hazards present a danger to the eyes and face, including dust, flying particles, metal fragments, chemicals, extreme glare and radiation. The Company offers a large number of task-specific non-prescription safety eyewear products. The three basic categories of non-prescription eye and face protection are non-prescription safety (or "plano") eyewear, goggles and faceshields.
- Plano (Non-prescription) Eyewear. Plano eyewear accounts for the majority of the Company's sales in this category and includes a wide range of products from disposable visitor safety spectacles to several lines of fashionable, reusable safety eyewear available in different colors and with a variety of applications. As part of the continuing product development efforts the Company recently introduced its unique Lexa and Fectoids safety eyewear products which feature a patented contoured lens which wraps around the wearer's face, improving peripheral vision, and eliminating the need for separate side shields.
- 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 manufactures a variety of vented and non-vented goggles with varying fields of view.
- 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 patented TuffMaster 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.
FIRST AID KITS. The acquisition of Eastern Safety Equipment Co., Inc. ("Eastern") on January 3, 1996 added first aid kits as a new product category for the Company while also increasing the Company's presence in the Consumer/DIY segment. First aid kits are either for general use or for industrial or commercial uses.
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).
SPECIALTY COMPOSITES
The Company's Specialty Composites operating unit manufactures a wide array of impact-resistant, shock-absorbing and energy-absorbing materials for a variety of noise, vibration and shock control applications using a wide range of technologies, manufacturing processes and applications know-how. Specialty Composites also produces the specially formulated foam used in the manufacture of Safety Products' PVC ear plugs. The principal strengths of Specialty Composites are its specialized polyurethane chemistry, 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.
Specialty Composites' products fall into three broad categories: barriers and absorbers for noise control; damping and isolation products for vibration and shock control; and energy control products for shock and comfort management. The Company's products include: Isoloss LS polyurethane high density cellular foams, which are manufactured by three production lines in a variety of thicknesses, widths, colors and densities for reduction of excessive vibration, noise and shock control and high resilience cushioning and sealing applications; the Confor heavily damped viscoelastic foam for ergonomic cushioning applications; the Tufcote polyurethane and PVC thin sheet foams for acoustical, absorption and noise control applications; and the Isodamp PVC foams for mechanical vibration reduction and noise and shock control.
Specialty Composite's products are sold into four market segments: transportation; health-related; footwear; and other original equipment manufacturers ("OEM") in industries such as electronics and communications.
TRANSPORTATION SEGMENT. Specialty Composites' products are incorporated into heavy trucks, automobiles, yachts, aircrafts, buses, leisure vehicles and defense, farm and construction equipment in order to control noise and vibration. For example, the Company supplies durable acoustical foams and barriers that control sound and help meet noise standards for Class 8 heavy trucks. The Company also provides complete noise and vibration control packages for high-end yachts in order to contain engine room noise and to soundproof passenger quarters. Specialty Composites applications also exist with respect to executive and commuter aircraft, where relatively thin, lightweight, multi-function damping composites efficiently control sound and vibration.
HEALTH-RELATED SEGMENT. Applications for the energy-absorbing characteristics of Specialty Composites' products, particularly its line of temperature-reactive foams, have been growing in the health-related segment. Such materials enhance physical protection and improve comfort in many devices including orthopedic mattress and pillows, leg braces, orthotic devices, surgical pillows, wheelchair cushions, bicycle helmets, keyboard wrist supports and occupational seating.
FOOTWEAR SEGMENT. Specialty Composites supplies a durable and highly shock-absorbent polyurethane foam, which is incorporated into insoles for high-wear cushioning applications, such as athletic shoes, dress shoes, military boots and work boots. Specialty Composites also offers an energy-absorbent material to help protect against skeletal shock in military boots, work boots and orthotic insoles.
OEM SEGMENT. The Company produces an extensive assortment of polyurethane and PVC die-cut and molded parts for vibration isolation and damping and for shock protection and noise control in a wide range of other products, including precision equipment and industrial machinery, computer disk drives, pagers, industrial compressors and generator sets.
SALES AND MARKETING
The Company divides its sales force into two principal categories: Safety Products and Specialty Composites.
SAFETY PRODUCTS OPERATING UNIT. Within Safety Products, sales are managed through five channels: North American Industrial Distribution; North American Industrial Direct; Consumer/Do-It-Yourself ("DIY"); Europe; and International. Each of these channels has its own sales force and its own distinct yet synergistic sales strategies. In addition, through the acquisition of Peltor, the Company has significantly expanded its sales coverage, including a dedicated effort to serve the specialty communications ear muff market.
- North American Industrial Distribution. This is the largest sales channel for Safety Products and includes approximately 200 Dialog industrial distributors and approximately 160 industrial dealers in the U.S., Canada and Mexico. Participation in the Dialog program requires minimum purchase levels while encouraging support across the full product line, in return for rebates based on growth and volume as well as preferred treatment regarding shipping terms, new products, field sales support, and cooperative advertising. The Company also offers Dialog distributors financial incentives for establishing electronic order entry/invoicing interfaces with the Company and for developing marketing programs which promote the Company's products.
- North American Industrial Direct. Approximately 90% of the Company's safety prescription eyewear is sold directly to more than 40,000 industrial companies, 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. In most states, current laws require that prescription eyewear be dispensed to the user by a licensed optical professional, traditionally a local optician. As an alternative to this approach, in 1994 the Company introduced its Dispensing Manager program, whereby the Company employs its own licensed opticians to dispense prescription safety eyewear.
- Consumer/DIY. The Company is the leading supplier of safety products to the consumer/DIY market and is the primary supplier to such leading retailers as ACE, Home Depot, Lowe's, Sears and Tru-Serv. The Company offers both its AOSafety brand of industrial grade products in consumer packaging and its Eastern brand of consumer grade products in consumer packaging.
- Europe. The Company has a significant presence in Europe with sales offices in the U.K., Sweden, Germany, France, Italy and Spain. While the Company's historical strength in this market has been in hearing protection devices sold through industrial distributors, the Company has recently been successful in pursuing sales of safety eyewear and has dedicated a full-time eyewear product sales manager to lead and train the existing sales organization.
- International. The Company exports its products around the world, and this channel is managed through sales representatives located in Singapore and Hong Kong (covering Asia), Miami (covering Latin America), Sydney (covering Australia and New Zealand) and South Africa (covering the Middle East).
SPECIALTY COMPOSITES OPERATING UNIT. The Company relies upon independent manufacturer representatives and the Company's factory sales representatives to identify OEM applications for Specialty Composites' products and technologies. Once such applications have been identified, the Company's sales and technical staffs work closely with OEMs to provide the customer with a low-cost, integrated solution for its noise, vibration, shock, cushioning and/or comfort management problems.
RESEARCH AND DEVELOPMENT
SAFETY PRODUCTS OPERATING UNIT. 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 (Energy Absorbing Resins) Division of Cabot Corporation ("Cabot"), has been a leader in the development of technology for understanding and measuring noise and hearing loss and in developing products and programs to encourage hearing 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 which is accredited for testing the efficacy of hearing protection products. The Company also operates sound chambers and testing facilities which measure the performance of its materials and designs. Similarly, the Company believes that it has been a pioneer and leader in the development and testing of safety eyewear and maintains extensive facilities for the design and testing of safety eyewear. The research and development personnel of the Company include recognized experts in the safety products industry.
SPECIALTY COMPOSITES OPERATING UNIT. The research and development efforts of Specialty Composites focus on developing proprietary materials and enhancing existing products in order to meet customer needs identified by the Company's sales and technical staff. Products such as the Isoloss LS polyurethane high density cellular foams and the Confor heavily damped viscoelastic foam are being introduced in a growing number of applications across all markets served by Specialty Composites.
RAW MATERIALS AND SUPPLIERS
The Company consumes a wide variety of raw materials, supplies and components, including, among others, paper products, chemicals, eyewear frames and optical lenses. The paper products category includes corrugated paper, folding cartons and packaging materials. The chemicals category includes plastic resins such as polycarbonate and propionate, as well as polyols, plasticizers, substrates, isocyanates and adhesives. The eyewear frames category includes frames for SRx products.
The Company has a diversified base of raw material suppliers. The Company does, however, use single sources for the supply of several raw materials, including General Electric Plastics, a division of General Electric Company, for polycarbonate resin, the primary raw material used in the production of the Company's non-prescription optical lenses. The Company has not experienced any significant delays or shortages in obtaining raw materials in recent years and believes that alternative supplies of raw materials can be located on commercially reasonable terms.
The Company outsources the production of less than 10% of its products to various manufacturers. Competition among these manufacturers is strong, and, although a change in manufacturers often results in a period of adjustment concerning product quality and distribution, the Company, in the past, has changed manufacturers with respect to certain of its outsourced products.
MANUFACTURING AND DISTRIBUTION OPERATIONS
The Company maintains a high degree of vertical integration, allowing it to manufacture over 90% 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 ear plugs); high speed assembly and packaging of ear plugs; plastic injection molding, coating and assembly of non-prescription eyewear; and assembly, grinding, polishing and coating of prescription eyewear. 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 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.
SAFETY PRODUCTS OPERATING UNIT. The Company's Indianapolis, Indiana plant is the largest ear plug manufacturing facility in the world. It fabricates, molds and packages hundreds of millions of pairs of ear plugs annually, utilizing automated, high speed assembly and packaging equipment. Because the economies of scale present in this operation are unique in the hearing protection products industry, management believes that they offer the Company a competitive advantage of lower costs within the production process. The plant's high-speed robotic fabrication, assembly and packaging of ear plugs facilitate cost-saving, high-volume production and improve cycle time and inventory management. Other safety products are manufactured at the Southbridge, Massachusetts facility, where during the period 1993 to 1995 the Company invested over $2 million in industrial robotics and cellular manufacturing to produce plano eyewear products previously outsourced from southeast Asia. As a result, the Company is now able to advertise these products as "Made in the USA."
The Company fills virtually all of its domestic and certain of its international orders, other than SRx, through its state-of-the-art distribution center located in Indianapolis, Indiana which has efficient bar-coding and scanning capabilities to assure rapid turn-around time and service levels for customer orders.
During 1993 and 1994 the Company completed a major program to consolidate and retool its SRx laboratory operations. The SRx production operations of six different manufacturing facilities were consolidated into two U.S. facilities that possess new lens surfacing, edging and grinding machinery capable of handling glass, plastic and polycarbonate lenses. These two facilities currently manufacture and distribute approximately 500,000 pairs of safety prescription glasses annually.
The Company's principal international manufacturing operations are located in Poynton, England; Mississauga, Ontario; Varnamo, Sweden; and Ettlingen, Germany. The Poynton facility serves customers in Western Europe, producing and packaging ear plugs and other hearing and eyewear products. In addition, Poynton has an SRx laboratory that primarily serves the U.K. market. The Mississauga plant fabricates prescription eyewear and, together with a small prescription eyewear laboratory in Montreal, produces SRx products for the Canadian market. The Varnamo, Sweden plant is the principal Peltor manufacturing location; finished goods and components are shipped to customers and other subsidiaries from this location. Certain of these products are received in the Ettlingen, Germany plant which provides an assembly operation for the components and a
stocking facility for finished goods for shipment to customers.
SPECIALTY COMPOSITES OPERATING UNIT. Specialty Composites' products are manufactured in Indianapolis, Indiana and Newark, Delaware. The Indianapolis plant, which supplies specially formulated foam for the Company's PVC ear plugs, manufactures and fabricates sheet and roll PVC and polyurethane materials and molds polyurethane foams and solids. This facility also houses applications engineering, research and development, quality assurance and customer service support. The Newark, Delaware facility manufacturers polyurethane foams and films and houses the Company's new proprietary, thinsheet foam casting line, which will permit the casting of both sheet and composite materials, including facings and substrates, in a single pass through the line.
COMPETITION
The PPE market is fragmented and highly competitive. The Company estimates that there are more than 500 manufacturers of PPE (other than safety clothing, gloves and shoes) in the United States, 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 and brand name recognition and, to a lesser extent, price. From a positive competitive standpoint, the Company believes it is well situated, primarily because of its large size and its broad product offerings, to compete in a fragmented industry. The Company enjoys certain economies of scale which are not available to smaller competitors. Many of the Company's customers, particularly in the growing consumer/DIY channel, prefer the type of "one stop shopping" that the Company can provide. The Company's advanced distribution center further facilitates timely and accurate deliveries.
The specialty composites industry is highly competitive, and participants compete on the basis of being able to provide cost-effective solutions to the noise, shock and vibration problems of OEMs.
EMPLOYEES
As of September 30, 1998, the Company had 1,858 employees, of whom 1,252 were primarily engaged in manufacturing, 395 in sales, marketing and distribution, 66 in research and development and 145 in general and administrative. The Company believes its employee relations are good. The Company has one facility that employs union members. This facility, located in Plymouth, Indiana, employs 55 members of the International Union of Electronic, Electrical, Salaried, Maritime and Furniture Workers (out of a total of 89 employees), and the Company's relations with these union members are fully satisfactory. The union contract expires on June 26, 2001.
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 values particularly highly its trademark for the color yellow for ear plugs in the United States and Canada and places significant value 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 over the next 17 to 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 are: the Occupational Safety and Health Administration ("OSHA"), which regulates the usage of all PPE, with the exception of respirators; the Environmental Protection Agency ("EPA"), which regulates 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; and the Food and Drug Administration ("FDA"), which regulates eye, face and respiratory protection products for the healthcare industry. 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, and any failures to comply with such regulations and standards in the past have not had a material adverse effect on its business.
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.
ITEM 2.
ITEM 2. PROPERTIES
The Company owns and/or leases facilities in the United States, Canada, and Europe. The following table sets forth the location of each, its square footage and the principal function of each.
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(1) As part of the Company's restructuring activities during fiscal year 1998, the Company's Corporate Offices have been relocated to Indianapolis and merged into one of the Company's existing manufacturing locations. As a result, this space has been vacated as of June 30, 1998, and has been made available for sublease. The Company's lease commitment runs through March, 2001.
(2) This facility also serves as an international distribution center and central packaging operation with respect to certain of the Company's 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, and (iv) 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 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 sold 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 which 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.
During fiscal 1997 the Company received a complaint from Gargoyles, Inc. alleging that one of the Company's recently introduced plano eyewear products (Fectoids) infringes a patented lens shape utilized in the plaintiff's sun and sporting glasses. On October 22, 1998, the Company announced that it had entered into a settlement agreement with Gargoyles, Inc. Under the terms of the settlement, in which the Company expressly denies any liability in the lawsuit, the Company will continue to manufacture its Fectoids line of eyewear for sale into safety eyewear markets. The Company also will have the right to sell into such markets other lines of safety eyewear that Gargoyles contended infringe its patents. The Company agreed to pay Gargoyles $1.2 million in exchange for a release of all claims relating to Gargoyles' patents and for uncontested rights to continue manufacturing and selling its Fectoids and other lines of eyewear.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On September 28, 1998, the Company held a special meeting of stockholders to approve the selection of Arthur Andersen LLP as the Company's independent public accountants.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
All of the common stock, par value $0.01 per share, of Aearo ("Aearo Common Stock") is held, collectively, by Vestar Equity Partners, L.P. (together with certain related persons, "Vestar"), Cabot Corporation ("Cabot") and management. 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 finance the Formation Acquisition, the Company incurred $47.5 million of senior secured debt ("Senior Bank Facilities") sold $100 million of 12 1/2% senior subordinated notes due 2005 (the "Senior Subordinated Notes"), 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 (collectively the "Management Investors") an aggregate of 100,000 shares of Aearo Common Stock. 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.
Effective September 30, 1998, the Company sold a total of 100 shares of its common stock to certain employees at a purchase price per share of $200 in a combination of cash and loans from the Company. The loans are secured by the purchased shares, have a term of 5 years and bear interest at an annual rate of 7%. The issuances of the above shares were made pursuant to the Company's 1995 Employee Stock Purchase Plan and were exempt from the registration requirements of the Securities Act of 1933, as amended (the "Act"), by virtue of Section 4(2) of the Act.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected historical financial data for the year ended September 30, 1994 are derived from the combined financial statements of Cabot Safety Corporation, which have been audited by Coopers & Lybrand LLP, independent public accountants. The selected income statement data for the period ended July 11, 1995 are also derived from the combined financial statements of Cabot Safety Corporation, which have been audited by Arthur Andersen LLP, independent public accountants. The balance sheet data for July 11, 1995 is unaudited but, in the opinion of management, includes all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation. The selected historical financial data as of and for the period ended September 30, 1995 and as of and for the years ended September 30, 1996, 1997 and 1998 are derived from the consolidated financial statements of Aearo Corporation and were also audited by Arthur Andersen LLP. The data should be read in conjunction with the combined and consolidated financial statements and related notes, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other financial information included herein.
AEARO CORPORATION
SELECTED FINANCIAL DATA (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS AND RATIOS)
AEARO CORPORATION
SELECTED FINANCIAL DATA - (CONTINUED)
NOTES TO SELECTED FINANCIAL DATA:
(1) For the period ended July 11, 1995, includes a $1.1 million charge related to termination of the Old Cabot Safety Corporation stock option plan and a $0.8 million charge related to a provision for potential value-added tax penalties by the Company's French subsidiary.
(2) For the period ended September 30, 1995, includes a $3.6 million charge related to allocation of purchase price to inventory.
(3) Operating results subsequent to the Formation Acquisition are comparable to prior periods, with the exception of cost of sales (due to the $3.6 million and $1.0 million charges in the period and year ended September 30, 1995 and 1996, respectively, related to the allocations of purchase price to inventory), depreciation expense, amortization of intangible assets and interest expense.
(4) Includes $1.0 million charged to cost of sales as a result of purchase price allocated to inventory acquired in the Peltor acquisition. This amount was recorded in cost of sales as the acquired inventory was sold during the year ended September 30, 1996.
(5) Includes $0.8 million charged to selling and administrative expense for costs related to the abandoned effort at an initial public offering.
(6) 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 above 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.
(7) 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) and a portion of rental expense assumed to represent interest. Earnings for the period ended September 30, 1995 and the years ended September 30, 1997 and 1998 were inadequate to cover fixed charges by $0.2 million, $6.0 million, and $9.2 million, respectively.
(8) During fiscal 1998 the Company took 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. (See Note 16 of Notes to Consolidated Financial Statements.)
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
In mid-1994 management began to address operational issues that had adversely affected the Company's sales and profitability. Management focused on four primary areas: (i) strengthening relationships with distributors and product end-users, (ii) increasing the Company's participation in projected high-growth markets, such as the consumer/DIY and catalog supply markets and the emerging international markets of Latin America and the Pacific Rim, (iii) expanding product innovation and development efforts and (iv) pursuing acquisitions. The impact of these initiatives became evident during fiscal 1996. In addition, the Company completed the acquisitions of Peltor and Eastern in that same fiscal year. Each of these acquisitions has been a key contribution to the Company's overall strategy.
In the latter part of fiscal 1996, the Company undertook efforts to implement a new management information system, integrate the Peltor and Eastern acquisitions, and change the manufacturing orientation at its Southbridge, Massachusetts facility towards cellular manufacturing. Difficulties associated with the systems conversion as well as the other initiatives resulted in problems with production planning and control, shipping and distribution, and overall customer service. Throughout most of fiscal 1997 the Company spent significant sums in order to mitigate the effects of these problems on its customer base. As the year progressed, the Company realized improvements in service levels as well as a return towards historic levels of profitability.
During fiscal year 1998 the Company continued to realize these improvements and experienced four successive quarters of operating profitability improvements, excluding the $11.6 million restructuring charge and $0.5 million of personnel relocation costs associated with the move of the corporate headquarters from Boston, MA to Indianapolis, IN, as compared with the same quarters of the prior year. A new management team was installed, starting with the appointment of Michael A. McLain as President and Chief Executive Officer on February 3, 1998. During fiscal 1998 the Company continued to realize operating improvements through greater utilization of the new management information system. To further accelerate its operational benefits, the Company completed a major update of its SAP management information system to version 3.1H in November, 1998.
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.
(1) Excludes $1.0 million charged to cost of sales as a result of purchase price allocated to inventory acquired in the Peltor acquisition. This amount was recorded in cost of sales as the acquired inventory was sold during the year ended September 30, 1996.
(2) Excludes $0.8 million charged to selling and administrative expense for costs related to the abandoned effort at an initial public offering.
The Company's business is slightly seasonal. Traditionally, net sales during the first fiscal quarter (October 1 -- December 31) are slightly lower than the other quarters. This is generally attributable to stock reductions by distributors and plant shutdowns by end-users towards the end of each calendar year.
FISCAL 1998 COMPARED TO FISCAL 1997
NET SALES. Net sales in the year ended September 30, 1998 increased 2.3% to $292.5 million from $285.8 million in the year ended September 30, 1997. Both operating segments enjoyed growth with Safety Products net sales in the year ended September 30, 1998 increasing 1.3% to $252.9 million from $249.6 million in the year ended September 30, 1997 as growth with U.S. Consumer and North American and European Industrial accounts more than offset the negative effect of a stronger U.S. Dollar and decline in business with customers in Asia. Specialty Composites' net sales in the year ended September 30, 1998 increased 9.4% to $39.6 million from $36.2 million in the year ended September 30, 1997. The increase was primarily driven by the strengthening general aviation and Class 8 truck markets.
GROSS PROFIT. Gross profit in the year ended September 30, 1998 increased 5.1% to $128.6 million from $122.3 million in the year ended September 30, 1997. Gross profit as a percentage of net sales in the year ended September 30, 1998 was 44.0% as compared to 42.8% in the year ended September 30, 1997. The gross profit amount was favorably impacted by the increased net sales, and the realization of operating improvements as the Company overcame the difficulties triggered by the conversion to a new management information system and the changes in manufacturing processes at the Southbridge, Massachusetts facility. These improvements have resulted in decreased spending at the Southbridge facility, predominantly in the first quarter of 1998 and to lesser extents in the second and third quarters. These decreased operating costs were the main determinants in the improvement in the gross profit as a percent of net sales.
SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative expenses in the year ended September 30, 1998 increased 2.2% to $88.9 million from $87.0 million in the year ended September 30, 1997. Within this increase is a reduction of $0.3 million of distribution expenses. Although net sales were up 2.3%, distribution expenses decreased as the Company continued to improve service levels and overcame the difficulties triggered by the conversion to the new management information system. Sales and marketing expenses decreased by $2.6 million. These reductions were more than offset by normalized incentive accruals, and an accrual for costs related to a patent infringement claim by Gargoyles, Inc., which was settled October 22, 1998, as well as $0.5 million of personnel relocation costs associated with the move of the corporate headquarters from Boston, MA to Indianapolis, IN in the current period compared to the year after period; in the current period these accounts increased compared to the prior period. Selling and administrative expenses as a percentage of net sales in the year ended September 30, 1998 were 30.4% of net sales, the same as in the year ended September 30, 1997.
RESEARCH AND TECHNICAL SERVICES EXPENSES. Research and technical services expenses in the year ended September 30, 1998 decreased 8.9% to $4.7 million from $5.1 million in the year ended September 30, 1997. This decrease was due primarily to the timing of European development activities, and to a lesser extent the effect of a stronger U.S. dollar relative to the Swedish Krona.
AMORTIZATION OF INTANGIBLES. Amortization expense remained at a relatively consistent $6.8 million in the year ended September 30, 1998 compared to $7.0 million in the year ended September 30, 1997.
OTHER CHARGES (INCOME), NET. Other Charges (Income), Net improved to income of $0.3 million for the year ended September 30, 1998 as compared to expense of $2.5 million for the year ended September 30, 1997. This change
was primarily a result of foreign currency transaction gains in the year ended September 30, 1998 as compared to foreign currency transaction losses and charges related to the abandonment of two automation related capital projects totaling approximately $0.5 million at the Company's Indianapolis, Indiana facility in the year ended September 30, 1997.
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 abandoned product lines. In addition, the charge provides $4.3 million to cover mainly employee severance and other contractual obligations.
OPERATING INCOME. Primarily as a result of the factors discussed above, operating income decreased 18.3% to $16.9 million in the year ended September 30, 1998 from $20.7 million in the year ended September 30, 1997. Operating income as a percentage of net sales in the year ended September 30, 1998 was 5.8% as compared to 7.2% in the year ended September 30, 1997.
INTEREST EXPENSE, NET. Interest expense, net in the year ended September 30, 1998 decreased 1.9% to $26.2 million from $26.7 million in the year ended September 30, 1997.
LOSS BEFORE PROVISION FOR INCOME TAXES. Loss before provision for income taxes increased $3.3 million in the year ended September 30, 1998 to a loss of $9.2 million compared to a loss of $6.0 million in the year ended September 30, 1997 due to the lower operating income partly offset by lower interest expense.
PROVISION FOR INCOME TAXES. The provision for income taxes in the year ended September 30, 1998 was $2.2 million compared to $0.9 million in the year ended September 30, 1997. The Company's foreign subsidiaries have taxable income in their jurisdictions, but the domestic subsidiaries have a loss for income tax purposes in the U.S. In the results for the years ended September 30, 1998 and 1997, 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.
NET LOSS. For the year ended September 30, 1998, the Company had a net loss of $11.4 million as compared to a net loss of $6.9 million for the year ended September 30, 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 disposition 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)
EBITDA for the year ended September 30, 1998 was $35.6 million as compared to $37.8 million for the year ended September 30, 1997. This decrease was due primarily to the decrease in operating income described previously partly offset by higher depreciation expense. EBITDA as a percentage of net sales in the year ended September 30, 1998 was 12.2% as compared to 13.2% in the year ended September 30, 1997. Excluding the $11.6 million restructuring charge and $0.5 million of personel relocation costs associated with the move of corporate headquarters, EBITDA would have been $47.7 million, or 16.3% of net sales for the year ended September 30, 1998.
FISCAL 1997 COMPARED TO FISCAL 1996
NET SALES. Net sales in the year ended September 30, 1997 increased 17.4% to $285.8 million from $243.5 million in the year ended September 30, 1996. The increase in net sales was primarily due to the acquisitions of Peltor and Eastern which were only included for four months of fiscal 1996 and nine months of fiscal 1996, respectively, as well as internal growth at Safety Products. Safety Products net sales increased 21.6% from $205.2 million to $249.6 million. Of this $44.4 million increase, the acquisitions of Peltor and Eastern contributed $28.6 million and $3.0 million respectively, and $12.8 million was from internal growth. There was growth in net sales of eye & face products due to increased volumes and successful new products, as well as in hearing protection due to increased volumes, a portion of which was due to larger purchases from the U.S. military in order to increase inventories. Comparisons to last year were particularly strong in the fourth fiscal quarter when sales at Safety Products increased by 14.1% as the Company continued to improve service levels and overcome the difficulties triggered by the conversion to a new management information system in the fourth quarter of last year. Net Sales in last year's fourth quarter were hampered by the conversion to the new management information system. The conversion effort resulted in inaccurate production planning, backorders and missed shipments particularly in eye & face products manufactured at the Company's Southbridge, Massachusetts facility. Specialty Composites net sales decreased 5.5% from $38.3 million to $36.2 million. This decrease was largely due to the impact of a $2.3 million shipment related to the Sea Wolf Submarine in the year ended September 30, 1996 and, to a lesser extent, softness in the Class 8 truck market.
GROSS PROFIT. Gross profit in the year ended September 30, 1997 increased 11.3% to $122.3 million from $109.9 million in the year ended September 30, 1996. Excluding the $1.0 million negative effect of purchase accounting for the Peltor acquisition in fiscal 1996, gross profit would have increased 10.3% from an adjusted gross profit of $110.9 million. The increase was primarily due to the acquisitions of Peltor and Eastern which were partially offset by higher costs in the Southbridge, Massachusetts manufacturing facility and, to a lesser extent, the Indianapolis, Indiana central packaging operation in the first quarter. These costs included temporary labor, overtime and excess material usage and were significantly increased by efforts to correct difficulties associated with the conversion to the new management information system as well
as changes in manufacturing. Gross profit as a percentage of sales in the year ended September 30, 1997 was 42.8% as compared to gross profit as a percentage of sales, on an adjusted basis, of 45.6% in the year ended September 30, 1996. The percentage decrease was primarily due to the increased costs at the Southbridge, Massachusetts facility. Gross profit as a percentage of sales increased towards historical levels in the second half of the year as improvements in operations were realized.
SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative expenses in the year ended September 30, 1997 increased 18.2% to $87.0 million from $73.6 million in the year ended September 30, 1996. Of this increase, approximately $5.0 million was due to the acquisitions of Peltor and Eastern. Of the remaining increase, approximately $2.5 million was due to higher distribution expenses. These expenses include higher freight charges as well as excess labor costs associated with a higher level of backorders and partial shipments as well as a higher level of product returns. In addition, the Company incurred higher costs in customer service in order to mitigate operational difficulties relating to the new management information system. Also there were higher sales and marketing expenses from the Company's growth initiatives which were partially offset by reductions in management and employee incentive accruals. Selling and administrative expenses as a percentage of net sales were 30.5% in fiscal 1997 compared to 30.2% in fiscal 1996. Excluding the $0.8 million of costs of an abandoned equity offering in fiscal 1996, such percentage would have been 29.9%.
RESEARCH AND TECHNICAL EXPENSES. Research and technical expenses in the year ended September 30, 1997 increased 57.5% to $5.1 million from $3.3 million in the year ended September 30, 1996. The increase was primarily due to the acquisition of Peltor which spends proportionately more on research and technical services because there is a more significant technical component to this product line.
AMORTIZATION EXPENSE. Amortization expense in the year ended September 30, 1997 increased to $7.0 million from $5.6 million in the year ended September 30, 1996 as a result of purchase accounting for the acquisitions of Peltor and Eastern.
OTHER CHARGES (INCOME), NET. Other charges increased to $2.5 million in the year ended September 30, 1997 from $0.3 million in the year ended September 30,1996. Approximately $1.7 million of this increase was due to foreign exchange losses primarily during the first three fiscal quarters. During the fourth quarter the Company initiated the use of forward contracts to mitigate the effects of changes in foreign currency rates on profitability. This program has been successful in significantly reducing these effects. The remaining charges relate to the abandonment of two automation-related capital projects totaling approximately $0.5 million at the Company's Indianapolis, Indiana Safety Products manufacturing facility.
OPERATING INCOME. Primarily as a result of the factors discussed above, operating income in the year ended September 30, 1997 decreased 23.8% to $20.7 million from $27.2 million in the year ended September 30, 1996.
INTEREST EXPENSE, NET. As a result of the increased borrowings to finance the acquisitions of Peltor and Eastern, interest expense, net in the year ended September 30, 1997 increased 28.8% to $26.7 million from $20.7 million in the year ended September 30, 1996.
PROVISION FOR INCOME TAXES. The provision for income taxes in the year ended September 30, 1997 was $0.9 million. The Company's subsidiaries have taxable income in foreign jurisdictions, but a loss for income tax purposes in the U.S. In the results for the year ended September 30, 1997 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.
NET INCOME (LOSS). As a result of the decrease in operating income as well as the higher interest expense the Company incurred a net loss of $6.9 million for the year ended September 30, 1997 as compared to net income of $2.2 million for the year ended September 30, 1996.
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. EBITDA for the year ended September 30, 1997 was $37.8 million as compared to $39.7 million
for the year ended September 30, 1996. This decrease was due to fact that the contribution from the acquisitions of Peltor and Eastern were more than offset by the combined effects of higher costs in the Company's Southbridge, Massachusetts manufacturing facility, higher selling and administrative costs and the foreign exchange losses. EBITDA as a percentage of sales declined from 16.3% to 13.2% due to the decreased profitability in the first three fiscal quarters of fiscal 1997. In the fourth fiscal quarter of 1997 EBITDA was $12.2 million or 16.3% of sales as compared to $10.4 million or 16.3% of sales in the fourth fiscal quarter of fiscal 1996. This increase was due to the favorable effect of higher volume in the period as well as improvements in profitability.
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 AB, 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 estimates that these exchange rate changes had the effect of decreasing operating profit by $1.5 million in the year ended September 30, 1998 compared to the effect of decreasing operating profit by $2.1 million, and $0.3 million in the years ended September 30, 1997 and 1996, respectively.
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 system and application) 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 these remaining conversions will 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. 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.
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 aggregating $140.0 million at inception (the Term Loans) and (ii) a Revolving Credit Facility providing for up to $25.0 million (the Senior Bank Facilities).
Maturities under the Company's Term Loans are: $13.3 million in fiscal 1999, $16.4 million in fiscal 2000, $21.2 million in fiscal 2001, $34.5 million in fiscal 2002 and $35.2 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 will also be required to make interest payments with respect to both the Senior Bank Facilities and the Notes.
The Company typically makes capital expenditures related primarily to the maintenance and improvement of manufacturing facilities. The Company spent $5.8 million for capital expenditures for the year ended September 30, 1998 as compared to $8.9 million for capital expenditures for the year ended September 30, 1997 and $9.2 million for the year ended September 30, 1996. Included in the capital expenditures over the past three years was $8.0 million for a worldwide management information system. The Company's capital spending is of a relatively short duration, with the complete commitment process typically involving less than one year.
The Company's principal source of cash to fund these capital requirements is net cash provided by operating activities. The Company's net cash provided by operating activities for the year ended September 30, 1998 totaled $20.2 million as compared to $9.1 million for the year ended September 30, 1997. The increase was due primarily to a $7.8 million improvement in Operating Income before the restructuring charge, a decrease in accounts receivables of $1.4 million as compared to an increase of $0.5 million in fiscal 1997, a reduction in inventories of $0.1 million before the restructuring charge in fiscal 1998 as compared to a decrease of $3.8 million in fiscal 1997, and a decrease in accounts payable, accruals and all other of $2.1 million as compared to a decrease of $6.6 million in fiscal 1997. In fiscal 1996, the Company's net cash provided by operating activities totaled $4.5 million.
Net cash used by investing activities was $5.8 million for the year ended September 30, 1998 as compared to $8.3 million for the year ended September 30, 1997 and $96.4 million in the year ended September 30, 1996. Net cash used by investing activities consisted of $5.8 million of capital expenditures in the year ended September 30, 1998 as compared to $8.9 million in the year ended September 30, 1997. Offsetting the spending in the year ended September 30, 1997 was $0.8 million in proceeds from the sale of the Rhode Island facility of Peltor as those operations were consolidated into the Company's Southbridge, Massachusetts and Indianapolis, Indiana facilities. In the year ended September 30, 1996, excluding the $83.6 million invested in the Peltor acquisition, the $6.6 million invested in the Eastern acquisition and the escrow for the Eastern acquisition, net cash used by investing activities would have been $9.3 million.
Net cash used by financing activities for the year ended September 30, 1998 was $13.0 million related primarily to repayment of term loans of $10.5 million, repayment of other long term debt of $0.3 million and decreased borrowings under the revolving credit facility of $2.2 million. Net cash used by financing activities for the year ended September 30, 1997 was $4.2 million as compared to cash provided by financing activities of $95.5 million in the year ended September 30, 1996. Net cash used by financing activities for the year ended September 30, 1997 was $4.2 million as repayment of term loans of $8.3 million and repayment of other long term debt of $0.8 million were partially offset by increased borrowings under the revolving credit facility of $5.2 million. In fiscal 1996 net cash provided by financing activities consisted primarily of proceeds from the amended and restated senior bank facility which were used to finance the acquisitions of Peltor and Eastern.
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 available under the Senior Bank Facilities, which provides for borrowings up to $25.0 million, subject to certain customary drawing conditions, to meet its liquidity needs. At September 30, 1998 the Company had borrowed $8.0 million under the revolving credit facility. Throughout most of fiscal 1997, borrowing levels remained high until the difficulties associated with the conversion to the new management information system were largely resolved and the improvements in production planning were beginning to be realized. Management believes that improvements will continue to be realized during the next fiscal year. 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.
The Company's ability to borrow is limited by covenants in the Senior Bank Facilities and the Notes. In April, 1997, the Company amended its credit agreement with its syndicate of lenders with respect to the financial covenants applicable to periods ending on and after June 30, 1997. The revised covenants reflected the reduced profitability that the Company had experienced due to the operating difficulties which were triggered by the new management information system. The amendment also provided the Company with the ability to simplify its corporate structure in Europe in order to further integrate the Peltor operation. On September 30, 1998, the Senior Bank Facilities were amended to exclude certain restructuring charges from the calculation of EBITDA, as used in determining compliance with certain financial covenants, for the year ended September 30, 1998. On December 4, 1998, the Senior Bank Facilities were amended with respect to certain covenants applicable to periods ending on and after December 31, 1998 to reflect the Company's current level of profitability.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(1) Index to Financial Statements
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of Aearo Corporation:
We have audited the accompanying consolidated balance sheets of Aearo Corporation and subsidiaries (a Delaware corporation) as of September 30, 1997 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for the years ended September 30, 1996, 1997 and 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Aearo Corporation and subsidiaries as of September 30, 1997 and 1998, and the results of its operations and its cash flows for the years ended September 30, 1996, 1997 and 1998, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule listed in the index to the accompanying consolidated financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a part of the basic consolidated financial statements. The schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly state, in all material respects, the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Boston, Massachusetts November 16, 1998
AEARO CORPORATION
CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of these consolidated financial statements.
AEARO CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in Thousands, Except Per Share and Share Amounts)
The accompanying notes are an integral part of these consolidated financial statements.
AEARO CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Dollars in Thousands, Except Share Amounts)
The accompanying notes are an integral part of these consolidated financial statements.
AEARO CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands)
The accompanying notes are an integral part of these consolidated financial statements.
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998
(1) BASIS OF PRESENTATION
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 world-wide, a wide array of energy-absorbing materials which are incorporated into other manufacturer's products to control noise, vibration and shock.
Aearo Corporation (formerly Cabot Safety Holdings Corporation) was formed by Vestar Equity Partners, L.P. (Vestar) in June 1995 to effect the acquisition of substantially all of the assets and liabilities of Cabot Safety Corporation and certain affiliates (the Predecessor) all of which were wholly owned by Cabot Corporation (Cabot), (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, as more fully described in Note 12. 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 material assets, liabilities or operations other than those that result from its ownership of the common stock of Aearo Company. 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 (see Note 7).
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 reflect carryover basis for the percentage ownership retained by Cabot.
(2) SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles. All significant intercompany balances and transactions have been eliminated. The significant accounting policies of the Company are described below.
USE OF ESTIMATES
The preparation of the consolidated 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
REVENUE RECOGNITION
The Company generally recognizes revenue upon shipment of its products to customers.
ADVERTISING
The Company expenses the costs of advertising as incurred. These expenses were approximately $3,794,000, $5,171,000, and $4,827,000 in the years ended September 30, 1996, 1997, and 1998, respectively.
CASH EQUIVALENTS
For purposes of the consolidated statements of cash flows, the Company considers all time deposits and short-term investments with an original maturity of three months or less at time of purchase to be cash equivalents.
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. For the years ended September 30, 1996, 1997, and 1998 the accompanying consolidated statements of operations include approximately $286,000, $2,101,000, and ($617,000), respectively, of transaction (gains) and losses included in other charges (income), net. During 1997, the Company initiated the use of forward foreign currency contracts 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.
As of September 30, 1998, the Company had forward foreign currency contracts open in the following amounts:
As of September 30, 1998, the Company has deferred an unrealized gain of $31,000 associated with the above forward foreign currency contract commitments.
INVENTORIES
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.
PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are 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 $2,263,000, $2,783,000, and $3,198,000 for the years ended September 30, 1996, 1997, and 1998, respectively.
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
Property, plant and equipment and their estimated useful lives consist of the following:
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 bases of assets and liabilities using currently enacted tax rates.
INTANGIBLE ASSETS
Intangible assets consist primarily of goodwill, patents and trademarks purchased in business acquisitions. Intangible assets are amortized over their estimated useful life.
The Company accounts for long-lived and 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 intangible assets for events or changes in circumstances which 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 intangibles 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. At September 30, 1997 and 1998, no such impairment of assets was indicated.
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
A summary of the estimated lives by major category of intangible assets at September 30, 1998 is as follows:
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.
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, accounts receivable, accounts payable, Senior Subordinated Notes and bank debt (including term loans, revolving credit facility and other debt). The carrying value of these assets and liabilities is a reasonable estimate of their fair market value at September 30, 1998, except for the Senior Subordinated Notes, for which the Company estimates the fair market value to approximate $108 million at September 30, 1998.
LOSS PER COMMON SHARE
In 1998, the Company adopted 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. As of September 30, 1996, 1997 and 1998, there were 5,000, 4,418 and 7,154 options outstanding, respectively. Of these potentially dilutive securities, none qualified for inclusion in the diluted earnings per share calculation for the years ended September 30, 1996, 1997 and 1998, respectively. The implementation of this standard did not have an effect on earnings per common share in 1996 or 1997 and, therefore, did not require restatement. Basic and diluted earnings per common share for the years ended September 30, 1996, 1997 and 1998 were equal; therefore, no reconciliation between basic and diluted earnings per common share is required.
SFAS NO. 123 -- ACCOUNTING FOR STOCK-BASED COMPENSATION
On October 1, 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 123 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 Principles Board Opinion (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 (See Note 12).
SFAS NO. 130 -- REPORTING COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards board issued SFAS No. 130, Reporting Comprehensive Income. SFAS No. 130 requires the reporting of comprehensive income in addition to net income from operations. SFAS No. 130 is effective for the Company beginning October 1, 1998. Adoption of this standard will not impact the Company's conosolidated financial position, results of
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
operations or cash flows, and any effect will be limited to the form and content of its disclosures.
SFAS NO. 131 - DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
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.
SFAS NO. 133 -- ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
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.
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
(3) INVENTORIES
Inventories consisted of the following at September 30 (dollars in thousands):
(4) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following at September 30 (dollars in thousands):
(5) INTANGIBLE ASSETS
Intangible assets consist of the following at September 30 (dollars in thousands):
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
(6) ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
Accounts payable and accrued liabilities consisted of the following at September 30 (dollars in thousands):
(7) DEBT
The long-term debt balances consisted of the following at September 30 (dollars in thousands):
Senior Bank Facilities
The Company's Senior Bank Facilities consist of Term Loans and a Revolving Credit Facility as hereinafter defined. In July 1995, Aearo Company entered into a credit agreement (the Agreement) that provides for secured borrowings from a syndicate of lenders. On May 30, 1996, Aearo Company and the Syndicated Lenders amended and restated the Agreement. The amended and restated Agreement consists of (a) a secured term loan facility consisting of A and B term loans providing for up to $90.0 million of A term loans and $50.0 million of B term loans (collectively, the Term Loans); a portion of the A term loans is denominated in an equivalent amount of foreign currencies and (b) a secured revolving credit facility (the Revolving Credit Facility) providing for up to $25.0 million of revolving loans, a portion of which may be denominated in foreign currencies, for general corporate purposes and, as to $15.0 million thereof, to finance permitted acquisitions. The Revolving Credit Facility provides for the issuance of letters of credit in an aggregate face amount of up to $5.0 million. Term A and B Loans amortize quarterly over five and six year periods, respectively. Amounts repaid or prepaid in respect of the Term Loans may not be reborrowed. Loans and letters of credit under the Revolving Credit Facility will be available until the Revolving Loan Maturity Date, which is May 30, 2002.
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 plus a margin of 2.25% in the case of A Term Loans and Revolving Loans and 2.75% in the case of B Term Loans; or (b) the Base Rate, as defined plus a margin of 1.00% in the case of A Term Loans and Revolving Loans and 1.50% in the case of B Term Loans. The Base Rate is the higher of Bankers Trust Company's announced prime lending rate and 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
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
undrawn portion of the commitments in respect of the Revolving Credit Facility based upon the Company's leverage ratio, and fees relating to the issuance of letters of credit.
Under the terms of the Senior Bank Facilities, Aearo Company is required to comply with a number of affirmative and negative covenants. Among other things, Aearo Company must satisfy certain financial covenants and ratios, including interest coverage ratios, leverage ratios and fixed charge coverage ratios. In April 1997, the Senior Bank Facilities were amended with respect to certain covenants applicable to periods ending on and after June 30, 1997. On September 30, 1998, the Senior Bank Facilities were amended to exclude certain restructuring charges from the calculation of EBITDA, as used in determining compliance with certain financial covenants, for the year ended September 30, 1998. On December 4, 1998, the Senior Bank Facilities were amended with respect to certain covenants applicable to periods ending on and after December 31, 1998. The Senior Bank Facilities also impose limitations on certain business activities of Aearo Company. The Senior Bank Facilities restrict, among other things, the incurrence of additional indebtedness, creation of certain liens, sales of certain assets and limitations on transactions with affiliates. As of September 30, 1998, Aearo Company is 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.
Term Loans
At September 30, 1998 the total balance outstanding on the Term Loans was $120.6 million U.S. dollars and interest rates were 7.9% for the US Dollar Term A Loan ($27.0 million U.S. Dollars outstanding at September 30, 1998), 5.8% for the German Deutsche Mark Term A Loan (23.9 million German Deutsche Marks outstanding at September 30, 1998), 10.1% for the British Pound Term A Loan (10.2 million British Pounds outstanding at September 30, 1998), 7.4% and for the Canadian Term A Loan (6.2 million Canadian Dollars outstanding at September 30, 1998), 10.1% for the British Pound Term A Loan (5.4 million British Pounds outstanding at September 30, 1998) and 8.4% for the US Dollar Term B Loan ($4.8 million U.S. Dollars outstanding at September 30, 1998). For the year ended September 30, 1998 the weighted average interest rates paid were 8.0%, 5.9%, 9.8%, 6.8%, 9.8% and 8.5% for the US Dollar Term A Loan, for the German Deutsche Mark Term A Loan, for the British Pound Term A Loan, for the Canadian Term A Loan, for the British Pound Term A Loan and for the US Dollar Term B Loan, respectively.
At September 30, 1997 the total balance outstanding on the Term Loans was $129.6 million U.S. dollars and interest rates were 8.0% for the US Dollar Term A Loan, 5.6% for the German Deutsche Mark Term A Loan, 9.6% for the British Pound Term A Loan, 5.9% for the Canadian Term A Loan, 9.6% for the British Pound Term A Loan and 8.5% for the US Dollar Term B Loan. For the year ended September 30, 1997 the weighted average interest rates paid were 7.9%, 5.5%, 8.7%, 5.6%, 8.7% and 8.4% for the US Dollar Term A Loan, for the German Deutsche Mark Term A Loan, for the British Pound Term A Loan, for the Canadian Term A Loan, for the British Pound Term A Loan and for the US Dollar Term B Loan, respectively.
At September 30, 1996 the total balance outstanding on the Term Loans was $139.4 million U.S. dollars and interest rates were 7.8% for the US Dollar Term A Loan, 5.4% for the German Deutsche Mark Term A Loan, 8.1% for the British Pound Term A Loan, 6.4% for the Canadian Term A Loan, 8.1% for the British Pound Term A Loan and 8.3% for the US Dollar Term B Loan. During the period of May 30, 1996 to September 30, 1996 the weighted average interest rates paid were 7.7%, 5.6%, 8.1%, 6.8%, 8.1% and 8.2% for the US Dollar Term A Loan, for the German Deutsche Mark Term A Loan, for the British Pound Term A Loan, for the Canadian Term A Loan, for the British Pound Term A Loan and for the US Dollar Term B Loan, respectively.
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
Revolving Credit Facility
At September 30, 1998 the balance outstanding on the Revolving Credit Facility was $8.0 million, and the interest rate was 9.25%. For the year ended September 30, 1998, the maximum amount outstanding was $16.3 million, the average was $9.9 million, and the weighted average interest rate paid was 8.7%.
At September 30, 1997 the balance outstanding on the Revolving Credit Facility was $10.2 million, and the interest rate was 9.5%. For the year ended September 30, 1997, the maximum amount outstanding was $20.3 million, the average was $12.9 million, and the weighted average interest rate paid was 9.4%.
At September 30, 1996 the balance outstanding on the Revolving Credit Facility was $5.1 million, and the interest rate was 9.25%. During the period from May 30, 1996 to September 30, 1996, the maximum amount outstanding was $8.9 million, the average was $1.0 million, and the weighted average interest rate paid during fiscal 1996 was 9.3%.
Senior Subordinated Notes
In connection with the acquisition, Aearo Company issued $100.0 million of Senior Subordinated Notes due 2005 (Notes) which are unsecured obligations of Aearo 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 Aearo Company, on or after July 15, 2000. From and after July 15, 2000, the Notes will be subject to redemption at the option of Aearo 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 Note 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, 1998, Aearo Company is in compliance with the various covenants of the Note agreement. The Notes are unconditionally guaranteed on an unsecured, senior subordinated basis by Aearo Corporation.
Maturities
The following is a summary of maturities of all of the Company's debt obligations due after September 30, 1998 (dollars in thousands):
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
(8) Interest Expense, Net
Interest expense (income) comprises the following items (dollars in thousands):
(9) EMPLOYEE BENEFIT PLANS
The Company previously had two noncontributory defined benefit pension plans, the Aearo Company Employees' Retirement Account Plan (the Aearo Plan), which is a cash balance plan, and the E-A-R Specialty Composites Division of Aearo Company Non-Union Employees Retirement Plan (the Specialty Composites Plan). Benefits provided under these plans are primarily based on years of service and the employee's compensation. Effective December 31, 1997, net assets available for benefits totaling $1,499,027 held by the Specialty Composites Plan were transferred to the Aearo Plan in a merger of the two plans.
The Aearo Plan, effective May 1, 1990, covers most employees in the United States and is funded quarterly based on actuarial and economic assumptions designed to achieve adequate funding of projected benefit obligations. Plan assets are invested in a portfolio consisting primarily of debt and equity securities. The Specialty Composites Plan resulted from a 1989 acquisition. As of March 31, 1989, the benefits under this plan were frozen. Plan assets were invested in fixed-income investments. Benefits earned under the Specialty Composites Plan are payable from the Aearo Plan. The Aearo Plan was amended to incorporate the vesting, forms of payment, commencement dates, and actuarial equivalence provisions which existed in the Specialty Composites Plan immediately prior to the merger, for purposes of determining such benefit. However, the lump sum present values of benefits accrued under the Specialty Composites Plan will be based on the actuarial equivalence methodology specified in the Aearo Plan.
Net periodic pension cost for these plans comprises the following elements (dollars in thousands):
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
The following table sets forth the funded status of the pension plans at September 30 (dollars in thousands):
At September 30, 1997, the pension liability of $2,350,000 comprised a liability of $2,384,000 related to the Aearo Plan and a prepaid pension asset of $34,000 related to the Specialty Composites Plan.
The following weighted average rates were used in the calculations at September 30:
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 $83,000, $90,000, and $61,000 for the years ended September 30, 1996, 1997 and 1998, respectively.
A 401(k) plan, the Aearo Company Employees' 401(k) Savings Plan, was established as of May 1, 1990. Employees can join the plan after six months of service, during which they work at least 500 hours and may contribute up to 15% 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. Prior to January 1, 1997, the Company provided a 40% match to a maximum of 2% of pay. The costs to the Company for this Plan were $425,000, $717,000, and $710,000 for the years ended September 30, 1996, 1997 and 1998, 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
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
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, 1996, 1997, and 1998, the Company contributed approximately $131,000, $158,000, and $160,000, respectively.
Postretirement Benefits
The Company does not provide defined benefit postretirement plans for retirees after age 65 except that all employees who elect early retirement at age 62 or older are eligible to receive life insurance coverage that terminates on their 65th birthday. In addition, employees who were age 55 or older with 10 years of service as of April 1, 1990 are eligible to receive limited health care and life insurance coverage for themselves and their eligible dependents upon early retirement at age 62 or older. These coverages terminate on the 65th birthday of the retiree or his or her spouse. The health care benefit is a fixed dollar contribution and the life insurance benefit is a fixed coverage amount.
As of September 30, 1997 and 1998, the accrued postretirement benefit cost was $62,000 and $104,000, respectively.
(10) RELATED PARTY TRANSACTIONS
An annual management fee, which is to be shared by Cabot and Vestar, is paid in aggregate amounts with respect to each fiscal year 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. This annual management fee is shared by Cabot and Vestar based on their relative equity ownership of the Company.
The Company and Cabot have entered into an arrangement relating to certain respirator claims asserted after the Formation Acquisition 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.
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. Such loans (i) are secured by Common Stock purchased with the proceeds thereof, (ii) have a term of from 5 to 10 years, (iii) bear interest at an annual rate determined pursuant to Section 7872(f)(2) of the 1986 Internal Revenue Code, and (iv) are subject to mandatory prepayment in the event the employment of such Management Investors terminates. The aggregate amount of these loans was approximately $409,000 and $1,475,000 at September 30, 1997 and 1998, respectively and are reflected as a reduction of the additional paid-in capital account in the consolidated statements of stockholders' equity.
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
(11) Income Taxes
Income (loss) before provision for income taxes is as follows (dollars in thousands):
A summary of provision (benefit) for income taxes is as follows (dollars in thousands):
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):
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
Significant components of deferred income taxes are as follows at September 30 (dollars in thousands):
The valuation allowance at September 30, 1997 and 1998 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 carry forwards, before the tax effect, is approximately $28.0 million as of September 30, 1998. Of the Tax assets covered by the valuation allowance, as of September 30, 1998, approximately $10.7 million will be used to reduce goodwill or other intangibles related to the purchase if the benefits are realized, with $1.4 million increasing equity related to foreign currency translation adjustments.
(12) STOCKHOLDERS' EQUITY
Stock Ownership and Stockholders' Agreement
As of September 30, 1998, Cabot owns 41.5% of common stock (42,500 shares) and 50% of redeemable preferred stock (22,500 shares), Vestar owns 41.5% of common stock (42,500 shares) and 50% of redeemable preferred stock (22,500 shares) and the Management Investors and certain other employees of the Company own 17% of common stock (17,338 shares). Vestar, Cabot 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.
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued) SEPTEMBER 30, 1998
The redeemable 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 daily. 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 ($45 million) plus a redemption payment based on the dividend rate. As of September 30, 1998, the redemption value of the preferred stock is $67,289,000.
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 $500,000 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 in respect to such purchases or redemptions does not exceed $1.5 million; 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 preferred stock.
Stock Option Plans
On June 27, 1996, the Company adopted the Executive Stock Option Plan (the Executive Plan) whereby the Company, subject to approval of the Board of Directors, may grant up to 5,000 non-qualified options to certain members of management. 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 have been reserved for issuance. Under the 1997 Option Plan non-qualified and qualified options may be granted to employees of the Company. 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 and Cabot on their investment in the Company and the tenth anniversary of the date of grant. The option term will be ten years except that options shall expire in certain instances of termination of employment and upon the sale of the Company. As of September 30, 1998, a total of 7,154 options had been granted under the Executive Plan and 1997 Option Plan and a total of 7,846 options ware available for grant.
Pro Forma Stock-Based Compensation Expense
In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, Accounting for Stock-Based Compensation, which 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. Had compensation cost for awards granted in fiscal 1996, fiscal 1997 and fiscal 1998 under the Company's stock-based compensation plans been determined based on the fair value at the grant dates consistent with the method set forth under SFAS No. 123, reported net income (loss) and net income (loss) per share would not have been affected for fiscal 1996, fiscal 1997 and fiscal 1998 as the Black-Scholes option pricing model calculated no value for the options granted in those years.
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) SEPTEMBER 30, 1998
The fair value of each option grant was estimated on the grant date using the Black-Scholes option pricing model with the following weighted average assumptions:
The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option pricing models require input of highly subjective assumptions, including expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion the existing models do not necessarily provide a reliable single measure of the fair value of the Company's stock options.
Stock Option Activity
Stock option data are summarized as follows for the Executive Plan and the 1997 Option Plan for the years ended September 30, 1996, 1997 and 1998:
The following table sets forth information regarding options outstanding at September 30, 1998:
At September 30, 1996, 1997 and 1998, none of the shares were currently exercisable. At September 30, 1998, there were 7,846 options available for grant.
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) SEPTEMBER 30, 1998
(13) 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. Rent expense under such arrangements totaled $4,395,000, $5,315,000 and $5,553,000 for the years ended September 30, 1996, 1997 and 1998, respectively. Future minimum rental commitments under noncancelable leases in effect at September 30, 1998 are as follows (dollars in thousands):
Contingencies
The Company is a defendant in various lawsuits and administrative proceedings which 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 which, in the aggregate, would have a material adverse effect on the Company's financial condition or results of operations.
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) SEPTEMBER 30, 1998
During fiscal 1997 the Company received a complaint from Gargoyles, Inc. alleging that one of the Company's recently introduced plano eyewear products (Fectoids) infringes a patented lens shape utilized in the plaintiff's sun and sporting glasses. On October 22, 1998, the Company announced that it had entered into a settlement agreement with Gargoyles, Inc. Under the terms of the settlement, in which the Company expressly denies any liability in the lawsuit, the Company will continue to manufacture its Fectoids line of eyewear for sale into safety eyewear markets. The Company also will have the right to sell into such markets other lines of safety eyewear that Gargoyles contended infringe its patents. The Company agreed to pay Gargoyles $1.2 million in exchange for a release of all claims relating to Gargoyles' patents and for uncontested rights to continue manufacturing and selling its Fectoids and other lines of eyewear.
(14) ACQUISITIONS
On May 30, 1996, the Company acquired Peltor Holding AB (the Acquisition) for approximately $85.6 million. The Acquisition has been accounted for as a purchase transaction in accordance with Accounting Principles Board Opinion No. 16, and accordingly, the consolidated financial statements for the periods subsequent to May 30, 1996 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 30, 1996.
The allocation of the $85.6 million purchase price and direct acquisition costs is summarized as follows (dollars in thousands):
Unaudited pro forma operating results of the Company for the year ended September 30, 1996, as adjusted for the debt financing and estimated effects of the Acquisition as if it had occurred on October 1, 1995, are as follows:
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) SEPTEMBER 30, 1998
(15) FINANCIAL INFORMATION BY INDUSTRY SEGMENT AND GEOGRAPHIC AREA
All of Aearo Corporation's operations are included in the Safety and Energy Absorbing Products industry segment. For the years ended September 30, 1996, 1997, and 1998, no single customer accounted for more than 10% of sales. Transfers between geographic areas are recorded at cost plus markup or at market. Financial information by geographic area for the years ended September 30, 1996, 1997, and 1998, is as follows (dollars in thousands):
- ---------- (a) Unallocated corporate expenses are corporate management costs.
AEARO CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) SEPTEMBER 30, 1998
(16) 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 September 30, 1998, there is approximately $3.0 million of remaining accruals related to cash charges for severance and non-cancelable lease payments to be substantially paid in fiscal 1999.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
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 15, 1998.
NAME AGE POSITION ---- --- -------- Michael A. McLain 48 Chief Executive Officer, President, and Director
Bryan J. Carey 38 Vice President, Chief Financial Officer, Treasurer and Assistant Secretary
James D. Hall 48 Vice President, Product Development
James H. Floyd 43 Vice President, Logistics
Joseph P. Marlette 55 Vice President, Manufacturing
M. Rand Mallitz 56 Vice President and General Manager, E-A-R Specialty Composites
Daniel P. O'Connor 54 Vice President, Sales - North America
James M. Phillips 46 Vice President, Human Resources
Rahul Kapur 47 Vice President, Corporate Development
Norman W. Alpert* 40 Chairman of the Board of Directors
Daniel S. O'Connell 44 Director
Arthur J. Nagle 60 Director
Bryan P. Marsal 47 Director
William E. Kassling 54 Director
Robert Rothberg 49 Director
Margaret J. Hanratty* 50 Director
John D. Curtin, Jr. 65 Director
* Member of Audit Committee and Compensation Committee
Michael A. McLain has been President and Chief Executive Officer of Aearo Corporation since January 1998. Prior to joining Aearo he was President and Chief Executive Officer of DowBrands, Inc., a large manufacturer of household consumer products. Mr. McLain is also a director of Auburn University and Park Tudor School.
Bryan J. Carey joined the Company as Chief Financial Officer in April 1994 from Cabot, where he had been Director of Strategic Planning since August 1992. Prior to joining Cabot, he was a principal with Chase Capital Partners and its predecessor.
James D. Hall joined the Company in October 1994 and served as a consultant to the Company from July 1994 to October 1994. Mr. Hall was Executive Vice President of Uvex Safety L.L.C. from 1993 to July 1994 and Vice President-Safety of Uvex Winter Optical, Inc. from 1990 to 1993.
James H. Floyd joined the Company in April 1998 as Vice President, Logistics. Prior to April 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 P. Marlette joined the Company in April 1998 as Vice President, Manufacturing. Prior to joining Aearo, he spent 33 years in various manufacturing positions with the Dow Chemical Company.
M. Rand Mallitz joined the Company in January 1992 as Vice President and General Manager, E-A-R Specialty Composites. He was Vice President and General Manager of the Caulk Cartridge Division of Sonoco Products in 1991, and prior to that he was President/CEO of Roth Office Products.
Daniel P. O'Connor joined the Company in 1991 and has held the positions of Vice President, Sales & Distribution; Vice President, Global Sales & Marketing; and Vice President and General Manager, Prescription Eyewear. Prior to joining the Company in 1991, he was Vice President of Sales and Marketing, Residential and Small Businesses Services Division, of Northern Telecom.
James M. Phillips joined the Company in May 1998 as Vice President, Human Resources. 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 joined DowBrands in 1987 in New Product Development and was 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. Mr. Alpert is Chairman of the Board of Directors of International AirParts Corporation and Advanced Organics, Inc. and a director of Cluett American Corp., Remington Products Company, L.L.C. and Russell-Stanley Corporation, all companies in which Vestar or its affiliates have a significant equity interest. He became a director of the Company in July 1995 and Chairman in February 1998.
Daniel S. O'Connell is the Chief Executive Officer and founder of Vestar Capital Partners. Mr. O'Connell is a director of Advanced Organics, Inc., Cluett American Corp., Remington Products Company, L.L.C. and Russell-Stanley Corporation, and is a member of the partnership committee of Insight Communications Company, L.P., all 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. Mr. Nagle is a director of Remington Products Company, L.L.C., and Russell-Stanley Corporation, 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 Chairman and Chief Executive Officer of Cluett American Corp. Mr. Marsal is a director of Timex Corporation and Long Manufacturing Corp. Cluett is an apparel manufacturer of Gold Toe socks and Arrow shirts. Mr. Marsal has served as Chief Executive Officer for many other companies on a temporary basis including Republic Health, Anthony Manufacturing, Gitano Corporation and Alexanders Department Store. He became a director of the Company in October 1998.
William E. Kassling is Chairman and Chief Executive Officer of Westinghouse Air Brake Company, a manufacturer of value added equipment for locomotives, railway freight cars and passenger transit vehicles. Prior to joining Westinghouse Air Brake Company in 1984, Mr. Kassling was with American Standard Incorporated , Clark Equipment Company and Boston Consulting Group. Mr. Kassling is a director of Commercial Intertech, DRAVO Corporation, the Historical Society of Western Pennsylvania, La Rouche College and Scientific Atlanta, Inc. He became a director of the Company in July 1998.
Robert Rothberg has been Vice President and General Counsel of Cabot Corporation since October 1993. Prior to joining Cabot in 1993, Mr. Rothberg was with Choate, Hall & Stewart from 1976 -1993. He became a director of the Company in December 1998.
Margaret J. Hanratty has been Vice President and Treasurer of Cabot since September 1993, and served previously as Director of Corporate Development. Prior to joining Cabot in 1990, she served as Vice President, Mergers and Acquisitions for The First Boston Corporation. She became a director of the Company in July 1995.
John D. Curtin, Jr. joined Cabot in 1989 as Chief Financial Officer. Mr. Curtin was named Chief Executive Officer of the Company in April 1994, became a director of the Company in July 1995, and assumed the role as President in February 1997. Mr. Curtin retired as President and Chief Executive Officer of the Company in February, 1998. 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 trustee of Eastern Enterprises and a director of Imperial Holly Corporation.
The number of directors of the Company is fixed at nine. Under a stockholders' agreement among Aearo, Vestar, Cabot, and the Management Investors dated July 11, 1995 (the "Stockholders' Agreement"), Vestar has the right to designate five directors, Cabot has the right to designate two directors, and the Management Investors have the right to designate two directors. Messrs. Alpert, O'Connell, Nagle, Kassling and Marsal are the directors designated by Vestar. Mr. Rothberg and Ms. Hanratty are the directors designated by Cabot. 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 in office of each director ends when his or her successor has been elected at the next following annual meeting of stockholders and qualified or upon his or her removal or resignation.
The Board of Directors has established an audit committee consisting of Margaret J. Hanratty and Norman W. Alpert (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.
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, as well as two former executive officers of the Company (the "Named Executive Officers") for services rendered to the Company in all capacities (including service as an officer or director) in fiscal 1998.
SUMMARY COMPENSATION TABLE
(1) Includes contributions made on behalf of Mr. McLain to the Company's Supplemental Executive Retirement Plan ($9,281).
(2) Includes contributions made on behalf of Mr. Curtin to the Company's 401(k) Savings Plan ($2,500); to the Company's Cash Balance Plan ($6,400); and to the Company's Supplemental Executive Retirement Plan ($23,595). In addition, and attributed to Mr. Curtin's retirement as President and Chief Executive Officer of the Company, Mr. Curtin received a lump sum payment of $400,000 as well as accrued vacation pay ($47,000).
(3) Includes contributions made on behalf of Mr. O'Connor to the Company's 401(k) Savings Plan ($4,286); to the Company's Cash Balance Plan ($6,627); and to the Company's Supplemental Executive Retirement Plan ($8,086). Also includes relocation allowance payments associated with the relocation of the Corporate Headquarters.($18,334).
(4) Includes contributions made on behalf of Mr. Mallitz to the Company's 401(k) Savings Plan ($4,325); to the Company's Cash Balance Plan ($6,733); and to the Company's Supplemental Executive Retirement Plan ($4,583).
(5) Includes contributions made on behalf of Mr. Carey to the Company's 401(k) Savings Plan ($2,000); to the Company's Cash Balance Plan ($6,843); and to the Company's Supplemental Executive Retirement Plan ($6,668).
(6) Includes contributions made on behalf of Mr. Hall to the Company's 401(k) Savings Plan ($4,286); to the Company's Cash Balance Plan ($6,945); and to the Company's Supplemental Executive Retirement Plan ($7,134).
(7) Includes contributions made on behalf of Mr. Hague to the Company's 401(k) Savings Plan ($4,750); and to the Company's Cash Balance Plan ($7,600); and to the Company's Supplemental Executive Retirement Plan ($10,460). Also includes payments associated with the termination of his employment as severance ($249,004) and accrued vacation pay ($12,692).
The following table sets forth information concerning the individual grant of options to purchase Aearo Common Stock to the Named Executive Officers during fiscal 1998.
OPTION GRANTS DURING FISCAL 1998
- ---------- (1) The options 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. All options are subject to the employee's continued employment and terminate ten years after the grant date, subject to earlier termination in accordance with the Company's applicable stock option plan and the applicable option agreement.
(2) This column shows the hypothetical gain or "option spreads" of the options granted based on both the fair market value of the Aearo Common Stock for financial reporting purposes and assumed annual compound stock appreciation rates of 5% and 10% over the term of the options. The 5% and 10% assumed rates of appreciation are mandated by the rules of the Securities and Exchange Commission and do not represent the Company's estimate or projection of future Aearo Common Stock prices. The gains shown are net of the option exercise price, but do not include deductions for taxes or other expenses associated with the exercise of the option or the sale of the underlying shares, or reflect nontransferability, vesting or termination provisions. The actual gains, if any, on the exercises of stock options will depend on the actual future performance of the Aearo Common Stock.
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 1998. None of the Named Executive Officers exercised any stock options during fiscal 1998.
(1) There was no public market for the Aearo Common Stock as of September 30, 1998. Accordingly, these values have been calculated on the basis of an assumed fair market value of $200 per share.
DIRECTOR COMPENSATION
Directors (other than two Directors unaffiliated with Cabot or 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 were given the opportunity to purchase a limited amount of shares of Aearo Common Stock; during fiscal 1998, William E. Kassling, one of the Outside Directors, purchased 250 shares at a price of $200 per share. In connection with such purchases Mr. Kassling became party to the Stockholders' Agreement. See Item 13, "Certain Relationships and Related Transactions -- Stock Ownership and Stockholders' Agreement."
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. In connection with Mr. Curtin's retirement as President and Chief Executive Officer, neither the Company nor Mr. Curtin exercised their right to require repurchase of 3,712.5 of the shares of common stock owned by Mr. Curtin. Such shares are no longer deemed to be covered by the Stock Purchase Plan. 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 15, 1998, 13,625 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) the fifth anniversary of the Formation Acquisition. 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, the Company'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. 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 have been reserved for issuance. Under the 1997 Option Plan non-qualified and qualified options may be granted to employees 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 December 15, 1998, Non-qualified options to acquire 7,922.5 shares at a price of $600 per share have been granted to officers and key employees of the Company under the Company's stock option plans and 7,077.5 options remain available for issuance; of outstanding options, 2,068.75 in the aggregate have been granted to executive officers, including Mr. McLain (1,100 options), Mr. O'Connor (250 options), Mr. Hall (250 options), Mr. Carey (313 options) and Mr. Mallitz (156 options). The options 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."
ANNUAL BONUS. The Company provides performance-based compensation awards to executive officers and key employees for achievement during each year as part of an annual bonus 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.
SUPPLEMENTAL SEVERANCE PAY PLAN. The Company has adopted a supplemental severance pay plan providing certain executive officers and key employees with salary continuation in the event of an eligible termination based on years of service. The plan provides for one month's base pay for each full year of service with a minimum amount payable of three months and a maximum amount payable of twelve months.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN. The Company has adopted a supplemental executive retirement plan, which is a non-qualified plan under the Code, and which provides unfunded deferred compensation benefits to certain executive officers and key employees. Pursuant to the plan, participants are credited annually with amounts representing 4% of compensation in excess of that amount of compensation subject to social security taxes.
401(K) PLAN. The Company has adopted a savings plan (the "Saving Plan"), which is qualified under Section 401(a) and 401(k) of the Code. All regular employees of the Company in the United States are eligible to participate in the Savings Plan after six months of service. 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 15.0% of such participant's eligible compensation. Contributions to the Savings Plan will be invested, as the employee directs, in a money market fund, income fund, growth and income fund, growth fund, or asset allocation fund.
PENSION PLAN. The Company has adopted a cash balance plan. Under such plan, the Company will provide participants with annual credits of 4% of eligible compensation. 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. The following table sets forth, for the Named Executive Officers, the estimated annual benefits payable upon retirement at normal retirement age, assuming in each case that such officer elects payment over time rather than in a lump sum:
- ----------
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Company has a compensation committee of the Board of Directors. As of December 15, 1998 the committee consists of Messrs. Alpert and McLain and Ms. Hanratty, three directors of the Company. This committee makes all executive officer compensation decisions, with Mr. McLain abstaining with respect to decisions affecting his own compensation, and reviews them with the full Board of Directors of the Company. On March 31, 1998, Mr. McLain acquired 4,050 shares of Aearo Common Stock under the Stock Purchase Plan at a price of $810,000. Ms. Hanratty is an officer of Cabot. On July 11, 1995, as part of the Formation Acquisition, Cabot and its subsidiaries sold assets to the Company for aggregate consideration of approximately $206.1 million. Messrs. Alpert, O'Connell and Nagle, three directors of the Company, are officers of Vestar. On July 11, 1995, as part of the Formation Acquisition, Vestar invested $31.0 million in capital stock of the Company.
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, the Directors, the Named Executive Officers and all of the Company's Directors and executive officers as a group as of December 15, 1998. All of the Subsidiary's issued and outstanding capital stock is owned by Aearo.
* 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. Individually, no stockholder, director or officer of V.A.C. is deemed to have or share such voting or investment power within the meaning of Rule 13d-3 under the Exchange Act. Accordingly no part of the shares of Aearo Common Stock owned of record by Vestar is beneficially owned by Messrs. Alpert, O'Connell or Nagle or any other stockholder, director or officer of V.A.C.
(2) The board of directors of Old Cabot Safety Corporation controls the voting and investment of the shares of Aearo Common Stock held by Old Cabot Safety Corporation. Old Cabot Safety Corporation is a wholly-owned subsidiary of Cabot. Cabot appoints the directors of Old Cabot Safety Corporation and exercises ultimate voting and investment power with respect to all shares held of record by Old Cabot Safety Corporation. Cabot is a publicly held company and, accordingly, no single stockholder, director or officer of Cabot is deemed to have or share such voting or investment power within the meaning of Rule 13d-3 under the Exchange Act. Accordingly, no part of the shares of Aearo Common Stock owned of record by Old Cabot Safety Corporation is beneficially owned by any stockholder, director or officer of Cabot.
(3) Messrs. Alpert, O'Connell and Nagle are affiliated with Vestar in the capacities described under
"Management -- 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, of which such persons disclaim beneficial ownership. Each such person's business address is c/o Vestar Equity Partners, L.P. at the address set forth above.
(4) Mr. Rothberg and Ms. Hanratty are affiliated with Cabot, the parent of Old Cabot Safety Corporation, 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 Old Cabot Safety Corporation, of which such persons disclaim beneficial ownership. Each such person's business address is c/o Cabot CSC Corporation at the address set forth above.
(5) Cabot, 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 1,275 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 an 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 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 Old Cabot Safety Corporation, and has elected to make this payment, with the result that Old Cabot Safety Corporation will 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 June 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 and Old Cabot Safety Corporation with respect to such claims.
STOCK OWNERSHIP AND STOCKHOLDERS' AGREEMENT
Prior to the Formation Acquisition, Cabot owned 100% of the outstanding shares of the Subsidiary, which enabled Cabot to elect all of the directors of the Subsidiary. As of December 15, 1998, (i) Cabot indirectly owns 41.5% of the Aearo Common Stock outstanding and 50% of the Aearo Preferred Stock outstanding, (ii) Vestar owns 41.5% of the Aearo Common Stock outstanding and 50% of the Aearo Preferred Stock outstanding and (iii) 17.0% of the Aearo Common Stock has been issued to management and certain directors (collectively the Management Investors). Cabot, Vestar and the Management Investors (the "Stockholders") own 100% of the outstanding shares of Aearo Common Stock and will elect all of the directors of Aearo and determine the outcome of all matters requiring stockholder approval, including mergers, consolidations and the sale of all or substantially all of the assets of Aearo, and to prevent or cause a change in control of Aearo, in each case subject to such restrictions, limitations and conditions as may be imposed under the Stockholders' Agreement. There can be no assurance as to how long any of Cabot, Vestar or the Management Investors will hold their shares of Aearo Common Stock.
Cabot, Vestar, and the Management Investors have entered into the Stockholders' Agreement which provides for, among other things, the matters described below.
ELECTION AND REMOVAL OF DIRECTORS. The Stockholders' Agreement provides that the Board of Directors of the Company shall consist of nine members. Currently there are eight directors serving. 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 the Vestar Relative Percentage (as defined below) is at least 75% or 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) Cabot may designate two directors so long as the Cabot Relative Percentage (as defined below) is at least 75% or Cabot and its affiliates own beneficially 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), (iii) Vestar may designate two additional directors who are not partners, officers or employees of any of Vestar or its affiliates so long as the Vestar Relative Percentage is as least 75% or 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), provided that Vestar must notify Cabot in writing in advance of the identities of these director nominees and obtain Cabot's approval thereof, which may not be unreasonably withheld, and (iv) 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 the principal executive officer and the principal operating officer of the Company. Currently only one designee of the Management Investors is serving on the Board of Directors. The foregoing provisions relating to the election of directors terminate in the event that both Cabot and its affiliates, on the one hand, and Vestar and its affiliates, on the other hand, 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). The term "Vestar Relative Percentage" means a percentage reflecting (a)(i) $31 million plus (ii) the amount paid for capital stock of Aearo by Vestar and its Affiliates after the Formation Acquisition less (iii) the value (based on price per share) of all shares of Aearo Common Stock and Aearo Preferred Stock acquired by Vestar and its affiliates in the Formation Transaction and no longer held by them, less (iv) the value of all shares of the Aearo Common Stock and Aearo Preferred Stock acquired by Vestar and its affiliates after the Formation Acquisition and no longer held by them, as a percentage of (b) the amount calculated pursuant to clause (a) for Cabot and its affiliates for such date. The term "Cabot Relative Percentage" has a correlative meaning focused on Cabot's remaining investment in Aearo capital stock relative to Vestar's.
Messrs. Alpert, O'Connell and Nagle were designated by Vestar as described in clause (i) above, Mr. Rothberg and Ms. Hanratty were designated by Cabot as described in clause (ii) above, Messrs. Kassling and Marsal were designated by Vestar as described in clause (iii) above and Mr. McLain and Mr. Curtin were designated by the Management Investors as described in clause (iv) 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) or the Vestar Relative Percentage is at least 75%, 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.
If Vestar intends to transfer Aearo Common Stock to a third party in any transaction in which these drag-along rights are invoked, Vestar must give Cabot 30 days' advance written notice and, at the request of Cabot must discuss the possibility of Cabot, in lieu of the third party, acquiring such Aearo Common Stock, provided that this provision does not obligate Cabot to purchase such Aearo Common Stock or Vestar to sell such Aearo Common Stock either to Cabot or to the third party.
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 Cabot and 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, Cabot and 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, Cabot and their affiliates is permitted.
PARTICIPATION RIGHTS. Under certain circumstances, if Aearo proposes to issue any capital stock to Vestar, Cabot 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 and Cabot 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 Cabot 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 or a written request by Cabot (but only in the event that a period of one year or more has elapsed since a public offering of Aearo Common Stock without Cabot having an opportunity to participate), 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) neither Vestar nor Cabot 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. The rights of Cabot under the Stockholders' Agreement will terminate on the earliest date when Cabot or 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 to be shared by Cabot and Vestar based on their relative equity ownership of the Company. Pursuant to the Management Advisory Agreement, each of Vestar and Cabot received $434,126 (including a $19,456 reduction to each party as an advisory fee adjustment for fiscal 1997) with respect to fiscal 1998, $311,949 (including $55,975 to each party as an advisory fee adjustment relative to fiscal 1996) with respect to fiscal 1997, and $200,000 to each party with respect to fiscal 1996. Messrs. Alpert, O'Connell and Nagle, three of the directors of the Company, are affiliated with Vestar in the capacities described under Item 11, "Management -- Directors and Executive Officers" and, accordingly, benefit from any payments received by Vestar. Mr. Rothberg and Ms. Hanratty, two of the directors for the Company, are affiliated with Cabot in the capacities described under Item 11, "Management -- Directors and Executive Officers" and, accordingly, benefit indirectly from any payments received by Cabot.
MANAGEMENT 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 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) have a term of between 5 and 10 years, (iii) bear interest at an annual rate of 7%, and (iv) are subject to mandatory prepayment in the event the employment of such Management Investor terminates. At September 30, 1998, amounts outstanding under such loans to Messrs. McLain, Kapur, Marlette, Floyd, Carey, O'Connor, Mallitz, Hall, and Phillips were $607,500, $150,000, $150,000, $150,000, $100,000, $81,000, $85,305, $75,867 and $75,000, respectively.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Exhibits
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* 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).
** Filed herewith.
(b) Financial Statement Schedules See next page.
(c) 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.
SCHEDULE I
AEARO CORPORATION
VALUATION AND QUALIFYING ACCOUNTS For the years ended September 30, 1996, 1997, and 1998 (Dollars in thousands)
NOTES: A. Acquisition date balance at acquired companies. B. Accrued liabilities.
SIGNATURES
Pursuant to the requirements of Section 15(d) 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 29, 1998 By: /s/ Michael A. McLain ----------------------------------------- Michael A. McLain President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that we, the undersigned officers and directors of Aearo Corporation hereby severally constitute Michael A. McLain and Bryan J. Carey, and each of them singly, our true and lawful attorney with full power to him to sign for us and in our names in the capacities indicated below, the Annual Report on Form 10-K filed herewith and any and all amendments to said Annual Report on Form 10-K, and generally to do all such things in our names and in our capacities as officers and directors to enable Aearo Corporation to comply with the provisions of the Securities Exchange Act of 1934, and all requirements of the Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our said attorney, to said Annual Report on Form 10-K and any and all amendments thereto.
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 29, 1998 /s/ Michael A. McLain ------------------------------------ Michael A. McLain President, Chief Executive Officer and Director (Principal Executive Officer)
Date: December 29, 1998 /s/ Bryan J. Carey ------------------------------------ Bryan J. Carey Vice President, Chief Financial Officer, Treasurer and Assistant Secretary (Principal Accounting Officer)
Date: December 29, 1998 /s/ John D. Curtin, Jr. ------------------------------------ John D. Curtin, Jr., Director
Date: December __, 1998 ------------------------------------ Norman W. Alpert, Director
Date: December 29, 1998 /s/ Robert Rothberg ------------------------------------ Robert Rothberg, Director
Date: December 29, 1998 /s/ Margaret J. Hanratty ------------------------------------ Margaret J. Hanratty, Director
Date: December __, 1998 ------------------------------------ Arthur J. Nagle, Director
Date: December __, 1998 ------------------------------------ Daniel S. O'Connell, Director
Date: December __, 1998 ------------------------------------ William Kassling, Director
Date: December 29, 1998 /s/ Bryan Marsal ------------------------------------ Bryan Marsal, Director
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT
No annual report or proxy material relating to the Registrant's fiscal year ended September 30, 1998 has been sent to security holders of the Registrant.
INDEX OF EXHIBITS
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* 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).
** Filed herewith.