-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AucNr1jGB0eLZBxg7KJ/GVQ8WQKa9TI2ZubvvdTU+YWkF1LQGD6gNR2ZYcP4Z3df 020SGKtWYDhWNAcEKpzZnA== 0000950135-99-005738.txt : 19991230 0000950135-99-005738.hdr.sgml : 19991230 ACCESSION NUMBER: 0000950135-99-005738 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991229 FILER: COMPANY DATA: COMPANY CONFORMED NAME: AEARO CORP CENTRAL INDEX KEY: 0000949957 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS MANUFACTURING INDUSTRIES [3990] IRS NUMBER: 133840356 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-26940 FILM NUMBER: 99782582 BUSINESS ADDRESS: STREET 1: 5457 W 79TH ST STREET 2: 8TH FL CITY: INDIANAPOLIS STATE: IN ZIP: 46268 BUSINESS PHONE: 3176926666 MAIL ADDRESS: STREET 1: 5457 W 79TH ST CITY: INDIANAPOLIS STATE: IN ZIP: 46268 FORMER COMPANY: FORMER CONFORMED NAME: CABOT SAFETY HOLDINGS CORP DATE OF NAME CHANGE: 19950828 10-K405 1 AEARO CORPORATION 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K405 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1999 COMMISSION FILE NUMBER 33-96190 AEARO CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) -------------------------- DELAWARE 13-3840450 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 5457 WEST 79TH STREET INDIANAPOLIS, INDIANA 46268 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) (317) 692-6666 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) -------------------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of December 1, 1999, all voting stock of the Registrant was held by affiliates of the Registrant. The number of shares of the Registrant's common stock, par value $.01 per share, outstanding as of December 15, 1999 was 102,537.5. 2 TABLE OF CONTENTS
PAGE ---- PART I Item 1. Business 2 Item 2. Properties 9 Item 3. Legal Proceedings 10 Item 4. Submission of Matters to a Vote of Security Holders 10 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 11 Item 6. Selected Financial Data 11 Item 7. Management's Discussion and Analysis of Financial Condition and Results Of Operations 14 Item 7A. Market Risk Disclosure 21 Item 8. Financial Statements and Supplementary Data 22 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 45 PART III Item 10. Directors and Executive Officers 46 Item 11. Executive Compensation 49 Item 12. Security Ownership of Certain Beneficial Owners and Management 53 Item 13. Certain Relationships and Related Transactions 54 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 57
1 3 PART I ITEM 1. BUSINESS GENERAL Aearo Corporation, a Delaware corporation ("Aearo"), and its direct wholly-owned subsidiary, Aearo Company I, doing business as Aearo Company, a Delaware corporation (the "Subsidiary"), are collectively referred to herein as the "Company". The Company is one of the leaders in the hearing, eye, face, head and respiratory protection segments of the personal protection equipment ("PPE") market worldwide. PPE encompasses all articles of equipment and clothing worn for the purpose of protecting against bodily injury, including safety eyewear and goggles, ear muffs and earplugs, respirators, hard hats, gloves, safety clothing and safety shoes. The Company manufactures and sells hearing protection devices, communication headsets, prescription and non-prescription safety eyewear, face shields, reusable and disposable respirators, hard hats and first aid kits in more than 85 countries under its well-known brand names: AOSafety(R), E-A-R(R), and Peltor(R). The Company attributes its leading market positions to: - Strong, well-recognized brand names - A reputation for providing innovative, quality products - Intensive coverage of multiple distribution channels targeting a wide array of end-users - One of the industry's broadest product offerings, and - A commitment to providing the highest level of customer service The Company also manufactures a wide array of energy-absorbing materials that are incorporated into other manufacturers' products to control noise, vibration and shock. These products are marketed under its brand name E-A-R(R) Specialty Composites. Aearo derives all of its operating income and cash flow from the Subsidiary, and its only material assets are the shares of common stock of the Subsidiary that Aearo owns. Other than its ownership of the Subsidiary and its guarantee of the indebtedness of the Subsidiary, Aearo has no business or operations. Aearo was incorporated in the state of Delaware in June 1995. Detailed information with respect to the Company's segment reporting is presented in Note 15 of Notes to Consolidated Financial Statements of Aearo Corporation contained in Item 8 hereof. RECENT DEVELOPMENTS On October 28, 1999, the Company acquired Ontario, Canada based Norhammer Limited for approximately Canadian $5.5 million. Norhammer is a market leader in the earmuff and communication headset segments in Canada and has been in operation for more than two decades. It has been the exclusive distributor of the Company's Peltor(R) brand products in Canada and had annual sales of Canadian $6.2 million in its last fiscal year. Norhammer specializes in adapting Peltor(R) products for the U.S. and Canada, by linking these products to two-way radios (made by such companies as Nokia and Motorola). Norhammer also provides after-sales service. Norhammer will be operated within the Safety Products segment of the Company. On August 2, 1999, the Company acquired Safety Optical, Inc. of Athens, Tennessee for approximately $3.7 million. Safety Optical is the fifth largest prescription safety eyewear manufacturer in the U.S. with revenues of approximately $4.5 million and has a history of growth in sales and profitability. Safety Optical will be operated within the Safety Prescription Eyewear segment of the Company. SEGMENTS The Company operates three business segments. The Safety Products segment manufactures and sells hearing protection devices, communication headsets, non-prescription safety eyewear, face shields, reusable and disposable respirators, hard hats and first aid kits in more than 85 countries under its well-known brand names: AOSafety(R), E-A-R(R), and Peltor(R). The Safety Products segment accounted for approximately 73% of the Company's net sales in fiscal 1999. The Safety Prescription Eyewear ("SRx") segment manufactures and sells products that are designed to protect the eyes from the typical hazards encountered in the industrial work environment. The Company purchases component parts (lenses and the majority of its frames) from various suppliers, grinds and shapes the lenses to the customer's prescription, and then assembles 2 4 the glasses using the customer's choice of frame. The Safety Prescription Eyewear segment accounted for approximately 12% of the Company's net sales in fiscal 1999. The Specialty Composites segment manufactures a wide array of energy-absorbing materials that are incorporated into other manufacturers' products to control noise, vibration and shock. Specific product applications for such materials include noise-reducing and vibration-damping matting used in under hood and cab treatments of transportation equipment such as Class 8 heavy truck, shock protection parts for electronic devices such as computer disk drives, servers, and durable energy-absorbent and cushioning foams used in footwear. Specialty Composites also produces specially formulated foam used in the manufacture of the Safety Products segment's polyvinylchloride ("PVC") earplugs. Specialty Composites accounted for approximately 15% of the Company's net sales in fiscal 1999. PRODUCTS - SAFETY PRODUCTS SEGMENT Within Safety Products, the Company classifies its products in five main categories: hearing protection and communication headsets; eyewear; face and head protection; respiratory protection; and other protection products. HEARING PROTECTION. The Company's hearing protection products primarily consist of disposable earplugs, reusable earplugs, and ear muffs. The Company has been a leader in hearing conservation research and development since 1972, when it first introduced the PVC disposable earplug. Today, this product is known as the "Classic" (R) and its color yellow is a registered trademark 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 earplugs 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. In addition the Company manufactures a full line of polyurethane earplugs, including its E-Z-Fit(R), TaperFit(R), E-A-Rsoft(TM), Yellow Neons(TM), and E-A-Rsoft(TM) Yellow Neon Blasts(TM) products. These products serve the same disposable earplug category, but the PVC earplugs have historically led the market. In the reusable earplug segment of the market, the Company offers its patented UltraFit(R) product, and the E-A-R(R) Express(TM), 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"(TM) 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 and communication headsets. The Company is a leader in providing 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. EYE 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 basic categories of non-prescription eyewear protection are non-prescription safety (or "plano") eyewear and goggles: - 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(R) and Fectoids(R) 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. 3 5 FACE AND HEAD PROTECTION. Face and head protection is used in work environments where a number of hazards present a danger to the eyes, face and head, including dust, flying particles, metal fragments, chemicals, extreme glare, radiation and items dropped from above. The basic categories of face and head protection are faceshields and hard hats: - Faceshields. Faceshields are designed to protect against heat, splash and flying particles and are worn in conjunction with other protective equipment, such as plano eyewear and respirators. The patented AO TuffMaster(R) line of faceshields is one of the leading brands in the market. - Hard Hats. The Company manufactures and sells a broad line of hard hats, including "bump" caps, full-brim hats and traditional hard hats, featuring four or six point suspension, ratchet adjustment, and a wide selection of colors and custom imprinting. 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). OTHER PROTECTION PRODUCTS. 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/Do-It-Yourself(DIY) market. First aid kits are either for general use or for industrial or commercial uses. Additional products in this group include safety vests and safety cones. PRODUCTS - SAFETY PRESCRIPTION EYEWEAR SEGMENT The Company's safety prescription eyewear ("SRx") products are designed to protect the eyes from the typical hazards encountered in the industrial work environment. The Company purchases component parts (lenses and the majority of its frames) from various suppliers, grinds and shapes the lenses to the end users's prescription, and then assembles the glasses using the end user's choice of frame. The Company views its ability to provide individual attention to each patient through Company-employed, as well as independently contracted, eye care professionals, as an essential part of its SRx business. PRODUCTS - SPECIALTY COMPOSITES SEGMENT The Company's Specialty Composites segment manufactures a wide array of impact-resistant, shock and energy-absorbing materials for a variety of applications employing 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 earplugs. The principal strengths of Specialty Composites are its specialized polyurethane formulations, its thin-sheet casting capability, its composite technologies and its applications and materials engineering. These strengths allow the Company to manufacture in a single process, high value-added composites using casting, extrusion and molding processes. Specialty Composites' products fall into three broad categories: barriers and absorbers for airborne 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: Isolos(R) 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(R) 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(R) PVC foams for mechanical vibration reduction and noise and shock control. Specialty Composites' products are sold into three markets: transportation; health-related; and original equipment manufacturers ("OEM") in industrial applications such as electronics and industrial equipment. TRANSPORTATION MARKET. 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. 4 6 HEALTH-RELATED MARKET. 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. OEM MARKET. 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 its three business segments, as follows: SALES AND MARKETING - SAFETY PRODUCTS SEGMENT Within Safety Products, sales are managed through four channels: North American Industrial Distribution; 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(TM) industrial distributors and approximately 160 industrial dealers in the U.S., Canada and Mexico. Participation in the Dialog(TM) 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(TM) distributors financial incentives for establishing electronic order entry/invoicing interfaces with the Company and for developing marketing programs which promote the Company's products. - 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, Wal-Mart and Tru-Serv. The Company offers its AOSafety(R) brand of industrial 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). SALES AND MARKETING - SAFETY PRESCRIPTION EYEWEAR SEGMENT (SRX) Approximately 90% of the Company's safety prescription eyewear is sold directly to more than 15,000 industrial locations, including a majority of the industrial companies in the Fortune 500. The remainder of the Company's SRx products are sold through the industrial distribution channel and direct to eye care professionals. In most states, current laws require that prescription eyewear be dispensed to the user by a licensed eye care professional, traditionally a local optician. To ensure quality service to it is customers the Company also employs its own licensed opticians. SALES AND MARKETING - SPECIALTY COMPOSITES SEGMENT 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. 5 7 RESEARCH AND DEVELOPMENT RESEARCH AND DEVELOPMENT - SAFETY PRODUCTS SEGMENT. The Company believes that its research and development facilities, personnel and programs are among the best in the PPE industry. Since its inception in 1972, the Company's ultimate predecessor, the former E-A-R(R) (Energy Absorbing Resins) Division of Cabot Corporation ("Cabot"), has been a leader in the development of technology for understanding 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 that 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. RESEARCH AND DEVELOPMENT - SAFETY PRESCRIPTION EYEWEAR SEGMENT This segment shares some of the expertise within the Safety Products Segment and works extensively with outside suppliers for development of frames, lenses and coatings. RESEARCH AND DEVELOPMENT - SPECIALTY COMPOSITES SEGMENT 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 Isolos(R) LS polyurethane high density cellular foams and the Confor(R) 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 earplugs); high speed assembly and packaging of earplugs; plastic injection molding, coating and assembly of non-prescription eyewear; and assembly, grinding, polishing and coating of prescription eyewear. 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. 6 8 MANUFACTURING AND DISTRIBUTION OPERATIONS - SAFETY PRODUCTS SEGMENT The Company's Indianapolis, Indiana plant is the largest earplug manufacturing facility in the world. It fabricates, molds and packages hundreds of millions of pairs of earplugs 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 earplugs facilitate cost-saving, high-volume production and improve cycle time and inventory management. The Southbridge, Massachusetts facility is the Company's largest manufacturing site and manufactures a wide variety of Personnel Protection Equipment. These manufactured safety products include respiratory, plug and muff type hearing, head and face, and a broad offering of safety eyewear protection. The Southbridge operation has implemented a number of World Class Manufacturing initiatives resulting in significant improvements in the areas of Safety, Quality, Cost, and Customer Service. The Company's principal international manufacturing operations are located in Poynton, England; Varnamo, Sweden; and Ettlingen, Germany. The Poynton facility serves customers in Western Europe, producing and packaging earplugs and other hearing and eyewear products. The Varnamo, Sweden plant is the principal Peltor manufacturing location; 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 that provides an assembly operation for the components and a stocking facility for finished goods for shipment to customers. The Company fills virtually all of its domestic and certain of its international orders 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. MANUFACTURING AND DISTRIBUTION OPERATIONS - SAFETY PRESCRIPTION EYEWEAR SEGMENT The SRx production operations are comprised of three U.S. facilities, including the newly acquired lab in Athens, Tennessee. In Canada, the Mississauga, Ontario plant fabricates prescription eyewear and, together with a small prescription eyewear laboratory in Montreal, produces SRx products for the Canadian market. In Poynton, England the Company has an SRx laboratory that serves primarily the U.K. market. These facilities possess lens surfacing, edging and grinding machinery capable of handling glass, plastic and polycarbonate lenses. These are then fitted into frames and the finished jobs are shipped to customers. These facilities currently manufacture and distribute approximately 500,000 pairs of safety prescription glasses annually. MANUFACTURING AND DISTRIBUTION OPERATIONS - SPECIALTY COMPOSITES SEGMENT Specialty Composites' products are manufactured in Indianapolis, Indiana and Newark, Delaware. The Indianapolis plant, which supplies specially formulated foam for the Company's PVC earplugs, 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 AND THE 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. The PPE market is fragmented and highly competitive as a large number of relatively small, independent manufacturers with limited product lines serve the PPE. 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 7 9 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, 1999, the Company had 1,728 employees, of whom 1,139 were primarily engaged in manufacturing, 405 in sales, marketing and distribution, 64 in research and development and 120 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 38 members of the International Union of Electronic, Electrical, Salaried, Maritime and Furniture Workers (out of a total of 80 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 earplugs 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. 8 10 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.
APPROXIMATE LOCATION SQUARE FEET FUNCTION - -------- ----------- -------- SAFETY PRODUCTS Southbridge, 295,000 Manufacturing/Administration Massachusetts................................ Indianapolis, Indiana 220,564 Distribution/Customer Service (1).......................................... Indianapolis, Indiana........................ 81,540 Manufacturing/Corporate Headquarters Poynton, England 56,530 Manufacturing/Distribution/Customer Service (2).......................................... Varnamo, Sweden.............................. 125,595 Manufacturing/Distribution/Customer Service Ettlingen, Germany........................... 45,000 Manufacturing/Distribution/Customer Service Bognor Regis, England........................ 2,700 Customer Service Paris, France................................ 1,894 Sales Office Gravenhurst, Ontario, Canada................. 7,500 Manufacturing/Distribution/Customer Service Barcelona, Spain............................. (*) Sales Office Milan, Italy................................. (*) Sales Office SAFETY PRESCRIPTION EYEWEAR Chickasha, Oklahoma.......................... 15,000 Manufacturing/Customer Service Plymouth, Indiana............................ 10,224 Manufacturing/Customer Service Athens, Tennessee............................ 28,000 Manufacturing/Customer Service Mississauga, Ontario, Canada................. 28,850 Manufacturing/Customer Service Montreal, Quebec, Canada..................... 1,800 Manufacturing/Customer Service SPECIALTY COMPOSITES Indianapolis, Indiana........................ 156,000 Manufacturing/Distribution Newark, Delaware............................. 157,300 Manufacturing/Distribution
- --------------------- (1) This facility also serves as an international distribution center and central packaging operation with respect to certain of the Company's products. (2) This facility's primary function is manufacturing safety products. However, the facility has a small prescription safety eyewear lab as well. (*) 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. 9 11 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(R) 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(R) 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(R)) 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(R) 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(R) and other lines of eyewear. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On August 5, 1999, the Company held a special meeting of stockholders. The stockholders approved the selection of Arthur Andersen LLP as the Company's independent public accountants with a total of 102,337.5 votes in favor and 250 abstention votes. The stockholders voted to elect the following directors for the fiscal year ending September 30, 2000 with a total of 102,337.5 votes in favor of each director and 250 abstention votes for each director: Norman W. Alpert, Bryan P. Marsal, John D. Curtin, Margaret J. Hanratty, William E. Kassling, Michael A. McLain, Arthur J. Nagle, Daniel S. O'Connell and Robert Rothberg. 10 12 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS As of December 15, 1999 there were outstanding 105,537.5 shares of common stock, par value $0.01 per share, of Aearo ("Aearo Common Stock"). All of the Aearo Common Stock is held, collectively, by Vestar Equity Partners, L.P. (together with certain related persons, "Vestar"), 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. Aearo has never paid cash dividends in the Aearo Common Stock. Payment of dividends on the Aearo Common Stock is limited by the terms of the Company's Senior Bank Facilities and Senior Notes. See Note 7 to the Consolidated Financial Statements. ITEM 6. SELECTED FINANCIAL DATA The selected income statement data for the period ended July 11, 1995 are 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, 1998 and 1999 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. 11 13 AEARO CORPORATION SELECTED FINANCIAL DATA (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS AND RATIOS)
PREDECESSOR COMPANY SUCCESSOR COMPANY - --------------------------------------------------------------------------------------------------------------------------------- PERIOD ENDED PERIOD ENDED JULY 11, SEPTEMBER 30, YEAR ENDED SEPTEMBER 30, 1995 1995 1996 1997 1998 1999 - ------------------------------------------------------------------------------------------------------------------------------- INCOME STATEMENT DATA: Net Sales -- Safety Products ................. $ 129.6 $ 40.0 $ 205.2 $ 249.6 $ 216.5 $ 212.1 Safety Prescription Eyewear ..... 36.4 35.5 Specialty Composites ............ 25.1 7.9 38.3 36.2 39.6 42.8 ----------------------------------------------------------------------------------------- Total net sales .............. 154.7 47.9 243.5 285.8 292.5 290.4 Cost of Sales ....................... 87.7 29.3(2) 133.6(4) 163.5 163.9 157.5 ----------------------------------------------------------------------------------------- Gross profit .................... 67.0 18.6 109.9 122.3 128.6 132.9 Operating Expenses -- Selling and inistrative ......... 47.1(1) 13.1 73.6(5) 87.0 88.9 86.0 Research and technical service .. 2.3 0.6 3.2 5.1 4.7 4.7 Amortization expense (3) ........ 4.3 0.8 5.6 7.0 6.8 6.8 Other charges (income), net ..... (0.2) 0.1 0.3 2.5 (0.3) 0.8 Restructuring charge ............ -- -- -- -- 11.6(8) -- ----------------------------------------------------------------------------------------- Operating Income ............. 13.5 4.0 27.2 20.7 16.9 34.6 Interest expense, net (3) .... 5.7 4.1 20.7 26.7 26.1 24.3 ----------------------------------------------------------------------------------------- Income (loss) before income taxes ........................ 7.8 (0.1) 6.5 (6.0) (9.2) 10.3 Provision for income taxes ...... 3.0 0.5 4.3 0.9 2.2 3.2 ----------------------------------------------------------------------------------------- Net income (loss) ................... $ 4.8 $ (0.6) $ 2.2 $ (6.9) $ (11.4) $ 7.1 ========================================================================================= Preferred stock dividend accrued .... 1.3 6.2 7.1 8.1 9.1 Net loss applicable to common shareholders ........................ (1.9) (4.1) (14.0) (19.5) (2.1) Net loss per common share ........... $ (18.67) $ (40.58) $ (142.77) $ (195.60) $ (20.35) OTHER DATA: EBITDA (6) .......................... $ 22.9 $ 6.1 $ 39.7 $ 37.8 $ 47.1 $ 51.0 Depreciation and amortization (3) ... 9.2 2.1 13.9 18.6 20.3 18.3 Capital expenditures ................ 10.4 2.7 9.2 8.9 5.8 8.4 Ratio of earnings to fixed charges (7) ......................... 2.2 - 1.3 - - 1.4 BALANCE SHEET DATA (AT PERIOD-END): Total assets ........................ $ 177.5 $ 218.3 $ 338.6 $ 314.1 $ 293.0 $ 282.3 Long-term debt (including current portion) .................... 78.4 152.3 250.3 244.7 233.2 214.8 Stockholders' equity ................ 40.1 32.0 35.0 23.1 11.1 16.5
12 14 NOTES TO SELECTED FINANCIAL DATA: (1) 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) 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. EBITDA presented for fiscal 1998 is excluding restructuring charges of $11.6 million recorded during fiscal 1998 (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). 13 15 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 the latter part of fiscal 1996, the Company undertook efforts to implement a new management information system, integrate the Peltor and Eastern acquisitions that were acquired earlier in that year, 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. Greater utilization of the new management information system allowed the Company to realize additional operating improvements. To further accelerate the operational benefits of the new management information system, the Company completed a major update of its SAP management information system to version 3.1H in November, 1998. During fiscal year 1999 the Company implemented the restructuring plan announced on Sept. 30, 1999. 1. The Company reorganized into strategic business segments. The reportable segments are Safety Products, Safety Prescription Eyewear and Specialty Composites. This change was made to allow greater management attention and focus. 2. The Company rationalized its product line in Safety Products, discontinuing over 50% of low volume, low margin stock keeping units. It consolidated its product offering to retail customers like Home Depot, Lowe's, ACE, etc. under the AOSafety(R) brand name and introduced improved packaging and new graphics at the same time. This rationalization has contributed to manufacturing efficiencies. 3. In the Safety Prescription Eyewear segment the company consolidated it customer service and distribution operations. In addition, there has been continued productivity improvements in purchasing, logistics and manufacturing. These, along with the restructuring efforts, have resulted in significant improvements in gross margin verses the previous year. A part of the savings was re-invested in selling and marketing to build brand equity and introduce new and innovative products. These included E-A-Rsoft(TM) Yellow Neons(TM), and E-A-Rsoft(TM) Neon Blasts(TM) earplugs, Rave safety eyewear, new safety prescription eyewear frames and several new Peltor(R) communication products. Lexa, introduced in 1998, has shown very positive growth. 14 16 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.
YEAR ENDED SEPTEMBER 30, ------------------------------------------- 1997 1998 1999 ------------------------------------------- Net sales:............................................. Safety Products........................................ 87.3 % 74.1 % 73.1 % Safety Prescription Eyewear 12.4 12.2 Specialty Composites................................... 12.7 13.5 14.7 --------------------------------------------------------- Total net sales........................................ 100.0 100.0 (1) 100.0 (1) Cost of sales.......................................... 57.2 56.0 54.2 --------------------------------------------------------- Gross profit........................................... 42.8 44.0 45.8 Selling and administrative............................. 30.4 30.4 29.7 Research and technical services........................ 1.8 1.6 1.6 Amortization expense................................... 2.5 2.3 2.3 Other charges (income), net............................ 0.9 (0.1) 0.3 Restructuring charge................................... -- 4.0 -- --------------------------------------------------------- Operating income....................................... 7.2 % 5.8 % 11.9 % =========================================================
(1) Effective October 1, 1998 the Company reorganized its financial reporting into the three reportable segments of Safety Products, Safety Prescription Eyewear and Specialty Composites. Fiscal year 1998 was restated to conform to the fiscal year 1999 reporting but fiscal year 1997 was not due to the cost required to restate. FISCAL 1999 COMPARED TO FISCAL 1998 NET SALES. Net sales in the year ended September 30, 1999 decreased 0.7% to $290.4 million from $292.5 million in the year ended September 30, 1998. The Safety Products segment net sales in the year ended September 30, 1999 decreased $4.4 million to $212.1 million from $216.5 million, or 2.0%. Higher sales in Europe and to Consumer customers in North America were offset by the effects of product rationalization, increased competitive activity in the eyewear product line earlier in the year, the effects of a stronger US dollar, and decline in business with customers in Asia. The effect of the stronger U.S. dollar as compared to the European and Canadian currencies, was to decrease sales by approximately $1.3 million. The Safety Prescription Eyewear segment net sales in the year ended September 30, 1999 decreased 2.4% to $35.5 million from $36.4 million in the year ended September 30, 1998. The Safety Prescription Eyewear segment net sales for the year ended September 30, 1999 included $0.7 million of sales from Safety Optical that was acquired in August 1999. The Specialty Composites segment net sales in the year ended September 30, 1999 increased $3.2 million to $42.8 million from $39.6 million, or 8.2%. Increased sales were due to continued growth in sales of engineered products to the general aviation and precision equipment markets. GROSS PROFIT. Gross profit in the year ended September 30, 1999 increased 3.3% to $132.9 million from $128.6 million in the year ended September 30, 1998. Gross profit as a percentage of net sales in the year ended September 30, 1999 was 45.8% as compared to 44.0% in the year ended September 30, 1998. The continued productivity improvements in purchasing and manufacturing, especially in the manufacturing of the eyewear product line were the primary factors behind a strong improvement in gross profit performance as compared to the previous year. Product rationalization as a result of the restructuring plan announced during fiscal year 1998 also contributed to efficiencies in operations due to reduced complexity. SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative expenses in the year ended September 30, 1999 decreased 3.3% to $86.0 million from $88.9 million in the year ended September 30, 1998. Within this decrease is an increase of $5.0 million in selling and marketing expenses as part of the Company's campaign to build brand awareness and loyalty by more strongly promoting its global brands. Customer service and distribution expenses decreased as the Company realized 15 17 headcount and overhead reductions in the Safety Prescription Eyewear segment through consolidations of these activities, and achieved productivity improvements within the Safety Products segment's international distribution facility in Indianapolis, Indiana. Administrative costs were lower due to decreased headcount as a result of the restructuring plan announced during fiscal year 1998. In addition, fiscal year 1998 expenses were higher due to the 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. Selling and administrative expenses as a percentage of net sales in the year ended September 30, 1999 were 29.7% of net sales, compared to 30.4% in the year ended September 30, 1998. OTHER CHARGES (INCOME), NET. Other Charges (Income), Net was an expense of $0.8 million for the year ended September 30, 1999 as compared to income of $0.3 million for the year ended September 30, 1998. This change was primarily a result of foreign currency transaction losses in the year ended September 30, 1999, as compared to foreign currency transaction gains in the year ended September 30, 1998. 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 that fiscal year. The restructuring included changes in senior management personnel, relocation of the Company headquarters from Boston to Indianapolis, and initiatives to improve profitability through complexity reduction and product line focus. The Company eliminated certain product offerings in its Eyewear and Respiratory product lines, reduced head count in its North American operations, and consolidated the branding in its Consumer product line. For the year ended September 30, 1999, no restructuring charge was recorded. OPERATING INCOME. Primarily as a result of the factors discussed above, operating income excluding the restructuring charge, increased $6.1 million or 21.5% in the year ended September 30, 1999 from $16.9 million in the year ended September 30, 1998. Operating income as a percentage of net sales in the year ended September 30, 1999 was 11.9% as compared to 5.8% in the year ended September 30, 1998. INTEREST EXPENSE, NET. Interest expense, net in the year ended September 30, 1999 decreased 7.0% to $24.3 million from $26.2 million in the year ended September 30, 1998. The decrease is attributed to lower average borrowings and a lower weighted average interest rate in the year ended September 30, 1999 as compared to the year ended September 30, 1998. INCOME (LOSS) BEFORE PROVISION FOR INCOME TAXES. Income before provision for income taxes, excluding the restructuring charge, increased $8.0 million in the year ended September 30, 1999 to income of $10.3 million compared to income of $2.3 million in the year ended September 30, 1998 due to the improved operating income and lower interest expense. PROVISION FOR INCOME TAXES. The provision for income taxes in the year ended September 30, 1999 was $3.2 million compared to $2.2 million in the year ended September 30, 1998. NET (LOSS) INCOME. For the year ended September 30, 1999, the Company had net income of $7.1 million as compared to a net loss of $11.4 million for the year ended September 30, 1998. 16 18 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)
Year Ended Change September 30, Favorable (Unfavorable) 1999 1998 Amount Percent ----------------------------------------------------- Operating Income (1) $ 34,619 $ 28,495 $ 6,124 21.5% Add Backs: Depreciation 9,399 11,537 (2,138) (18.5%) Amortization of Intangibles 6,793 6,833 (40) (0.6%) Non-operating Costs (Income) 190 281 (91) (32.4%) --------------------------------------------------- EBITDA $ 51,001 $ 47,146 $ 3,855 8.2% ===================================================
(1) Excluding restructuring charge of $11.6 million recorded during fiscal year 1998. EBITDA for the year ended September 30, 1999 was $51.0 million, which was $3.9 million higher than September 30, 1998. This increase was due primarily to the strong gross margin performance combined with reduced selling, general and administrative costs. EBITDA as a percentage of net sales in the year ended September 30, 1999 was 17.6% as compared to 16.1% in the year ended September 30, 1998, excluding the 1998 restructuring charge. 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 17 19 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 that 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. 18 20 EBITDA CALCULATION (DOLLARS IN THOUSANDS)
Year Ended Change September 30, Favorable (Unfavorable) 1998 1997 Amount Percent ------------------------------------------------------------ Operating Income (1) $ 28,495 $ 20,706 $ 7,789 37.6% Add Backs: Depreciation 11,537 9,773 1,764 18.1% Amortization of Intangibles 6,833 6,957 (124) (1.8%) Non-operating Costs (Income) 281 404 (123) (30.4%) ----------------------------------------------------------- EBITDA $ 47,146 $ 37,840 $ 9,306 24.6% ===========================================================
(1) Excluding restructuring charge of $11.6 million recorded during fiscal year 1998. EBITDA for the year ended September 30, 1998 was $47.1 million (excluding the restructuring charge of $11.6 million recorded during fiscal year 1998) as compared to $37.8 million for the year ended September 30, 1997. This increase was due primarily to the increase in operating income (excluding the restructuring charge of $11.6 million recorded during fiscal year 1998) described previously partly offset by higher depreciation expense. EBITDA as a percentage of net sales in the year ended September 30, 1998 was 16.1% as compared to 13.2% in the year ended September 30, 1997. 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. 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, 99 rather than 1999). 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. Y2K readiness activities for those critical IT and manufacturing systems required to support business operations have been completed. Several ancillary systems, classified as low risk and having no impact on critical business operations, will be completed by the end of the calendar year. As it relates to internal E-mail and desktop hardware and software systems, the Company has completed a desktop update and standardization effort, which in addition to providing efficiency tools to the global organization, has addressed year 2000 compliance issues that may have existed in that environment. 19 21 The Company has contacted its major customers and vendors regarding their readiness for year 2000 compliance, and efforts continue with the evaluations of any impact that their readiness may have on the Company's systems. 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 assessment of other companies on which the Company's systems rely is substantially complete. Contingencies have been developed to counteract the possible impact of a lack of readiness of external suppliers who have been assessed as being high risk. Since the majority of the Company's products are passive in nature and do not utilize date sensitive 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: $15.9 million in fiscal 2000, $20.6 million in fiscal 2001, $34.1 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 $8.4 million for capital expenditures for the year ended September 30, 1999 as compared to $5.8 million for capital expenditures for the year ended September 30, 1998 and $8.9 million for the year ended September 30, 1997. 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, 1999 totaled $26.0 million as compared to $20.2 million in 1998. The increase was due primarily to a $6.9 million improvement in Operating Income (excluding the $11.6 million restructuring charge in 1998), and an increase of $5.6 million in accounts payable and accrued liabilities. Offsetting this increase was $3.2 million increase in inventories, a $1.1 million increase in accounts receivable and a $2.0 million reduction in depreciation and amortization. In fiscal 1997, the Company's net cash provided by operating activities totaled $9.1 million. Net cash used by investing activities was $11.8 million for the year ended September 30, 1999 as compared to $5.8 million for the year ended September 30, 1998 and $8.3 million in the year ended September 30, 1997. Net cash used by investing activities consisted of $8.4 million of capital expenditures in the year ended September 30, 1999 as compared to $5.8 million in the year ended September 30, 1998. In addition the Company invested $3.4 million for the acquisition of Safety Optical in fiscal 1999. Net cash used by investing activities in 1997 was $8.3 million consisting of $8.9 million of capital expenditures, $0.2 million for the acquisition of the Shoplyne assets, offset by $0.8 million in proceeds from the sale of the Rhode Island facility of Peltor. Net cash used by financing activities for the year ended September 30, 1999 was $16.2 million compared with $13.0 million in 1998 and $4.2 million in 1997. The increase of $3.2 million in fiscal 1999 consisted of $2.4 million for repayment of term loans, $1.1 million for repayment of long-term debt, $1.0 million for the repurchase of common stock offset by a $1.3 million repayment of shareholder notes. In 1997 net cash used for financing activities included $8.3 million for the repayment of term loans, $0.8 million for the repayment of other long term debt, partially offset by increased borrowings under the revolving credit facility of $5.2 million. The Company has a substantial amount of indebtedness. The Company relies on internally generated funds, and to the extent necessary, on borrowings under the revolving credit facility 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, 1999 the Company had borrowed $5.9 million under the revolving credit facility. Throughout most of fiscal 1997, borrowing 20 22 levels under the revolver 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. As a result of these improvements, and continued productivity improvements in purchasing, logistics and manufacturing, revolver balances decreased by approximately $2.2 million during fiscal year 1998 and fiscal year 1999. 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 that 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, 1999, 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, 1999. On December 4, 1999, the Senior Bank Facilities were amended with respect to certain covenants applicable to periods ending on and after December 31, 1999 to reflect the Company's current level of profitability. ITEM 7A: MARKET RISK DISCLOSURES The Company is exposed to market risks related to change in foreign currencies, interest rates and commodity pricing. The Company uses derivatives to mitigate impact of changes in foreign currencies and interest rates. FOREIGN CURRENCY RISK The Company's results of operations are subject to risk associated with operating in foreign countries, including fluctuations in currency exchange rates. With a large portion of product sold in Europe produced in the United States and Sweden a decline in the dollar or krona can have a negative impact on the profitability of the Company (see Effects of Changes in Exchange Rates). The Company executes two hedging programs; one for transaction exposures, and the other for cash flow impact on European operations. The Company utilizes forward contracts for transaction exposures and a combination of forward contracts and zero premium collars for cash flow exposures. During 1999 transaction hedge losses were $.2 million, while cash flow hedges were a gain of $.2 million. In addition, the Company limits foreign exchange impact on the balance sheet with foreign denominated debt in Great Britain Pound Sterling (GBP) and German Marks (DEM). The Company does not consider the notional amount of outstanding hedge contracts at September 30, 1999 as material. Settlement of outstanding contracts will not have a material impact on the profitability of the Company. INTEREST RATES The Company is exposed to market risk changes in interest rates through its debt. The Company utilizes a zero premium collar agreement to reduce the impact of increased interest rates in its floating rate debt. The collar allows the Company the ability to maintain borrowing at the short end of the yield curve, while retaining a hedge against an increase in rates. The zero premium collar was modified in March of 1999 to expire in September 2001. The zero premium collar has a notional amount of $100 million, a cap of 7.75% and floor of 5.33% indexed off 3 month LIBOR. During 1999 LIBOR rates dropped to 5.03% and the Company recorded additional interest expense of $.1 million. At September 30, 1999 LIBOR interest rates had increased to 5.53%. The Company is of the opinion that it is well positioned to manage interest expense through 2001 and a change in interest rates will not have a material impact on the profitability of the Company. COMMODITY RISK The Company is subject to market risk with respect to pricing of paperboard material and polycarbonate (resin). The Company has built price increases into fiscal year 2000 cost to cover anticipated shortage of paperboard products. The Company currently manages its polycarbonate exposures through strategic price negotiations utilizing current market prices from alternative vendors. The Company does not enter into derivative instruments to manage commodity risk. 21 23 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA (1) Index to Financial Statements
Page ---- Report of Independent Public Accountants -- Arthur Andersen LLP..................... 23 Consolidated Balance Sheets -- September 30, 1998 and 1999.......................... 24 Consolidated Statements of Operations -- Years ended September 30, 1997, 1998, and 1999................................................................. 25 Consolidated Statements of Stockholders' Equity -- Years ended September 30, 1997, 1998, and 1999........................................................... 26 Consolidated Statements of Cash Flows -- Years ended September 30, 1997, 1998, and 1999....................................................................... 27 Notes to Consolidated Financial Statements.......................................... 28 Valuation and Qualifying Accounts -- Years ended September 30, 1997, 1998 and 1999........................................................................... 63
22 24 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, 1998 and 1999, and the related consolidated statements of operations, stockholders' equity and cash flows for the years ended September 30, 1997, 1998 and 1999. These consolidated financial statements and the schedule referred to below 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, 1998 and 1999, and the results of its operations and its cash flows for the years ended September 30, 1997, 1998 and 1999, 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 26, 1999 23 25 AEARO CORPORATION CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
SEPTEMBER 30, --------------------------------- 1998 1999 --------- --------- Current Assets: Cash and cash equivalents ...................................................... $ 6,737 $ 4,050 Accounts receivable (net of reserve for doubtful accounts of $1,239 and $1,296 in 1998 and 1999, respectively) ............................................................... 44,486 43,801 Inventories .................................................................... 30,466 33,286 Deferred and prepaid expenses .................................................. 3,572 3,750 --------- --------- Total current assets ........................................................ 85,261 84,887 --------- --------- Property, plant and equipment, net ............................................. 57,729 55,881 Intangible assets, net ......................................................... 144,057 137,776 Other assets ................................................................ 5,909 3,749 --------- --------- Total assets ................................................................ $ 292,956 $ 282,293 ========= ========= Current Liabilities: Current portion of long-term debt .............................................. $ 14,573 $ 16,093 Accounts payable and accrued liabilities ....................................... 37,957 40,528 Accrued interest ............................................................... 3,732 3,400 U.S. and foreign income taxes .................................................. 3,506 3,758 --------- --------- Total current liabilities ................................................... 59,768 63,779 --------- --------- Long-term debt ..................................................................... 218,592 198,716 Deferred income taxes .............................................................. 959 825 Other liabilities .................................................................. 2,586 2,499 Commitments and Contingencies Stockholders' Equity: Preferred stock, $.01 par value -- (Redemption value of $76,834,000 as of September 30, 1999) Authorized -- 200,000 shares Issued and outstanding -- 45,000 shares Common stock, $.01 par value -- Authorized -- 200,000 shares Issued and outstanding -- 102,338 and 102,538 shares in 1998 and 1999, ........................................................... 1 1 Additional paid-in capital ......................................................... 32,383 32,566 Accumulated deficit ................................................................ (16,715) (9,662) Cumulative foreign currency translation adjustments ................................ (4,618) (6,431) --------- --------- Total stockholders' equity .................................................. 11,051 16,474 --------- --------- Total liabilities and stockholders' equity .................................. $ 292,956 $ 282,293 ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 24 26 AEARO CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
YEAR ENDED SEPTEMBER 30, ------------------------------------------------------- 1997 1998 1999 --------- --------- --------- Net Sales ..................................................... $ 285,783 $ 292,459 $ 290,389 Cost of Sales ................................................. 163,460 163,877 157,535 --------- --------- --------- Gross profit ......................................... 122,323 128,582 132,854 Selling and Administrative .................................... 87,036 88,929 86,043 Research and Technical Services ............................... 5,119 4,661 4,651 Amortization Expense .......................................... 6,957 6,833 6,793 Other Charges (Income), net ................................... 2,505 (336) 748 Restructuring Charge .......................................... -- 11,585 -- --------- --------- --------- Operating income ..................................... 20,706 16,910 34,619 Interest Expense, net ................................ 26,665 26,152 24,322 --------- --------- --------- (Loss) Income before provision for income taxes ..................................... (5,959) (9,242) 10,297 Provision for Income Taxes ........................... 917 2,204 3,244 --------- --------- --------- Net (loss) income .................................... (6,876) (11,446) 7,053 Preferred Stock Dividend Accrued ..................... 7,112 8,052 9,139 --------- --------- --------- Net Loss applicable to Common Shareholders ..................................... $ (13,988) $ (19,498) $ (2,086) ========= ========= ========= Basic and Diluted Net Loss per Common Share ......................................................... $ (142.77) $ (195.60) $ (20.35) ========= ========= ========= Diluted Weighted average Common Shares ........................ 97,979 99,685 102,502 ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 25 27 AEARO CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (Dollars in Thousands, Except Share Amounts)
Cumulative Foreign Compre- Preferred Stock Common Stock Additional Currency hensive --------------- -------------- Paid-in Accumulated Translation (Loss) Shares Amount Shares Amount Capital Deficit Adjustment Total Income --------------- --------------- ---------- ----------- ----------- ------ -------- Balance, September 30, 1996..... 45,000 $ -- 99,350 $ 1 $32,640 $ 1,607 $ 726 $34,974 Repayment of shareholder notes....................... -- -- -- -- 258 -- -- 258 Repurchase of common stock, net.................. -- -- (2,540) -- (422) -- -- (422) Foreign currency translation adjustment...... -- -- -- -- -- -- (4,811) (4,811) (4,811) Net loss...................... -- -- -- -- -- (6,876) -- (6,876) (6,876) -------- Comprehensive loss for the year ended September 30, 1997.......... $(11,687) ------------------------------------------------------------------------------------ ======== Balance, September 30, 1997..... 45,000 -- 96,810 1 32,476 (5,269) (4,085) 23,123 Issuance of shareholder notes....................... -- -- -- -- (1,157) -- -- (1,157) Sales of common stock, net.... -- -- 5,528 -- 1,064 -- -- 1,064 Foreign currency translation adjustment...... -- -- -- -- -- -- (533) (533) $ (533) Net loss...................... -- -- -- -- -- (11,446) -- (11,446) (11,446) -------- Comprehensive loss for the year ended September 30, 1998.......... $(11,979) ------------------------------------------------------------------------------------- ======== Balance, September 30, 1998.... 45,000 -- 102,338 1 32,383 (16,715) (4,618) 11,051 Repayment of shareholder notes....................... -- -- -- -- 143 -- -- 143 Sales of common stock, net.... -- -- 200 -- 40 -- -- 40 Foreign currency translation adjustment...... -- -- -- -- -- -- (1,813) (1,813) $ (1,813) Net income.................... -- -- -- -- -- 7,053 -- 7,053 7,053 -------- Comprehensive income for the year ended September 30, 1999.......... $ 5,240 ------------------------------------------------------------------------------------ ======== Balance, September 30, 1999..... 45,000 $ -- 102,538 $ 1 $32,556 $ (9,662) $(6,431) $16,474 =====================================================================================
====== The accompanying notes are an integral part of these consolidated financial statements. 26 28 AEARO CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
Year Ended September 30, -------------------------------------------------- 1997 1998 1999 -------- -------- -------- Cash Flows from Operating Activities: Net (loss) income .................................................. $ (6,876) $(11,446) $ 7,053 Adjustments to reconcile net (loss) income to cash provided by operating activities -- Depreciation ...................................................... 9,773 11,537 9,399 Amortization ...................................................... 8,858 8,742 8,853 Deferred income taxes ............................................. 109 85 (70) Provision for restructuring charge ................................ -- 11,585 -- Other non-cash items, net ......................................... 517 262 346 Changes in assets and liabilities -- Accounts receivable .............................................. (479) 1,435 300 Inventories ...................................................... 3,787 62 (3,156) Accounts payable and accrued liabilities ......................... (3,325) (2,452) 3,126 Other ............................................................ (3,296) 340 147 -------- -------- -------- Net cash provided by operating activities ....................... 9,068 20,150 25,998 -------- -------- -------- Cash Flows from Investing Activities: Cash paid for Safety Optical ....................................... -- -- (3,425) Purchase of Shoplyne assets ........................................ (242) -- -- Additions to property, plant and equipment ......................... (8,901) (5,809) (8,355) Proceeds provided by disposals of property, plant and equipment ............................................... 818 41 29 -------- -------- -------- Net cash used in investing activities ........................... (8,325) (5,768) (11,751) -------- -------- -------- Cash Flows from Financing Activities: (Repurchase) sale of common stock, net ............................. (422) 1,064 40 Repayment (issuance) of shareholder notes .......................... 258 (1,157) 143 Proceeds from (repayment of) revolving credit facility, net .............................................. 5,150 (2,200) (2,150) Repayment of term loans ............................................ (8,335) (10,455) (12,853) Repayment of other long-term debt .................................. (840) (280) (1,386) -------- -------- -------- Net cash used in financing activities (4,189) (13,028) (16,206) -------- -------- -------- Effect of Exchange Rate Changes on Cash ............................. 382 (93) (728) -------- -------- -------- Net (Decrease) Increase in Cash and Cash Equivalents ................ (3,064) 1,261 (2,687) Cash and Cash Equivalents, beginning of year ........................ 8,540 5,476 6,737 -------- -------- -------- Cash and Cash Equivalents, end of year .............................. $ 5,476 $ 6,737 $ 4,050 ======== ======== ======== Cash Paid for: Interest ........................................................... $ 22,316 $ 24,537 $ 22,641 ======== ======== ======== Income taxes ....................................................... $ 3,345 $ 1,299 $ 1,485 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 27 29 AEARO CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1999 (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") manufactures and sells products through three reportable segments. The Company's segments are Safety Products, Safety Prescription Eyewear and Specialty Composites. The Safety Products segment manufactures and sells hearing protection devices, non-prescription safety eyewear, face shields, reusable and disposable respirators, hard hats and first aid kits under the brand names: AOSafety(R), E-A-R(R), and Peltor(R). The Safety Prescription Eyewear segment manufactures and sells prescription eyewear products that are designed to protect the eyes from the typical hazards encountered in the industrial work environment. The Company's Safety Prescription Eyewear segment purchases component parts (lenses and the majority of its frames) from various suppliers, grinds and shapes the lenses to the customer's prescription, and then assembles the glasses using the customer's choice of frame. The Specialty Composites segment manufactures and sells a wide array of energy-absorbing materials that are incorporated into other manufacturers' products to control noise, vibration and shock. Aearo Corporation was formed by Vestar Equity Partners, L.P. (Vestar) 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 periods. Actual results could differ from those estimates. RECLASSIFICATIONS Certain amounts included in the prior years' consolidated financial statements may have been reclassified to conform to the current period presentation. 28 30 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 $5,171,000, $4,827,000, and $7,507,000 in the years ended September 30, 1997, 1998, and 1999, 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, 1997, 1998, and 1999 the accompanying consolidated statements of operations include approximately $2,101,000, ($617,000), and $559,000 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. During 1999, the Company initiated the use of Great Britain Pound Sterling (GBP) forward contracts and Euro Zero Premium Collar contracts to mitigate the impact of the effects of changes in foreign currency rates on profitability related to cash flows from European operations. For the year ended September 30, 1999, the consolidated statement of operation included approximately $191,000 of gains related to these instruments. Cash flow hedges are placed for a three to six month time frame and a portion is unwound monthly based on forecasted cash flows. At September 30, 1999, cash flow hedges were approximately 3,100,000 GBP for coverage to December 23, 1999 and approximately 3,100,000 GBP for coverage to March 31, 1999. As of September 30, 1999, the Company had forward foreign currency contracts open in the following amounts:
Contract Currency Amount (000s) Position -------- ------------- -------- British Pound 4,263 Buy Canadian Dollar 1,846 Buy Norwegian Krona 5,198 Sell Swedish Krona 61,814 Buy Swiss Franc 1,668 Buy Euro 4,639 Sell Danish Krona 1,385 Sell
As of September 30, 1999, the Company has recorded an unrealized gain of $49,000 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 $2,783,000, $3,198,000, and $2,902,000 for the years ended September 30, 1997, 1998, and 1999, respectively. 29 31 Property, plant and equipment and their estimated useful lives consist of the following:
ASSET CLASSIFICATION ESTIMATED USEFUL LIFE -------------------- --------------------- Buildings 25-40 Years Leasehold improvements Life of the lease or useful life, whichever is shorter Machinery and equipment, furniture and fixtures 3-10 Years
Upon the sale or retirement of assets, the cost and related accumulated depreciation are removed from the consolidated financial statements, and any resultant gain or loss is recognized. INCOME TAXES Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax 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 that might indicate the carrying amount of the assets may not be recoverable. The Company assesses the recoverability of the assets by determining whether the amortization of such 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, 1998 and 1999, no such impairment of assets was indicated. A summary of the estimated lives by major category of intangible assets at September 30, 1999 is as follows: Goodwill............................................. 25 Years Patents.............................................. 17 Years Non-compete agreements............................... Life of agreements (up to 5 years) Trademarks, Tradenames and Other.............................................. Varies from 15 to 25 Years
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, bank debt (including term loans, revolving credit facility and other debt) and interest rate collars. The carrying value of these assets and liabilities is a reasonable estimate of their fair market value at September 30, 1999, except for the Senior Subordinated Notes, for which the Company estimates the fair market value to approximate $105 million at September 30, 1999, and except for interest rate collars for which the Company estimates the fair market value to approximate $71,000 at September 30, 1999. 30 32 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 (loss) income 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, 1997, 1998, and 1999 there were 5,025, 7,154, and 7,729 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, 1997, 1998, and 1999, respectively. The implementation of this standard did not have an effect on earnings per common share in 1997 and, therefore, did not require restatement. Basic and diluted earnings per common share for the years ended September 30, 1997,1998 and 1999 were equal; therefore, no reconciliation between basic and diluted earnings per common share is required. 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). COMPREHENSIVE (LOSS) INCOME On October 1, 1998, the Company adopted SFAS No. 130, Reporting Comprehensive Income, which requires the reporting of comprehensive (loss) income and its components in the consolidated financial statements. Comprehensive (loss) income includes net earnings and unrealized gains and losses from currency translations and minimum pension liability adjustments. The components of the Company's comprehensive (loss) income and the effect on earnings, for the three years ended September 30, 1999, are detailed in the accompanying consolidated statements of stockholders' equity. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES SFAS No. 133, as amended by SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities- Deferral of the Effective Date of SFAS No. 133 - an Amendment of SFAS No. 133 issued in June 1999, is effective for fiscal quarters of all fiscal years beginning after June 15, 2000. A company may 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, as amended by SFAS No. 137, must be applied to (a) derivative instruments and (b) certain derivative instruments embedded in hybrid contracts that were issued, acquired or substantially modified after either January 1, 1998 or January 1, 1999, as selected by the company. 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. 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. 31 33 (3) INVENTORIES Inventories consisted of the following at September 30 (dollars in thousands):
1998 1999 ------------------------------------- Raw materials............................... $ 9,113 $ 8,725 Work in process............................. 9,257 7,649 Finished goods.............................. 12,096 16,912 ------------------------------------- $ 30,466 $ 33,286 =====================================
(4) PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consisted of the following at September 30 (dollars in thousands):
1998 1999 ------------------------------------- Land........................................ $ 2,669 $ 2,649 Buildings and Improvements.................. 17,640 18,186 Machinery and equipment..................... 45,566 49,031 Furniture and fixtures...................... 16,799 17,700 Construction in progress.................... 3,120 5,570 ------------------------------------- 85,794 93,136 Less -- Accumulated depreciation............ 28,065 37,255 ------------------------------------- $ 57,729 $ 55,881 =====================================
(5) INTANGIBLE ASSETS Intangible assets consist of the following at September 30 (dollars in thousands):
1998 1999 ------------------------------------- Goodwill.................................... $ 88,652 $ 88,593 Patents..................................... 1,638 1,638 Trademarks and tradenames................... 74,122 74,122 Non-compete agreement....................... 194 834 Other....................................... 585 228 ------------------------------------- 165,191 165,415 Less -- Accumulated depreciation............ 21,134 27,639 ------------------------------------- $ 144,057 $ 137,776 =====================================
(6) ACCOUNTS PAYABLE AND ACCRUED LIABILITIES Accounts payable and accrued liabilities consisted of the following at September 30 (dollars in thousands):
1998 1999 ------------------------------- Accounts payable -- trade................................ $ 15,131 $ 15,407 Accrued Liabilities -- Employee compensation and benefits (Note 9).......... 10,615 13,874 Restructuring reserve (Note 16)...................... 2,990 52 Product liability accruals........................... 4,063 4,097 Other................................................ 5,158 7,098 ------------------------------- $ 37,957 $ 40,528 ===============================
32 34 (7) DEBT The long-term debt balances consisted of the following at September 30 (dollars in thousands):
1998 1999 -------- -------- Revolving credit facility $ 8,000 $ 5,850 Term loans, due 2003 120,590 105,786 Senior subordinated notes, due 2005, 12.5% 100,000 100,000 Note payable, other 555 447 Mortgage note, due 1998 - 2006, 10.1% 2,410 2,358 Industrial Revenue Bonds, due 1998 - 2003, 6.4% less advance deposit of $122 368 368 Industrial Revenue Bonds, due 2002, 13.0% 1,000 -- Capitalized lease obligations 242 -- -------- -------- 233,165 214,809 Less -- Current portion of long-term debt 14,573 16,093 ======== ======== Total $218,592 $198,716 ======== ========
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 (LIBOR) 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 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 33 35 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, 1999, 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, 1999 the total balance outstanding on the Term Loans was $105.8 million U.S. dollars and interest rates were 7.7% for the US Dollar Term A Loan ($21.9 million U.S. Dollars outstanding at September 30, 1999), 4.9% for the German Deutsche Mark Term A Loan (19.4 million German Deutsche Marks outstanding at September 30, 1999), 7.5% for the British Pound Term A Loan (8.3 million British Pounds outstanding at September 30, 1999), 7.2% for the Canadian Term A Loan (6.2 million Canadian Dollars outstanding at September 30, 1999), 7.5% for the British Pound Term A Loan (4.4 million British Pounds outstanding at September 30, 1999) and 8.2% for the US Dollar Term B Loan ($48.4 million U.S. Dollars outstanding at September 30, 1999). For the year ended September 30, 1999 the weighted average interest rates paid were 7.5%, 5.4%, 8.5%, 7.3%, 8.5% and 7.9% 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, 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, 5.8% for the German Deutsche Mark Term A Loan, 10.1% for the British Pound Term A Loan, 7.4% for the Canadian Term A Loan, 10.1% for the British Pound Term A Loan and 8.4% for the US Dollar Term B Loan. 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. Revolving Credit Facility At September 30, 1999 the balance outstanding on the Revolving Credit Facility was $5.9 million, of which $3.0 million bears interest at LIBOR (7.6% at September 30, 1999) and $2.9 million bears interest at the Base Rate (9.3% at September 30,1999). For the year ended September 30, 1999, the maximum amount outstanding was $14.8 million, the average was $7.3 million, and the weighted average interest rate paid was 8.3%. At September 30, 1998 the balance outstanding on the Revolving Credit Facility was $8.0 million, and the interest rate was 9.3%. 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%. 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. 34 36 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, 1999, 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, 1999 (dollars in thousands):
Amount ------ 2000 .............................. $ 16,093 2001 .............................. 20,923 2002 .............................. 40,160 2003 .............................. 35,347 2004 .............................. 90 Thereafter ........................ 102,196 --------- $ 214,809 =========
(8) INTEREST EXPENSE, NET Interest expense (income) comprises the following items (dollars in thousands):
Year Ended September 30, --------------------------------- 1997 1998 1999 -------- -------- ------- Expense ......................... $ 26,896 $ 26,406 $24,553 Income .......................... (231) (254) (231) -------- -------- ------- Interest expense, net............ $ 26,665 $ 26,152 $24,322 ======== ======== =======
(9) EMPLOYEE BENEFIT PLANS On October 1, 1998, the Company adopted SFAS No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits. SFAS No. 132 standardizes the disclosure requirements about pensions and other postretirement benefits to the extent practicable. The Company previously had two noncontributory defined benefit pension plans (collectively, the plans), the Aearo Company Employees' Retirement Account Plan (the Aearo Plan), which is a cash balance plan, and the E-A-R(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. 35 37 The tables that follow provides a reconciliation of benefit obligation, plan assets and funded status of both the Aearo plan and the Specialty Composites plan (dollars in thousands):
YEAR ENDED SEPTEMBER 30, ------------------------------- CHANGE IN BENEFIT OBLIGATION 1997 1998 1999 ------- ------- ------- Benefit obligation at beginning of year $ 6,316 $ 7,064 $ 9,650 Service Cost 1,273 1,348 1,414 Interest Cost 393 523 624 Plan amendments -- -- 115 Acquisitions/divestitures -- 1,444 -- Benefits Paid (516) (694) (1,306) Actuarial (gain) or loss (402) (35) (997) ------ ------ ------ Benefit obligation at end of year $ 7,064 $ 9,650 $ 9,500 ======= ======= =======
YEAR ENDED SEPTEMBER 30, ------------------------------- CHANGE IN PLAN ASSETS 1997 1998 1999 ------- ------- ------- Fair value of plan assets at beginning of year $ 5,303 $ 6,173 $ 8,732 Actual return of plan assets 1,218 575 1,327 Acquisitions/divestitures -- 1,418 -- Employer contributions 168 1,260 350 Benefits Paid (516) (694) (1,306) ------- ------- ------- Fair value of plan assets at end of year $ 6,173 $ 8,732 $ 9,103 ======= ======= =======
AS OF SEPTEMBER 30, ------------------------------- FUNDED STATUS AND STATEMENT OF FINANCIAL POSITION 1997 1998 1999 ------- ------- ------- Fair value of plan assets at end of year 6,173 8,732 9,103 Benefit obligations at end of year 7,064 9,650 9,500 ------- ------- ------- Funded status $ (891) $ (918) $ (397) Unrecognized actuarial (gain) or loss (1,493) (1,412) (2,924) ------- ------- ------- Net pension liability included in accrued liabilities $(2,384) $(2,330) $(3,321) ======= ======= =======
ADDITIONAL YEAR END INFORMATION FOR PENSION AS OF SEPTEMBER 30, PLANS WITH ACCUMULATED BENEFIT OBLIGATIONS -------------------------- IN EXCESS OF PLAN ASSETS: 1997 1998 1999 ------ ------ ------ Project benefit obligation $7,064 $9,650 $9,500 Accumulated benefit obligation 7,001 9,557 9,324 Fair value of plan assets 6,173 8,732 9,103
Net periodic benefit cost for the Plans is comprised of the following elements:
YEARS ENDED SEPTEMBER 30, ------------------------------- 1997 1998 1999 ------- ------- ------- Service Cost $ 1,273 $ 1,348 $ 1,414 Interest Cost 394 523 624 Expected return on plan assets (403) (566) (670) Recognized actuarial (gain) or obligation -- (61) (28) ------- ------- -------- Net periodic benefit cost $ 1,264 $ 1,244 $ 1,340 ======= ======= =======
36 38 The weighted average assumptions used in determining net periodic benefit cost and the projected benefit obligation are as follows:
AS OF SEPTEMBER 30 ------------------------------- 1997 1998 1999 ------- ------- ------- Discount rate 7.00% 7.00% 6.75% Expected long-term rate of return on plan assets 8.00 8.00 8.00 Rate of compensation increase 4.00 4.00 4.00
In addition, the Company has an unfunded, noncontributory defined benefit pension plan, the Aearo Company Supplemental Executive Retirement Plan (the SERP Plan) which is also a cash balance plan. The SERP Plan, effective January 1, 1994, covers certain employees in the United States. The costs to the Company for the SERP Plan were $90,000, $61,000, and $81,000 for the years ended September 30, 1997, 1998 and 1999, 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 $717,000, $710,000, and $765,000 for the years ended September 30, 1997, 1998 and 1999, respectively. The Company has a defined contribution savings plan for U.K. employees, under which eligible employees are allowed to contribute up to 15% of their compensation. The Company contributes 5% of pay for all eligible employees and additional amounts equal to 40% of the employee's contribution to a maximum of 2% of the employee's pay. For the years ended September 30, 1997, 1998, and 1999, the Company contributed approximately $158,000, $160,000, and $197,000, 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, 1998 and 1999, the accrued postretirement benefit cost was $62,000 and $0, 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 and totaled approximately $624,000, $434,000 and $706,000 for the years ended September 30, 1997, 1998 and 1999, respectively. 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 37 39 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 $1,572,000 and $1,429,000 at September 30, 1998 and 1999, respectively and are reflected as a reduction of the additional paid-in capital account in the consolidated statements of stockholders' equity. (11) INCOME TAXES Income (loss) before provision for income taxes is as follows (dollars in thousands):
Year Ended September 30, -------------------------------- 1997 1998 1999 ------- -------- ------- Domestic ............ $(7,126) $(12,685) $ 3,836 Foreign ............. 1,167 3,443 6,461 -------------------------------- Total ............. $(5,959) $ (9,242) $10,297 ================================
A summary of provision (benefit) for income taxes is as follows (dollars in thousands):
Year Ended September 30, ---------------------------- 1997 1998 1999 ---------------------------- U.S. Federal and State -- Current ......................... $123 $ 231 $ 347 Deferred ........................ -- -- 716 ---------------------------- 123 231 1,063 ---------------------------- Foreign -- Current ......................... 608 1,897 2,315 Deferred ........................ 186 76 (134) ---------------------------- 794 1,973 2,181 ---------------------------- Total ............................ $917 $2,204 $ 3,244 ============================
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):
Year Ended September 30, -------------------------------- 1997 1998 1999 -------------------------------- Computed tax expense (benefit) at the expected statutory rate .................. $(2,086) $(3,143) $ 3,502 State taxes, net of federal effect ............................. 81 (201) 322 Foreign income taxed at different rates .... (1,890) 296 (147) Foreign dividends .......................... -- -- 1,888 Goodwill amortization ...................... 1,112 871 1,076 Non-deductible expenses .................... 112 96 90 Increase / (decrease) in valuation allowance ................................. 3,551 4,185 (3,708) Other, net ................................. 37 100 221 -------------------------------- Provision for income taxes ............... $ 917 $ 2,204 $ 3,244 ================================
38 40 Significant components of deferred income taxes are as follows at September 30 (dollars in thousands):
1998 1999 ---------------------- Deferred tax assets Pension and other benefits ................. $ 2,786 $ 2,367 Property, plant and equipment .............. (4,739) (5,046) Intangible assets .......................... 2,697 1,572 Restructuring charges ...................... 3,564 71 Inventory .................................. 1,876 1,652 Net operating loss -- foreign .............. 1,690 895 Net operating loss carryforwards -- domestic 9,410 11,155 Other ...................................... 469 1,101 ---------------------- Subtotal .................................... 17,753 13,767 Valuation allowances ........................ (18,712) (14,592) ======== ======== Total deferred tax liability ................ $ (959) $ (825) ======== ========
The valuation allowance at September 30, 1998 and 1999 relates to the uncertainty of realizing the tax benefits of reversing temporary differences and net operating loss carryforwards. The gross amount of domestic and foreign net operating loss carryforwards, before the tax effect, is approximately $32.8 million and $3.2 million, respectively, as of September 30, 1999. Of the valuation allowance recorded as of September 30, 1999, approximately $10.0 million will be used to reduce goodwill related to the purchase if the benefits are realized. During the current year, approximately $0.7 million of valuation allowances originally established through purchase accounting have been reversed through goodwill. (12) STOCKHOLDERS' EQUITY Stock Ownership and Stockholders' Agreement As of September 30, 1999, Cabot owns 41.4% of common stock (42,500 shares) and 50% of redeemable preferred stock (22,500 shares), Vestar owns 41.4% 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 17.2% of common stock (17,538 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. 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, 1999, the redemption value of the preferred stock is $76,834,000. 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 39 41 "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, 1999, a total of 7,729 options were outstanding under the Executive Plan and 1997 Option Plan and a total of 7,271 options were available for grant. Pro Forma Stock-Based Compensation Expense SFAS No. 123, Accounting for Stock-Based Compensation, sets forth a fair-value-based method of recognizing stock-based compensation expense. As permitted by SFAS No. 123, the Company has elected to continue to apply APB No. 25 to account for its stock-based compensation plans. Had compensation cost for awards granted in fiscal 1997, fiscal 1998 and fiscal 1999 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 (loss) income and net (loss) income per share would not have been affected for fiscal 1997, fiscal 1998 and fiscal 1999 as the Black-Scholes option pricing model calculated no value for the options granted in those years. 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:
1997 1998 1999 ---- ---- ---- Risk-free interest rate 6.10% 5.52% 4.99% Expected life of options granted 10 years 10 years 10 years Expected volatility of underlyling stock 0% 0% 0% Dividend Yield 0% 0% 0%
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. 40 42 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, 1997, 1998 and 1999:
Number Weighted Average of Shares Exercise Price Outstanding, September 30, 1996 5,000 $600 Granted 1,344 600 Exercised -- -- Forfeited (1,319) 600 Expired -- -- ------ ---- Outstanding, September 30, 1997 5,025 $600 Granted 3,529 600 Exercised -- -- Forfeited (1,400) 600 Expired -- -- ------ ---- Outstanding, September 30, 1998 7,154 $600 Granted 1,044 600 Exercised -- -- Forfeited (469) 600 Expired -- -- ------ ---- Outstanding, September 30, 1999 7,729 $600 ====== ====
The following table sets forth information regarding options outstanding at September 30, 1999:
Weighted Weighted Average Number Weighted Average Exercise Price Number of Currently Average Remaining for Currently Options Exercise Price Exercisable Exercise Price Contractual Life Exercisable 7,729 $600.00 0 $600.00 7.94 years N/A At September 30, 1997, 1998 and 1999, none of the shares were currently exercisable. At September 30, 1999, there were 7,271 options available for grant.
41 43 (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 $5,315,000, $5,553,000, and $5,544,000 for the years ended September 30, 1997, 1998, and 1999 respectively. Future minimum rental commitments under noncancelable leases in effect at September 30, 1999 are as follows (dollars in thousands): 2000 $ 4,856 2001 4,759 2002 4,213 2003 3,536 2004 3,151 2005 and thereafter 5,205 -------- Total $ 25,720 ========
Contingencies The Company is a defendant in various lawsuits and administrative proceedings that are being handled in the ordinary course of business. In the opinion of management of the Company, these suits and claims should not result in final judgments or settlements which, in the aggregate, would have a material adverse effect on the Company's financial condition or results of operations. During fiscal 1997 the Company received a complaint from Gargoyles, Inc. alleging that one of the Company's recently introduced plano eyewear products (Fectoids (R)) 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 (R) 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 (R) and other lines of eyewear. (14) ACQUISITIONS On August 2, 1999, the Company acquired Safety Optical, Inc. of Athens, Tennessee. 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 August 2, 1999 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 August 2, 1999. The allocation of the $3.7 million purchase price and direct acquisition costs is summarized as follows (dollars in thousands): Cash paid for Safety Optical, Inc .............................. $ 3,425 Acquisition costs .............................................. 300 ------- Total consideration and acquisition costs .................... 3,725 Historical Cost of Net Assets Acquired ......................... 1,029 ------- Excess of consideration paid over historical cost ............ $ 2,696 =======
Allocation of Excess of Consideration Paid over Historical Cost: Property, plant and equipment, net ........................... $ 193 Intangible assets ............................................ 3,429 Accrued liabilities .......................................... (926) ------- $ 2,696 =======
42 44 (15) SEGMENT DATA Effective October 1, 1998 the Company adopted SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information. The Company's three reportable segments are Safety Products, Safety Prescription Eyewear and Specialty Composites. Fiscal year 1998 was restated to conform to the fiscal year 1999 reporting but fiscal year 1997 was not due to the cost required to restate. The Safety Products segment manufactures and sells hearing protection devices, non-prescription safety eyewear, face shields, reusable and disposable respirators, hard hats and first aid kits under its well-known brand names: AOSafety(R), E-A-R(R), and Peltor(R). The Safety Prescription Eyewear segment manufactures and sells prescription eyewear products that are designed to protect the eyes from the typical hazards encountered in the industrial work environment. The Company's Safety Prescription Eyewear segment purchases component parts (lenses and the majority of its frames) from various suppliers, grinds and shapes the lenses to the customer's prescription, and then assembles the glasses using the customer's choice of frame. The Specialty Composites segment manufactures a wide array of energy-absorbing materials that are incorporated into other manufacturers' products to control noise, vibration and shock. NET SALES TO EXTERNAL CUSTOMERS BY BUSINESS SEGMENT (DOLLARS IN THOUSANDS)
1998 1999 Safety Products $216,546 $212,118 Safety Prescription Eyewear 36,362 35,489 Specialty Composites 39,551 42,782 -------- -------- TOTAL $292,459 $290,389 ======== ========
EBITDA BY BUSINESS SEGMENT AND RECONCILIATION TO (LOSS) INCOME BEFORE PROVISION FOR INCOME TAXES (DOLLARS IN THOUSANDS)
1998 1999 Safety Products $ 41,365 $42,246 Safety Prescription Eyewear 2,730 3,491 Specialty Composites 3,054 2,954 Reconciling items (11,588) 2,310 -------- ------- Total EBITDA $ 35,561 $51,001 Depreciation 11,537 9,399 Amortization of Intangibles 6,833 6,793 Non-operating Costs (Income) 281 190 Interest, net 26,152 24,322 -------- ------- (Loss) Income before provision for income taxes $ (9,242) $10,297 ======== =======
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. 43 45 Intersegment sales of the Specialty Composites segment to the Safety Products segment totaled $4,323 and $4,635 for the years ended September 30, 1998 and 1999, respectively. The intersegment sales value is generally determined at fully absorbed inventory cost at standard rates plus 25%. Reconciling items for both years include unallocated selling, administrative, research and technical expenses as well as manufacturing profit realized on intercompany transactions not allocable to a specific segment. Reconciling items for 1998 include $10,550 for restructuring and restructuring related items primarily attributed to the Safety Products segment. DEPRECIATION BY BUSINESS SEGMENT (DOLLARS IN THOUSANDS)
1998 1999 Safety Products $ 8,926 $6,898 Safety Prescription Eyewear 746 682 Specialty Composites 1,865 1,819 ------- ------ TOTAL $11,537 $9,399 ======= ======
CAPITAL EXPENDITURES BY BUSINESS SEGMENT (DOLLARS IN THOUSANDS)
1998 1999 Safety Products $4,513 $5,088 Safety Prescription Eyewear 6 883 Specialty Composites 739 1,804 Reconciling items 551 580 ------ ------ TOTAL $5,809 $8,355 ====== ======
Reconciling items for both years include corporate level expenditures for items such as enterprise wide information technology systems. NET SALES BY PRINCIPAL GEOGRAPHIC AREAS (DOLLARS IN THOUSANDS)
1997 1998 1999 United States $197,341 $204,309 $201,531 Canada 16,656 16,791 16,233 United Kingdom 18,264 18,636 17,438 Germany 10,441 10,977 11,892 Sweden 10,506 6,175 9,601 France 7,437 7,504 8,014 Italy 5,205 5,065 5,320 All others 19,933 23,002 20,360 -------- -------- -------- TOTAL $285,783 $292,459 $290,389 ======== ======== ========
The sales as shown above represent the value of shipments into the customer's country of residence. For the years ended September 30, 1997, 1998, and 1999, no single customer accounted for more than 10% of sales. NET IDENTIFIABLE ASSETS BY PRINCIPAL GEOGRAPHIC AREAS (DOLLARS IN THOUSANDS)
1997 1998 1999 United States $203,489 $183,397 $184,603 Canada 6,963 6,787 5,693 United Kingdom 21,129 19,972 17,458 Germany 2,836 2,124 1,830 Sweden 78,125 79,863 72,027 All others 1,507 813 682 -------- -------- -------- TOTAL $314,049 $292,956 $282,293 ======== ======== ========
44 46 (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 that fiscal year. The restructuring included changes in senior management personnel, relocation of the Company headquarters from Boston to Indianapolis, and initiatives to improve profitability through complexity reduction and product line focus. The Company eliminated certain product offerings in its Eyewear and Respiratory product lines, reduced head count in its North American operations, and consolidated the branding in its Consumer product line. The $11.6 million charge included a $6.1 million provision for inventories and product returns for products that were discontinued. The charge also provided $1.1 million for certain property, plant, and equipment for which the Company determined there was no future use, and $0.1 million related to intangibles for an abandoned product line. In addition, the charge provided $4.3 million to cover employee severance and other contractual obligations. As of September 30, 1999, these restructuring initiatives were substantially completed and the associated accruals had been depleted. (17) SUBSEQUENT EVENTS On October 28, 1999, the Company acquired Ontario, Canada based Norhammer Limited for approximately Canadian $5.5 million. The transaction was accounted for using the purchase method of accounting. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 45 47 PART III 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 November 30, 1999.
NAME AGE POSITION - ---------------------------------------------------------------------------------------------------- Michael A. McLain 49 Chief Executive Officer, President, and Director Bryan J. Carey 39 Executive Vice President, Chief Financial Officer, Treasurer, Assistant Secretary, and Managing Director - Europe James D. Hall 49 Senior Vice President, Chief Marketing Officer, Managing Director - Peltor(R) Communications, North America James H. Floyd 44 Vice President, Logistics and Business Director - Consumer Joseph P. Marlette 56 Vice President, Manufacturing and Research and Development M. Rand Mallitz 57 Senior Vice President and General Manager, E-A-R(R) Specialty Composites D. Garrad (Gary) Warren 47 Vice President, North American Industrial Safety Sales and Managing Director - International James M. Phillips 47 Vice President, Human Resources Rahul Kapur 48 Vice President, Corporate Development and Business Manager - SRx Norman W. Alpert* 41 Chairman of the Board of Directors Daniel S. O'Connell 45 Director Arthur J. Nagle 61 Director Bryan P. Marsal 48 Director William E. Kassling 55 Director Robert Rothberg 50 Director Margaret J. Hanratty* 51 Director John D. Curtin, Jr. 66 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, Park Tudor School, Pleasant Run Children's Homes and Little Rapids Corporation. 46 48 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(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. D. Garrad (Gary) Warren joined the Company in November 1999 and holds the position of Vice President, North American Industrial Safety Sales. Most recently, he was Senior Vice President - Marketing and New Business Development for Spectrum Brands in St. Louis, Missouri. Prior to that, Gary was Senior Vice President, Sales and Customer Development for International Home Foods in Parsippany, New Jersey. 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 1985 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 Advanced Organics, Inc. and a director of Siegel & Gale Corporation, 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 Advanced Organics, Inc., 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 Wabtec Corporation, 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. 47 49 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 of 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"). 48 50 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 (the "Named Executive Officers") for services rendered to the Company in all capacities (including service as an officer or director) in fiscal 1999. SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION ALL OTHER FISCAL ANNUAL YEAR SALARY BONUS COMPENSATION --------------------------------------------- Michael A. McLain 1999 $439,754 $191,309 $ 56,416(1) Chief Executive Officer, President, and Director 1998 $283,336 $120,000 $ 53,239 Daniel P. O'Connor 1999 $223,668 $ 80,784 $542,911(2) Formerly Vice President, Sales -- North America 1998 $220,008 $ 79,200 $ 37,333 1997 $199,333 $ 44,000 $ 19,661 M. Rand Mallitz 1999 $187,500 $ 69,552 $ 19,069(3) Senior Vice President and General Manager, 1998 $180,000 $ 64,800 $ 15,641 E-A-R(R) Specialty Composites 1997 $163,666 $ 50,000 $ 17,618 Bryan J. Carey 1999 $213,668 $ 80,811 $ 43,614(4) Executive Vice President, Chief Financial Officer, 1998 $197,502 $ 73,800 $ 15,512 Treasurer, Assistant Secretary and Managing 1997 $177,667 $ 30,000 $ 17,066 Director -- Europe James D. Hall 1999 $213,588 $ 77,939 $ 20,307(5) Senior Vice President, Chief Marketing Officer 1998 $205,008 $ 73,800 $ 18,365 and Managing Director -- Peltor Communications, 1997 $179,750 $ 41,000 $ 19,740 North America
(1) Includes contributions made on behalf of Mr. McLain to the Company's 401(k) Savings Plan ($7,800); to the Company's Cash Balance Plan ($7,422); and to the Company's Supplemental Executive Retirement Plan ($41,194). (2) Includes contributions made on behalf of Mr. O'Connor to the Company's 401(k) Savings Plan ($5,478); to the Company's Cash Balance Plan ($7,422); to the Company's Supplemental Executive Retirement Plan ($11,731); and $518,280 attributed to Mr. O'Connor's separation from the Company. (3) Includes contributions made on behalf of Mr. Mallitz to the Company's 401(k) Savings Plan ($5,169); to the Company's Cash Balance Plan ($8,422); and to the Company's Supplemental Executive Retirement Plan ($5,478). (4) Includes contributions made on behalf of Mr. Carey to the Company's 401(k) Savings Plan ($7,650); to the Company's Cash Balance Plan ($7,872); and to the Company's Supplemental Executive Retirement Plan ($11,008). Also includes relocation allowance payment associated with the relocation of the Corporate Headquarters ($17,084). (5) Includes contributions made on behalf of Mr. Hall to the Company's 401(k) Savings Plan ($4,964); to the Company's Cash Balance Plan ($7,672); and to the Company's Supplemental Executive Retirement Plan ($7,671). During fiscal 1999 there were no grants of options to purchase Aearo Common Stock issued to named executive officers. 49 51 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 1999. None of the Named Executive Officers exercised any stock options during fiscal 1999.
VALUE OF OUTSTANDING SHARES NUMBER OF BENEFICIAL IN-THE-MONEY OPTIONS ACQUIRED VALUE OPTIONS AT FISCAL YEAR-END AT FISCAL YEAR-END(1) NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ----------------------------------------------------------------------------------------------------- Michael A. McLain -- -- -- 1,100 $0 $0 Daniel P. O'Connor -- -- -- 250 0 0 M. Rand Mallitz -- -- -- 156 0 0 Bryan J. Carey -- -- -- 313 0 0 James D. Hall -- -- -- 250 0 0
(1) There was no public market for the Aearo Common Stock as of September 30, 1999. Accordingly, these values have been calculated on the basis of an assumed fair market value of $600 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 number of shares of Aearo Common Stock; during fiscal 1999, Bryan Marsal, one of the Outside Directors, purchased 250 shares at a price of $200 per share. In connection with such purchases Mr. Marsal 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, 1999, 13,825 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. 50 52 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 1, 1999, Non-qualified options to acquire 7,666.25 shares at a price of $600 per share, and 1,466.25 shares at a price of $800 per share have been granted to officers and key employees of the Company under the Company's stock option plans and 5,867.5 options remain available for issuance; of outstanding options, 2,568.75 in the aggregate have been granted to executive officers, including Mr. McLain (1,100 options), Mr. O'Connor (250 options), Mr. Hall (400 options), Mr. Carey (562.5 options) and Mr. Mallitz (256.25 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 severance pay policy providing certain executive officers and key employees with salary continuation in the event of a termination. The plan generally 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 individuals who's salary exceeds the Qualified Plan Compensation Limit set forth by the Internal Revenue Service (IRS). Pursuant to the plan, participants are credited annually with amounts representing 8% of compensation in excess of that amount of compensation in excess of the Qualified Plan Compensation Limit. DEFERRED COMPENSATION PLAN. The Company has adopted a Deferred Compensation Plan which is a non-qualified savings plan under the IRS code and which provides officers and paid directors the opportunity to defer the receipt of base salary and/or bonus. The plan is effective for fiscal years beginning with fiscal year 2000 and provides unfunded deferred compensation payments upon a participant's retirement or termination from the Company. Participant deferrals are credited annually with amounts based upon long-term bond rates and with amounts replicating the Company match in the 401(K) for savings from income above the qualified plan limits. 401(k) PLAN. The Company has adopted a savings plan (the "Savings Plan"), which is qualified under Section 401(a) and 401(k) of the Code. All regular employees of the Company in the United States 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, not to exceed the 401(k) plan elective deferral limit set forth by the IRS. Contributions to the Savings Plan will be invested, as the employee directs, in a money market fund, income fund, growth and income fund, growth fund, or asset allocation fund. 51 53 PENSION PLAN. The Company has adopted a cash balance plan. Under such plan, the Company will provide participants with annual credits of 4.0% of eligible compensation up to the Social Security Wage Base as set forth annually by the Social Security Administration and Department of Health and Human Services. An additional annual credit of 8.0% of eligible compensation from the Social Security Wage Base up to the Qualified Plan Compensation Limit set forth by the Internal Revenue Service (IRS) is provided. All balances in the accounts of participants will be credited with interest based on the prior year's U.S Treasury bill rate. At retirement, participants eligible for benefits may receive the balance standing in their account in a lump sum or as a monthly pension having equivalent actuarial value. 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 officers elects payment over time rather that in a lump sum:
ANNUAL BENEFITS NAME AND PRINCIPAL POSITION PAYABLE --------------------------- --------- Michael A. McLain .................................... $23,404 President and Chief Executive Officer Daniel P. O'Connor ................................... $20,731 Formerly Vice President, Sales M. Rand Mallitz ...................................... $17,098 Senior Vice President and General Manager, E-A-R(R) Specialty Composites Bryan J. Carey ....................................... $64,231 Executive Vice President, Chief Financial Officer, Treasurer, Assistant Secretary and Managing Director -- Europe James D. Hall ........................................ $29,496 Senior Vice President, Chief Marketing Officer and Managing Director -- Peltor Communications, North America
- -------------------- COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Company has a compensation committee of the Board of Directors. As of December 1, 1999 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. 52 54 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, 1999. All of the Subsidiary's issued and outstanding capital stock is owned by Aearo.
NUMBER OF SHARES PERCENTAGE OF OF AEARO OUTSTANDING NAME AND ADDRESS OF BENEFICIAL OWNER COMMON STOCK SHARES - -------------------------------------------------------------------------------------------------- Vestar Equity Partners, L.P.(1) ........................... 42,500 41.44% 245 Park Avenue New York, New York ...................................... 10017 Cabot CSC Corporation(2) .................................. 42,500 41.44% 75 State Street, 13th Floor Boston, Massachusetts ................................... 02109 Michael A. McLain ......................................... 4,050 3.95% John D. Curtin, Jr ........................................ 3,713 3.62% Bryan J. Carey ............................................ 1,500 1.46% James D. Hall ............................................. 1,050 1.02% Daniel P. O'Connor ........................................ 1,050 1.02% Norman W. Alpert(3) ....................................... 42,500 41.44% Daniel S. O'Connell(3) .................................... 42,500 41.44% Arthur J. Nagle(3) ........................................ 42,500 41.44% Robert Rothberg(4) ........................................ 42,500 41.44% Margaret J. Hanratty(4) ................................... 42,500 41.44% Bryan P. Marsal ........................................... 250 * William E. Kassling ....................................... 250 * M. Rand Mallitz ........................................... 950 * Directors and executive officers as a group (14 persons)(5) 101,313 98.81%
- ------------------------------------- * 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 Cabot CSC Corporation controls the voting and investment of the shares of Aearo Common Stock held by Cabot CSC Corporation. Cabot CSC Corporation is a wholly-owned subsidiary of Cabot. Cabot appoints the directors of Cabot CSC Corporation and exercises ultimate voting and investment power with respect to all shares held of record by Cabot CSC 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 Cabot CSC 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 53 55 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 1,225 shares of Aearo Common Stock held by Management Investors who are not executive officers. 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, 1999, (i) Cabot indirectly owns 41.4% of the Aearo Common Stock outstanding and 50% of the Aearo Preferred Stock outstanding, (ii) Vestar owns 41.4% of the Aearo Common Stock outstanding and 50% of the Aearo Preferred Stock outstanding and (iii) 17.2% 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 will have the power 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 nine 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), 54 56 (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. 55 57 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 $352,806 (including $58,144 to each party as an advisory fee relative to fiscal year 1998) with respect to fiscal 1999, $217,063 (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 between 6..31% and 7%, and (iv) are subject to mandatory prepayment in the event the employment of such Management Investor terminates. At September 30, 1999, amounts outstanding under such loans to Messrs. McLain, Kapur, Marlette, Floyd, Carey, O'Connor, Mallitz, Hall, and Phillips were $607,500, $123,916, $123,916, $123,916, $100,000, $81,000, $75,780, $60,955 and $61,958, respectively. 56 58 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Exhibits EXHIBIT NUMBER DESCRIPTION 2.1 -- Asset Transfer Agreement, dated as of June 13, 1995, among Aearo Company (formerly, Cabot Safety Corporation), Cabot Canada Ltd., Cabot Safety Limited, Cabot Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation), and Cabot Safety Acquisition Corporation. (Incorporated by reference to Exhibit No. 2.1 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.) 2.2 -- Trademark Coexistence Agreement, dated July 11, 1995, between Cabot Corporation and Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.2 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 2.3 -- Subscription Agreement, dated July 11, 1995, between Aearo Corporation (formerly, Cabot Safety Holdings Corporation) and Vestar Equity Partners, L.P. (Incorporated by reference to Exhibit No. 2.3 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.4 -- Stockholders' Agreement, dated as of July 11, 1995, among Vestar Equity Partners, L.P., Cabot CSC Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Corporation, and the Management Investors. (Incorporated by reference to Exhibit No. 2.4 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.5 -- Form of Executive Security Purchase Agreement, dated as of July 11, 1995, between Aearo Corporation (formerly, Cabot Safety Holdings Corporation) and the Management Investors (Senior Management). (Incorporated by reference to Exhibit No. 2.5 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.6 -- Form of Executive Security Purchase Agreement, dated as of July 11, 1995, between Aearo Corporation (formerly, Cabot Safety Holdings Corporation) and the Management Investors (Middle Management). (Incorporated by reference to Exhibit No. 2.6 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.7 -- Assignment and Assumption Agreement, dated as of July 11, 1995, by and between Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation and Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.7 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.8 -- Assignment and Assumption Agreement, dated as of July 11, 1995, by and between Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation and Cabot Safety Acquisition Limited (UK). (Incorporated by reference to Exhibit No. 2.8 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.9 -- Assignment and Assumption Agreement, dated as of July 11, 1995, by and between Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation and Cabot Safety Canada Acquisition Ltd. (Canada). (Incorporated by reference to Exhibit No. 2.9 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.10 -- Bill of Sale and Assignment, dated as of July 11, 1995, made by Aearo Company (formerly, Cabot Safety Corporation), Cabot Canada Ltd., and Cabot Safety Limited in favor of Aearo Corporation (formerly, Cabot 57 59 Safety Holdings Corporation), Cabot Safety Acquisition Corporation, Cabot Safety Intermediate Corporation, Cabot Safety Acquisition Limited and Cabot Safety Canada Acquisition Ltd. (Incorporated by reference to Exhibit No. 2.10 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.) 2.11 -- Assumption Agreement, dated as of July 11, 1995, by Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation, Cabot Safety Intermediate Corporation, Cabot Safety Acquisition Limited and Cabot Safety Canada Acquisition Ltd. in favor of Cabot Corporation, Aearo Company (formerly, Cabot Safety Corporation), Cabot Canada Ltd. and Cabot Safety Limited. (Incorporated by reference to Exhibit No. 2.11 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.) 2.12 -- Worldwide Trademark Assignment, dated July 11, 1995, by Aearo Company (formerly, Cabot Safety Corporation) to Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.12 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 2.13 -- Worldwide Copyright Assignment, dated July 11, 1995, by Aearo Company (formerly, Cabot Safety Corporation) to Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.13 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 2.14 -- Worldwide Patent Assignment, dated July 11, 1995, by Aearo Company (formerly, Cabot Safety Corporation) to Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.14 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 2.15 -- Management Advisory Agreement made as of July 11, 1995, among Aearo Company (formerly, Cabot Safety Corporation), Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Certain Subsidiaries of Aearo Corporation, Vestar Capital Partners and Cabot Corporation. (Incorporated by reference to Exhibit No. 2.15 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.) 2.16 -- Aearo Corporation (formerly, Cabot Safety Holdings Corporation) 1995 Employee Stock Purchase Plan. (Incorporated by reference to Exhibit No. 2.16 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.17 -- Assignment and Assumption Agreement dated July 11, 1995, by and between Aearo Company (formerly, Cabot Safety Corporation) and Cabot Safety Acquisition Corporation with Respect to the Installment Sale Agreement dated September 1, 1978 by and between the Department of Community Affairs and Economic Development of the State of Delaware and Specialty Composites Corporation (Predecessor to Cabot Safety Corporation) Pertaining to Real Property Located in New Castle County, Delaware, Tax Parcel Number 11-010.00-003 (Delaware IRB). (Incorporated by reference to Exhibit No. 2.17 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 2.18 -- Assignment and Assumption Agreement dated July 11, 1995, by and between Cabot Corporation and Cabot Safety Acquisition Corporation with Respect to that Certain Loan Agreement dated as of June 1, 1982 by and between the City of Indianapolis, Indiana and Cabot Corporation (Indianapolis IRB). (Incorporated by reference to Exhibit No. 2.18 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 2.19 -- Stock Purchase Agreement by and among Aearo Company (formerly, Cabot Safety Corporation), Peltor Holding AB, Leif Palmaer Invest AB, Leif Anderzon Invest AB and Active i Malmo All, dated April 25, 1996. (Incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K of Aearo Corporation (formerly, Cabot Safety Holdings Corporation) dated May 30, 1996.) 58 60 2.20* -- Stock Purchase Agreement by and among Aearo Company (formerly, Cabot Safety Corporation), Eastern Safety Equipment Co., Inc., Alfred H. Jacobson and William Klein and Jack P. Hecht as Trustees of a certain Trust, dated September 19, 1995. 2.21* -- Amendment to Stockholder's Agreement dated as of July 3, 1996, by and among Vestar Equity Partners, L.P., Cabot CSC Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation) Cabot Corporation, and certain other stockholders of Aearo Corporation. 2.22* -- Amendment to Stock Purchase Agreement by and among Aearo Company (formerly, Cabot Safety Corporation), Peltor Holding AB, Leif Palmaer Invest AB, Leif Anderzon Invest AB and Active i Malmo AB, dated May 15, 1996. 3.1 -- Amended and Restated Certificate of Incorporation of Aearo Corporation (formerly, Cabot Safety Holdings Corporation). (Incorporated by reference to Exhibit No. 3.(i).2 to the Registration statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 3.2 -- By-Laws of Aearo Corporation (formerly, Cabot Safety Holdings Corporation). (Incorporated by reference to Exhibit No. 3(ii).2 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 4.1 -- Indenture dated as of July 11, 1995 between Aearo Company (formerly, Cabot Safety Corporation), Aearo Corporation (formerly, Cabot Safety Holdings Corporation), and Fleet National Bank of Connecticut (formerly, Shawmut Bank Connecticut, National Association), as Trustee. (Incorporated by reference to Exhibit No. 4.1 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.) 4.2 -- Form of Note. (Incorporated by reference to Exhibit No. 4.2 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 4.3 -- Form of Exchange Note. (Incorporated by reference to Exhibit No. 4.3 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 4.4 -- Registration Rights Agreement, dated as of July 11, 1995, among Cabot Safety Acquisition Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation), BT Securities Corporation and Chemical Securities Inc. (Incorporated by reference to Exhibit No. 4.4 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 4.5 -- First Supplemental Indenture, dated December 6, 1995. (Incorporated by reference to Exhibit No. 4.5 to the Annual Report on Form 10-K of Aearo Corporation (formerly, Cabot Safety Holdings Corporation) for the fiscal year ended September 30, 1995.) 10.1* -- Credit Agreement, dated as of July 11, 1995, and amended and restated as of May 30, 1996, among Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Aearo Company (formerly, Cabot Safety Corporation), Certain of its Subsidiaries, Various Banks, and Bankers Trust Company as Co-Arranger and Administrative Agent. 10.2* -- Amended and Restated US Pledge Agreement dated as of July 11, 1995, as made by Cabot Safety Acquisition Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Intermediate Corporation and CSC FSC, Inc., in favor of Bankers Trust Company as Collateral Agent for the Benefit of the Secured Creditors. 10.3* -- Amended and Restated Foreign Pledge Agreement as of July 11, 1995, amended and restated as of May 30, 1996, made by Cabot Safety Canada Acquisition Limited and Cabot Safety Acquisition Limited in favor of Bankers Trust Company as Collateral Agent for the Benefit of the Secured Creditors. 59 61 10.4 -- Charge Over United Kingdom Patents and Trademarks made the 11th Day of July, 1995, by Cabot Safety Intermediate Corporation and the Bankers Trust Company as Collateral Agent for Itself and for the Secured Creditors. (Incorporated by reference to Exhibit No. 10.4 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.5* -- Amended and Restated US Security Agreement dated as of July 11, 1995, as amended and restated as of May 30, 1996, among Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation, Cabot Safety Intermediate Corporation, CSC FSC, Inc., and Bankers Trust Company as Collateral Agent for the Benefit of the Secured Creditors. 10.6* -- Amended and Restated Canadian Security Agreement dated as of July 11, 1995, as amended and restated as of May 30, 1996, granted by Cabot Safety Canada Acquisition Limited in favor of Bankers Trust Company as Collateral Agent for the Benefit of the Secured Creditors. 10.7 -- English Security Agreement (The Debenture) made on the 11th Day of July, 1995 between the Cabot Safety Acquisition Limited and Bankers Trust Company as Collateral Agent for Itself and for the Secured Creditors. (Incorporated by reference to Exhibit No. 10.7 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.8 -- Mortgage and Security Agreement, Assignment of Leases, Rents and Profits, Financing Statement, and Fixture Filing made by Cabot Safety Acquisition Corporation, as Mortgagor, to Bankers Trust Company, as Collateral Agent, as Mortgagee (recorded in Marion County, Indiana) pertaining to Real Property located at 7911 Zionsville Road, Indianapolis, Indiana. (Incorporated by reference to Exhibit No. 10.8 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.9 -- Mortgage and Security Agreement, Assignment of Leases, Rents and Profits, Financing Statement, and Fixture Filing made by Cabot Safety Acquisition Corporation, as Mortgagor, to Bankers Trust Company, as Collateral Agent, as Mortgagee (recorded in New Castle County, Delaware) pertaining to l0 Acre Site of Unimproved Land adjacent to 5457 West 79th Street, Indianapolis, Indiana. (Incorporated by reference to Exhibit No. 10.9 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.10 -- Mortgage and Security Agreement, Assignment of Leases, Rents and Profits, Financing Statement, and Fixture Filing made by Cabot Safety Acquisition Corporation, as Mortgagor, to Bankers Trust Company, as Collateral Agent, as Mortgagee (recorded in New Castle County, Delaware) pertaining to Real Property located at 650 Dawson Drive, Newark, Delaware. (Incorporated by reference to Exhibit No. 10.10 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.11 -- Aearo Company (formerly, Cabot Safety Corporation) Employees' Retirement Account Plan, dated as of May 1, 1990, as amended. (Incorporated by reference to Exhibit No. 10.11 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.12 -- Fidelity Corporate (401(k)) Plan for Retirement, dated August 1, 1993, as amended. (Incorporated by reference to Exhibit No. 10.12 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.13 -- Aearo Company (formerly, Cabot Safety Corporation) Supplemental Executive Retirement Plan, dated May 1, 1993. (Incorporated by reference to Exhibit No. 10.13 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.14 -- Sublease, dated June 4, 1994, between C.W. Kay-Bee Inc. and Aearo Company (formerly, Cabot Safety Corporation), pertaining to 8001-8003 Woodland Drive, Indianapolis, Indiana, as amended. (Incorporated by reference to Exhibit No. 10.14 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 60 62 10.15 -- Sublease, dated April 16, 1990, between American Optical Corporation and Aearo Company (formerly, Cabot Safety Corporation), pertaining to Southbridge, Massachusetts manufacturing facility. (Incorporated by reference to Exhibit No. 10.15 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.16* -- Aearo Corporation (formerly, Cabot Safety Holdings Corporation) Amended and Restated 1995 Employee and Non-Employee Director Stock Purchase Plan. 10.17* -- Form of Executive Security Purchase Agreement. 10.18* -- Aearo Corporation (formerly, Cabot Safety Holdings Corporation) Executive Stock Option Plan. 10.19* -- Amended and Restated US Subsidiary Guaranty dated July 11, 1995 delivered by Cabot Safety Intermediate Corporation, CSC FSC, Inc. and Eastern Safety Equipment Co., Inc. in favor of Bankers Trust Company. 10.20* -- Aearo Corporation (formerly, Cabot Safety Holdings Corporation) 1996 Stock Option Plan. 10.21* -- Form of Incentive Stock Option Agreement under the Aearo Corporation (formerly, Cabot Safety Holdings Corporation) 1996 Stock Option Plan. 10.22* -- Form of Non-Qualified Stock Option Agreement for Company Employees under the Aearo Corporation (formerly, Cabot Safety Holdings Corporation) 1996 Stock Option Plan. 10.23* -- Employment Agreement between Peltor AB and Leif Palmact, dated January 1, 1996. 10.24* -- Employment Agreement between Peltor AB and Leif Anderzon, dated January 1, 1996. 10.25* -- Amended and Restated US Subsidiary Guaranty dated July 11, 1995 as amended and restated as of May 30, 1996, delivered by Cabot Safety Intermediate Corporation, CSC FSC, Inc. and Eastern Safety Equipment Co., Inc. in favor of Bankers Trust Company. 10.26 -- Fourth Amendment to Credit Agreement, dated as of December 4, 1998, by and among Aearo Corporation, Aearo Company, certain of its Subsidiaries, Various Banks, and Bankers Trust Company as Administrative Agent (incorporated by reference to the same numbered exhibit of the Company's Annual Report on 1998 10-K for the year ended September 30, 1998). 10.27 -- Aearo Corporation 1997 Stock Option Plan Agent (incorporated by reference to the same numbered exhibit of the Company's Annual Report on 1998 10-K for the year ended September 30, 1998). 12.1** -- Statements re: Computation of Ratios. 21.1* -- List of Subsidiaries. 24.1** -- Powers of Attorney (see page 64 of this report). 27.1** -- Financial Data Schedule. - ---------------- * Incorporated by reference to the same numbered exhibit to the registration statement on Form S-1, No. 333-05047, of Aearo Corporation (formerly, Cabot Safety Holdings Corporation). ** Filed herewith. (b) Financial Statement Schedules See page 63 of this report 61 63 (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. On August 2, 1999, the Company filed a Current Report on Form 8-K containing its press release regarding certain the acquisition of Safety Optical, Inc of Athens, Tennessee. On November 3, 1999, the Company filed a Current Report on Form 8-K containing its press release regarding the acquisition of Norhammer Limited of Ontario, Canada. 62 64 SCHEDULE II AEARO CORPORATION VALUATION AND QUALIFYING ACCOUNTS For the years ended September 30, 1997, 1998, and 1999 (Dollars in thousands)
Additions ----------------------- Net Balance at Provisions Charged Deductions Balance beginning Charged to to Other From at end of Period Operations Accounts Allowances of Period ------------------------------------------------------------------- Year ended September 30, 1997 Bad Debt Reserve 1,200 622 100 A (621) 1,301 Sales Returns & Allowances Reserve 1,519 203 -- (838) 884 Year ended September 30, 1998 Bad Debt Reserve 1,301 497 -- (559) 1,239 Sales Returns & Allowances Reserve 884 -- -- (285) 599 Restructure Reserve -- 11,585 -- (8,595) 2,990 Year ended September 30, 1999 Bad Debt Reserve 1,239 594 -- (537) 1,296 Sales Returns & Allowances Reserve 599 -- -- (26) 573 Restructure Reserve 2,990 -- -- (2,938) 52
NOTES: A. Accrued liabilities. 63 65 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 1, 1999 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: November 3, 1999 /s/ Michael A. McLain -------------------------------------------- Michael A. McLain President, Chief Executive Officer and Director (Principal Executive Officer) Date: November 3, 1999 /s/ Bryan J. Carey -------------------------------------------- Bryan J. Carey Vice President, Chief Financial Officer, Treasurer and Assistant Secretary (Principal Accounting Officer) Date: November 8, 1999 /s/ John D. Curtin, Jr. -------------------------------------------- John D. Curtin, Jr., Director Date: November 3, 1999 /s/ Norman W. Alpert, Director -------------------------------------------- Date: November 3, 1999 /s/ Robert Rothberg -------------------------------------------- Robert Rothberg, Director Date: November 3, 1999 /s/ Margaret J. Hanratty -------------------------------------------- Margaret J. Hanratty, Director 64 66 Date: November 3, 1999 /s/ Arthur J. Nagle, Director -------------------------------------------- Date: November 3, 1999 /s/ Daniel S. O'Connell, Director -------------------------------------------- Date: November 3, 1999 /s/ William Kassling, Director -------------------------------------------- Date: November 3, 1999 /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, 1999 has been sent to security holders of the Registrant. 65 67 INDEX OF EXHIBITS EXHIBIT NUMBER DESCRIPTION - -------------------------------------------------------------------------------- 2.1 -- Asset Transfer Agreement, dated as of June 13, 1995, among Aearo Company (formerly, Cabot Safety Corporation), Cabot Canada Ltd., Cabot Safety Limited, Cabot Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation), and Cabot Safety Acquisition Corporation. (Incorporated by reference to Exhibit No. 2.1 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.) 2.2 -- Trademark Coexistence Agreement, dated July 11, 1995, between Cabot Corporation and Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.2 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 2.3 -- Subscription Agreement, dated July 11, 1995, between Aearo Corporation (formerly, Cabot Safety Holdings Corporation) and Vestar Equity Partners, L.P. (Incorporated by reference to Exhibit No. 2.3 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.4 -- Stockholders' Agreement, dated as of July 11, 1995, among Vestar Equity Partners, L.P., Cabot CSC Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Corporation, and the Management Investors. (Incorporated by reference to Exhibit No. 2.4 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.5 -- Form of Executive Security Purchase Agreement, dated as of July 11, 1995, between Aearo Corporation (formerly, Cabot Safety Holdings Corporation) and the Management Investors (Senior Management). (Incorporated by reference to Exhibit No. 2.5 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.6 -- Form of Executive Security Purchase Agreement, dated as of July 11, 1995, between Aearo Corporation (formerly, Cabot Safety Holdings Corporation) and the Management Investors (Middle Management). (Incorporated by reference to Exhibit No. 2.6 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.7 -- Assignment and Assumption Agreement, dated as of July 11, 1995, by and between Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation and Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.7 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.8 -- Assignment and Assumption Agreement, dated as of July 11, 1995, by and between Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation and Cabot Safety Acquisition Limited (UK). (Incorporated by reference to Exhibit No. 2.8 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.9 -- Assignment and Assumption Agreement, dated as of July 11, 1995, by and between Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation and Cabot Safety Canada Acquisition Ltd. (Canada). (Incorporated by reference to Exhibit No. 2.9 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.10 -- Bill of Sale and Assignment, dated as of July 11, 1995, made by Aearo Company (formerly, Cabot Safety Corporation), Cabot Canada Ltd., and Cabot Safety Limited in favor of Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation, Cabot Safety Intermediate Corporation, Cabot Safety Acquisition Limited and Cabot Safety Canada Acquisition Ltd. (Incorporated by reference to Exhibit No. 2.10 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.) 66 68 EXHIBIT NUMBER DESCRIPTION - -------------------------------------------------------------------------------- 2.11 -- Assumption Agreement, dated as of July 11, 1995, by Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition Corporation, Cabot Intermediate Corporation, Cabot Safety Acquisition Limited and Cabot Safety Canada Acquisition Ltd. in favor of Cabot Corporation, Aearo Company (formerly, Cabot Safety Corporation), Cabot Canada Ltd. and Cabot Safety Limited. (Incorporated by reference to Exhibit No. 2.11 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.) 2.12 -- Worldwide Trademark Assignment, dated July 11, 1995, by Aearo Company (formerly, Cabot Safety Corporation) to Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.12 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 2.13 -- Worldwide Copyright Assignment, dated July 11, 1995, by Aearo Company (formerly, Cabot Safety Corporation) to Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.13 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 2.14 -- Worldwide Patent Assignment, dated July 11, 1995, by Aearo Company (formerly, Cabot Safety Corporation) to Cabot Safety Intermediate Corporation. (Incorporated by reference to Exhibit No. 2.14 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 2.15 -- Management Advisory Agreement made as of July 11, 1995, among Aearo Company (formerly, Cabot Safety Corporation), Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Certain Subsidiaries of Aearo Corporation, Vestar Capital Partners and Cabot Corporation. (Incorporated by reference to Exhibit No. 2.15 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.) 2.16 -- Aearo Corporation (formerly, Cabot Safety Holdings Corporation) 1995 Employee Stock Purchase Plan. (Incorporated by reference to Exhibit No. 2.16 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 2.17 -- Assignment and Assumption Agreement dated July 11, 1995, by and between Aearo Company (formerly, Cabot Safety Corporation) and Cabot Safety Acquisition Corporation with Respect to the Installment Sale Agreement dated September 1, 1978 by and between the Department of Community Affairs and Economic Development of the State of Delaware and Specialty Composites Corporation (Predecessor to Cabot Safety Corporation) Pertaining to Real Property Located in New Castle County, Delaware, Tax Parcel Number 11-010.00-003 (Delaware IRB). (Incorporated by reference to Exhibit No. 2.17 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 2.18 -- Assignment and Assumption Agreement dated July 11, 1995, by and between Cabot Corporation and Cabot Safety Acquisition Corporation with Respect to that Certain Loan Agreement dated as of June 1, 1982 by and between the City of Indianapolis, Indiana and Cabot Corporation (Indianapolis IRB). (Incorporated by reference to Exhibit No. 2.18 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 2.19 -- Stock Purchase Agreement by and among Aearo Company (formerly, Cabot Safety Corporation), Peltor Holding AB, Leif Palmaer Invest AB, Leif Anderzon Invest AB and Active i Malmo All, dated April 25, 1996. (Incorporated by reference to Exhibit 2.1 to the Current Report on Form 8-K of Aearo Corporation (formerly, Cabot Safety Holdings Corporation) dated May 30, 1996.) 2.20* -- Stock Purchase Agreement by and among Aearo Company (formerly, Cabot Safety Corporation), Eastern Safety Equipment Co., Inc., Alfred H. Jacobson and William Klein and Jack P. Hecht as Trustees of a certain Trust, dated September 19, 1995. 2.21* -- Amendment to Stockholder's Agreement dated as of July 3, 1996, by and among Vestar Equity Partners, L.P., Cabot CSC Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation) Cabot Corporation, and certain other stockholders of Aearo Corporation. 67 69 EXHIBIT NUMBER DESCRIPTION - -------------------------------------------------------------------------------- 2.22* -- Amendment to Stock Purchase Agreement by and among Aearo Company (formerly, Cabot Safety Corporation), Peltor Holding AB, Leif Palmaer Invest AB, Leif Anderzon Invest AB and Active i Malmo AB, dated May 15, 1996. 3.1 -- Amended and Restated Certificate of Incorporation of Aearo Corporation (formerly, CabotSafety Holdings Corporation). (Incorporated by reference to Exhibit No. 3.(i).2 to the Registration statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 3.2 -- By-Laws of Aearo Corporation (formerly, Cabot Safety Holdings Corporation). (Incorporated by reference to Exhibit No. 3(ii).2 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 4.1 -- Indenture dated as of July 11, 1995 between Aearo Company (formerly, Cabot Safety Corporation), Aearo Corporation (formerly, Cabot Safety Holdings Corporation), and Fleet National Bank of Connecticut (formerly, Shawmut Bank Connecticut, National Association), as Trustee. (Incorporated by reference to Exhibit No. 4.1 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation.) 4.2 -- Form of Note. (Incorporated by reference to Exhibit No. 4.2 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 4.3 -- Form of Exchange Note. (Incorporated by reference to Exhibit No. 4.3 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 4.4 -- Registration Rights Agreement, dated as of July 11, 1995, among Cabot Safety Acquisition Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation), BT Securities Corporation and Chemical Securities Inc. (Incorporated by reference to Exhibit No. 4.4 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation.) 4.5 -- First Supplemental Indenture, dated December 6, 1995. (Incorporated by reference to Exhibit No. 4.5 to the Annual Report on Form 10-K of Aearo Corporation (formerly, Cabot Safety Holdings Corporation) for the fiscal year ended September 30, 1995.) 10.1* -- Credit Agreement, dated as of July 11, 1995, and amended and restated as of May 30, 1996, among Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Aearo Company (formerly, Cabot Safety Corporation), Certain of its Subsidiaries, Various Banks, and Bankers Trust Company as Co- Arranger and Administrative Agent. 10.2* -- Amended and Restated US Pledge Agreement dated as of July 11, 1995, as made by Cabot Safety Acquisition Corporation, Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Intermediate Corporation and CSC FSC, Inc., in favor of Bankers Trust Company as Collateral Agent for the Benefit of the Secured Creditors. 10.3* -- Amended and Restated Foreign Pledge Agreement as of July 11, 1995, amended and restated as of May 30, 1996, made by Cabot Safety Canada Acquisition Limited and Cabot Safety Acquisition Limited in favor of Bankers Trust Company as Collateral Agent for the Benefit of the Secured Creditors. 10.4 -- Charge Over United Kingdom Patents and Trademarks made the 11th Day of July, 1995, by Cabot Safety Intermediate Corporation and the Bankers Trust Company as Collateral Agent for Itself and for the Secured Creditors. (Incorporated by reference to Exhibit No. 10.4 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.5* -- Amended and Restated US Security Agreement dated as of July 11, 1995, as amended and restated as of May 30, 1996, among Aearo Corporation (formerly, Cabot Safety Holdings Corporation), Cabot Safety Acquisition 68 70 EXHIBIT NUMBER DESCRIPTION - -------------------------------------------------------------------------------- Corporation, Cabot Safety Intermediate Corporation, CSC FSC, Inc., and Bankers Trust Company as Collateral Agent for the Benefit of the Secured Creditors. 10.6* -- Amended and Restated Canadian Security Agreement dated as of July 11, 1995, as amended and restated as of May 30, 1996, granted by Cabot Safety Canada Acquisition Limited in favor of Bankers Trust Company as Collateral Agent for the Benefit of the Secured Creditors. 10.7 -- English Security Agreement (The Debenture) made on the 11th Day of July, 1995 between the Cabot Safety Acquisition Limited and Bankers Trust Company as Collateral Agent for Itself and for the Secured Creditors. (Incorporated by reference to Exhibit No. 10.7 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.8 -- Mortgage and Security Agreement, Assignment of Leases, Rents and Profits, Financing Statement, and Fixture Filing made by Cabot Safety Acquisition Corporation, as Mortgagor, to Bankers Trust Company, as Collateral Agent, as Mortgagee (recorded in Marion County, Indiana) pertaining to Real Property located at 7911 Zionsville Road, Indianapolis, Indiana. (Incorporated by reference to Exhibit No. 10.8 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.9 -- Mortgage and Security Agreement, Assignment of Leases, Rents and Profits, Financing Statement, and Fixture Filing made by Cabot Safety Acquisition Corporation, as Mortgagor, to Bankers Trust Company, as Collateral Agent, as Mortgagee (recorded in New Castle County, Delaware) pertaining to l0 Acre Site of Unimproved Land adjacent to 5457 West 79th Street, Indianapolis, Indiana. (Incorporated by reference to Exhibit No. 10.9 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.10 -- Mortgage and Security Agreement, Assignment of Leases, Rents and Profits, Financing Statement, and Fixture Filing made by Cabot Safety Acquisition Corporation, as Mortgagor, to Bankers Trust Company, as Collateral Agent, as Mortgagee (recorded in New Castle County, Delaware) pertaining to Real Property located at 650 Dawson Drive, Newark, Delaware. (Incorporated by reference to Exhibit No. 10.10 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.11 -- Aearo Company (formerly, Cabot Safety Corporation) Employees' Retirement Account Plan, dated as of May 1, 1990, as amended. (Incorporated by reference to Exhibit No. 10.11 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.12 -- Fidelity Corporate (401(k)) Plan for Retirement, dated August 1, 1993, as amended. (Incorporated by reference to Exhibit No. 10.12 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company (formerly, Cabot Safety Corporation) and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.13 -- Aearo Company (formerly, Cabot Safety Corporation) Supplemental Executive Retirement Plan, dated May 1, 1993. (Incorporated by reference to Exhibit No. 10.13 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.14 -- Sublease, dated June 4, 1994, between C.W. Kay-Bee Inc. and Aearo Company (formerly, Cabot Safety Corporation), pertaining to 8001-8003 Woodland Drive, Indianapolis, Indiana, as amended. (Incorporated by reference to Exhibit No. 10.14 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 10.15 -- Sublease, dated April 16, 1990, between American Optical Corporation and Aearo Company (formerly, Cabot Safety Corporation), pertaining to Southbridge, Massachusetts manufacturing facility. (Incorporated by reference to Exhibit No. 10.15 to the Registration Statement on Form S-4, No. 33-96190, of Aearo Company and Aearo Corporation (formerly, Cabot Safety Holdings Corporation).) 69 71 EXHIBIT NUMBER DESCRIPTION - -------------------------------------------------------------------------------- 10.16* -- Aearo Corporation (formerly, Cabot Safety Holdings Corporation) Amended and Restated 1995 Employee and Non-Employee Director Stock Purchase Plan. 10.17* -- Form of Executive Security Purchase Agreement. 10.18* -- Aearo Corporation (formerly, Cabot Safety Holdings Corporation) Executive Stock Option Plan. 10.19* -- Amended and Restated US Subsidiary Guaranty dated July 11, 1995 delivered by Cabot Safety Intermediate Corporation, CSC FSC, Inc. and Eastern Safety Equipment Co., Inc. in favor of Bankers Trust Company. 10.20* -- Aearo Corporation (formerly, Cabot Safety Holdings Corporation) 1996 Stock Option Plan. 10.21* -- Form of Incentive Stock Option Agreement under the Aearo Corporation (formerly, Cabot Safety Holdings Corporation) 1996 Stock Option Plan. 10.22* -- Form of Non-Qualified Stock Option Agreement for Company Employees under the Aearo Corporation (formerly, Cabot Safety Holdings Corporation) 1996 Stock Option Plan. 10.23* -- Employment Agreement between Peltor AB and Leif Palmact, dated January 1, 1996. 10.24* -- Employment Agreement between Peltor AB and Leif Anderzon, dated January 1, 1996. 10.25* -- Amended and Restated US Subsidiary Guaranty dated July 11, 1995 as amended and restated as of May 30, 1996, delivered by Cabot Safety Intermediate Corporation, CSC FSC, Inc. and Eastern Safety Equipment Co., Inc. in favor of Bankers Trust Company. 10.26 -- Fourth Amendment to Credit Agreement, dated as of December 4, 1998, by and among Aearo Corporation, Aearo Company, certain of its Subsidiaries, Various Banks, and Bankers Trust Company as Administrative Agent (incorporated by reference to the same numbered exhibit of the Company's Annual Report on 1998 10-K for the year ended September 30, 1998). 10.27 -- Aearo Corporation 1997 Stock Option Plan (incorporated by reference to the same numbered exhibit of the Company's Annual Report on 1998 10-K for the year ended September 30, 1998). 12.1** -- Statements re: Computation of Ratios. 21.1* -- List of Subsidiaries. 24.1** -- Powers of Attorney. (See page 64 of this report) 27.1** -- Financial Data Schedule. - ------------------------ * Incorporated by reference to the same numbered exhibit to the registration statement on Form S-1, No. 333-05047, of Aearo Corporation (formerly, Cabot Safety Holdings Corporation). ** Filed herewith. 70 EX-12.1 2 STATEMENTS RE: COMPUTATION OF RATIOS 1 EXHIBIT 12.1 AEARO CORPORATION CALCULATION OF RATIO OF EARNINGS TO FIXED CHARGES (DOLLARS IN THOUSANDS) (UNAUDITED)
PREDECESSOR COMPANY SUCCESSOR COMPANY ------------ ------------------------------------------------------------------- PERIOD ENDED PERIOD ENDED JULY 11, SEPTEMBER 30, YEAR ENDED SEPTEMBER 30, 1995 1995 1996 1997 1998 1999 ------------ ------------------------------------------------------------------- EARNINGS: Pre-tax income (loss) from continuing operations ............... $ 7,815 $ (159) $ 6,477 $ (5,959) $ (9,242) $ 10,297 Fixed charges (see below) ........... 6,599 4,388 22,153 28,419 27,984 26,152 -------- -------- -------- -------- -------- -------- Earnings as defined ................. $ 14,414 $ 4,229 $ 28,630 $ 22,460 $ 18,742 $ 36,449 -------- -------- -------- -------- -------- -------- Fixed Charge: Interest expense, net ............... $ 5,673 $ 4,135 $ 20,703 $ 26,665 $ 26,152 $ 24,322 Interest component of operating lease 926 253 1,450 1,754 1,832 1,830 -------- -------- -------- -------- -------- -------- Fixed charges as defined ............ $ 6,599 $ 4,388 $ 22,153 $ 28,419 $ 27,984 $ 26,152 -------- -------- -------- -------- -------- -------- Ratio of Earnings to Fixed Charges .. 2.2 -- 1.3 -- -- 1.4 -------- -------- -------- -------- -------- --------
Note: Ratio of earnings to fixed charges is defined as pre-tax income from continuing operations plus fixed charges divided by fixed charges. Fixed charges included interest (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 insufficient to cover fixed charges by $0.2 million, $6.0 million, and $9.2 million, respectively. EX-27.1 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM (A) THE BALANCE SHEET OF AEARO CORPORATION AS OF SEPTEMBER 30, 1999 AND THE STATEMENT OF OPERATIONS OF AEARO CORPORATION FOR THE YEAR ENDED SEPTEMBER 30, 1999 CONTAINED IN AEARO CORPORATION'S FORM 10-K-405 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH (B) FORM 10-K-405. 1,000 YEAR SEP-30-1999 OCT-01-1998 SEP-30-1999 4,050 0 43,801 0 33,286 84,887 93,136 37,255 282,293 63,779 198,716 0 0 1 16,473 282,293 290,389 290,389 157,535 157,535 98,235 0 24,322 10,297 3,244 7,053 0 0 0 7,053 (20.35) (20.35)
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