AEARO CORPORATION


                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                            ------------------------

                                    FORM 10-Q


                QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
                      OF THE SECURITIES EXCHANGE ACT O 1934


                  For the quarterly period ended June 30, 2001


                         Commission file number 33-96190


                                AEARO CORPORATION
             (Exact name of registrant as specified in its charter)


                            ------------------------


                 Delaware                           13-3840450
      (State or other jurisdiction of        (IRS Employer Identification No.)
       incorporation or organization)

            5457 West 79th Street                      46268
           Indianapolis, Indiana                     (Zip Code)
    (Address of principal executive offices)

                                 (317) 692-6666
              (Registrant's telephone number, including area code)


                            ------------------------


     Indicate  by check mark  whether the  registrant  (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. Yes X No_

     The number of share of the  registrant's  common stock,  par value $.01 per
share, outstanding as of August 14, 2001 was 102,087.5.





<PAGE>

                                AEARO CORPORATION

                                Table of Contents

             Form 10-Q for the Quarterly Period Ended June 30, 2001

PART I.........................................................................3
 Item 1.  Financial Statements.................................................3
   Aearo Corporation...........................................................3
   Condensed Consolidated Balance Sheets -- Assets.............................3
   Condensed Consolidated Balance Sheets --
     Liabilities and Stockholders' Equity......................................4
   Condensed Consolidated Statements of Operations.............................5
   Condensed Consolidated Statements of Cash Flows.............................6
   Notes to Condensed Consolidated Financial Statements........................6
   Notes to Condensed Consolidated Financial Statements........................7
 Item 2. Management's Discussion and Analysis of
   Financial Condition and Results of Operations..............................14
 Item 3. Quantitative and Qualitative Disclosures about Market Risk...........22
PART II.......................................................................24
 Item 1.  Legal Proceedings...................................................24
 Item 2.  Changes in Securities and Use of Proceeds...........................24
 Item 3.  Defaults Upon Senior Securities.....................................24
 Item 4.  Submission of Matters to a Vote of Security-Holders.................24
 Item 5.  Other Information...................................................24
 Item 6.  Exhibits and Reports on Form 8-K....................................24
 Signatures...................................................................25
 Exhibit Index................................................................26



                                      -2-
<PAGE>

                                     PART I

Item 1.  Financial Statements

                                AEARO CORPORATION

                 CONDENSED CONSOLIDATED BALANCE SHEETS -- ASSETS

                             (Dollars in Thousands)

                                                      June 30,   September 30,
                                                       2001          2000
                                                    ---------      --------
                                                   (Unaudited)
CURRENT ASSETS:
  Cash and cash equivalents                          $  8,954      $  3,495
  Accounts receivable (net of reserve for doubtful
   accounts of $883 and $1,354 respectively)           42,207        44,342
  Inventories                                          34,690        34,310
  Deferred and prepaid expenses                         3,192         2,623
                                                     --------      --------

    Total current assets                               89,043        84,770
                                                     --------      --------

PROPERTY, PLANT AND EQUIPMENT, NET                     50,239        53,163

INTANGIBLE ASSETS, NET                                118,364       126,242

OTHER ASSETS                                            1,861         2,691
                                                     --------      --------

    Total Assets                                      259,507       266,866
                                                     ========      ========


              The accompanying notes are an integral part of these
                  condensed consolidate financial statements.



                                      -3-
<PAGE>


                                AEARO CORPORATION


  CONDENSED CONSOLIDATED BALANCE SHEETS -- LIABILITIES AND STOCKHOLDERS' EQUITY

                             (Dollars in Thousands)

<TABLE>
<CAPTION>
                                                           June 30,       September 30,
                                                            2001             2000
                                                          ---------        ---------
                                                         (Unaudited)
CURRENT LIABILITIES:
<S>                                                       <C>              <C>
  Current portion of long-term debt                       $   7,978        $  19,313
  Accounts payable and accrued liabilities                   31,370           39,427
  Accrued interest                                            6,064            3,423
  U.S. and foreign income taxes                               5,312            5,375
                                                          ---------        ---------

    Total current liabilities                                50,724           67,538
                                                          ---------        ---------

LONG-TERM DEBT                                              189,459          180,506

DEFERRED INCOME TAXES                                           332              507

OTHER LIABILITIES                                             2,407            2,466
                                                          ---------        ---------

    Total Liabilities                                     $ 242,922        $ 251,017
                                                          ---------        ---------

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value-
 (Redemption value of $95,903 and $87,237, respectively)
  Authorized - 200,000 shares
  Issued and outstanding - 45,000 shares                       --               --
Common stock $.01 par value-
  Authorized -- 200,000 shares
  Issued and outstanding -- 102,088 and 102,088 at
    June 30, 2001 and September 30, 2000, respectively            1                1
Additional paid-in-capital                                   32,386           32,213
Retained earnings (deficit)                                   5,047             (613)
Accumulated other comprehensive loss                        (20,849)         (15,752)
                                                          ---------        ---------

Total stockholders' equity                                   16,585           15,849
                                                          ---------        ---------

Total liabilities and stockholders' equity                $ 259,507        $ 266,866
                                                          =========        =========

</TABLE>

              The accompanying notes are an integral part of these
                  condensed consolidate financial statements.

                                      -4-
<PAGE>


                                AEARO CORPORATION

                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

           (Dollars in Thousands, Except per Share and Share Amounts)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                          For the                     For the
                                                     Three Months Ended         Nine Months Ended
                                                          June 30,                    June 30,

                                                  ---------    ---------       ---------    ---------
                                                      2001        2000             2001        2000
                                                  ---------    ---------       ---------    ---------

<S>                                               <C>          <C>             <C>          <C>
NET SALES                                         $  72,043    $  80,158       $ 214,250    $ 229,782

COST OF SALES                                        39,207       42,254         116,276      122,333
                                                  ---------    ---------       ---------    ---------
    Gross Profit                                     32,836       37,904          97,974      107,449

SELLING AND ADMINISTRATIVE                           19,275       24,388          64,772       71,346

RESEARCH AND TECHNICAL SERVICES                       1,138        1,423           3,987        4,141

AMORIZATION OF INTANGIBLES                            1,593        1,684           4,882        5,175

OTHER CHARGES (INCOME), NET                             (87)        (319)            437         (728)
                                                  ---------    ---------       ---------    ---------
    Operating Income                                 10,917       10,728          23,896       27,515

INTEREST EXPENSE, NET                                 5,451        6,140          17,131       18,299
                                                  ---------    ---------       ---------    ---------
    Income before provision for income taxes          5,466        4,588           6,765        9,216

PROVISION FOR INCOME TAXES                              454        1,095           1,105        2,509
                                                  ---------    ---------       ---------    ---------
    Net Income                                        5,012        3,493           5,660        6,707

PREFERRED STOCK DIVIDEND ACCRUED                      2,980        2,626           8,666        7,662
                                                  ---------    ---------       ---------    ---------
    Net Income (Loss) applicable to
    Common Shareholders                           $   2,032    $     867       $  (3,006)   $    (955)
                                                  =========    =========       =========    =========
AVERAGE COMMON AND DILUTED
COMMON SHARES OUTSTANDING                           102,088      102,088         102,088      102,175
                                                  =========    =========       =========    =========
BASIC AND DILUTED NET INCOME (LOSS)
PER COMMON SHARE                                  $   19.90    $    8.49       $  (29.45)   $   (9.35)
                                                  =========    =========       =========    =========
</TABLE>

              The accompanying notes are an integral part of these
                  condensed consolidate financial statements.

                                      -5-
<PAGE>



                                AEARO CORPORATION

                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

                             (Dollars in Thousands)
                                   (UNAUDITED)
<TABLE>
<CAPTION>

                                                                 For the Nine Months Ended
                                                                         June 30,
                                                                  -----------------------
                                                                     2001           2000
                                                                  --------       --------
<S>                                                               <C>            <C>
CASH FLOWS FROM OPERATING ACTIVITES:
 Net Income                                                       $  5,660       $  6,707
 Adjustments to reconcile net income to cash provided by
 operating activities--
  Depreciation                                                       7,695          7,488
  Amortization of intangible assets and deferred financing cost      5,990          6,607
  Deferred income taxes                                               (150)          (123)
  Other, net                                                           186             56
  Changes in assets and liabilities--
   Accounts receivable                                               1,276         (4,440)
   Inventories                                                      (1,178)        (1,232)
   Accounts payable and accrued liabilities                         (4,809)         2,174
   Other, net                                                         (731)         2,200
                                                                  --------       --------

    Net cash provided by operting activities                        13,939         19,437
                                                                  --------       --------

CASH FLOWS FROM INVESTING ACTIVITIES:
 Additions to property, plant and equipment                         (5,804)        (7,155)
 Cash paid for Norhammer                                              --           (3,970)
 Proceeds provided by disposals of property, plant and equipment        36             10
                                                                  --------       --------

    Net cash used by investing activities                           (5,768)       (11,115)
                                                                  --------       --------

CASH FLOWS FROM FINANCING ACTIVITIES:
 Proceeds from revolving credit facility, net                       11,750          4,300
 Repayment of term loans                                           (13,301)       (10,635)
 Repayment of external long-term debt                                  (97)          (145)
 Repurchase of common stock, net                                      --             (286)
 Increase (decrease) in shareholders notes, net                        173            (87)
                                                                  --------       --------

    Net cash used by financing activities                           (1,475)        (6,853)
                                                                  --------       --------

EFFECT OF EXCHANGE RATES ON CASH                                    (1,237)        (1,739)

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                     5,459           (270)

CASH AND EQUIVALENTS, BEGINNING OF PERIOD                            3,495          4,050
                                                                  --------       --------

CASH AND CASH EQUIVALENTS, END OF PERIOD                          $  8,954       $  3,780
                                                                  ========       ========

CASH PAID FOR:
Interest                                                          $ 13,646       $ 13,844
                                                                  ========       ========
Income Taxes                                                      $  1,557       $  1,709
                                                                  ========       ========

</TABLE>

              The accompanying notes are an integral part of these
                  condensed consolidate financial statements.

                                      -6-
<PAGE>



                                AEARO CORPORATION

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 2001
                                   (UNAUDITED)

(1)      CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

         In the opinion of  management,  the  accompanying  unaudited  condensed
         consolidated  financial statements contain all adjustments necessary to
         present  fairly,  in accordance with  accounting  principles  generally
         accepted  in the  United  States,  the  Company's  financial  position,
         results of operations and cash flows for the interim periods presented.
         The results of operations for the interim  periods shown in this report
         are not necessarily indicative of results for any future interim period
         or  for  the  entire  year.  These  condensed   consolidated  financial
         statements  do not  include  all  disclosures  associated  with  annual
         financial statements and accordingly should be read in conjunction with
         the consolidated financial statements and notes thereto included in the
         Company's Annual Report on Form 10-K.

(2)      FORMATION ACQUISITION AND FINANCING

         Aearo Corporation, a Delaware corporation,  and its direct wholly owned
         subsidiary,   Aearo  Company,  a  Delaware  corporation   (collectively
         referred to herein as "the  Company")  manufactures  and sells products
         under the brand names:  AOSafety(R),  E-A-R(R),  and  Peltor(R).  These
         products are sold through three reportable  segments,  which are Safety
         Products, Safety Prescription Eyewear and Specialty Composites.

         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.   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.

         The  Formation  Acquisition  has  been  accounted  for  as  a  purchase
         transaction   effective  as  of  July  11,  1995,  in  accordance  with
         Accounting Principles Board Opinion No. 16, Business Combinations,  and
         EITF Issue No.  88-16,  Basis in  Leveraged  Buyout  Transactions,  and
         accordingly,  the  consolidated  financial  statements  for the periods
         subsequent  to July 11, 1995  reflect  the  purchase  price,  including
         transaction costs, allocated to tangible and intangible assets acquired
         and  liabilities  assumed,  based on a portion of their  estimated fair
         values as of July 11, 1995.  The  valuation  of assets and  liabilities
         acquired reflect carryover basis for the percentage  ownership retained
         by Cabot.

 (3)     SIGNIFICANT ACCOUNTING POLICIES

         Use  of  Estimates.  The  preparation  of  the  condensed  consolidated
         financial statements in conformity with accounting principles generally
         accepted in the United  States of America  requires  management to make
         estimates and  assumptions  that affect the reported  amounts of assets
         and liabilities and disclosure of contingent  assets and liabilities at
         the  date of the  financial  statements  and the  reported  amounts  of
         revenues and expenses  during the  reporting  periods.  Actual  results
         could differ from those estimates.

                                      -7-
<PAGE>



                                AEARO CORPORATION

              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 2001
                                   (UNAUDITED)


         Reclassifications.   Certain  amounts  included  in  the  prior  period
         financial  statements  may have been  reclassified  to  conform  to the
         current period presentation.  The  reclassifications  have no impact on
         net income previously reported.

         Revenue  Recognition.  The Company  recognizes revenue upon shipment of
         its products to customers,  at which time title of ownership  transfers
         to the buyer.

         Foreign Currency  Translation.  Assets and liabilities of the Company's
         foreign operations are translated at period-end  exchange rates. Income
         and expenses are translated at the approximate  average rate during the
         period.  Foreign  currency  translation  adjustments  are recorded as a
         separate component of stockholders' equity.  Foreign currency gains and
         losses arising from  transactions by any of the Company's  subsidiaries
         are reflected in net income.

         Income Taxes.  Deferred tax assets and liabilities are determined based
         on the  difference  between the  financial  statement  and tax basis of
         assets and liabilities using enacted tax rates.

         Intangible Assets. Intangible assets consist primarily of the goodwill,
         patents, and trademarks purchased in business acquisitions.  Intangible
         assets are amortized over their estimated useful lives.

         Income (Loss) per Common Share. Basic income (loss) per common share is
         computed by dividing net income (loss) by the weighted  average  number
         of shares of common stock outstanding during the period. Diluted income
         (loss) per share  reflects the  potential  dilution that could occur if
         securities or other  contracts to issue common stock were  exercised or
         converted.  As of June 30,  2001 and 2000,  there were 12,189 and 9,789
         options outstanding,  respectively. The stock options were not dilutive
         and  were  not  included  in  the  diluted   income  (loss)  per  share
         calculation for the three and nine months ended June 30, 2001 and 2000.
         Basic and diluted income (loss) per common share for the three and nine
         months  ended  June 30,  2001  and  2000,  were  equal;  therefore,  no
         reconciliation  between  basic and diluted  income  (loss) per share is
         required.

         Business  Combinations,  Goodwill and Other Intangibles.  In June 2001,
         the Financial Accounting Standards Board issued two new pronouncements:
         Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
         Combinations" and SFAS No. 142 "Goodwill and Other  Intangibles."  SFAS
         No. 141 requires that the purchase method of accounting be used for all
         business combinations initiated after June 30, 2001 and that the use of
         the  pooling-of-interest  method is no  longer  allowed.  SFAS No.  142
         requires that upon  adoption,  amortization  of goodwill will cease and
         instead,  the carrying value of goodwill be evaluated for impairment on
         an annual  basis.  Identifiable  intangible  assets will continue to be
         amortized  over their  useful  lives and  reviewed  for  impairment  in
         accordance  with  SFAS  No.  121  "Accounting  for  the  Impairment  of
         Long-Lived  Assets to be Disposed  Of".  SFAS No. 142 is effective  for
         fiscal years  beginning after December 15, 2001;  however,  the Company
         may elect early  adoption  of this  statement  on October 1, 2001,  the
         beginning of its 2002 fiscal year. The Company is evaluating the impact
         of the  adoption  of these  standards  and has not yet  determined  the
         effect of adoption on its financial position and results of operations.


                                      -8-
<PAGE>


         Shipping and Handling Fees and Costs.  In September  2000, the Emerging
         Issues Task Force ("EITF") reached a consensus on issue No. 00-10 (EITF
         00-10),  "Accounting  for Shipping and  Handling  Fees and Costs".  The
         Company is required to adopt the provisions of EITF 00-10 in the fourth
         quarter  of 2001.  EITF  00-10  requires  that the  Company  reclassify
         amounts  billed to customers for shipping and handling costs to revenue
         and  disclose  costs  related to  shipping  and  handling  that are not
         included in cost of sales. This reclassification will have no effect on
         income from operations or financial position.

         Accounting  for  Derivative  Instruments  and Hedging  Activities.  The
         Company  adopted  the  provisions  of  SFAS  No.  133,  Accounting  for
         Derivative  Instruments and Hedging Activities on October 1, 2000. SFAS
         No. 133 requires  that every  derivative  instrument be recorded in the
         balance  sheet as either an asset or a  liability  measured at its fair
         value.  The  adoption of SFAS No. 133 on October 1, 2000  resulted in a
         $0.4  million   transition   adjustment  charge  to  accumulated  other
         comprehensive  income to  recognize  the fair value of all  derivatives
         that are designated as cash flow hedges.

         The  Company  has  formally   documented  its  hedging   relationships,
         including  identification  of the  hedging  instruments  and the  hedge
         items,  as well as its risk  management  objectives  and strategies for
         undertaking  each  hedge  transaction.  From  time to time the  Company
         enters into foreign currency exchange  contracts and interest rate swap
         agreements,  which are  derivatives  as  defined by SFAS No.  133.  The
         Company enters into foreign currency forward  contracts to mitigate the
         effects  of  changes in foreign  currency  rates on  profitability  and
         enters into  interest  rate swap  agreements  to hedge  their  variable
         interest rate risk.  These  derivatives  are cash flow hedges.  For all
         qualifying and highly  effective  cash flow hedges,  the changes in the
         fair  value of the  derivatives  are  recorded  in other  comprehensive
         income.  Amounts  accumulated  in other  comprehensive  income  will be
         reclassified as earnings when the related product sales affect earnings
         for forward currency contracts or when related interest payments affect
         earnings for interest rate swaps.  As a result of the foreign  currency
         forward  contracts and the interest rate swap  agreements,  the Company
         has  recorded a derivative  liability of $70,000 at June 30, 2001.  All
         forward  contracts  and swap  agreements  will  expire  over the next 3
         months.

         During  the  three  month  period  ending  June 30,  2001  the  Company
         reclassified  into  earnings  a  net  gain  of  approximately   $49,000
         resulting  from the exercise of foreign  currency  contracts  and a net
         loss of $259,000  resulting  from interest rate swap  settlements.  All
         foreign  currency  contracts  and interest  rate swap  agreements  were
         determined  to be  highly  effective  whereby  no  ineffectiveness  was
         recorded in earnings.

         The Company also executes foreign  currency  contracts for up to 30 day
         terms to  protect  against  the  adverse  effects  that  exchange  rate
         fluctuations  may  have  on  the   foreign-currency-denominated   trade
         activities  (receivables,  payables and cash) of foreign  subsidiaries.
         These  contracts have not been  designated as hedges under SFAS No. 133
         and  accordingly,  the gains  and  losses  on both the  derivative  and
         foreign-currency-denominated   trade   activities   are   recorded   as
         transaction adjustments in current earnings. The impact on earnings was
         a gain of approximately $31,000 for the quarter ended June 30, 2001.

                                      -9-
<PAGE>


(4)      COMPREHENSIVE INCOME

         Comprehensive income consisted of the following (dollars in thousands):

                                  Three Months Ended          Nine Months Ended
                                       June 30,                   June 30,
                                  2001      2000              2001       2000
                               -------    -------          -------     -------

Net Income                     $ 5,012    $ 3,493          $ 5,660     $ 6,707

Foreign currency translation
adjustment                      (1,633)    (1,663)          (5,028)     (5,349)
Unrealized gain (loss) on
derivative instruments             613        --               (70)        --
                               -------    -------          -------     -------

Comprehensive income           $ 3,992    $ 1,830          $   562     $ 1,358
                               =======    =======          =======     =======


(5)      INVENTORIES

         Inventories consisted of the following (dollars in thousands):

                                     June 30,         September 30,
                                       2001               2000
                                  ----------------   ----------------
                                    (unaudited)

Raw Materials                             $ 8,169            $ 8,246
Work in process                             8,176              7,662
Finished goods                             18,345             18,402
                                  ----------------   ----------------

                                         $ 34,690           $ 34,310
                                  ================   ================


         Inventories, which include materials, labor and manufacturing overhead,
         are stated at the lower of cost or market,  cost being determined using
         the first-in, first-out method.

(6)      DEBT

         The  Company's  debt  structure   includes  $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  and  (ii)  a  secured  revolving  credit  facility
         providing  for up to $25.0  million of  revolving  loans,  a portion of
         which is to be used for  general  corporate  purposes,  and as to $15.0
         million thereof,  to finance permitted  acquisitions  (collectively the
         Senior  Bank  Facilities).  Under  the  terms of both the  Senior  Bank
         Facilities and the Notes indenture, Aearo Company is required to comply
         with certain  financial  covenants  and  restrictions.  On December 14,
         2000,  the Senior Bank  Facilities  were amended to increase the amount
         available to finance  acquisitions  from $15.0 million to $33.0 million
         and to modify  certain  financial  covenants for periods  ending on and
         after December 31, 2000. The amounts  outstanding on the term loans and
         the revolving credit facility at June 30, 2001 were approximately $75.7
         million and $21.8 million, respectively.

                                      -10-
<PAGE>

         On July 13, 2001, the Company amended and restated its credit agreement
         that  provides  for  secured  borrowings  from a  syndicate  of lenders
         consisting  of (i) a secured  term  loan  facility  consisting  of $100
         million,  (ii) a revolving  credit  facility  for up to $30 million and
         (iii) a UK Overdraft  Facility of up to an  equivalent of $5 million in
         Great   Britain   Pounds   (collectively   the  Restated   Senior  Bank
         Facilities).  As a result of the refinancing,  the Company has reported
         the current  portion of long term debt under the terms of the  Restated
         Senior Bank  Facilities  per SFAS No. 6  "Classification  of Short-Term
         Obligations Expected to Be Refinanced".

(7)      COMMITMENTS AND CONTINGENCIES

         Lease Commitments.  The Company leases certain transportation vehicles,
         warehouse  facilities,  office space, and machinery and equipment under
         cancelable and  non-cancelable  leases,  most of which expire within 10
         years and may be renewed by the Company.

         Contingencies. Various lawsuits and claims arise against the Company in
         the ordinary course of its business.  Most of these lawsuits and claims
         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 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  asserted  after July 11,  1995 (the date of the
         Company's  formation)  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,  however  management  intends to continue  the
         annual payment of $400,000 to Cabot. The Company may be responsible for
         claims alleged to arise out of the use of respirators  manufactured  by
         the Company as well as products purchased for resale. In addition,  the
         Company  may  also  be  responsible  for  certain  claims  of  acquired
         companies other than the  AOSafety(R)  Division that are not covered by
         the agreement with Cabot.

         At June 30, 2001 the Company has  reserved  approximately  $4.7 million
         for product  liabilities  including  those  arising from  asbestosis or
         silicosis  litigation.  The reserve is  re-evaluated  periodically  and
         additional  charges to operations may result as additional  information
         becomes  available.  Consistent  with  the  general  environment  being
         experienced by other companies involved in asbestos-related litigation,
         there has been an increase in the number of asserted  legal claims that
         could  potentially  involve the Company.  Various factors  increase the
         difficulty in determining the Company's potential liability, if any, in
         such claims,  including the fact that the  defendants in these lawsuits
         are often  numerous and the claims  generally do not specify the amount

                                      -11-
<PAGE>


         of  damages  sought.  Additionally,  the  bankruptcy  filings  of other
         companies with asbestos  related  litigation could affect the Company's
         cost over  time.  However,  it is  management's  opinion,  taking  into
         account  currently  available   information,   historical   experience,
         uncertainties,  the Cabot agreement,  and the Company's  reserve,  that
         these  suits  and  claims  should  not  result  in final  judgments  or
         settlements that, in the aggregate, would have a material effect on the
         Company's financial condition or results of operation.

(8)      SEGMENT REPORTING

         The Company  manufactures  and sells  products  under the brand  names:
         AOSafety(R),  E-A-R(R), and Peltor(R).  These products are sold through
         three  reportable   segments,   which  are  Safety   Products,   Safety
         Prescription  Eyewear and  Specialty  Composites.  The Safety  Products
         segment    manufactures   and   sells   hearing   protection   devices,
         non-prescription safety eyewear, face shields,  reusable and disposable
         respirators,  hard hats, and other products  including  first aid kits.
         The  Safety  Prescription   Eyewear  segment   manufactures  and  sells
         prescription  eyewear  products  that are  designed to protect the eyes
         from  the  typical   hazards   encountered  in  the   industrial   work
         environment.   The  Company's  Safety   Prescription   Eyewear  segment
         purchases  component parts (lenses and the majority of its frames) from
         various suppliers, grinds, shapes and applies coatings to the lenses in
         accordance  with the  customer's  prescription,  and then assembles the
         glasses using the customer's choice of frame. The Specialty  Composites
         segment  manufactures a wide array of  energy-absorbing  materials that
         are incorporated into other  manufacturers'  products to control noise,
         vibration and shock.

         Net  Sales to  External  Customers  by  Business  Segment  (dollars  in
         thousands)

                            Three Months Ended          Nine Months Ended
                                  June 30,                  June 30,
                                2001       2000          2001       2000
                              --------   --------      --------   --------
Safety Products               $ 52,842   $ 58,040      $154,975   $164,049
Safety Prescription Eyewear     10,074     10,387        29,716     30,181
Specialty Composites             9,127     11,731        29,559     35,552
                              --------   --------      --------   --------
Total                         $ 72,043   $ 80,158      $214,250   $229,782
                              ========   ========      ========   ========


         Intersegment  sales of the Specialty  Composites  segment to the Safety
         Products  segment  totaled  $1.1 million and $0.7 million for the three
         months ended June 30, 2001 and 2000,  respectively.  Intersegment sales
         totaled  $3.1  million and $2.8  million for the nine months ended June
         30,  2001 and  2000,  respectively.  The  intersegment  sales  value is
         determined at fully absorbed inventory cost at standard rates plus 25%.


                                      -12-
<PAGE>


         EBITDA  by  Business  Segment  and   reconciliation  to  Income  before
         provision for income taxes (dollars in thousands)

                                 Three Months Ended     Nine Months Ended
                                      June 30,              June 30,
                                2001        2000        2001        2000
                              --------    --------    --------    --------

Safety Products               $ 11,367    $ 13,618    $ 28,953    $ 35,042
Safety Prescription Eyewear        650       1,113       1,724       3,041
Specialty Composites               408       1,237       1,622       3,409
Reconciling items                2,655        (771)      4,059      (1,226)
                              --------    --------    --------    --------
Total EBITDA                    15,080      15,197      36,358      40,266

Depreciation                     2,574       2,625       7,695       7,488
Amortization                     1,593       1,684       4,882       5,175
Non-operating Costs                 (4)        160        (115)         88
Interest                         5,451       6,140      17,131      18,299
                              --------    --------    --------    --------
Income before tax provision   $  5,466    $  4,588    $  6,765    $  9,216
                              ========    ========    ========    ========


         EBITDA is defined by the Company 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  (loss)  determined  in
         accordance with accounting  principles generally accepted in the United
         States of America 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.

         Reconciling items include unallocated selling, administrative, research
         and  technical  expenses as well as  manufacturing  profit  realized on
         inter-company transactions not allocable to a specific segment.


                                      -13-
<PAGE>

Item 2. Management's  Discussion and Analysis of Financial Condition and Results
of Operations


The  following  discussion  should  be read in  conjunction  with the  Condensed
Consolidated  Financial  Statements  of the Company,  including  notes  thereto,
appearing  elsewhere  in  this  Report.  This  Report  contains  forward-looking
statements  within the meaning of Section 27A of the  Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. The Company's actual results
could differ materially from those set forth in such forward-looking statements.
The factors  that might  cause such a  difference  include,  among  others,  the
following:  risks associated with  indebtedness;  risks related to acquisitions;
risks associated with conversions to new management  information  systems;  high
levels of competition in the Company's  markets;  risks and uncertainties of new
product  innovations;  risks associated with international  operations;  product
liability   exposures;   unpredictability   of  patent   protections  and  other
intellectual  property issues;  dependencies on key personnel;  risks of adverse
effects  of  economic  and  regulatory  conditions;  and risks  associated  with
environmental matters.

Results of  Operations  -- Three  Months  Ended June 30, 2001  Compared to Three
                           Months Ended June 30, 2000

                                    Unaudited
                (Dollars in Thousands, Except Per Share Amounts)
<TABLE>
<CAPTION>

                                                   Three Months Ended June 30,

                                             2001         %         2000        %
                                           --------    -------    --------    ------
<S>                                        <C>         <C>        <C>         <C>
Net Sales
Safety Products                            $ 52,842       73.3    $ 58,040      72.4
Safety Prescription Eyewear                  10,074       14.0      10,387      13.0
Specialty Composites                          9,127       12.7      11,731      14.6
                                           --------    -------    --------    ------
Total net sales                              72,043      100.0      80,158     100.0
Cost of Sales                                39,207       54.4      42,254      52.7
                                           --------    -------    --------    ------
Gross profit                                 32,836       45.6      37,904      47.3
Operating Expenses-
Selling and administrative                   19,275       26.8      24,388      30.4
Research and technical services               1,138        1.6       1,423       1.8
Amortization of intangibles                   1,593        2.2       1,684       2.1
Other charges (income), net                     (87)      (0.1)       (319)     (0.4)
                                           --------    -------    --------    ------
Operating income                             10,917       15.2      10,728      13.4
Interest expense, net                         5,451        7.6       6,140       7.7
                                           --------    -------    --------    ------
Income before provision for                   5,466        7.6       4,588       5.7
income taxes
Provision for income
taxes                                           454        0.6       1,095       1.4
                                           --------    -------    --------    ------
Net income                                    5,012        7.0       3,493       4.4
Preferred stock dividend accrued              2,980        4.1       2,626       3.3
                                           --------    -------    --------    ------
Income applicable to common shareholders   $  2,032        2.8  $      867       1.1
                                           ========    =======    ========    ======
Income per common share                    $  19.90                   8.49
                                           ========               ========
EBITDA                                     $ 15,080       20.9    $ 15,197      19.0
                                           ========    =======    ========    ======

</TABLE>

                                      -14-
<PAGE>

Net Sales.  Net sales in the three months ended June 30, 2001 decreased 10.1% to
$72.0  million from $80.2  million in the three months ended June 30, 2000.  The
change  in  sales  was  primarily  driven  by the  significant  slowdown  in the
manufacturing  sector of the economy as well as  weakness  in global  currencies
relative to the U.S. dollar. Safety Products net sales in the three months ended
June 30, 2001  decreased  9.0% to $52.8  million from $58.0 million in the three
months ended June 30, 2000. The strength of the U.S.  dollar relative to foreign
currencies had the impact of reducing  Safety  Products  sales by  approximately
$2.1 million.  On a constant  currency  basis sales were down $3.1  million,  or
5.5%,  as  compared  to the  three  months  ended  June  30,  2000.  The  Safety
Prescription  Eyewear  segment net sales in the three months ended June 30, 2001
decreased  3.0% to $10.1  million  from $10.4  million in the three months ended
June 30, 2000.  Specialty  Composites'  net sales in the three months ended June
30, 2001 decreased  22.2% to $9.1 million from $11.7 million in the three months
ended June 30, 2000. The decrease was primarily driven by continued  weakness in
the North American  economy and resulted in volume  declines in the truck market
and the electronics  segment of the precision  equipment market,  which includes
computers and personal communication system (PCS) applications.

Gross  Profit.  Gross profit in the three  months ended June 30, 2001  decreased
13.4% to $32.8  million  from $37.9  million in the three  months ended June 30,
2000.  Gross profit as a percentage  of net sales in the three months ended June
30, 2001  decreased to 45.6% as compared to 47.3% in the three months ended June
30, 2000. This decrease in the gross profit percentage of net sales is primarily
due to lower capacity  utilization,  higher utility costs and the adverse impact
of foreign  currencies  partially  offset by productivity  improvements and cost
reduction  efforts to manage  expenses  relative to the  decline in volume.  The
strong US dollar relative to European currencies negatively affects gross profit
since it depresses revenue while having a limited impact on manufacturing costs.
The  average  exchange  rate  used  for the  euro  in  preparing  the  condensed
consolidated  financial  statements for the three months ended June 30, 2001 and
2000 was 0.861 and  0.931,  respectively.

Selling and Administrative Expenses.  Selling and administrative expenses in the
three months  ended June 30, 2001  decreased  21.0% to $19.3  million from $24.4
million in the three  months  ended June 30,  2000.  Selling and  administrative
expenses as a  percentage  of net sales in the three  months ended June 30, 2001
decreased to 26.8% as compared to 30.4% in the three months ended June 30, 2000.
The  decrease is primarily  due to the  Company's  proactive  measures to reduce
expenses in line with the continued slowdown in the manufacturing  sector of the
economy.

Research and Technical Service Expenses. Research and technical service expenses
in the three  months  ended June 30, 2001  decreased  20.0% to $1.1 million from
$1.4 million in the three months ended June 30, 2000.

Amortization of Intangibles. Amortization expense in the three months ended June
30, 2001  decreased  5.4% to $1.6  million from $1.7 million in the three months
ended June 30, 2000.

Other Charges  (Income),  Net.  Other charges  (income),  net was income of $0.1
million for the three  months  ended June 30, 2001 as compared to income of $0.3
million for the three months ended June 30, 2000.  This  reduction of income was
primarily a result of a lower  level of gains from  foreign  currency  cash flow
hedges in the three  months  ended June 30, 2001 as compared to the three months
ended June 30, 2000.

Operating Income.  Operating income increased 1.8% to $10.9 million in the three
months ended June 30, 2001 from $10.7 million in the three months ended June 30,
2000.  Operating  income as a percentage  of net sales  improved to 15.2% in the
three  months ended June 30, 2001 as compared to 13.4% in the three months ended
June 30, 2000. The increase is primarily due to the Company's proactive measures
to reduce expenses in line with the slowdown in the economy.
                                      -15-
<PAGE>


Interest Expense,  Net. Interest expense, net in the three months ended June 30,
2001 decreased 11.2% to $5.5 million from $6.1 million in the three months ended
June 30,  2000.  The  reduction  in interest  expense was due to a reduction  in
average  borrowings  partially  offset by an  increase in the  weighted  average
interest rates in effect for the three months ended June 30, 2001 as compared to
the three months ended June 30, 2000.

Provision For Income  Taxes.  The provision for income taxes in the three months
ended  June 30,  2001 was $0.5  million  compared  to $1.1  million in the three
months ended June 30, 2000.  The  effective  tax rate was 8.3% and 23.9% for the
three  months  ended June 30, 2001 and 2000,  respectively.  The decrease in the
effective tax rate reflects a change in the  relationship of taxable income from
foreign subsidiaries to domestic operations.

Net Income.  Net income for the three months ended June 30, 2001 increased 43.5%
to $5.0 million from $3.5 million for the three months ended June 30, 2000.

EBITDA.  EBITDA is defined by the Company 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 accounting  principles  generally  accepted in the
United  States of America 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
                                    Unaudited
                             (Dollars in Thousands)

                               Three Months Ended             Change
                                    June 30,            Favorable/(Unfavorable)
                                2001        2000          Amount        %
                              --------    --------       --------    -------
Operating Income              $ 10,917    $ 10,728       $    189        1.8 %
Add Backs:
Depreciation                     2,574       2,625            (51)      (1.9)
Amortization of Intangibles      1,593       1,684            (91)      (5.4)
Non-operating income, net           (4)        160           (164)    (102.5)
                              --------    --------       ---------   -------

EBITDA                        $ 15,080    $ 15,197       $   (117)      (0.8)%
                              ========    ========       ========    =======


EBITDA for the three months ended June 30, 2001 was $15.1 million as compared to
$15.2  million for the three months ended June 30, 2000.  EBITDA as a percentage
of net  sales in the three  months  ended  June 30,  2001  improved  to 20.9% as
compared to 19.0% in the three months ended June 30, 2000.

                                      -16-
<PAGE>


Results of  Operations  -- Nine  Months  Ended June 30,  2001,  Compared to Nine
                           Months Ended June 30, 2000

                                    Unaudited
                (Dollars in Thousands, Except Per Share Amounts)

                                         Nine Months Ended June 30,

                                      2001         %         2000          %
                                   ---------    -------    ---------    --------
Net Sales
Safety Products                    $ 154,975       72.3      164,049       71.4
Safety Prescription Eyewear           29,716       13.9       30,181       13.1
Specialty Composites                  29,559       13.8       35,552       15.5
                                   ---------    -------    ---------    -------
Total net sales                      214,250      100.0      229,782      100.0
Cost of Sales                        116,276       54.3      122,333       53.2
                                   ---------    -------    ---------    -------
Gross profit                          97,974       45.7      107,449       46.8
Operating Expenses-
Selling and administrative            64,772       30.2       71,346       31.0
Research and technical services        3,987        1.9        4,141        1.8
Amortization of intangibles            4,882        2.3        5,175        2.3
Other charges (income), net              437        0.2         (728)      (0.3)
                                   ---------    -------    ---------    -------
Operating income                      23,896       11.2       27,515       12.0
Interest expense, net                 17,131        8.0       18,299        8.0
                                   ---------    -------    ---------    ------
Income before provision
for income  taxes                      6,765        3.2        9,216        4.0
Provision for income
taxes                                  1,105        0.5        2,509        1.1
                                   ---------    -------    ---------    -------
Net income                             5,660        2.6        6,707        2.9
Preferred stock dividend accrued       8,666        4.0        7,662        3.3
Loss applicable to common
shareholders                       $  (3,006)      (1.4)   $    (955)      (0.4)
                                   =========    =======    =========    =======
Loss per common share              $  (29.45)              $   (9.35)
                                   =========               =========
EBITDA                             $  36,358       17.0    $  40,266       17.5
                                   =========    =======    =========    =======



Net Sales.  Net sales in the nine months ended June 30, 2001  decreased  6.8% to
$214.3  million from $229.8  million in the nine months ended June 30, 2000. The
change  in  sales  was  primarily  driven  by the  significant  slowdown  in the
manufacturing sector of the economy as well as weakness in foreign currencies as
compared to the U.S. dollar.  Safety Products net sales in the nine months ended
June 30, 2001  decreased  5.8% to $154.6 million from $164.0 million in the nine
months ended June 30, 2000. The strength of the U.S.  dollar relative to foreign
currencies had the impact of reducing  Safety  Products  sales by  approximately
$6.5  million in the nine months  ended June 30,  2001,  as compared to the nine
months ended June 30, 2000.  On a constant  currency  basis sales were down $2.9
million, or 1.8%, as compared to the nine months ended June 30, 2000. The Safety
Prescription  Eyewear  segment net sales in the nine months  ended June 30, 2001
decreased 1.5% to $29.7 million from $30.2 million in the nine months ended June
30, 2000. Specialty Composites' net sales in the nine months ended June 30, 2001
decreased  15.7% to $30.0  million  from $35.6  million in the nine months ended
June 30, 2000.  The decrease was primarily  driven by continued  weakness in the
North American  economy and resulted in volume  declines in the truck market and
the  electronic  segment  of the  precision  equipment  market,  which  includes
computers and PCS applications.


                                      -17-
<PAGE>


Gross Profit. Gross profit in the nine months ended June 30, 2001 decreased 8.8%
to $98.0  million  from $107.4  million in the nine months  ended June 30, 2000.
Gross Profit as a percentage of net sales in the nine months ended June 30, 2001
was 45.7% as  compared  to 46.8% in the nine  months  ended June 30,  2000.  The
decrease in the gross profit  percentage  of net sales is primarily due to lower
capacity  utilization,  higher  utility costs and the adverse  impact of foreign
currencies  partially  offset by  productivity  improvements  and cost reduction
efforts to manage  expenses  relative to the decline in volume..  The lower Euro
creates an unfavorable  impact on gross margins since it depresses revenue while
having a limited impact on  manufacturing  costs. The average exchange rate used
for the euro in the condensed  consolidated  financial  statements  for the nine
months ended June 30, 2001 and 2000 was 0.888 and 0.973, respectively.

Selling and Administrative Expenses.  Selling and administrative expenses in the
nine  months  ended June 30, 2001  decreased  9.2% to $64.8  million  from $71.3
million in the nine  months  ended June 30,  2000.  Selling  and  administrative
expenses as a  percentage  of net sales in the nine  months  ended June 30, 2001
decreased  to 30.2% of net sales as  compared  to 31.0% of net sales in the nine
months ended June 30,  2000.  The  decrease is  primarily  due to the  Company's
proactive measures to reduce expenses in line with the slowdown in the economy.

Research and Technical Service Expenses. Research and technical service expenses
in the nine months ended June 30, 2001  decreased 3.7% to $4.0 million from $4.1
million in the nine months ended June 30, 2000.

Amortization of Intangibles.  Amortization expense in the nine months ended June
30, 2001  decreased  5.7% to $4.9  million  from $5.2 million in the nine months
ended June 30, 2000.

Other Charges  (Income),  Net. Other charges  (income),  net was expense of $0.4
million  for the nine  months  ended June 30, 2001 as compared to income of $0.7
million for the nine months  ended June 30,  2000.  This change was  primarily a
result of net foreign  currency  cash flow hedge losses in the nine months ended
June 30, 2001 as compared to net foreign  currency  cash flow losses in the nine
months ended June 30, 2000.

Operating Income.  Operating income decreased 13.2% to $23.9 million in the nine
months ended June 30, 2001 from $27.5  million in the nine months ended June 30,
2000.  Operating  income as a  percentage  of net sales in the nine months ended
June 30, 2001 was 11.2% as  compared to 12.0% in the nine months  ended June 30,
2000. The decrease is primarily due to the softening  global  economy  partially
offset by the Company's  proactive  measures to reduce expenses in line with the
slowdown.

Interest Expense,  Net. Interest expense,  net in the nine months ended June 30,
2001 decreased 6.4% to $17.1 million from $18.3 million in the nine months ended
June 30,  2000.  The  reduction  in interest  expense was due to a reduction  in
average  borrowings  partially  offset by an  increase in the  weighted  average
interest  rates in effect for the nine months ended June 30, 2001 as compared to
the nine months ended June 30, 2000.

Provision  For Income  Taxes The  provision  for income taxes in the nine months
ended June 30, 2001 was $1.1 million compared to $2.5 million in the nine months
ended June 30,  2000.  The  effective  tax rate was 16.3% and 27.2% for the nine
months ended June 30, 2001 and 2000, respectively. The decrease in the effective
tax rate reflects a change in the  relationship  of taxable  income from foreign
subsidiaries to domestic operations.

Net Income.  Net income for the nine months ended June 30, 2001 decreased  15.6%
to $5.7 million from $6.7 million for the nine months ended June 30, 2000.


                                      -18-
<PAGE>

EBITDA.  EBITDA is defined by the Company 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 accounting  principles  generally  accepted in the
United  States of America 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
                                    Unaudited
                             (Dollars in Thousands)

                                     Nine Months Ended          Change
                                          June 30,       Favorable/(Unfavorable)
                                      2001        2000      Amount        %
                                   --------    --------   --------    --------
Operating Income                   $ 23,896    $ 27,515   $ (3,619)     (13.2)%
Add Backs:
Depreciation                          7,695       7,488        207        2.8
Amortization of Intangibles           4,882       5,175       (293)      (5.7)
Non-operating costs (income), net      (115)         88       (203)    (230.7)
                                   --------    --------   --------

EBITDA                             $ 36,358    $ 40,266   $ (3,908)      (9.7)%
                                   ========    ========   ========


EBITDA for the nine months ended June 30, 2001 was $36.4  million as compared to
$40.3 million for the nine months ended June 30, 2000. EBITDA as a percentage of
net sales in the nine months  ended June 30, 2001 was 17.0% as compared to 17.5%
in the nine months ended June 30, 2000.


                                      -19-
<PAGE>

Effects of Changes in Exchange Rates

In general,  the  Company's  results of  operations  are  affected by changes in
exchange rates. Subject to market conditions, the Company prices its products in
Europe and Canada in local  currencies.  While many of the Company's selling and
distribution costs are also denominated in these currencies,  a large portion of
product costs are U.S. Dollar  denominated.  As a result, a decline in the value
of the U.S. Dollar relative to other  currencies can have a favorable  impact on
the profitability of the Company and an increase in the value of the U.S. Dollar
relative  to  these  other   currencies  can  have  a  negative  effect  on  the
profitability  of the Company.  As a result of the  acquisition  of Peltor,  the
Company's  operations are also affected by changes in exchange rates relative to
the  Swedish  Krona.  A  decline  in the value of the  Krona  relative  to other
currencies can have a favorable  impact on the  profitability of the Company and
an increase in the value of the Krona  relative to other  currencies  can have a
negative  impact on the  profitability  of the  Company.  The  Company  utilizes
forward foreign currency contracts to mitigate the effects of changes in foreign
currency rates on profitability.

Effects of Inflation

For the three most recent  fiscal  years,  inflation has been modest and has not
had a material impact upon the results of the Company's operations.

Effects of Economic Conditions

Softening of the North American economy began during the first fiscal quarter of
this year.  Since that time the overall  economic  downturn has resulted in many
companies  announcing  layoffs which has also had an impact on overall  consumer
confidence.  The Company  sells mainly into the  manufacturing  sector and, to a
lesser  extent,  the  consumer  marketplace.  The  announced  layoffs have had a
significant impact on the number of employed  industrial workers. As a result of
this there has been, and it is expected to continue for some time, a slowdown in
the market for our products. To address these changes the Company has taken, and
expects to continue to take,  proactive measures which have included a reduction
of workforce, frozen hiring, a reduction of senior managers pay, and a reduction
of our planned capital spending and expense budgets.

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 and (ii) a revolving  credit facility  providing for
up to $25.0 million (the Senior Bank Facilities), for general corporate purposes
and, as to $33.0 million thereof, to finance permitted acquisitions. On December
14,  2000,  the Senior  Bank  Facilities  were  amended to  increase  the amount
available to finance  acquisitions  from $15.0  million to $33.0  million and to
modify certain financial  covenants for periods ending on and after December 31,
2000.

On July 13, 2001,  the Company  amended and restated its credit  agreement  that
provides for secured  borrowings from a syndicate of lenders consisting of (i) a
secured term loan facility  consisting of $100 million,  (ii) a revolving credit
facility  for up to $30  million and (iii) a UK  overdraft  facility of up to an
equivalent  of $5 million in Great  Britain  Pounds  (collectively  the Restated
Senior  Bank  Facilities).  As a result  of the  refinancing,  the  Company  has
reported  the current  portion of long term debt under the terms of the Restated
Senior Bank Facilities per SFAS No. 6 "Classification of Short-Term  Obligations
Expected to Be Refinanced".

                                      -20-
<PAGE>

Term Loan maturities  under the Restated Senior Bank Facilities are $2.0 million
for the remainder of fiscal 2001, $8.0 million in fiscal 2002,  $12.0 million in
fiscal 2003, and $78.0 million  thereafter.  Other than upon a change of control
or as a result of certain asset sales, or in the event that certain excess funds
exist at the end of a fiscal year,  the Company will not be required to make any
principal  payments  in  respect of the Notes  until  maturity.  The  Company is
required to make interest payments with respect to both the Restated Senior Bank
Facilities and the Notes. The Company's  revolver and Term Loan matures in March
2005.

The  Company's  net cash  provided by operating  activities  for the nine months
ended June 30, 2001 totaled  $13.9  million as compared to $19.4 million for the
nine months ended June 30, 2000. The decrease was due primarily to a decrease of
$1.0  million in net income and a $4.5  million  decrease in the  Company's  net
changes in assets  and  liabilities.  The  Company's  net  changes in assets and
liabilities were primarily driven by a reduction in accounts payable and accrued
liabilities,  a reduction in other assets and liabilities  partially offset by a
decrease in receivables.

Net cash used by investing activities was $5.8 million for the nine months ended
June 30, 2001 as compared  to $11.1  million for the nine months  ended June 30,
2000. The decrease in net cash used by investing  activities is primarily due to
a decrease in capital  additions and the  acquisition  of Norhammer in the prior
period.

Net cash used by  financing  activities  for the nine months ended June 30, 2001
was $1.5 million  compared  with $6.9 million for the nine months ended June 30,
2000.  The  decrease of cash used by  financing  activities  of $5.3  million is
primarily  attributed  to an increase in borrowings  from the  revolving  credit
facility of $7.5 million offsetting a $2.7 million increase in cash used for the
repayment of term loans.

The Company has a  substantial  amount of  indebtedness.  The Company  relies on
internally generated funds, and to the extent necessary, on borrowings under the
revolving credit facility (subject to certain  customary drawing  conditions) to
meet its liquidity needs. The Company  anticipates that operating cash flow will
be adequate to meet its operating and capital  expenditure  requirements for the
next several years,  although there can be no assurances that existing levels of
sales and normalized profitability,  and therefore cash flow, will be maintained
in the  future.  Levels of sales and  profitability  may be  impacted by service
levels,  continued new product  development,  worldwide economic  conditions and
competitive  pressures.  In  particular,  the  Company  expects  that  sales and
profitability  over the  remainder of fiscal 2001 will be adversely  affected by
the  significant  slowdown  in the  manufacturing  sector of the economy and the
strength of the U.S. Dollar relative to the global currencies.  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.


                                      -21-
<PAGE>



Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Company is exposed to market risks related to change in foreign  currencies,
interest rates and commodity  pricing.  The Company uses derivatives to mitigate
the impact of changes in foreign  currencies and interest rates. All derivatives
are for purposes  other than  trading.  The Company  adopted the  provisions  of
Statement  of  Financial  Accounting  Standard  (SFAS) No. 133,  Accounting  for
Derivative  Instruments  and Hedging  Activities on October 1, 2000. The Company
has formally documented its hedging relationships,  including  identification of
hedging  instruments  and  the  hedge  items,  as well  as its  risk  management
objectives.

Foreign Currency Risk

The  Company's  results  of  operations  are  subject  to risk  associated  with
operating in foreign  countries,  including  fluctuations  in currency  exchange
rates.   While  many  of  the  Company's  selling  and  distribution  costs  are
denominated  in Canadian and  European  currencies,  a large  portion of product
costs are U.S. Dollar  denominated.  As a result,  a decline in the value of the
U.S.  Dollar  relative to other  currencies  can have a favorable  impact on the
profitability  of the Company  and an  increase in the value of the U.S.  Dollar
relative  to  these  other   currencies  can  have  a  negative  effect  on  the
profitability of the Company. The Company executes two hedging programs, one for
transaction  exposures,  and the  other  for cash  flow  exposures  on  European
operations.  The Company has utilized forward contracts for transaction and cash
flow  exposures.  During the three  months  ended June 30, 2001 net  transaction
gains were  $31,000,  and cash flow hedges were a gain of $99,000.  In addition,
the Company  limits  foreign  exchange  impact on the balance sheet with foreign
denominated debt in Great Britain Pound Sterling (GBP) and euros.

The  adoption  of SFAS No.  133 on October 1, 2000  resulted  in a $0.3  million
transition  adjustment  charge  to  accumulated  other  comprehensive  income to
recognize the fair value of foreign  currency  forward  contracts  designated as
cash flow  hedges.  During  the three  months  ended June 30,  2001 the  Company
recorded a reduction  of $0.4 million to the  derivative  liability to recognize
the change in fair value of foreign currency forward contracts outstanding. As a
result of the foreign  currency  forward  contracts  the Company has  recorded a
derivative  liability of $0.4 million as of June 30, 2001. The foreign  currency
forward contracts will expire over the next 3 months.

Interest Rates

The Company is exposed to market  risk  changes in  interest  rates  through its
debt. The Company utilizes interest rate swaps to reduce the impact of potential
increased interest rates on its floating debt. On February 28, 2000, the Company
unwound its zero premium collar by rolling  unrealized gains into a new interest
rate swap that matched the notional amounts of the credit agreement by each loan
currency.  The  interest  rate swaps will  expire  August 31,  2001.  During the
quarter  ended June 30, 2001,  the Company  incurred an  additional  $259,000 of
interest  expense as a result of the  interest  rate swaps and expects  that the
additional interest expense as a result of the interest rate swaps will continue
until the maturity of the interest rate swap agreement.

The  adoption  of SFAS No.  133 on October 1, 2000  resulted  in a $0.1  million
transition  adjustment  charge  to  accumulated  other  comprehensive  income to
recognize  the fair value of interest  rate swap  agreements  designated as cash
flow hedges. During the three months ended June 30, 2001 the Company recorded an
reduction of $0.2  million of  derivative  liability to recognize  the change in
fair value of the  interest  rate swap  agreements.  As a result of the interest
rate swap  agreements  the Company has recorded a  derivative  liability of $0.4
million as of June 30, 2001.


                                      -22-
<PAGE>

Commodity Risk

The Company is subject to market risks with respect to industry pricing in paper
and crude oil as it relates  to various  commodity  items.  The  Company is also
exposed to market  risks for  electricity,  fuel oil and natural gas consumed in
its operations.  Items with potential  impact are paperboard,  packaging  films,
nylons,  resins,  propylene,  ethylene,  plasticizer  and  freight.  The Company
manages pricing  exposures on larger volume  commodities such as  polycarbonate,
polyols and  polyvinyl  chloride via price  negotiations  utilizing  alternative
supplier  competitive  pricing. The Company sources some products and parts from
Far East sources where resource  availability,  competition,  and infrastructure
stability has provided a favorable purchasing environment.  The Company does not
enter into derivative instruments to manage commodity risk.


                                      -23-
<PAGE>


                                     PART II

Item 1. Legal Proceedings  Various lawsuits and claims arise against the Company
in the ordinary course of its business. Most of these lawsuits and claims relate
to the  Company's  safety  eyewear and  respiratory  product lines and primarily
involve  accidents  and/or exposures  occurring after the Company's  predecessor
acquired the  AOSafety(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  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
asserted  after July 11, 1995 (the date of the Company's  formation)  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  however,  management  intends to  continue  the annual
payment of $400,000 to Cabot.  The Company may be responsible for claims alleged
to arise out of the use of  respirators  manufactured  by the Company as well as
products  purchased for resale.  The Company may also be responsible for certain
claims of acquired  companies other than the AO Safety(R)  division that are not
covered by the agreement with Cabot.

Item 2.  Changes in Securities and Use of Proceeds
         None.

Item 3.  Defaults Upon Senior Securities
         None.

Item 4.  Submission of Matters to a Vote of Security-Holders

         None.

Item 5.  Other Information
         None.

Item 6.  Exhibits and Reports on Form 8-K
(a) Exhibits

     Credit Agreement,  dated as of July 11, 1995 and Amended and Restated as of
     July 13, 2001.

(b) Reports on form 8-K

     On May 17, 2001,  the Company filed a Current Report on Form 8-K disclosing
     a change in its certifying  accountant from Arthur Andersen to Deloitte and
     Touche.

     On July 19, 2001, the Company filed a Current Report on Form 8-K containing
     its press release regarding the refinancing of its indebtedness.


                                      -24-
<PAGE>

Signatures

     Pursuant to the  requirements  of the Securities  Exchange Act of 1934, the
     Registrant  has duly  caused  this report to be signed on its behalf by the
     undersigned thereunto duly authorized.

     Date: August 14, 2001 AEARO CORPORATION

                           /s/ Jeffrey S. Kulka

                           ---------------------------------------------------
                           Jeffrey S. Kulka
                           Vice President, Finance, Treasurer, and Secretary
                           (Principal Financial and Accounting Officer)



                                      -25-
<PAGE>



Exhibit Index

EXHIBITS            DESCRIPTION


*Credit Agreement
                    Dated as of July 11,  1995 and  Amended  and  Restated as of
                    July 13,  2001 among  Aearo  Corporation,  Aearo  Company I,
                    Certain of its  Subsidiaries,  Various  Banks,  and  Bankers
                    Trust Company, as Administrative Agent.


*Filed herewith.

                                      -26-
<PAGE>