<PAGE>   1


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

                                    FORM 10-K

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

                  FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998

                         COMMISSION FILE NUMBER 33-96190

                                AEARO CORPORATION
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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

               DELAWARE                                        13-3840450
   (STATE OR OTHER JURISDICTION OF                          (I.R.S. EMPLOYER
    INCORPORATION OR ORGANIZATION)                         IDENTIFICATION NO.)

         5457 WEST 79TH STREET
         INDIANAPOLIS, INDIANA                                   46268
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                       (ZIP CODE)

                                 (317) 692-6666
              (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
                                 ---------------

        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 15, 1998, 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, 1998 was 102,338.

                                       

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                                TABLE OF CONTENTS
<TABLE>
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                                                                                                            PAGE
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<S>                                                                                                         <C>
PART I................................................................................................         1
     Item 1.  Business................................................................................         1
     Item 2.  Properties..............................................................................         8
     Item 3.  Legal Proceedings.......................................................................         9
     Item 4.  Submission of Matters to a Vote of Security Holders.....................................         9

PART II...............................................................................................        10
     Item 5.  Market For Registrant's Common Equity and Related Stockholder Matters...................        10
     Item 6.  Selected Financial Data.................................................................        10
     Item 7.  Management's Discussion and Analysis of Financial Condition and
                     Results of Operations............................................................        12
     Item 8.  Financial Statements and Supplementary Data.............................................        20
     Item 9.  Changes in and Disagreements with Accountants on Accounting and
                     Financial Disclosure.............................................................        46

PART III..............................................................................................        46
     Item 10. Directors and Executive Officers........................................................        46
     Item 11. Executive Compensation..................................................................        48
     Item 12. Security Ownership of Certain Beneficial Owners and Management..........................        53
     Item 13. Certain Relationships and Related Transactions..........................................        54

PART IV...............................................................................................        59
     Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................        59
     Signatures.......................................................................................        67
</TABLE>



<PAGE>   3




                                     PART I

ITEM 1.  BUSINESS

GENERAL

Aearo Corporation (formerly Cabot Safety Holdings Corporation), a Delaware
corporation ("Aearo"), and its direct wholly-owned subsidiary, Aearo Company I,
doing business as Aearo Company (formerly Cabot Safety Corporation), a Delaware
corporation (the "Subsidiary"), are collectively referred to herein as the
"Company". The Company is one of the leaders in the hearing, eye, face, head and
respiratory protection segments of the personal protection equipment ("PPE")
market worldwide through its safety products operating unit ("Safety Products"),
which manufactures and sells hearing protection devices, prescription and
non-prescription safety eyewear, face shields, reusable and disposable
respirators, hard hats and first aid kits in more than 85 countries under its
well-known brand names: AOSafety, E-A-R, Eastern and Peltor. PPE encompasses all
articles of equipment and clothing worn for the purpose of protecting against
bodily injury, including safety eyewear and goggles, ear muffs and ear plugs,
respirators, hard hats, gloves, safety clothing and safety shoes. Safety
Products accounted for approximately 86% of the Company's net sales in fiscal
1998. The Company attributes its leading market positions to:

         -        Strong, well-recognized brand names

         -        A reputation for providing innovative, quality products

         -        Intensive coverage of multiple distribution channels targeting
                  a wide array of end-users 

         -        One of the industry's broadest product offerings, and

         -        A commitment to providing the highest level of customer
                  service

Through its specialty composites operating unit ("Specialty Composites"), the
Company manufactures a wide array of energy-absorbing materials which are
incorporated into other manufacturers' products to control noise, vibration and
shock. Specific product applications for such materials include noise-reducing
and vibration-dampening matting used in the lining of transportation equipment
such as heavy truck cabs, shock protection parts for electronic devices such as
computer disk drives, and durable energy-absorbent and cushioning foams used in
footwear. Specialty Composites also produces specially formulated foam used in
the manufacture of Safety Products' polyvinylchloride ("PVC") ear plugs.
Specialty Composites accounted for approximately 14% of the Company's net sales
in fiscal 1998.

Aearo derives all of its operating income and cash flow from the Subsidiary, and
its only material assets are the shares of common stock of the Subsidiary that
Aearo owns. Other than its ownership of the Subsidiary and its guarantee of the
indebtedness of the Subsidiary, Aearo has no business or operations. Aearo was
incorporated in the state of Delaware in June 1995. Detailed information with
respect to the Company's revenue, operating profit, and identifiable assets by
geographic area and amount of export sales is presented in Note 15 of Notes to
Consolidated Financial Statements of Aearo Corporation contained in Item 8
hereof.

PERSONAL PROTECTION EQUIPMENT MARKET

A 1998 industry study prepared by Frost & Sullivan estimates that the size of
the U.S. segment of the PPE market in which the Company competes (which excludes
safety clothing, gloves and shoes) was approximately $1.3 billion in 1997.
Management estimates annual sales outside the United States for the segment of
the PPE market in which the Company competes were in excess of $1.2 billion in
1997. Historically, a large number of relatively small, independent
manufacturers with limited product lines served the PPE market and the industry
remains highly fragmented.



<PAGE>   4



PRODUCT OVERVIEW

The Company operates through two separate operating units: Safety Products and
Specialty Composites.

       SAFETY PRODUCTS

Within Safety Products, the Company classifies its products in five main
categories: hearing protection; safety prescription eyewear; eye, face and head
protection; respiratory protection; and first aid kits.

HEARING PROTECTION. The Company's hearing protection products primarily consist
of disposable ear plugs, reusable ear plugs, and ear muffs. The Company has been
a leader in hearing conservation research and development since 1972, when it
first introduced the PVC disposable ear plug. Today, this product is known as
the "Classic" and its color yellow is a registered trademark of the Company in
the United States and Canada. This product is designed to be "rolled down" or
compressed before being inserted into the ear, and, as a result of its unique
slow recovery characteristics, the plug slowly expands (or "recovers") to fill
the ear canal and provide the desired protection. The Company's PVC ear plugs
are available corded and uncorded and in a variety of packaging options. The
Company also produces versions of the PVC plug for many of the international
airlines for inclusion in their amenity kits. The Company also manufactures a
full line of polyurethane ear plugs, including its E-Z-Fit and TaperFit
products. These products serve the same disposable ear plug category, but the
PVC ear plugs have historically led the market.

In the reusable ear plug segment of the market, the Company offers its patented
UltraFit product, and the E-A-R Express, a patented product, which features a
polyurethane pod and a short plastic stem to facilitate sanitary and easy
insertion of the plug into the ear. The Company also offers the "Flex" line of
"semi-aural" banded products, designed for intermittent use. These products
feature articulating arms which allows for use in multiple positions and for
easy storage around the neck.

The Company sells a full range of ear muffs. Through its Peltor AB subsidiary
("Peltor"), acquired on May 30, 1996, the Company manufactures, assembles and
sells a broad line of ear muffs, hard hats/visors, noise attenuating headsets
and wireless and hardwire communication headsets. These products serve a variety
of end user markets where protection from harmful high and low frequency noise
is sought or the need for easy communication in noisy or remote environment
exists, such as in the construction, heavy machinery, airport, forestry, textile
and mining industries. The Company also offers auditory systems products, which
are sold to audiologists and are used in the testing of hearing.

SAFETY PRESCRIPTION EYEWEAR. The Company's safety prescription eyewear ("SRx")
products are designed to protect the eyes from the typical hazards encountered
in the industrial work environment. The Company purchases component parts
(lenses and the majority of its frames) from various suppliers, grinds and
shapes the lenses to the employee's prescription, and then assembles the glasses
using the employee's choice of frame. The Company views its ability to provide
individual attention to each patient through Company-employed, as well as
independently contracted, eye professionals, as an essential part of its SRx
business.

EYE, FACE AND HEAD PROTECTION. Non-prescription eye and face protection is used
in work environments where a number of hazards present a danger to the eyes and
face, including dust, flying particles, metal fragments, chemicals, extreme
glare and radiation. The Company offers a large number of task-specific
non-prescription safety eyewear products. The three basic categories of
non-prescription eye and face protection are non-prescription safety (or
"plano") eyewear, goggles and faceshields.

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         -        Plano (Non-prescription) Eyewear. Plano eyewear accounts for
                  the majority of the Company's sales in this category and
                  includes a wide range of products from disposable visitor
                  safety spectacles to several lines of fashionable, reusable
                  safety eyewear available in different colors and with a
                  variety of applications. As part of the continuing product
                  development efforts the Company recently introduced its unique
                  Lexa and Fectoids safety eyewear products which feature a
                  patented contoured lens which wraps around the wearer's face,
                  improving peripheral vision, and eliminating the need for
                  separate side shields.

         -        Goggles. The Company manufactures and sells a broad line of
                  goggles, which are typically required in work environments
                  where a higher degree of impact protection is required, where
                  increased protection against dust, mist or chemical splash is
                  needed and/or for use in welding operations. To meet these
                  requirements, the Company manufactures a variety of vented and
                  non-vented goggles with varying fields of view.

         -        Faceshields. Faceshields are designed to protect against heat,
                  splash and flying particles and are worn in conjunction with
                  other protective equipment, such as plano eyewear and
                  respirators. The patented TuffMaster line of faceshields is
                  one of the leading brands in the market.

         -        Hard Hats. The Company manufactures and sells a broad line of
                  hard hats, including "bump" caps, full-brim hats and
                  traditional hard hats, featuring four or six point suspension,
                  ratchet adjustment, and a wide selection of colors and custom
                  imprinting.

FIRST AID KITS. The acquisition of Eastern Safety Equipment Co., Inc.
("Eastern") on January 3, 1996 added first aid kits as a new product category
for the Company while also increasing the Company's presence in the Consumer/DIY
segment. First aid kits are either for general use or for industrial or
commercial uses.

RESPIRATORY PROTECTION. Respiratory protection products are used to protect
against the harmful effects of contamination and pollution caused by dust,
gases, fumes, sprays and other contaminants. The Company offers a broad line of
disposable dust and mist masks, cartridge-equipped quarter-, half- and full-face
respirators, and "escape" respirators (a single-use respirator for emergencies).

      SPECIALTY COMPOSITES

The Company's Specialty Composites operating unit manufactures a wide array of
impact-resistant, shock-absorbing and energy-absorbing materials for a variety
of noise, vibration and shock control applications using a wide range of
technologies, manufacturing processes and applications know-how. Specialty
Composites also produces the specially formulated foam used in the manufacture
of Safety Products' PVC ear plugs. The principal strengths of Specialty
Composites are its specialized polyurethane chemistry, its thin-sheet casting
capability, its composite technologies and its applications and materials
engineering. These strengths allow the Company to manufacture in a single
process, high value-added composites using casting, extrusion and molding
processes.

Specialty Composites' products fall into three broad categories: barriers and
absorbers for noise control; damping and isolation products for vibration and
shock control; and energy control products for shock and comfort management. The
Company's products include: Isoloss LS polyurethane high density cellular foams,
which are manufactured by three production lines in a variety of thicknesses,
widths, colors and densities for reduction of excessive vibration, noise and
shock control and high resilience cushioning and sealing applications; the
Confor heavily damped viscoelastic foam for ergonomic cushioning applications;
the Tufcote polyurethane and PVC thin sheet foams for acoustical, absorption and
noise control applications; and the Isodamp PVC foams for mechanical vibration
reduction and noise and shock control.


Specialty Composite's products are sold into four market segments:
transportation; health-related; footwear; and other original equipment
manufacturers ("OEM") in industries such as electronics and communications.

                                       3

<PAGE>   6

TRANSPORTATION SEGMENT. Specialty Composites' products are incorporated into
heavy trucks, automobiles, yachts, aircrafts, buses, leisure vehicles and
defense, farm and construction equipment in order to control noise and
vibration. For example, the Company supplies durable acoustical foams and
barriers that control sound and help meet noise standards for Class 8 heavy
trucks. The Company also provides complete noise and vibration control packages
for high-end yachts in order to contain engine room noise and to soundproof
passenger quarters. Specialty Composites applications also exist with respect to
executive and commuter aircraft, where relatively thin, lightweight,
multi-function damping composites efficiently control sound and vibration.

HEALTH-RELATED SEGMENT. Applications for the energy-absorbing characteristics of
Specialty Composites' products, particularly its line of temperature-reactive
foams, have been growing in the health-related segment. Such materials enhance
physical protection and improve comfort in many devices including orthopedic
mattress and pillows, leg braces, orthotic devices, surgical pillows, wheelchair
cushions, bicycle helmets, keyboard wrist supports and occupational seating.

FOOTWEAR SEGMENT. Specialty Composites supplies a durable and highly
shock-absorbent polyurethane foam, which is incorporated into insoles for
high-wear cushioning applications, such as athletic shoes, dress shoes, military
boots and work boots. Specialty Composites also offers an energy-absorbent
material to help protect against skeletal shock in military boots, work boots
and orthotic insoles.

OEM SEGMENT. The Company produces an extensive assortment of polyurethane and
PVC die-cut and molded parts for vibration isolation and damping and for shock
protection and noise control in a wide range of other products, including
precision equipment and industrial machinery, computer disk drives, pagers,
industrial compressors and generator sets.

SALES AND MARKETING

The Company divides its sales force into two principal categories: Safety
Products and Specialty Composites.

SAFETY PRODUCTS OPERATING UNIT. Within Safety Products, sales are managed
through five channels: North American Industrial Distribution; North American
Industrial Direct; Consumer/Do-It-Yourself ("DIY"); Europe; and International.
Each of these channels has its own sales force and its own distinct yet
synergistic sales strategies. In addition, through the acquisition of Peltor,
the Company has significantly expanded its sales coverage, including a dedicated
effort to serve the specialty communications ear muff market.

         -        North American Industrial Distribution. This is the largest
                  sales channel for Safety Products and includes approximately
                  200 Dialog industrial distributors and approximately 160
                  industrial dealers in the U.S., Canada and Mexico.
                  Participation in the Dialog program requires minimum purchase
                  levels while encouraging support across the full product line,
                  in return for rebates based on growth and volume as well as
                  preferred treatment regarding shipping terms, new products,
                  field sales support, and cooperative advertising. The Company
                  also offers Dialog distributors financial incentives for
                  establishing electronic order entry/invoicing interfaces with
                  the Company and for developing marketing programs which
                  promote the Company's products.

         -        North American Industrial Direct. Approximately 90% of the
                  Company's safety prescription eyewear is sold directly to more
                  than 40,000 industrial companies, including a majority of the
                  industrial companies in the Fortune 500. The remainder of the
                  Company's SRx products are sold through the industrial
                  distribution channel. In most states, current laws require
                  that prescription eyewear be dispensed to the user by a
                  licensed optical professional, traditionally a local optician.
                  As an alternative to this approach, in 1994 the Company
                  introduced its Dispensing Manager program, whereby the Company
                  employs its own licensed opticians to dispense prescription
                  safety eyewear.

         -        Consumer/DIY. The Company is the leading supplier of safety
                  products to the consumer/DIY market and is the primary
                  supplier to such leading retailers as ACE, Home Depot, Lowe's,
                  Sears and Tru-Serv. The Company offers both its AOSafety brand
                  of industrial grade products in consumer packaging and its
                  Eastern brand of consumer grade products in consumer
                  packaging.


                                       4

<PAGE>   7


         -        Europe. The Company has a significant presence in Europe with
                  sales offices in the U.K., Sweden, Germany, France, Italy and
                  Spain. While the Company's historical strength in this market
                  has been in hearing protection devices sold through industrial
                  distributors, the Company has recently been successful in
                  pursuing sales of safety eyewear and has dedicated a full-time
                  eyewear product sales manager to lead and train the existing
                  sales organization.

         -        International. The Company exports its products around the
                  world, and this channel is managed through sales
                  representatives located in Singapore and Hong Kong (covering
                  Asia), Miami (covering Latin America), Sydney (covering
                  Australia and New Zealand) and South Africa (covering the
                  Middle East).

SPECIALTY COMPOSITES OPERATING UNIT. The Company relies upon independent
manufacturer representatives and the Company's factory sales representatives to
identify OEM applications for Specialty Composites' products and technologies.
Once such applications have been identified, the Company's sales and technical
staffs work closely with OEMs to provide the customer with a low-cost,
integrated solution for its noise, vibration, shock, cushioning and/or comfort
management problems.

RESEARCH AND DEVELOPMENT

SAFETY PRODUCTS OPERATING UNIT. The Company believes that its research and
development facilities, personnel and programs are among the best in the PPE
industry. Since its inception in 1972, the Company's ultimate predecessor, the
former E-A-R (Energy Absorbing Resins) Division of Cabot Corporation ("Cabot"),
has been a leader in the development of technology for understanding and
measuring noise and hearing loss and in developing products and programs to
encourage hearing conservation. In order to test the efficacy of its hearing
protection products, the Company owns and operates a National Voluntary
Laboratory Accreditation Program ("NVLAP") laboratory in the United States which
is accredited for testing the efficacy of hearing protection products. The
Company also operates sound chambers and testing facilities which measure the
performance of its materials and designs. Similarly, the Company believes that
it has been a pioneer and leader in the development and testing of safety
eyewear and maintains extensive facilities for the design and testing of safety
eyewear. The research and development personnel of the Company include
recognized experts in the safety products industry.

SPECIALTY COMPOSITES OPERATING UNIT. The research and development efforts of
Specialty Composites focus on developing proprietary materials and enhancing
existing products in order to meet customer needs identified by the Company's
sales and technical staff. Products such as the Isoloss LS polyurethane high
density cellular foams and the Confor heavily damped viscoelastic foam are being
introduced in a growing number of applications across all markets served by
Specialty Composites.

RAW MATERIALS AND SUPPLIERS

The Company consumes a wide variety of raw materials, supplies and components,
including, among others, paper products, chemicals, eyewear frames and optical
lenses. The paper products category includes corrugated paper, folding cartons
and packaging materials. The chemicals category includes plastic resins such as
polycarbonate and propionate, as well as polyols, plasticizers, substrates,
isocyanates and adhesives. The eyewear frames category includes frames for SRx
products.

The Company has a diversified base of raw material suppliers. The Company does,
however, use single sources for the supply of several raw materials, including
General Electric Plastics, a division of General Electric Company, for
polycarbonate resin, the primary raw material used in the production of the
Company's non-prescription optical lenses. The Company has not experienced any
significant delays or shortages in obtaining raw materials in recent years and
believes that alternative supplies of raw materials can be located on
commercially reasonable terms.


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The Company outsources the production of less than 10% of its products to
various manufacturers. Competition among these manufacturers is strong, and,
although a change in manufacturers often results in a period of adjustment
concerning product quality and distribution, the Company, in the past, has
changed manufacturers with respect to certain of its outsourced products.

MANUFACTURING AND DISTRIBUTION OPERATIONS

The Company maintains a high degree of vertical integration, allowing it to
manufacture over 90% of the products that it sells. The Company's strengths
include the manufacture of foams (casting, molding and fabricating) for
Specialty Composites' products (including the foam used in the manufacture of
PVC ear plugs); high speed assembly and packaging of ear plugs; plastic
injection molding, coating and assembly of non-prescription eyewear; and
assembly, grinding, polishing and coating of prescription eyewear. Consistent
across all of the Company's manufacturing operations is an emphasis on producing
high quality products. Currently, all of the Company's manufacturing facilities
have been awarded ISO 9002 or ISO 9001 certification, indicating that the
Company has achieved and sustained a high degree of quality and consistency with
respect to its products. The Company believes that ISO certification is an
increasingly important selling feature both domestically and internationally,
and certain customers require ISO certification from all their vendors.

The Company's products are generally shipped within several days from the
receipt of a purchase order. As a result, backlog is not material to the
Company's business.

SAFETY PRODUCTS OPERATING UNIT. The Company's Indianapolis, Indiana plant is the
largest ear plug manufacturing facility in the world. It fabricates, molds and
packages hundreds of millions of pairs of ear plugs annually, utilizing
automated, high speed assembly and packaging equipment. Because the economies of
scale present in this operation are unique in the hearing protection products
industry, management believes that they offer the Company a competitive
advantage of lower costs within the production process. The plant's high-speed
robotic fabrication, assembly and packaging of ear plugs facilitate cost-saving,
high-volume production and improve cycle time and inventory management. Other
safety products are manufactured at the Southbridge, Massachusetts facility,
where during the period 1993 to 1995 the Company invested over $2 million in
industrial robotics and cellular manufacturing to produce plano eyewear products
previously outsourced from southeast Asia. As a result, the Company is now able
to advertise these products as "Made in the USA."

The Company fills virtually all of its domestic and certain of its international
orders, other than SRx, through its state-of-the-art distribution center located
in Indianapolis, Indiana which has efficient bar-coding and scanning
capabilities to assure rapid turn-around time and service levels for customer
orders.

During 1993 and 1994 the Company completed a major program to consolidate and
retool its SRx laboratory operations. The SRx production operations of six
different manufacturing facilities were consolidated into two U.S. facilities
that possess new lens surfacing, edging and grinding machinery capable of
handling glass, plastic and polycarbonate lenses. These two facilities currently
manufacture and distribute approximately 500,000 pairs of safety prescription
glasses annually.

The Company's principal international manufacturing operations are located in
Poynton, England; Mississauga, Ontario; Varnamo, Sweden; and Ettlingen, Germany.
The Poynton facility serves customers in Western Europe, producing and packaging
ear plugs and other hearing and eyewear products. In addition, Poynton has an
SRx laboratory that primarily serves the U.K. market. The Mississauga plant
fabricates prescription eyewear and, together with a small prescription eyewear
laboratory in Montreal, produces SRx products for the Canadian market. The
Varnamo, Sweden plant is the principal Peltor manufacturing location; finished
goods and components are shipped to customers and other subsidiaries from this
location. Certain of these products are received in the Ettlingen, Germany plant
which provides an assembly operation for the components and a 

                                       6

<PAGE>   9

stocking facility for finished goods for shipment to customers.

SPECIALTY COMPOSITES OPERATING UNIT. Specialty Composites' products are
manufactured in Indianapolis, Indiana and Newark, Delaware. The Indianapolis
plant, which supplies specially formulated foam for the Company's PVC ear plugs,
manufactures and fabricates sheet and roll PVC and polyurethane materials and
molds polyurethane foams and solids. This facility also houses applications
engineering, research and development, quality assurance and customer service
support. The Newark, Delaware facility manufacturers polyurethane foams and
films and houses the Company's new proprietary, thinsheet foam casting line,
which will permit the casting of both sheet and composite materials, including
facings and substrates, in a single pass through the line.

COMPETITION

The PPE market is fragmented and highly competitive. The Company estimates that
there are more than 500 manufacturers of PPE (other than safety clothing, gloves
and shoes) in the United States, Europe and Southeast Asia. Participants in the
industry range in size from small, independent, single-product companies with
annual sales of less than $15 million, to a small number of multinational
corporations with annual sales in excess of $100 million. The Company believes
that participants in the PPE market compete primarily on the basis of product
characteristics (such as design, style and functional performance), product
quality, service and brand name recognition and, to a lesser extent, price. From
a positive competitive standpoint, the Company believes it is well situated,
primarily because of its large size and its broad product offerings, to compete
in a fragmented industry. The Company enjoys certain economies of scale which
are not available to smaller competitors. Many of the Company's customers,
particularly in the growing consumer/DIY channel, prefer the type of "one stop
shopping" that the Company can provide. The Company's advanced distribution
center further facilitates timely and accurate deliveries.

The specialty composites industry is highly competitive, and participants
compete on the basis of being able to provide cost-effective solutions to the
noise, shock and vibration problems of OEMs.

EMPLOYEES

As of September 30, 1998, the Company had 1,858 employees, of whom 1,252 were
primarily engaged in manufacturing, 395 in sales, marketing and distribution, 66
in research and development and 145 in general and administrative. The Company
believes its employee relations are good. The Company has one facility that
employs union members. This facility, located in Plymouth, Indiana, employs 55
members of the International Union of Electronic, Electrical, Salaried, Maritime
and Furniture Workers (out of a total of 89 employees), and the Company's
relations with these union members are fully satisfactory. The union contract
expires on June 26, 2001.

PATENTS AND TRADEMARKS

The Company owns and has obtained licenses to various domestic and foreign
patents, patent applications and trademarks related to its products, processes
and business. The Company values particularly highly its trademark for the color
yellow for ear plugs in the United States and Canada and places significant
value on its overall patent portfolio. However, no single patent or patent
application is material to the Company. The Company's patents expire at various
times over the next 17 to 20 years.

GOVERNMENT REGULATION

As a manufacturer of safety products, the Company is subject to regulation by
numerous governmental bodies. Principal among the federal regulatory agencies in
the United States are: the Occupational Safety and Health Administration
("OSHA"), which regulates the usage of all PPE, with the exception of
respirators; the Environmental Protection Agency ("EPA"), which regulates
hearing protection devices; the Mine Safety and Health Administration ("MSHA")
and the National Institute of Occupational Safety and Health ("NIOSH"), both of
which certify respirators; and the Food and Drug Administration ("FDA"), which
regulates eye, face and respiratory protection products for the healthcare
industry. These agencies generally mandate that the Company's products meet
standards established by private groups, such as American National Standards
Institute ("ANSI"). The Company's products are also subject to foreign laws and
regulations. In particular, they must comply with the Canadian Standards
Association, European Committee for Normalization and Standards Australia. The
Company believes it is in compliance in all material respects with the
regulations and standards of these governmental bodies, and any failures to
comply with such regulations and standards in the past have not had a material
adverse effect on its business.


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ENVIRONMENTAL MATTERS

The Company is subject to various evolving federal, state and local
environmental laws and regulations governing, among other things, emissions to
air, discharge to waters and the generation, handling, storage, transportation,
treatment and disposal of hazardous substances and wastes. The Company believes
that it is in substantial compliance with all such laws and regulations.

ITEM 2.  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.

<TABLE>
<CAPTION>
                                            APPROXIMATE
LOCATION                                    SQUARE FEET                FUNCTION


<S>                                         <C>                <C>                                         
Boston, Massachusetts.....................        8,031        (1)

U.S. SAFETY PRODUCTS
Southbridge, Massachusetts................      295,000        Manufacturing/Administration
Indianapolis, Indiana(2)..................      220,564        Distribution/Customer Service
Indianapolis, Indiana.....................       81,540        Manufacturing/Corporate Headquarters
Chickasha, Oklahoma.......................       15,000        Manufacturing/Customer Service
Plymouth, Indiana.........................       10,224        Manufacturing/Customer Service

INTERNATIONAL SAFETY PRODUCTS
Poynton, England..........................       56,530        Manufacturing/Distribution/Customer
                                                               Service
Varnamo, Sweden...........................      125,595        Manufacturing/Distribution/Customer
                                                               Service
Mississauga, Ontario, Canada..............       28,850        Manufacturing/Customer Service
Ettlingen, Germany........................       45,000        Manufacturing/Distribution/Customer
                                                               Service
Bognor Regis, England.....................        2,700        Customer Service
Paris, France.............................        1,894        Sales Office
Montreal, Quebec, Canada..................        1,800        Manufacturing/Customer Service
Barcelona, Spain..........................          (*)        Sales Office
Milan, Italy..............................          (*)        Sales Office

SPECIALTY COMPOSITES
Indianapolis, Indiana.....................      156,000        Manufacturing/Distribution
Newark, Delaware..........................       82,300        Manufacturing/Distribution
</TABLE>


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

(1)      As part of the Company's restructuring activities during fiscal year
         1998, the Company's Corporate Offices have been relocated to
         Indianapolis and merged into one of the Company's existing
         manufacturing locations. As a result, this space has been vacated as of
         June 30, 1998, and has been made available for sublease. The Company's
         lease commitment runs through March, 2001.

(2)      This facility also serves as an international distribution center and
         central packaging operation with respect to certain of the Company's 
         products.



                                       8
<PAGE>   11



(*) Less than 1,000 square feet.

The Company believes that its facilities are suitable for its operations and
provide sufficient capacity to meet the Company's requirements for the
foreseeable future. All of the Company's facilities are leased except for the
following facilities owned by the Company: (i) the Safety Products manufacturing
facility in Indianapolis, (ii) the Specialty Composites
manufacturing/distribution facility in Indianapolis, (iii) the Specialty
Composites manufacturing facility in Newark, and (iv) the Safety Products
manufacturing facility in Ettlingen, Germany. The Company believes that it will
be able to renew each of its leases upon their respective expiration dates on
commercially reasonable terms. In addition, the Company believes that it would
be able to lease suitable additional or replacement space on commercially
reasonable terms.

ITEM 3.  LEGAL PROCEEDINGS

Various lawsuits and claims arise against the Company in the ordinary course of
its business. Most of these lawsuits and claims relate to the Company's safety
eyewear and respiratory product lines and primarily involve accidents and/or
exposures occurring after the Company's predecessor acquired the AOSafety
Division from American Optical Corporation in April 1990. The Company is
contingently liable with respect to numerous lawsuits involving respirators sold
by American Optical Corporation prior to the acquisition of the AOSafety
Division in April 1990. These lawsuits typically involve plaintiffs alleging
that they suffer from asbestosis or silicosis, and that such condition results
in part from respirators which were negligently designed or manufactured. The
defendants in these lawsuits are often numerous, and include, in addition to
respirator manufacturers, employers of the plaintiffs and manufacturers of sand
(used in sand blasting) and asbestos. Responsibility for legal costs, as well as
for settlements and judgments, is shared contractually by the Company, American
Optical Corporation and a prior owner of American Optical Corporation. The
Company and Cabot have entered into an arrangement relating to certain
respirator claims asserted after July 11, 1995 (the date of the Company's
formation) whereby, so long as the Company pays to Cabot an annual fee of
$400,000, which the Company has elected to pay, Cabot will retain responsibility
and liability for, and indemnify the Company against, certain legal claims
alleged to arise out of the use of respirators manufactured prior to July 1995.
The Company has the right to discontinue the payment of such annual fee at any
time, in which case the Company will assume responsibility for and indemnify
Cabot with respect to such claims.

During fiscal 1997 the Company received a complaint from Gargoyles, Inc.
alleging that one of the Company's recently introduced plano eyewear products
(Fectoids) infringes a patented lens shape utilized in the plaintiff's sun and
sporting glasses. On October 22, 1998, the Company announced that it had entered
into a settlement agreement with Gargoyles, Inc. Under the terms of the
settlement, in which the Company expressly denies any liability in the lawsuit,
the Company will continue to manufacture its Fectoids line of eyewear for sale
into safety eyewear markets. The Company also will have the right to sell into
such markets other lines of safety eyewear that Gargoyles contended infringe its
patents. The Company agreed to pay Gargoyles $1.2 million in exchange for a
release of all claims relating to Gargoyles' patents and for uncontested rights
to continue manufacturing and selling its Fectoids and other lines of eyewear.




ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF  SECURITY HOLDERS

On September 28, 1998, the Company held a special meeting of stockholders to
approve the selection of Arthur Andersen LLP as the Company's independent public
accountants.


                                       9
<PAGE>   12

                                     PART II

ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

All of the common stock, par value $0.01 per share, of Aearo ("Aearo Common
Stock") is held, collectively, by Vestar Equity Partners, L.P. (together with
certain related persons, "Vestar"), Cabot Corporation ("Cabot") and management.
In July 1995, Vestar, Cabot and management effected through the Company the
acquisition of substantially all of the assets and certain liabilities of Cabot
CSC Corporation ("Old Cabot Safety Corporation"), a wholly-owned subsidiary of
Cabot, and certain of its affiliates (the "Formation Acquisition") for $206.1
million. To finance the Formation Acquisition, the Company incurred $47.5
million of senior secured debt ("Senior Bank Facilities") sold $100 million of
12 1/2% senior subordinated notes due 2005 (the "Senior Subordinated Notes"),
issued to Vestar and Cabot an aggregate of $45 million of 12 1/2% redeemable
preferred stock (the "Aearo Preferred Stock"), and issued to Vestar, Cabot and
certain members of management and key employees of the Company (collectively the
"Management Investors") an aggregate of 100,000 shares of Aearo Common Stock.
See Item 12, "Security Ownership of Certain Beneficial Owners and Management."
All of the common stock of the Subsidiary is owned by Aearo, and thus no trading
market exists for such stock. Accordingly, no trading market exists for any
capital stock of the Company.

Effective September 30, 1998, the Company sold a total of 100 shares of its
common stock to certain employees at a purchase price per share of $200 in a
combination of cash and loans from the Company. The loans are secured by the
purchased shares, have a term of 5 years and bear interest at an annual rate of
7%. The issuances of the above shares were made pursuant to the Company's 1995
Employee Stock Purchase Plan and were exempt from the registration requirements
of the Securities Act of 1933, as amended (the "Act"), by virtue of Section 4(2)
of the Act. 

ITEM 6.  SELECTED FINANCIAL DATA

The selected historical financial data for the year ended September 30, 1994
are derived from the combined financial statements of Cabot Safety Corporation,
which have been audited by Coopers & Lybrand LLP, independent public
accountants. The selected income statement data for the period ended July 11,
1995 are also derived from the combined financial statements of Cabot Safety
Corporation, which have been audited by Arthur Andersen LLP, independent public
accountants. The balance sheet data for July 11, 1995 is unaudited but, in the
opinion of management, includes all adjustments (consisting only of normal
recurring accruals) necessary for a fair presentation. The selected historical
financial data as of and for the period ended September 30, 1995 and as of and
for the years ended September 30, 1996, 1997 and 1998 are derived from the
consolidated financial statements of Aearo Corporation and were also audited by
Arthur Andersen LLP. The data should be read in conjunction with the combined
and consolidated financial statements and related notes, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
other financial information included herein.




                                       10
<PAGE>   13



                                AEARO CORPORATION

                             SELECTED FINANCIAL DATA
           (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS AND RATIOS)


<TABLE>
<CAPTION>
                                     PREDECESSOR COMPANY                           SUCCESSOR COMPANY
                                     -------------------          --------------------------------------------------
                                  YEAR ENDED        PERIOD        PERIOD ENDED              YEAR ENDED SEPTEMBER 30,
                                  SEPTEMBER 30,  ENDED JULY 11,   SEPTEMBER 30,             ------------------------
                                      1994           1995             1995                1996         1997        1998
                                      ----           ----             ----                ----         ----        ----
<S>                                 <C>             <C>              <C>                <C>           <C>        <C>    
INCOME STATEMENT DATA:                                                             
Net Sales --
  Safety Products ...............   $ 149.7         $ 129.6          $   40.0           $ 205.2      $  249.6    $  252.9
  Specialty Composites ..........      28.6            25.1               7.9              38.3          36.2        39.6
                                    -------         -------          --------           -------      --------    --------
     Total net sales ............     178.3           154.7              47.9             243.5         285.8       292.5
Cost of Sales ...................      99.5            87.7              29.3(2)          133.6(4)      163.5       163.9
                                    -------         -------          --------           -------      --------    --------
     Gross profit ...............      78.8            67.0              18.6             109.9         122.3      128.6
Operating Expenses --
  Selling and administrative ....      51.7            47.1(1)           13.1              73.6(5)       87.0       88.9
  Research and technical service.       2.7             2.3               0.6               3.2           5.1        4.7
  Amortization expense (3) ......       5.6             4.3               0.8               5.6           7.0        6.8
  Other charges (income), net....        --            (0.2)              0.1               0.3           2.5       (0.3)
  Restructuring charge...........        --              --                --                --            --       11.6(8)
                                    -------         -------          --------           -------      --------    -------
     Operating Income............      18.8            13.5               4.0              27.2          20.7       16.9
     Interest expense, net (3)...       5.8             5.7               4.1              20.7          26.7       26.1
                                    -------         -------          --------           -------      --------    -------
     Income (loss) before income 
        taxes....................      13.0             7.8              (0.1)              6.5          (6.0)      (9.2)
Provision for income taxes.......       5.0             3.0               0.5               4.3           0.9        2.2
                                    -------         -------          --------           -------      --------    -------
Net income (Loss)................   $   8.0        $    4.8          $   (0.6)         $   2.2       $   (6.9)   $  (11.4)
                                    =======        ========          ========          =======       ========    ========
Preferred stock dividend
  accrued........................                                         1.3              6.2            7.1         8.1

Net loss applicable to
  common shareholders............                                        (1.9)            (4.1)         (14.0)      (19.5)
 
Net loss per common
  share..........................                                    $ (18.67)         $(40.58)      $(142.77)   $(195.60)

OTHER DATA:                                                                                                 

EBITDA (6).......................   $  30.6        $   22.9          $    6.1          $  39.7       $   37.8    $   35.6

Depreciation  and amortization   
(3)..............................      11.7             9.2               2.1             13.9           18.6        20.3

Capital expenditures.............       4.5            10.4               2.7              9.2            8.9         5.8
                                                                                  
Ratio of earnings to fixed                                                                                             
charges(7).......................       2.8             2.2                --              1.3             --          --

BALANCE SHEET DATA (AT                                                                            
PERIOD-END):

  Total assets...................   $ 171.2         $ 177.5           $ 218.3          $ 338.4        $ 310.9     $ 286.7

  Long-term debt (including
     current portion)............      76.9            78.4             152.3            250.3          244.7       233.2
 
  Stockholders' equity...........      35.2            40.1              32.0             34.8           20.0         4.8

</TABLE>



                                       11

<PAGE>   14



                                AEARO CORPORATION

                      SELECTED FINANCIAL DATA - (CONTINUED)

NOTES TO SELECTED FINANCIAL DATA:

(1)      For the period ended July 11, 1995, includes a $1.1 million charge
         related to termination of the Old Cabot Safety Corporation stock option
         plan and a $0.8 million charge related to a provision for potential
         value-added tax penalties by the Company's French subsidiary.

(2)      For the period ended September 30, 1995, includes a $3.6 million charge
         related to allocation of purchase price to inventory.

(3)      Operating results subsequent to the Formation Acquisition are
         comparable to prior periods, with the exception of cost of sales
         (due to the $3.6 million and $1.0 million charges in the period and
         year ended September 30, 1995 and 1996, respectively, related to
         the allocations of purchase price to inventory), depreciation
         expense, amortization of intangible assets and interest expense.

(4)      Includes $1.0 million charged to cost of sales as a result of purchase
         price allocated to inventory acquired in the Peltor acquisition. This
         amount was recorded in cost of sales as the acquired inventory was sold
         during the year ended September 30, 1996.

(5)      Includes $0.8 million charged to selling and administrative expense for
         costs related to the abandoned effort at an initial public offering.

(6)      EBITDA is defined as earnings before interest, taxes, depreciation,
         amortization, and non-operating income or expense. Non-operating income
         or expense is further defined as extraordinary gains or losses, or
         gains or losses from sales of assets other than in the ordinary course
         of business. While the Company believes EBITDA is a useful indicator of
         its ability to service debt, EBITDA should not be considered as a
         substitute for net income determined in accordance with generally
         accepted accounting principles as an indicator of operating performance
         or as an alternative to cash flow as a measure of liquidity. Investors
         should be aware that EBITDA as presented above may not be comparable to
         similarly titled measures presented by other companies and comparisons
         could be misleading unless all companies and analysts calculate this
         measure in the same fashion.

(7)      Ratio of earnings to fixed charges is defined as pretax income from
         continuing operations plus fixed charges divided by fixed charges.
         Fixed charges include interest expense (including amortization of debt
         issuance costs) and a portion of rental expense assumed to represent
         interest. Earnings for the period ended September 30, 1995 and the
         years ended September 30, 1997 and 1998 were inadequate to cover fixed
         charges by $0.2 million, $6.0 million, and $9.2 million, respectively.

(8)      During fiscal 1998 the Company took a restructuring charge of $11.6
         million related to the restructuring plans announced by the Company
         during the fiscal year. On February 3, 1998, the Company announced the
         appointment of Michael A. McLain as President and Chief Executive
         Officer and on March 25, 1998 the Company announced plans to close the
         Boston headquarters and relocate it to Indianapolis, Indiana, where the
         Company has substantial operations. In addition, on September 30, 1998
         the Company announced plans to improve profitability through complexity
         reduction and restructuring. (See Note 16 of Notes to Consolidated
         Financial Statements.)


ITEM 7. 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


                                       12

<PAGE>   15

related to acquisitions; risks associated with the conversion to a new
management information system; high level of competition in the Company's
markets; importance and costs of product innovation; risks associated with
international operations; product liability exposure; unpredictability of
patent protection and other intellectual property issues; dependence on key
personnel; the risk of adverse effect of economic and regulatory conditions on
sales; and risks associated with environmental matters.

GENERAL

In mid-1994 management began to address operational issues that had adversely
affected the Company's sales and profitability. Management focused on four
primary areas: (i) strengthening relationships with distributors and product
end-users, (ii) increasing the Company's participation in projected high-growth
markets, such as the consumer/DIY and catalog supply markets and the emerging
international markets of Latin America and the Pacific Rim, (iii) expanding
product innovation and development efforts and (iv) pursuing acquisitions. The
impact of these initiatives became evident during fiscal 1996. In addition, the
Company completed the acquisitions of Peltor and Eastern in that same fiscal
year. Each of these acquisitions has been a key contribution to the Company's
overall strategy.

In the latter part of fiscal 1996, the Company undertook efforts to implement a
new management information system, integrate the Peltor and Eastern
acquisitions, and change the manufacturing orientation at its Southbridge,
Massachusetts facility towards cellular manufacturing. Difficulties associated
with the systems conversion as well as the other initiatives resulted in
problems with production planning and control, shipping and distribution, and
overall customer service. Throughout most of fiscal 1997 the Company spent
significant sums in order to mitigate the effects of these problems on its
customer base. As the year progressed, the Company realized improvements in
service levels as well as a return towards historic levels of profitability.

During fiscal year 1998 the Company continued to realize these improvements and
experienced four successive quarters of operating profitability improvements,
excluding the $11.6 million restructuring charge and $0.5 million of personnel
relocation costs associated with the move of the corporate headquarters from
Boston, MA to Indianapolis, IN, as compared with the same quarters of the
prior year. A new management team was installed, starting with the appointment
of Michael A. McLain as President and Chief Executive Officer on February 3,
1998. During fiscal 1998 the Company continued to realize operating
improvements through greater utilization of the new management information
system. To further accelerate its operational benefits, the Company completed a
major update of its SAP management information system to version 3.1H in
November, 1998.



                                       13
<PAGE>   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.

<TABLE>
<CAPTION>
                                          YEAR ENDED SEPTEMBER 30,
                                          ------------------------
                                     1996           1997           1998
                                     ----           ----           ----
<S>                                 <C>            <C>            <C>  
Net sales:
  Safety Products ...............    84.3%          87.3%          86.5%
  Specialty Composites ..........    15.7           12.7           13.5
                                    -----          -----          -----
    Total net sales .............   100.0          100.0          100.0
Cost of sales ...................    54.5 (1)       57.2           56.0
                                    -----          -----          -----
Gross profit ....................    45.5 (1)       42.8           44.0
Selling and administrative ......    29.9 (2)       30.4           30.4
Research and technical services..     1.3            1.8            1.6
Amortization expense ............     2.3            2.5            2.3
Other charges (income), net .....     0.1            0.9           (0.1)
Restructuring charge ............      --             --            4.0
                                    -----          -----          -----
  Operating income ..............    11.9%(1)(2)     7.2%           5.8%
                                    =====          =====          =====
</TABLE>


(1)      Excludes $1.0 million charged to cost of sales as a result of purchase
         price allocated to inventory acquired in the Peltor acquisition. This
         amount was recorded in cost of sales as the acquired inventory was sold
         during the year ended September 30, 1996.

(2)      Excludes $0.8 million charged to selling and administrative expense for
         costs related to the abandoned effort at an initial public offering.

The Company's business is slightly seasonal. Traditionally, net sales during the
first fiscal quarter (October 1 -- December 31) are slightly lower than the
other quarters. This is generally attributable to stock reductions by
distributors and plant shutdowns by end-users towards the end of each calendar
year.


FISCAL 1998 COMPARED TO FISCAL 1997

NET SALES. Net sales in the year ended September 30, 1998 increased 2.3% to
$292.5 million from $285.8 million in the year ended September 30, 1997. Both
operating segments enjoyed growth with Safety Products net sales in the year
ended September 30, 1998 increasing 1.3% to $252.9 million from $249.6 million
in the year ended September 30, 1997 as growth with U.S. Consumer and North
American and European Industrial accounts more than offset the negative effect
of a stronger U.S. Dollar and decline in business with customers in Asia.
Specialty Composites' net sales in the year ended September 30, 1998 increased
9.4% to $39.6 million from $36.2 million in the year ended September 30, 1997.
The increase was primarily driven by the strengthening general aviation and
Class 8 truck markets.

GROSS PROFIT. Gross profit in the year ended September 30, 1998 increased 5.1%
to $128.6 million from $122.3 million in the year ended September 30, 1997.
Gross profit as a percentage of net sales in the year ended September 30, 1998
was 44.0% as compared to 42.8% in the year ended September 30, 1997. The gross
profit amount was favorably impacted by the increased net sales, and the
realization of operating improvements as the Company overcame the difficulties
triggered by the conversion to a new management information system and the
changes in manufacturing processes at the Southbridge, Massachusetts facility.
These improvements have resulted in decreased spending at the Southbridge
facility, predominantly in the first quarter of 1998 and to lesser extents in
the second and third quarters. These decreased operating costs were the main
determinants in the improvement in the gross profit as a percent of net sales.

SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative expenses in the
year ended September 30, 1998 increased 2.2% to $88.9 million from $87.0 million
in the year ended September 30, 1997. Within this increase is a reduction of
$0.3 million of distribution expenses. Although net sales were up 2.3%,
distribution expenses decreased as the Company continued to improve service
levels and overcame the difficulties triggered by the conversion to the new
management information system. Sales and marketing expenses decreased by $2.6
million. These reductions were more than offset by normalized incentive
accruals, and an accrual for costs related to a patent infringement claim by
Gargoyles, Inc., which was settled October 22, 1998, as well as $0.5 million of
personnel relocation costs associated with the move of the corporate
headquarters from Boston, MA to Indianapolis, IN in the current period compared
to the year after period; in the current period these accounts increased
compared to the prior period. Selling and administrative expenses as a
percentage of net sales in the year ended September 30, 1998 were 30.4% of net
sales, the same as in the year ended September 30, 1997.

RESEARCH AND TECHNICAL SERVICES EXPENSES. Research and technical services
expenses in the year ended September 30, 1998 decreased 8.9% to $4.7 million
from $5.1 million in the year ended September 30, 1997. This decrease was due
primarily to the timing of European development activities, and to a lesser
extent the effect of a stronger U.S. dollar relative to the Swedish Krona.

AMORTIZATION OF INTANGIBLES. Amortization expense remained at a relatively
consistent $6.8 million in the year ended September 30, 1998 compared to $7.0
million in the year ended September 30, 1997.

OTHER CHARGES (INCOME), NET. Other Charges (Income), Net improved to income of
$0.3 million for the year ended September 30, 1998 as compared to expense of
$2.5 million for the year ended September 30, 1997. This change 



                                       14
<PAGE>   17

was primarily a result of foreign currency transaction gains in the year ended
September 30, 1998 as compared to foreign currency transaction losses and
charges related to the abandonment of two automation related capital projects
totaling approximately $0.5 million at the Company's Indianapolis, Indiana
facility in the year ended September 30, 1997.

RESTRUCTURING CHARGE. During fiscal 1998 the Company recorded a restructuring
charge of $11.6 million related to the restructuring plans announced by the
Company during the fiscal year. On February 3, 1998, the Company announced the
appointment of Michael A. McLain as President and Chief Executive Officer and on
March 25, 1998 the Company announced plans to close the Boston headquarters and
relocate it to Indianapolis, Indiana, where the Company has substantial
operations. In addition, on September 30, 1998 the Company announced plans to
improve profitability through complexity reduction and restructuring. The
Company is eliminating certain product offerings in its Eyewear and Respiratory
product lines, reducing head count in North America through restructuring and
outsourcing, consolidating the branding in its Consumer product line and
reducing selling and manufacturing cost in its Prescription eyewear product
line.

The $11.6 million charge includes a $6.1 million provision for inventories and
product returns for products that are being discontinued. The charge also
provides $1.1 million for certain property, plant and equipment for which the
Company has determined there is no future use, and $0.1 million related to
intangibles on abandoned product lines. In addition, the charge provides $4.3
million to cover mainly employee severance and other contractual obligations.

OPERATING INCOME. Primarily as a result of the factors discussed above,
operating income decreased 18.3% to $16.9 million in the year ended September
30, 1998 from $20.7 million in the year ended September 30, 1997. Operating
income as a percentage of net sales in the year ended September 30, 1998 was
5.8% as compared to 7.2% in the year ended September 30, 1997.

INTEREST EXPENSE, NET. Interest expense, net in the year ended September 30,
1998 decreased 1.9% to $26.2 million from $26.7 million in the year ended
September 30, 1997.

LOSS BEFORE PROVISION FOR INCOME TAXES. Loss before provision for income taxes
increased $3.3 million in the year ended September 30, 1998 to a loss of $9.2
million compared to a loss of $6.0 million in the year ended September 30, 1997
due to the lower operating income partly offset by lower interest expense.

PROVISION FOR INCOME TAXES. The provision for income taxes in the year ended
September 30, 1998 was $2.2 million compared to $0.9 million in the year ended
September 30, 1997. The Company's foreign subsidiaries have taxable income in
their jurisdictions, but the domestic subsidiaries have a loss for income tax
purposes in the U.S. In the results for the years ended September 30, 1998 and
1997, the Company has not recognized any of the tax benefits which will occur in
future periods if there is taxable income in the U.S.

NET LOSS. For the year ended September 30, 1998, the Company had a net loss of
$11.4 million as compared to a net loss of $6.9 million for the year ended
September 30, 1997.

EBITDA. EBITDA is defined as earnings before interest, taxes, depreciation,
amortization, and non-operating income or expense. Non-operating income or
expense is further defined as extraordinary gains or losses, or gains or losses
from disposition of assets other than in the ordinary course of business. While
the Company believes EBITDA is a useful indicator of its ability to service
debt, EBITDA should not be considered as a substitute for net income determined
in accordance with generally accepted accounting principles as an indicator of
operating performance or as an alternative to cash flow as a measure of
liquidity. Investors should be aware that EBITDA as presented below may not be
comparable to similarly titled measures presented by other companies and
comparisons could be misleading unless all companies and analysts calculate this
measure in the same fashion.

                                       15
<PAGE>   18

                               EBITDA CALCULATION
                             (DOLLARS IN THOUSANDS)


<TABLE>
<CAPTION>
                                                          Year Ended                              Change
                                                        September 30,                     Favorable (Unfavorable)
                                                    1998              1997               Amount            Percent
                                                    ----              ----               ------            -------
<S>                                              <C>                <C>               <C>                  <C>    
     Operating Income                            $     16,910       $    20,706       $    (3,796)          (18.3%)
     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) (1)                281               404              (123)          (30.4%)
                                                 ------------       -----------       -----------

     EBITDA                                      $     35,561       $    37,840       $    (2,279)           (6.0%)
                                                 ============       ===========       ============


    (1) Other Charges (Income), Net Summary:
       Non-operating Costs (Income), Net         $        281       $       404       $      (123)          (30.4%)
       Foreign Transaction (Gains) Losses                (617)            2,101             2,718           129.4%
                                                 ------------       -----------       -----------
     Total Other Charges (Income), Net           $       (336)      $     2,505       $     2,841           113.4%
                                                 ============       ===========       ===========
</TABLE>



EBITDA for the year ended September 30, 1998 was $35.6 million as compared to
$37.8 million for the year ended September 30, 1997. This decrease was due
primarily to the decrease in operating income described previously partly offset
by higher depreciation expense. EBITDA as a percentage of net sales in the year
ended September 30, 1998 was 12.2% as compared to 13.2% in the year ended
September 30, 1997. Excluding the $11.6 million restructuring charge and $0.5
million of personel relocation costs associated with the move of corporate
headquarters, EBITDA would have been $47.7 million, or 16.3% of net sales for
the year ended September 30, 1998.


FISCAL 1997 COMPARED TO FISCAL 1996

NET SALES. Net sales in the year ended September 30, 1997 increased 17.4% to
$285.8 million from $243.5 million in the year ended September 30, 1996. The
increase in net sales was primarily due to the acquisitions of Peltor and
Eastern which were only included for four months of fiscal 1996 and nine months
of fiscal 1996, respectively, as well as internal growth at Safety Products.
Safety Products net sales increased 21.6% from $205.2 million to $249.6 million.
Of this $44.4 million increase, the acquisitions of Peltor and Eastern
contributed $28.6 million and $3.0 million respectively, and $12.8 million was
from internal growth. There was growth in net sales of eye & face products due
to increased volumes and successful new products, as well as in hearing
protection due to increased volumes, a portion of which was due to larger
purchases from the U.S. military in order to increase inventories. Comparisons
to last year were particularly strong in the fourth fiscal quarter when sales at
Safety Products increased by 14.1% as the Company continued to improve service
levels and overcome the difficulties triggered by the conversion to a new
management information system in the fourth quarter of last year. Net Sales in
last year's fourth quarter were hampered by the conversion to the new management
information system. The conversion effort resulted in inaccurate production
planning, backorders and missed shipments particularly in eye & face products
manufactured at the Company's Southbridge, Massachusetts facility. Specialty
Composites net sales decreased 5.5% from $38.3 million to $36.2 million. This
decrease was largely due to the impact of a $2.3 million shipment related to the
Sea Wolf Submarine in the year ended September 30, 1996 and, to a lesser extent,
softness in the Class 8 truck market.


GROSS PROFIT. Gross profit in the year ended September 30, 1997 increased 11.3%
to $122.3 million from $109.9 million in the year ended September 30, 1996.
Excluding the $1.0 million negative effect of purchase accounting for the Peltor
acquisition in fiscal 1996, gross profit would have increased 10.3% from an
adjusted gross profit of $110.9 million. The increase was primarily due to the
acquisitions of Peltor and Eastern which were partially offset by higher costs
in the Southbridge, Massachusetts manufacturing facility and, to a lesser
extent, the Indianapolis, Indiana central packaging operation in the first
quarter. These costs included temporary labor, overtime and excess material
usage and were significantly increased by efforts to correct difficulties
associated with the conversion to the new management information system as well



                                       16
<PAGE>   19

as changes in manufacturing. Gross profit as a percentage of sales in the year
ended September 30, 1997 was 42.8% as compared to gross profit as a percentage
of sales, on an adjusted basis, of 45.6% in the year ended September 30, 1996.
The percentage decrease was primarily due to the increased costs at the
Southbridge, Massachusetts facility. Gross profit as a percentage of sales
increased towards historical levels in the second half of the year as
improvements in operations were realized.

SELLING AND ADMINISTRATIVE EXPENSES. Selling and administrative expenses in the
year ended September 30, 1997 increased 18.2% to $87.0 million from $73.6
million in the year ended September 30, 1996. Of this increase, approximately
$5.0 million was due to the acquisitions of Peltor and Eastern. Of the remaining
increase, approximately $2.5 million was due to higher distribution expenses.
These expenses include higher freight charges as well as excess labor costs
associated with a higher level of backorders and partial shipments as well as a
higher level of product returns. In addition, the Company incurred higher costs
in customer service in order to mitigate operational difficulties relating to
the new management information system. Also there were higher sales and
marketing expenses from the Company's growth initiatives which were partially
offset by reductions in management and employee incentive accruals. Selling and
administrative expenses as a percentage of net sales were 30.5% in fiscal 1997
compared to 30.2% in fiscal 1996. Excluding the $0.8 million of costs of an
abandoned equity offering in fiscal 1996, such percentage would have been 29.9%.


RESEARCH AND TECHNICAL EXPENSES. Research and technical expenses in the year
ended September 30, 1997 increased 57.5% to $5.1 million from $3.3 million in
the year ended September 30, 1996. The increase was primarily due to the
acquisition of Peltor which spends proportionately more on research and
technical services because there is a more significant technical component to
this product line.

AMORTIZATION EXPENSE. Amortization expense in the year ended September 30, 1997
increased to $7.0 million from $5.6 million in the year ended September 30, 1996
as a result of purchase accounting for the acquisitions of Peltor and Eastern.

OTHER CHARGES (INCOME), NET. Other charges increased to $2.5 million in the year
ended September 30, 1997 from $0.3 million in the year ended September 30,1996.
Approximately $1.7 million of this increase was due to foreign exchange losses
primarily during the first three fiscal quarters. During the fourth quarter the
Company initiated the use of forward contracts to mitigate the effects of
changes in foreign currency rates on profitability. This program has been
successful in significantly reducing these effects. The remaining charges relate
to the abandonment of two automation-related capital projects totaling
approximately $0.5 million at the Company's Indianapolis, Indiana Safety
Products manufacturing facility.

OPERATING INCOME. Primarily as a result of the factors discussed above,
operating income in the year ended September 30, 1997 decreased 23.8% to $20.7
million from $27.2 million in the year ended September 30, 1996.

INTEREST EXPENSE, NET. As a result of the increased borrowings to finance the
acquisitions of Peltor and Eastern, interest expense, net in the year ended
September 30, 1997 increased 28.8% to $26.7 million from $20.7 million in the
year ended September 30, 1996.

PROVISION FOR INCOME TAXES. The provision for income taxes in the year ended
September 30, 1997 was $0.9 million. The Company's subsidiaries have taxable
income in foreign jurisdictions, but a loss for income tax purposes in the U.S.
In the results for the year ended September 30, 1997 the Company has not
recognized any of the tax benefits which will occur in future periods if there
is taxable income in the U.S.

NET INCOME (LOSS). As a result of the decrease in operating income as well as
the higher interest expense the Company incurred a net loss of $6.9 million for
the year ended September 30, 1997 as compared to net income of $2.2 million for
the year ended September 30, 1996.

EBITDA. EBITDA is defined as earnings before interest, taxes, depreciation,
amortization, and non-operating income or expense. Non-operating income or
expense is further defined as extraordinary gains or losses, or gains or losses
from sales of assets other than in the ordinary course of business. EBITDA for
the year ended September 30, 1997 was $37.8 million as compared to $39.7 million



                                       17
<PAGE>   20

for the year ended September 30, 1996. This decrease was due to fact that the
contribution from the acquisitions of Peltor and Eastern were more than offset
by the combined effects of higher costs in the Company's Southbridge,
Massachusetts manufacturing facility, higher selling and administrative costs
and the foreign exchange losses. EBITDA as a percentage of sales declined from
16.3% to 13.2% due to the decreased profitability in the first three fiscal
quarters of fiscal 1997. In the fourth fiscal quarter of 1997 EBITDA was $12.2
million or 16.3% of sales as compared to $10.4 million or 16.3% of sales in the
fourth fiscal quarter of fiscal 1996. This increase was due to the favorable
effect of higher volume in the period as well as improvements in profitability.

EFFECTS OF CHANGES IN EXCHANGE RATES

In general, the Company's results of operations are affected by changes in
exchange rates. Subject to market conditions, the Company prices its products in
Europe and Canada in local currency. While many of the Company's selling and
distribution costs are also denominated in these currencies, a large portion of
product costs are U.S. Dollar denominated. As a result, a decline in the value
of the U.S. Dollar relative to other currencies can have a favorable impact on
the profitability of the Company and an increase in the value of the U.S. Dollar
relative to these other currencies can have a negative effect on the
profitability of the Company. As a result of the acquisition of Peltor AB, the
Company's operations are also affected by changes in exchange rates relative to
the Swedish Krona. A decline in the value of the Krona relative to other
currencies can have a favorable impact on the profitability of the Company and
an increase in the value of the Krona relative to other currencies can have a
negative impact on the profitability of the Company. The Company estimates that
these exchange rate changes had the effect of decreasing operating profit by
$1.5 million in the year ended September 30, 1998 compared to the effect of
decreasing operating profit by $2.1 million, and $0.3 million in the years ended
September 30, 1997 and 1996, respectively.

EFFECTS OF INFLATION

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

YEAR 2000 COMPLIANCE

The "Year 2000 problem" is a flaw existing in many computer hardware and
software programs caused by historical use of dates represented by only two
digits (for example, 98 rather than 1998). This causes computer programs (both
system and application) that perform arithmetic operations, comparisons, or
sorting of data fields to yield incorrect results when working with years
outside the range of 1900-1999. To evaluate the impact of this the Company has
assembled a "Y2K" cross functional team which has assessed the impact of year
2000 compliance with respect to Information Technology (IT) and manufacturing
systems as well as the Company's exposure to significant third party risks.
Accordingly, the Company has initiated and substantially completed a plan to
replace or modify existing systems and technology as required and to assure
itself that major customers and critical vendors are also addressing these
issues.

The Company's recent conversion to a new management information system that has
been in use by a majority of the Company's operating units has brought the
advantage of year 2000 compliance to the bulk of the internal systems that could
potentially otherwise have material adverse impacts on the Company's operations.
The prescription eyewear product line is the remaining operating unit that is
not predominantly operated on the new management information system. The
software for this unit will be modified and eventually a new operating system
will be installed. It is anticipated that this project will be completed by the
end of fiscal 1999. It is expected that these remaining conversions will be
substantially completed by the end of fiscal 1999, and at this time a
contingency plan has not been developed in the event these system conversions
are not completed on a timely basis. As it relates to internal E-mail and
desktop hardware and software systems, the Company has begun a desktop update
and standardization effort which in addition to providing efficiency tools to
the global organization will also address those remaining year 2000 compliance
issues that may exist in that environment. Including the remaining conversion
and desktop standardization initiatives and the costs of modifying internal
software for the prescription eyewear product line, the cost to achieve Year
2000 compliance is anticipated to be less than $1.0 million.

The Company has contacted and is in the process of surveying its major customers
and vendors. However, there can be no assurance that year 2000 deficiencies in
the systems of other companies on which the Company's systems rely will be
timely corrected or that any such failure by another company to correct its
deficiencies would not have an adverse effect on the Company's systems, business



                                       18
<PAGE>   21

or results of operations. The Company is continuing its assessment of the
remainder of its internal systems and that of other companies on which the
Company's systems rely.

Since the majority of the Company's products are passive in nature and do not
utilize chip technologies, it is not anticipated that product returns could
materially impact the Company.

LIQUIDITY AND CAPITAL RESOURCES

The Company's sources of funds have consisted primarily of operating cash flow
and debt financing. The Company's uses of those funds consist principally of
debt service, capital expenditures and acquisitions.

The Company's debt structure includes $100.0 million of Senior Subordinated
Notes (Notes) due 2005, as well as a senior bank facility comprised of (i) term
loans denominated in U.S., Canadian, British and German currencies aggregating
$140.0 million at inception (the Term Loans) and (ii) a Revolving Credit
Facility providing for up to $25.0 million (the Senior Bank Facilities).

Maturities under the Company's Term Loans are: $13.3 million in fiscal 1999,
$16.4 million in fiscal 2000, $21.2 million in fiscal 2001, $34.5 million in
fiscal 2002 and $35.2 million in fiscal 2003. Other than upon a change of
control or as a result of certain asset sales, or in the event that certain
excess funds exist at the end of a fiscal year, the Company will not be required
to make any principal payments in respect of the Notes until maturity. The
Company will also be required to make interest payments with respect to both the
Senior Bank Facilities and the Notes.

The Company typically makes capital expenditures related primarily to the
maintenance and improvement of manufacturing facilities. The Company spent $5.8
million for capital expenditures for the year ended September 30, 1998 as
compared to $8.9 million for capital expenditures for the year ended September
30, 1997 and $9.2 million for the year ended September 30, 1996. Included in the
capital expenditures over the past three years was $8.0 million for a worldwide
management information system. The Company's capital spending is of a relatively
short duration, with the complete commitment process typically involving less
than one year.

The Company's principal source of cash to fund these capital requirements is net
cash provided by operating activities. The Company's net cash provided by
operating activities for the year ended September 30, 1998 totaled $20.2 million
as compared to $9.1 million for the year ended September 30, 1997. The increase
was due primarily to a $7.8 million improvement in Operating Income before the
restructuring charge, a decrease in accounts receivables of $1.4 million as
compared to an increase of $0.5 million in fiscal 1997, a reduction in
inventories of $0.1 million before the restructuring charge in fiscal 1998 as
compared to a decrease of $3.8 million in fiscal 1997, and a decrease in
accounts payable, accruals and all other of $2.1 million as compared to a
decrease of $6.6 million in fiscal 1997. In fiscal 1996, the Company's net cash
provided by operating activities totaled $4.5 million.

Net cash used by investing activities was $5.8 million for the year ended
September 30, 1998 as compared to $8.3 million for the year ended September 30,
1997 and $96.4 million in the year ended September 30, 1996. Net cash used by
investing activities consisted of $5.8 million of capital expenditures in the
year ended September 30, 1998 as compared to $8.9 million in the year ended
September 30, 1997. Offsetting the spending in the year ended September 30, 1997
was $0.8 million in proceeds from the sale of the Rhode Island facility of
Peltor as those operations were consolidated into the Company's Southbridge,
Massachusetts and Indianapolis, Indiana facilities. In the year ended September
30, 1996, excluding the $83.6 million invested in the Peltor acquisition, the
$6.6 million invested in the Eastern acquisition and the escrow for the Eastern
acquisition, net cash used by investing activities would have been $9.3 million.

Net cash used by financing activities for the year ended September 30, 1998 was
$13.0 million related primarily to repayment of term loans of $10.5 million,
repayment of other long term debt of $0.3 million and decreased borrowings under
the revolving credit facility of $2.2 million. Net cash used by financing
activities for the year ended September 30, 1997 was $4.2 million as compared to
cash provided by financing activities of $95.5 million in the year ended
September 30, 1996. Net cash used by financing activities for the year ended
September 30, 1997 was $4.2 million as repayment of term loans of $8.3 million
and repayment of other long term debt of $0.8 million were partially offset by
increased borrowings under the revolving credit facility of $5.2 million. In
fiscal 1996 net cash provided by financing activities consisted primarily of
proceeds from the amended and restated senior bank facility which were used to
finance the acquisitions of Peltor and Eastern.


                                       19
<PAGE>   22

The Company has a substantial amount of indebtedness. The Company relies on
internally generated funds, and to the extent necessary, on borrowings under the
revolving credit facility available under the Senior Bank Facilities, which
provides for borrowings up to $25.0 million, subject to certain customary
drawing conditions, to meet its liquidity needs. At September 30, 1998 the
Company had borrowed $8.0 million under the revolving credit facility.
Throughout most of fiscal 1997, borrowing levels remained high until the
difficulties associated with the conversion to the new management information
system were largely resolved and the improvements in production planning were
beginning to be realized. Management believes that improvements will continue to
be realized during the next fiscal year. The Company anticipates that operating
cash flow will be adequate to meet its debt service and capital expenditure
requirements for the next several years, although there can be no assurances
that existing levels of sales and normalized profitability, and therefore cash
flow, will be maintained in the future. Levels of sales and profitability may be
impacted by service levels, continued new product development, worldwide
economic conditions and competitive pressures. In addition, the Company may make
additional acquisitions in the future and would rely on internally generated
funds and, to the extent necessary, on borrowings to finance such acquisitions.

The Company's ability to borrow is limited by covenants in the Senior Bank
Facilities and the Notes. In April, 1997, the Company amended its credit
agreement with its syndicate of lenders with respect to the financial covenants
applicable to periods ending on and after June 30, 1997. The revised covenants
reflected the reduced profitability that the Company had experienced due to the
operating difficulties which were triggered by the new management information
system. The amendment also provided the Company with the ability to simplify its
corporate structure in Europe in order to further integrate the Peltor
operation. On September 30, 1998, the Senior Bank Facilities were amended to
exclude certain restructuring charges from the calculation of EBITDA, as used in
determining compliance with certain financial covenants, for the year ended
September 30, 1998. On December 4, 1998, the Senior Bank Facilities were amended
with respect to certain covenants applicable to periods ending on and after
December 31, 1998 to reflect the Company's current level of profitability.



                                       20
<PAGE>   23

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

(1)      Index to Financial Statements

<TABLE>
<CAPTION>
                                                                                       PAGE
<S>                                                                                    <C>
     Report of Independent Public Accountants-- Arthur Andersen LLP................     21
     Consolidated Balance Sheets-- September 30, 1997 and 1998.....................     22
     Consolidated  Statements  of  Operations  -- Years ended  September  30, 1996,
     1997, and 1998................................................................     23
     Consolidated  Statements of  Stockholders'  Equity--Years ended  September 30,
     1996, 1997, and 1998..........................................................     24
     Consolidated  Statements of Cash Flows-- Years ended September 30, 1996, 1997,
     and 1998......................................................................     25
     Notes to Consolidated Financial Statements....................................     26
     Valuation and Qualifying  Accounts -- Years ended September 30, 1996, 1997 and
     1998..........................................................................     66
</TABLE>




                                      
<PAGE>   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, 1997
and 1998, and the related consolidated statements of operations, stockholders'
equity and cash flows for the years ended September 30, 1996, 1997 and 1998.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the consolidated financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Aearo Corporation
and subsidiaries as of September 30, 1997 and 1998, and the results of its
operations and its cash flows for the years ended September 30, 1996, 1997 and
1998, in conformity with generally accepted accounting principles.

Our audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The schedule listed in the
index to the accompanying consolidated financial statements is presented for
purposes of complying with the Securities and Exchange Commission's rules and
is not a part of the basic consolidated financial statements. The schedule has
been subjected to the auditing procedures applied in the audits of the basic
consolidated financial statements and, in our opinion, fairly state, in all
material respects, the financial data required to be set forth therein in
relation to the basic consolidated financial statements taken as a whole.



                                      ARTHUR ANDERSEN LLP



Boston, Massachusetts
November 16, 1998


                                       21

<PAGE>   25


                                AEARO CORPORATION

                           CONSOLIDATED BALANCE SHEETS
                             (DOLLARS IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                  SEPTEMBER 30,
                                                             ----------------------
                                                               1997          1998
                                                             --------      --------
<S>                                                         <C>              <C>         
Current Assets:                                            
  Cash and cash equivalents..............................    $  5,476      $  6,737
  Accounts receivable (net of reserve for doubtful                          
    accounts of $1,301 and $1,239 in 1997 and                               
    1998, respectively)..................................      45,876        44,486
  Inventories............................................      36,693        30,466
  Deferred and prepaid expenses..........................       3,397         3,572
                                                             --------      --------
      Total current assets...............................      91,442        85,261
                                                             --------      --------
Property, plant and equipment, net.......................      64,948        57,729
Intangible assets, net...................................     146,906       137,848
Other assets.............................................       7,580         5,909
                                                             --------      --------
      Total assets.......................................    $310,876      $286,747
                                                             ========      ========
                                                                            
Current Liabilities:                                                        
  Current portion of long-term debt......................    $ 10,937      $ 14,573
  Accounts payable and accrued liabilities...............      36,186        37,957
  Accrued interest.......................................       3,769         3,732
  U.S. and foreign income taxes..........................       2,734         3,506
                                                             --------      --------
      Total current liabilities..........................      53,626        59,768
                                                             --------      --------
Long-term debt...........................................     233,729       218,592
Deferred income taxes....................................         883           959
Other liabilities........................................       2,688         2,586
                                                                            
                                                                            
Commitments and Contingencies                                               
Stockholders' Equity:                                                       
  Preferred stock, $.01 par value --                                        
    (Redemption value of $67,289,000 as of                                  
    September 30, 1998)                                                     
    Authorized -- 200,000 shares ........................                   
    Issued and outstanding-- 45,000 shares...............          --            --
  Common stock, $.01 par value --                                           
    Authorized -- 200,000 shares                                            
    Issued and outstanding -- 96,810 and 102,338 shares                     
    in 1997 and 1998, respectively.......................           1             1
Additional paid-in capital...............................      32,476        32,383
Accumulated deficit......................................      (5,269)      (16,715)
Cumulative foreign currency translation adjustments......      (7,258)      (10,827)
                                                             --------      --------
      Total stockholders' equity.........................      19,950         4,842
                                                             --------      --------
      Total liabilities and stockholders' equity.........    $310,876      $286,747
                                                             ========      ========
</TABLE>

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


                                       22
<PAGE>   26
                                AEARO CORPORATION

                      CONSOLIDATED STATEMENTS OF OPERATIONS
           (Dollars in Thousands, Except Per Share and Share Amounts)

<TABLE>
<CAPTION>
                                                                               Year Ended September 30,
                                                                     -------------------------------------------
                                                                        1996             1997             1998
                                                                     ---------        ---------        ---------

<S>                                                                  <C>              <C>              <C>      
Net Sales ....................................................       $ 243,459        $ 285,783        $ 292,459
Cost of Sales ................................................         133,551          163,460          163,877
                                                                     ---------        ---------        ---------
        Gross profit .........................................         109,908          122,323          128,582
Selling and  Administrative ..................................          73,614           87,036           88,929
Research and Technical Services ..............................           3,250            5,119            4,661
Amortization  Expense ........................................           5,563            6,957            6,833
Other Charges (Income), net ..................................             301            2,505             (336)
Restructuring Charge .........................................              --               --           11,585
                                                                     ---------        ---------        ---------
        Operating income .....................................          27,180           20,706           16,910
        Interest Expense, net ................................          20,703           26,665           26,152
                                                                     ---------        ---------        ---------
        Income (loss) before provision for income taxes ......           6,477           (5,959)          (9,242)
        Provision for Income Taxes ...........................           4,286              917            2,204
                                                                     ---------        ---------        ---------
        Net  income (loss) ...................................           2,191           (6,876)         (11,446)
        Preferred Stock Dividend Accrued .....................           6,248            7,112            8,052
                                                                     ---------        ---------        --------- 
        Net Loss applicable to Common Shareholders ...........       $  (4,057)       $ (13,988)       $ (19,498)
                                                                     =========        =========        =========
Basic and Diluted Net Loss per Common Share ..................       $  (40.58)       $ (142.77)       $ (195.60)
                                                                     =========        =========        =========

Diluted Weighted average Common Shares .......................          99,980           97,979           99,685
                                                                     =========        =========        =========
</TABLE>


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


                                       23
<PAGE>   27
                                AEARO CORPORATION

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                  (Dollars in Thousands, Except Share Amounts)



<TABLE>
<CAPTION>

                                                                                                        
                                                                                                         Cumulative 
                                                                                                          Foreign
                                     Preferred Stock        Common Stock       Additional                 Currency
                                     ----------------     ------------------    Paid-in     Accumulated  Translation    
                                     Shares    Amount     Shares      Amount    Capital       Deficit    Adjustments      Total
                                     ------    ------     ------      ------   --------     -----------  -----------     --------


<S>                                  <C>       <C>        <C>         <C>      <C>           <C>          <C>            <C>     
Balance, September 30, 1995 .....    45,000     $  --      100,000      $1     $ 32,530      $   (584)     $      7      $ 31,954

  Repayment of shareholder
      notes .....................        --        --           --       -          260            --            --           260
  Repurchase of common
     stock, net .................        --        --         (650)      -         (150)           --            --          (150)
  Foreign currency translation
     adjustment .................        --        --           --       -           --            --           546           546
  Net income ....................        --        --           --       -           --         2,191            --         2,191
                                     ------     -----      -------      --     --------      --------      --------      --------

Balance, September 30, 1996 .....    45,000        --       99,350       1       32,640         1,607           553        34,801

  Repayment of shareholder
     notes ......................        --        --           --       -          258            --            --           258
  Repurchase of common
    stock, net ..................        --        --       (2,540)      -         (422)           --            --          (422)
  Foreign currency translation
     adjustment .................        --        --           --       -           --            --        (7,811)       (7,811)
  Net loss ......................        --        --           --       -           --        (6,876)           --        (6,876)
                                     ------     -----      -------      --     --------      --------      --------      --------
Balance, September 30, 1997 .....    45,000        --       96,810       1       32,476        (5,269)       (7,258)       19,950

  Issuance of shareholder notes..        --        --           --       -       (1,157)           --            --        (1,157)
  Sale of common stock, net .....        --        --        5,528       -        1,064            --            --         1,064
  Foreign currency translation
     adjustment .................        --        --           --       -           --            --        (3,569)       (3,569)
  Net loss ......................        --        --           --       -           --       (11,446)           --       (11,446)
                                     ------     -----      -------      --     --------      --------      --------      --------

Balance, September 30, 1998 .....    45,000     $  --      102,338      $1     $ 32,383      $(16,715)     $(10,827)     $  4,842
                                     ======     =====      =======      ==     ========      ========      ========      ========
</TABLE>


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


                                       24
<PAGE>   28
                                AEARO CORPORATION

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             (Dollars in Thousands)

<TABLE>
<CAPTION>
                                                                Year Ended September 30,
                                                        -----------------------------------------

                                                          1996            1997            1998
                                                        --------        --------        --------
<S>                                                     <C>             <C>             <C>      
Cash Flows from Operating Activities:

  Net income (loss) ...............................     $  2,191        $ (6,876)       $(11,446)
  Adjustments to reconcile net income  (loss) to
    cash provided by operating activities--
    Depreciation ..................................        6,908           9,773          11,537
    Amortization ..................................        7,028           8,858           8,742
    Deferred income taxes .........................           --             109              85
    Provision for restructuring charge ............           --              --          11,585
    Other non-cash items, net .....................          423             517             262
    Changes in assets and liabilities --
      Accounts receivable .........................       (4,431)           (479)          1,435
      Inventory ...................................       (3,748)          3,787              62
      Accounts payable and accruals ...............       (3,040)         (3,325)         (2,452)
      Other, net ..................................         (855)         (3,296)            340
                                                        --------        --------        --------
        Net cash provided by operating activities..        4,476           9,068          20,150
                                                        --------        --------        --------
Cash Flows from Investing Activities:
  Cash paid for Peltor AB and Eastern .............      (90,204)             --              --
  Eastern escrow deposit ..........................        3,000              --              --
  Purchase of Shoplyne assets .....................           --            (242)             --
  Additions to property, plant and equipment ......       (9,249)         (8,901)         (5,809)
  Proceeds provided by disposals of property,
     plant and equipment ..........................           26             818              41
                                                        --------        --------        --------
        Net cash used by investing activities .....      (96,427)         (8,325)         (5,768)
                                                        --------        --------        --------
Cash Flows from Financing Activities:
  (Repurchase) sale of common stock, net ..........         (150)           (422)          1,064
  Repayment (issuance) of shareholder notes .......          260             258          (1,157)
  Proceeds from Amended and Restated
    Senior Bank Facility, net .....................       94,311              --              --
  Proceeds from (repayment of) revolving
    credit facility, net ..........................        1,250           5,150          (2,200)
  Repayment of term loans .........................           --          (8,335)        (10,455)
  Repayment of other long-term debt ...............         (218)           (840)           (280)
                                                        --------        --------        --------
        Net cash (used) provided by
        financing activities ......................       95,453          (4,189)        (13,028)
                                                        --------        --------        --------
Effect of Exchange Rate Changes on Cash ...........          331             382             (93)
                                                        --------        --------        --------
Increase (Decrease) in Cash and Cash Equivalents ..        3,833          (3,064)          1,261
Cash and Cash Equivalents, beginning of year ......        4,707           8,540           5,476
                                                        --------        --------        --------
Cash and Cash Equivalents, end of year ............     $  8,540        $  5,476        $  6,737
                                                        ========        ========        ========
Cash Paid for:
  Interest ........................................     $ 18,879        $ 22,316        $ 24,537
                                                        ========        ========        ========
  Income taxes ....................................     $  1,138        $  3,345        $  1,299
                                                        ========        ========        ========
</TABLE>

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


                                       25
<PAGE>   29
                                AEARO CORPORATION

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                               SEPTEMBER 30, 1998

(1)  BASIS OF PRESENTATION

Aearo Corporation, a Delaware corporation, and its direct wholly-owned 
subsidiary, Aearo Company, a Delaware corporation (collectively referred to
herein as "the Company") manufacture and sell hearing protection devices (ear
plugs and ear muffs), prescription and non-prescription safety eyewear, face
shields, reusable and disposable respirators, hard hats and first aid kits which
are protection segments of the personal protection equipment market world-wide.
Additionally, the Company manufactures and sells world-wide, a wide array of
energy-absorbing materials which are incorporated into other manufacturer's
products to control noise, vibration and shock.

Aearo Corporation (formerly Cabot Safety Holdings Corporation) was formed by
Vestar Equity Partners, L.P. (Vestar) in June 1995 to effect the acquisition of
substantially all of the assets and liabilities of Cabot Safety Corporation and
certain affiliates (the Predecessor) all of which were wholly owned by Cabot
Corporation (Cabot), (the Formation Acquisition). The Formation Acquisition
closed on July 11, 1995, when Aearo Corporation acquired substantially all of
the assets and certain liabilities of the Predecessor for cash, preferred stock
and a 42.5% common equity interest in Aearo Corporation, as more fully described
in Note 12. Aearo Corporation immediately contributed the acquired assets and
liabilities to Aearo Company, a wholly owned subsidiary of Aearo Corporation,
pursuant to an asset transfer agreement dated June 13, 1995. Aearo Corporation
has no other material assets, liabilities or operations other than those that
result from its ownership of the common stock of Aearo Company. Separate
financial statements of Aearo Company are not presented because they do not
provide any additional information from what is presented in the consolidated 
financial statements of Aearo Corporation that would be meaningful to the
holders of the Senior Subordinated Notes (see Note 7).

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

(2)  SIGNIFICANT ACCOUNTING POLICIES

The accompanying consolidated financial statements have been prepared in
conformity with generally accepted accounting principles. All significant
intercompany balances and transactions have been eliminated. The significant
accounting policies of the Company are described below.

     USE OF ESTIMATES

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


                                       26
<PAGE>   30
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                               SEPTEMBER 30, 1998


    REVENUE RECOGNITION

The Company generally recognizes revenue upon shipment of its products to
customers.

    ADVERTISING

The Company expenses the costs of advertising as incurred. These expenses were
approximately  $3,794,000, $5,171,000, and $4,827,000 in the years ended
September 30, 1996, 1997, and 1998, respectively.

    CASH EQUIVALENTS

For purposes of the consolidated statements of cash flows, the Company considers
all time deposits and short-term investments with an original maturity of three
months or less at time of purchase to be cash equivalents.

    FOREIGN CURRENCY TRANSLATION

Assets and liabilities of the Company's foreign operations are translated at
year-end exchange rates. Revenues and expenses are translated at the average
rate during the year. Translation gains and losses are reflected as a separate
component of stockholders' equity. Foreign currency gains and losses arising
from transactions by any of the  Company's subsidiaries are reflected in net
income. For the years ended September 30, 1996, 1997, and 1998 the accompanying
consolidated statements of operations include approximately $286,000, 
$2,101,000, and ($617,000), respectively, of transaction (gains) and losses
included in other charges (income), net. During 1997, the Company initiated the
use of forward foreign currency contracts to mitigate the effects of changes in
foreign currency rates on profitability related to trade accounts receivable and
trade accounts payable denominated in foreign currencies.

As of September 30, 1998, the Company had forward foreign currency contracts
open in the following amounts:


<TABLE>
<CAPTION>
                                          Contract
           Currency                     Amount (000s)         Position
           --------                     -------------         --------
        <S>                              <C>                    <C>

        Bristish Pound                      4,783               Buy
        Canadian Dollar                       571               Buy
        French Franc                        8,216               Sell
        German Deutsche Mark                3,855               Sell
        Irish Punt                            130               Sell
        Italian Lira                    1,610,704               Sell
        Norwegian Krona                     4,236               Sell
        Spanish Peseta                     68,565               Sell
        Swedish Krona                      17,352               Buy
        Swiss Franc                         1,624               Buy
        Finnish Markka                      1,664               Sell

</TABLE>

As of September 30, 1998, the Company has deferred an unrealized gain of $31,000
associated with the above forward foreign currency contract commitments.

    INVENTORIES

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

    PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are recorded at cost. Depreciation of property,
plant and equipment is calculated using the straight-line method based on
estimated economic useful lives. Expenditures for maintenance and repairs and
minor renewals are charged to expense. Expenses for maintenance and repairs
totaled approximately $2,263,000, $2,783,000, and $3,198,000 for the years
ended September 30, 1996, 1997, and 1998, respectively.


                                       27
<PAGE>   31
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                               SEPTEMBER 30, 1998

Property, plant and equipment and their estimated useful lives consist of the
following:


<TABLE>
<CAPTION>
    Asset Classification                                            Estimated Useful Life
    --------------------                                            ---------------------
<S>                                                               <C>
    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
</TABLE>

Upon the sale or retirement of assets, the cost and related accumulated
depreciation are removed from the consolidated financial statements, and any
resultant gain or loss is recognized.

    INCOME TAXES

Deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities using
currently enacted tax rates.

    INTANGIBLE ASSETS

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

The Company accounts for long-lived and intangible assets in accordance with
Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for the
Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of.
The Company continually reviews its intangible assets for events or changes in
circumstances which might indicate the carrying amount of the assets may not be
recoverable. The Company assesses the recoverability of the assets by
determining whether the amortization of such intangibles over their remaining
lives can be recovered through projected undiscounted future cash flows. The
amount of impairment, if any, is measured based on projected discounted future
cash flows using a discount rate reflecting the Company's average cost of
funds. At September 30, 1997 and 1998, no such impairment of assets was 
indicated.


                                       28
<PAGE>   32
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                               SEPTEMBER 30, 1998



A summary of the  estimated  lives by major category of intangible assets at
September 30, 1998 is as follows:


<TABLE>
<S>                                                <C>     
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
</TABLE>


    DEFERRED FINANCING COSTS

Deferred financing costs are stated at cost as a component of other assets and
amortized over the life of the related debt. Amortization of deferred financing
costs is included in interest expense.

    FAIR VALUE OF FINANCIAL INSTRUMENTS

In accordance with the requirements of SFAS No. 107, Disclosures About Fair
Value of Financial Instruments, the Company has determined the estimated fair
value of its financial instruments using appropriate market information and
valuation methodologies. Considerable judgment is required to develop the
estimates of fair value; thus, the estimates are not necessarily indicative of
the amounts that could be realized in a current market exchange. The Company's
financial instruments consist of cash, accounts receivable, accounts payable,
Senior Subordinated Notes and bank debt (including term loans, revolving credit
facility and other debt). The carrying value of these assets and liabilities is
a reasonable estimate of their fair market value at September 30, 1998, except
for the Senior Subordinated Notes, for which the Company estimates the fair 
market value to approximate $108 million at September 30, 1998.

    LOSS PER COMMON SHARE

In 1998, the Company adopted SFAS No. 128, Earnings Per Share. Basic earnings
per common share is computed by dividing net income (loss) by the weighted
average number of shares of common stock outstanding during the year. Diluted
earnings per common share is calculated the same as basic except, if not
antidilutive, stock options are included using the treasury stock method to the
extent that the average share trading  price exceeds the exercise  price. As of
September 30, 1996, 1997 and 1998, there were 5,000, 4,418 and 7,154 options
outstanding, respectively. Of these potentially dilutive securities, none
qualified for inclusion in the diluted earnings per share calculation for the
years ended September 30, 1996, 1997 and 1998, respectively. The implementation
of this standard did not have an effect on earnings per common share in 1996 or
1997 and, therefore, did not require restatement. Basic and diluted earnings per
common share for the years ended September 30, 1996, 1997 and 1998 were equal;
therefore, no reconciliation between basic and diluted earnings per common share
is required.

    SFAS NO. 123 -- ACCOUNTING FOR STOCK-BASED COMPENSATION

     On October 1, 1996, the Company adopted SFAS No. 123, Accounting for
Stock-Based Compensation. SFAS No. 123 addresses accounting and reporting
requirements for stock options and other equity instruments issued or granted
based on their fair market values. The Company intends to continue accounting
for its stock based compensation plans for employees in accordance with
Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to
Employees. Under SFAS No. 123, companies choosing to continue to use APB No. 25
to account for stock based compensation plans for employees must make footnote
disclosure of the pro forma effects on earnings per share had the principles
contained within SFAS No. 123 been applied (See Note 12).

    SFAS NO. 130 -- REPORTING COMPREHENSIVE INCOME


In June 1997, the  Financial Accounting Standards board issued SFAS No. 130,
Reporting Comprehensive Income. SFAS No. 130 requires the reporting of
comprehensive income in addition to net income from operations. SFAS No. 130 is
effective for the Company beginning October 1, 1998. Adoption of this standard
will not impact the Company's conosolidated financial position, results of


                                       29
<PAGE>   33
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                               SEPTEMBER 30, 1998



operations or cash flows, and any effect will be limited to the form and
content of its disclosures.

     SFAS NO. 131 -  DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
     INFORMATION

In June 1997, the Financial Accounting Standards board issued SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information. SFAS No.
131 requires companies to present segment information using the management
approach. The management approach is based upon the way that management
organizes the segments within a Company for making operating decisions and
assessing performance. SFAS No. 131 is effective for the Company beginning
September 30, 1999. Adoption of this standard will not impact the Company's
consolidated financial position, results of operations or cash flows, and any
effect will be limited to the form and content of its disclosures.

    SFAS NO. 133 -- ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

In June 1998, the  Financial Accounting Standards board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133
establishes accounting and reporting  standards requiring that every derivative
instrument (including certain derivative instruments embedded in other 
contracts) be recorded in the balance sheet as either an asset or a liability
measured at its fair value. SFAS  No. 133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate and assess the effectiveness of transactions that receive
hedge accounting.

SFAS No. 133 is effective for fiscal quarters of all fiscal years beginning
after June 15, 1999. A company may also implement SFAS No. 133 as of the
beginning of any fiscal quarter after issuance (that is, fiscal quarters
beginning June 16, 1998 and thereafter). SFAS  No. 133 cannot be applied
retroactively. SFAS  No. 133 must be applied to (a) derivative instruments and
(b) certain derivative instruments embedded in hybrid contracts that were
issued, acquired or substantially modified after December 31, 1997 (and, at a
company's election, before January 1, 1998).

The Company has not yet quantified the impact of adopting SFAS No. 133 on the
consolidated financial statements and has not determined the timing of or method
of the adoption of SFAS No. 133. However, SFAS No. 133 could increase volatility
in earnings and other comprehensive income.


                                       30
<PAGE>   34
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                               SEPTEMBER 30, 1998


(3)  INVENTORIES

Inventories consisted of the following at September 30 (dollars in thousands):

<TABLE>
<CAPTION>
                        1997           1998
                      --------        -------
<S>                   <C>             <C>    
Raw materials .....   $ 10,031        $ 9,113
Work in process ...      9,982          9,257
Finished goods ....     16,680         12,096
                      --------        -------

                      $ 36,693        $30,466
                      ========        =======
</TABLE>

(4) PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consisted of the following at September 30 
(dollars in thousands):

<TABLE>
<CAPTION>
                                        1997          1998
                                       -------       -------

<S>                                    <C>           <C>    
Land ...........................       $ 2,669       $ 2,669
Buildings and improvements .....        16,171        17,640
Machinery and equipment ........        43,069        45,566
Furniture and fixtures .........        15,485        16,799
Construction in progress .......         4,768         3,120
                                       -------       -------
                                        82,162        85,794
Less -- Accumulated depreciation        17,214        28,065
                                       -------       -------
                                       $64,948       $57,729
                                       =======       =======
</TABLE>

(5)  INTANGIBLE ASSETS

Intangible assets consist of the following at September 30 (dollars in 
thousands):

<TABLE>
<CAPTION>
                                        1997           1998
                                      --------       --------

<S>                                   <C>            <C>     
Goodwill ......................       $ 84,800       $ 82,443
Patents .......................          1,638          1,638
Trademarks and tradenames .....         74,122         74,122
Non-compete agreement .........            269            194
Other .........................            585            585
                                      --------       --------
                                       161,414        158,982
Less-- Accumulated amortization         14,508         21,134
                                      --------       --------
                                      $146,906       $137,848
                                      ========       ========
</TABLE>


                                       31
<PAGE>   35
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                               SEPTEMBER 30, 1998


(6)  ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities consisted of the following at September
30 (dollars in thousands):

<TABLE>
<CAPTION>
                                                     1997          1998
                                                    -------       -------
<S>                                                 <C>           <C>    
Accounts payable-- trade ....................       $18,378       $15,131

Accrued Liabilities--
  Employee compensation and benefits (Note 9)       $ 9,169       $10,615
  Restructuring reserve (Note 16) ...........            --         2,990
  Product liability accruals ................         3,774         4,063
  Other .....................................         4,865         5,158
                                                    -------       -------
                                                    $36,186       $37,957
                                                    =======       =======
</TABLE>

(7)  DEBT

The long-term debt balances consisted of the following at September 30 (dollars
in thousands):

<TABLE>
<CAPTION>
                                                              1997           1998 
                                                            --------       --------
<S>                                                         <C>            <C>     
Revolving credit facility loan ......................       $ 10,200       $  8,000
Term loans, due 2003 ................................        129,592        120,590
Senior subordinated notes, due 2005, 12.5% ..........        100,000        100,000
Note payable, other .................................            646            555
Mortgage note, due 1998-- 2006, 10.1% ...............          2,458          2,410
Industrial Revenue Bonds, due 1998 -- 2003, 6.4% less
  advance deposit of $122 ...........................            448            368
Industrial Revenue Bonds, due 2002, 13.0% ...........          1,000          1,000
Capitalized lease obligations--
  Lease term ends 2003, 6.5% ........................            286            242
  Lease term ends 1998, 9.0% ........................             36             --
                                                            --------       --------
                                                             244,666        233,165
Less-- Current portion of long-term debt ............         10,937         14,573
                                                            --------       --------
          Total .....................................       $233,729       $218,592
                                                            ========       ========
</TABLE>


Senior Bank Facilities

The Company's Senior Bank Facilities consist of Term Loans and a Revolving
Credit Facility as hereinafter defined. In July 1995, Aearo Company entered into
a credit agreement (the Agreement) that provides for secured borrowings from a
syndicate of lenders. On May 30, 1996, Aearo Company and the Syndicated Lenders
amended and restated the Agreement. The amended and restated Agreement consists
of (a) a secured term loan facility consisting of A and B term loans providing
for up to $90.0 million of A term loans and $50.0 million of B term loans
(collectively, the Term Loans); a portion of the A term loans is denominated in
an equivalent amount of foreign currencies and (b) a secured revolving credit
facility (the Revolving Credit Facility) providing for up to $25.0 million of
revolving loans, a portion of which may be denominated in foreign currencies,
for general corporate purposes and, as to $15.0 million thereof, to finance
permitted acquisitions. The Revolving Credit Facility provides for the issuance
of letters of credit in an aggregate face amount of up to $5.0 million. Term A
and B Loans amortize quarterly over five and six year periods, respectively.
Amounts repaid or prepaid in respect of the Term Loans may not be reborrowed.
Loans and letters of credit under the Revolving Credit Facility will be
available until the Revolving Loan Maturity Date, which is May 30, 2002.

At the Company's option, the interest rates per annum applicable to the Senior
Bank Facilities are either (a) an adjusted rate based on the London Interbank
Offered Rate plus a margin of 2.25% in the case of A Term Loans and Revolving
Loans and 2.75% in the case of B Term  Loans; or (b) the Base Rate, as defined
plus a margin of 1.00% in the case of A Term Loans and Revolving Loans and 1.50%
in the case of B Term Loans. The Base Rate is the higher of Bankers Trust
Company's announced prime lending rate and the Overnight Federal Funds rate plus
0.50%. The Company must pay certain fees in connection with the Senior Bank
Facilities, including a commitment fee ranging from 0.375% to 0.50% on the


                                       32
<PAGE>   36
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                               SEPTEMBER 30, 1998



undrawn portion of the commitments in respect of the Revolving Credit Facility
based upon the Company's leverage ratio, and fees relating to the issuance of
letters of credit.

     Under the terms of the Senior Bank Facilities, Aearo Company is required to
comply with a number of affirmative and negative covenants. Among other things,
Aearo Company must satisfy certain financial covenants and ratios, including
interest coverage ratios, leverage ratios and fixed charge coverage ratios. In
April 1997, the Senior Bank Facilities were amended with respect to certain
covenants applicable to periods ending on and after June 30, 1997. On September
30, 1998, the Senior Bank Facilities were amended to exclude certain
restructuring charges from the calculation of EBITDA, as used in determining
compliance with certain financial covenants, for the year ended September 30,
1998. On December 4, 1998, the Senior Bank Facilities were amended with respect
to certain covenants applicable to periods ending on and after December 31,
1998. The Senior Bank Facilities also impose limitations on certain business
activities of Aearo Company. The Senior Bank Facilities restrict, among other
things, the incurrence of additional indebtedness, creation of certain liens,
sales of certain assets and limitations on transactions with affiliates. As of
September 30, 1998, Aearo Company is in compliance with the covenants of the
Senior Bank Facilities. The Senior Bank Facilities are unconditionally
guaranteed by Aearo Corporation and secured by first priority security
interests in substantially all the capital stock and tangible and intangible
assets of the Company.

Term Loans

At September 30, 1998 the total balance outstanding on the Term Loans was $120.6
million U.S. dollars and interest rates were 7.9% for the US Dollar Term A Loan
($27.0 million U.S. Dollars outstanding at September 30, 1998), 5.8% for the
German Deutsche Mark Term A Loan (23.9 million German Deutsche Marks outstanding
at September 30, 1998), 10.1% for the British Pound Term A Loan (10.2 million
British Pounds outstanding at September 30, 1998), 7.4% and for the Canadian
Term A Loan (6.2 million Canadian Dollars outstanding at September 30, 1998),
10.1% for the British Pound Term A Loan (5.4 million British Pounds outstanding
at September 30, 1998) and 8.4% for the US Dollar Term B Loan ($4.8 million U.S.
Dollars outstanding at September 30, 1998). For the year ended September 30,
1998 the weighted average interest rates paid were 8.0%, 5.9%, 9.8%, 6.8%, 9.8%
and 8.5% for the US Dollar Term A Loan, for the German Deutsche Mark Term A
Loan, for the British Pound Term A Loan, for the Canadian Term A Loan, for the
British Pound Term A Loan and for the US Dollar Term B Loan, respectively.

At September 30, 1997 the total balance outstanding on the Term Loans was $129.6
million U.S. dollars and interest rates were 8.0% for the US Dollar Term A Loan,
5.6% for the German Deutsche Mark Term A Loan, 9.6% for the British Pound Term A
Loan, 5.9% for the Canadian Term A Loan, 9.6% for the British Pound Term A Loan
and 8.5% for the US Dollar Term B Loan. For the year ended September 30, 1997
the weighted average interest rates paid were 7.9%, 5.5%, 8.7%, 5.6%, 8.7% and
8.4% for the US Dollar Term A Loan, for the German Deutsche Mark Term A Loan,
for the British Pound Term A Loan, for the Canadian Term A Loan, for the British
Pound Term A Loan and for the US Dollar Term B Loan, respectively.

At September 30, 1996 the total balance outstanding on the Term Loans was $139.4
million U.S. dollars and interest rates were 7.8% for the US Dollar Term A Loan,
5.4% for the German Deutsche Mark Term A Loan, 8.1% for the British Pound Term
A Loan, 6.4% for the Canadian Term A Loan, 8.1% for the British Pound Term A
Loan and 8.3% for the US Dollar Term B Loan. During the period of May 30, 1996
to September 30, 1996 the weighted average interest rates paid were 7.7%, 5.6%,
8.1%, 6.8%, 8.1% and 8.2% for the US Dollar Term A Loan, for the German Deutsche
Mark Term A Loan, for the British Pound Term A Loan, for the Canadian Term A
Loan, for the British Pound Term A Loan and for the US Dollar Term B Loan,
respectively.


                                       33
<PAGE>   37
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                               SEPTEMBER 30, 1998

Revolving Credit Facility

At September 30, 1998 the balance outstanding on the Revolving Credit Facility
was $8.0 million, and the interest rate was 9.25%. For the year ended September
30, 1998, the maximum amount outstanding was $16.3 million, the average was $9.9
million, and the weighted average interest rate paid was 8.7%.

At September 30, 1997 the balance outstanding on the Revolving Credit Facility
was $10.2 million, and the interest rate was 9.5%. For the year ended September
30, 1997, the maximum amount outstanding was $20.3 million, the average was
$12.9 million, and the weighted average interest rate paid was 9.4%.

At September 30, 1996 the balance outstanding on the Revolving Credit Facility
was $5.1 million, and the interest rate was 9.25%. During the period from May
30, 1996 to September 30, 1996, the maximum amount outstanding was $8.9 million,
the average was $1.0 million, and the weighted average interest rate paid during
fiscal 1996 was 9.3%.

Senior Subordinated Notes

In connection with the acquisition, Aearo Company issued $100.0 million of
Senior Subordinated Notes due 2005 (Notes) which are unsecured obligations of
Aearo Company. The Notes bear interest at a rate of 12.5% per annum and interest
is payable semiannually on each January 15 and July 15.

The Notes are redeemable at the option of Aearo Company, on or after July 15,
2000. From and after July 15, 2000, the Notes will be subject to redemption at
the option of Aearo Company, in whole or in part, at various redemption prices,
declining from 106.3% of the principal amount to par on and after July 15, 2004.

The Note indenture contains affirmative and negative covenants and restrictions
similar to those required under the terms of the Senior Bank Facilities
discussed above. As of September 30, 1998, Aearo Company is in compliance with
the various covenants of the Note agreement. The Notes are unconditionally
guaranteed on an unsecured, senior subordinated basis by Aearo Corporation.

Maturities

The following is a summary of maturities of all of the Company's debt
obligations due after September 30, 1998 (dollars in thousands):

<TABLE>
<CAPTION>
                              Amount
                             --------
<S>                         <C>     
                 
1999 ........               $ 14,573
2000 ........                 16,635
2001 ........                 21,528
2002 ........                 42,754
2003 ........                 35,382
Thereafter ..                102,293
                            --------
                            $233,165
                            ========
</TABLE>


                                       34
<PAGE>   38
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                               SEPTEMBER 30, 1998

 (8)  Interest Expense, Net

Interest expense (income) comprises the following items (dollars in thousands):

<TABLE>
<CAPTION>
                                   Year Ended September 30,                   
                            ----------------------------------------
                              1996            1997            1998 
                            --------        --------        --------
<S>                         <C>             <C>             <C>     
Expense .............       $ 20,975        $ 26,896        $ 26,406
Income ..............           (272)           (231)           (254)
                            --------        --------        --------
Interest expense, net       $ 20,703        $ 26,665        $ 26,152
                            ========        ========        ========
</TABLE>


(9)  EMPLOYEE BENEFIT PLANS

The Company  previously had two noncontributory defined benefit pension plans,
the Aearo Company Employees' Retirement Account Plan (the Aearo Plan), which is
a cash balance plan, and the E-A-R Specialty Composites  Division of Aearo
Company Non-Union Employees Retirement Plan (the Specialty Composites Plan).
Benefits provided under these plans are primarily based on years of service and
the employee's compensation. Effective December 31, 1997, net assets available
for benefits totaling $1,499,027 held by the Specialty Composites Plan were
transferred to the Aearo Plan in a merger of the two plans.

The Aearo Plan, effective May 1, 1990, covers most employees in the United
States and is funded quarterly based on actuarial and economic assumptions
designed to achieve adequate funding of projected benefit obligations. Plan
assets are invested in a portfolio consisting primarily of debt and equity
securities. The Specialty Composites Plan resulted from a 1989 acquisition. As
of March 31, 1989, the benefits under this plan were frozen. Plan assets were
invested in fixed-income investments. Benefits earned under the Specialty
Composites Plan are payable from the Aearo Plan. The Aearo Plan was amended to
incorporate the vesting, forms of payment, commencement dates, and actuarial
equivalence provisions which existed in the Specialty Composites Plan
immediately  prior to the merger, for purposes of determining such benefit.
However, the lump sum present values of benefits accrued under the Specialty
Composites Plan will be based on the actuarial equivalence methodology
specified in the Aearo Plan.

Net periodic pension cost for these plans comprises the following elements
(dollars in thousands):


<TABLE>
<CAPTION>
                                          Year Ended September 30,
                                    -------------------------------------
                                     1996           1997           1998
                                    -------        -------        -------

<S>                                 <C>            <C>            <C>    
Service cost ................       $ 1,180        $ 1,273        $ 1,348
Interest cost ...............           415            485            523
Return on plan assets .......          (718)        (1,283)          (575)
Net amortization and deferral           266            783            (52)
                                    -------        -------        -------

  Net periodic pension cost .       $ 1,143        $ 1,258        $ 1,244
                                    =======        =======        =======
</TABLE>


                                       35
<PAGE>   39
                                AEARO CORPORATION


            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                               SEPTEMBER 30, 1998

The following table sets forth the funded status of the pension plans at
September 30 (dollars in thousands):


<TABLE>
<CAPTION>
                                                                 1997           1998
                                                                -------        -------
<S>                                                             <C>            <C>     
Actuarial present value of benefit obligations --
  Vested benefit obligation .............................       $(6,458)       $(7,490)
                                                                =======        =======
  Accumulated benefit obligation ........................       $(8,350)       $(9,557)
                                                                =======        =======
  Projected benefit obligation ..........................       $(8,413)       $(9,650)
  Plan assets at fair value .............................         7,551          8,732
                                                                -------        -------
  Excess of projected benefit obligation over plan
     assets .............................................          (862)          (918)
  Unrecognized net gain .................................        (1,488)        (1,413)
                                                                -------        -------
  Pension liability (included in accrued liabilities) ...       $(2,350)       $(2,331)
                                                                =======        =======
</TABLE>


At September 30, 1997, the pension liability of $2,350,000 comprised a liability
of $2,384,000 related to the Aearo Plan and a prepaid pension asset of $34,000
related to the Specialty Composites Plan.

The following weighted average rates were used in the calculations at September
30:

<TABLE>
<CAPTION>
                                                                 1997          1998
                                                                 ----          ----

<S>                                                              <C>           <C> 
     Discount rate-- projected benefit obligation........         7.0%          7.0%
     Expected rate of return on plan assets..............         7.8           8.0
     Assumed rate of increase in compensation............         4.0           4.0
</TABLE>


In addition, the Company has an unfunded, noncontributory defined benefit
pension plan, the Aearo Company Supplemental Executive Retirement Plan (the SERP
Plan) which is also a cash balance plan. The SERP Plan, effective January 1,
1994, covers certain employees in the United States. The costs to the Company
for the SERP Plan were $83,000, $90,000, and $61,000 for the years ended
September 30, 1996, 1997 and 1998, respectively.

A 401(k) plan, the Aearo Company Employees' 401(k) Savings Plan, was established
as of May 1, 1990. Employees can join the plan after six months of service,
during which they work at least 500 hours and may contribute up to 15% of their
compensation. The Company contributes amounts equal to 50% of the employee's
contribution to a maximum of 3% of the employee's pay. Prior to January 1, 1997,
the Company provided a 40% match to a maximum  of 2% of pay. The costs to the
Company for this Plan were $425,000, $717,000, and $710,000 for the years ended
September 30, 1996, 1997 and 1998, respectively.

The Company has a defined contribution savings plan for U.K. employees, under
which eligible employees are allowed to contribute up to 15% of their 

                                       36
<PAGE>   40


                              AEARO CORPORATION

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                              SEPTEMBER 30, 1998

compensation. The Company contributes 5% of pay for all eligible employees and
additional amounts equal to 40% of the employee's contribution to a maximum of
2% of the employee's pay. For the years ended September 30, 1996, 1997, and
1998, the Company contributed approximately $131,000, $158,000, and $160,000,
respectively.


Postretirement Benefits

The Company does not provide defined benefit postretirement plans for retirees
after age 65 except that all employees who elect early retirement at age 62 or
older are eligible to receive life insurance coverage that terminates on their
65th birthday. In addition, employees who were age 55 or older with 10 years of
service as of April 1, 1990 are eligible to receive limited health care and life
insurance coverage for themselves and their eligible dependents upon early
retirement at age 62 or older. These coverages terminate on the 65th birthday of
the retiree or his or her spouse. The health care benefit is a fixed dollar
contribution and the life insurance benefit is a fixed coverage amount.

As of September 30, 1997 and 1998, the accrued postretirement benefit cost was
$62,000 and $104,000, respectively.

(10) RELATED PARTY TRANSACTIONS

An annual management fee, which is to be shared by Cabot and Vestar, is paid in
aggregate amounts with respect to each fiscal year equal to the greater of (i)
$400,000 or (ii) 1.25% of the consolidated net income of the Company and its
subsidiaries before cash interest, taxes, depreciation and amortization for such
fiscal year. This annual management fee is shared by Cabot and Vestar based on
their relative equity ownership of the Company.

The Company and Cabot have entered into an arrangement relating to certain
respirator claims asserted after the Formation Acquisition whereby, so long as
the Company pays to Cabot an annual fee of $400,000, which the Company has
elected to pay, Cabot will retain responsibility and liability for, and
indemnify the Company against, certain legal claims alleged to arise out of the
use of respirators manufactured prior to July 1995. The Company has the right
to discontinue the payment of such annual fee at any time, in which case the
Company will assume responsibility for and indemnify Cabot with respect to such 
claims.

The Company has made available to certain members of management (Management
Investors) loans in order to provide such Management Investors with funds to be
applied to a portion of the purchase price of the Common Stock purchased by such
Management Investors under the Stock Purchase Plan. Such loans (i) are secured
by Common Stock purchased with the proceeds thereof, (ii) have a term of from 5
to 10 years, (iii) bear interest at an annual rate determined pursuant to
Section 7872(f)(2) of the 1986 Internal Revenue Code, and (iv) are subject
to mandatory prepayment in the event the employment of such Management Investors
terminates. The aggregate amount of these loans was approximately $409,000 and
$1,475,000 at September 30, 1997 and 1998, respectively and are reflected as a 
reduction of the additional paid-in capital account in the consolidated 
statements of stockholders' equity.


                                      37
<PAGE>   41
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                               SEPTEMBER 30, 1998

(11)  Income Taxes

Income  (loss)  before  provision  for income  taxes is as follows  (dollars  in
thousands):

<TABLE>
<CAPTION>
                                                      Year Ended September 30,
                                           ---------------------------------------------
                                               1996            1997            1998
                                           -------------   -------------   -------------

<S>                                            <C>           <C>             <C>     
Domestic ..............................        $5,614        $(7,126)        $(12,685)

Foreign ...............................           863          1,167            3,443
                                               ------        -------         --------

          Total .......................        $6,477        $(5,959)        $ (9,242)
                                               ======        =======         ========
</TABLE>


A summary of  provision  (benefit)  for income  taxes is as follows  (dollars in
thousands):


<TABLE>
<CAPTION>
                                                      Year Ended September 30,
                                           ---------------------------------------------
                                               1996            1997            1998
                                           -------------   -------------   -------------
<S>                                            <C>              <C>            <C>     
U.S. Federal and State --
  Current .............................        $  155           $123           $  231

  Deferred ............................         2,135             --               --
                                               ------           ----           ------
                                                2,290            123              231
                                               ------           ----           ------

Foreign --
  Current .............................         1,996            608            1,897
  Deferred ............................            --            186               76
                                               ------           ----           ------
                                                1,996            794            1,973 
                                               ------           ----           ------
          Total .......................        $4,286           $917           $2,204
                                               ======           ====           ======
</TABLE>


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):


<TABLE>
<CAPTION>
                                                      Year Ended September 30,
                                           ---------------------------------------------
                                               1996            1997            1998
                                           -------------   -------------   -------------
<S>                                           <C>            <C>              <C>     
Computed tax expense (benefit) at the 
  expected statutory rate .............       $ 2,267        $(2,086)         $(3,143)
State taxes,  net of federal effect ...           (22)            81             (201)
Foreign income taxed at different rates          (602)        (1,890)             296
Goodwill amortization .................         1,132          1,112              871
Non-deductible expenses ...............           106            112               96
Increase in valuation allowance .......         1,357          3,551            4,185
Other,  net ...........................            48             37              100  
                                              -------        -------          -------
  Provision for income taxes ..........       $ 4,286        $   917          $ 2,204
                                              =======        =======          =======
</TABLE>


                                       38
<PAGE>   42
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                               SEPTEMBER 30, 1998

Significant components of deferred income taxes are as follows at September 30
(dollars in thousands):

<TABLE>
<CAPTION>
                                                     1997            1998
                                                   --------        --------
Deferred tax assets
<S>                                                <C>             <C>     
  Pension and other benefits ...............       $  2,295        $  2,786
  Property, plant and equipment ............         (3,095)         (4,739)
  Intangible assets ........................          3,312           2,697
  Restructuring charges ....................            270           3,564
  Inventory ................................          2,519           1,876
  Net operating loss--foreign ..............          2,671           3,491
  Net operating loss carryforwards--domestic          6,642           9,410
  Other ....................................            321             469
                                                   --------        --------
     Subtotal ..............................         14,935          19,554
Valuation allowances .......................        (15,818)        (20,513)
                                                   --------        --------
     Total deferred tax liability ..........       $   (883)       $   (959)
                                                   ========        ========
</TABLE>


The valuation allowance at September 30, 1997 and 1998 relates to the
uncertainty of realizing the tax benefits of reversing temporary differences and
net operating loss carryforwards. The gross amount of domestic net operating
loss carry forwards, before the tax effect, is approximately $28.0 million as of
September 30, 1998. Of the Tax assets covered by the valuation allowance, as of
September 30, 1998, approximately $10.7 million will be used to reduce goodwill
or other intangibles related to the purchase if the benefits are realized, with
$1.4 million increasing equity related to foreign currency translation
adjustments.

 (12) STOCKHOLDERS' EQUITY

Stock Ownership and Stockholders' Agreement

As of September 30, 1998, Cabot owns 41.5% of common stock (42,500 shares) and
50% of redeemable preferred stock (22,500 shares), Vestar owns 41.5% of common
stock (42,500 shares) and 50% of redeemable preferred stock (22,500 shares) and
the Management Investors and certain other employees of the Company own 17% of
common stock (17,338 shares). Vestar, Cabot and the Management Investors are
parties to a stockholders' agreement (the Stockholders' Agreement). The
Stockholders' Agreement contains stock transfer  restrictions, as well as
provisions granting certain tag-along rights, drag-along rights, registration
rights and participation rights.
     

                                       39
<PAGE>   43
                               AEARO CORPORATION
                                        
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
                               SEPTEMBER 30, 1998

The redeemable preferred stock is cumulative redeemable $.01 par value stock.
Dividends accrue whether or not dividends are declared or funds are available at
an annual rate of 12.5%, compounded daily. Accrued dividends may be paid in cash
or in additional shares of preferred stock. Shares are redeemable for cash at
any time, subject to certain exceptions, at the option of the Company at a
redemption price equal to the actual or implied purchase price ($45 million)
plus a redemption payment based on the dividend rate. As of September 30, 1998,
the redemption value of the preferred stock is $67,289,000.

Aearo Company is permitted to pay cash dividends to Aearo Corporation for taxes
and expenses in the ordinary course of business. The maximum amount of cash
dividends paid to Aearo Corporation for ordinary business expenses may not
exceed $500,000 in any fiscal year. As long as no event of default would result,
Aearo Corporation and Aearo Company are permitted to pay dividends consisting of
shares of qualified capital stock as defined in the Senior Bank Facilities, and
Aearo Corporation may redeem or purchase shares of its capital stock held by
former employees of Aearo Corporation or any of its subsidiaries following the
termination of their employment, provided that the aggregate amount paid by
Aearo Corporation in respect to such purchases or redemptions does not exceed
$1.5 million; Aearo Company may pay cash dividends to Aearo Corporation for the
latter purpose. Additionally, Aearo Corporation may pay dividends on its
preferred stock in additional shares of preferred stock.

Stock Option Plans

On June 27, 1996, the Company adopted the Executive Stock Option Plan (the
Executive Plan) whereby the Company, subject to approval of the Board of
Directors, may grant up to 5,000 non-qualified options to certain members of
management. In July 1997, the Company's Board of Directors adopted and the
stockholders subsequently approved the 1997 Stock Option Plan (the "1997 Option
Plan") under which 10,000 shares of Aearo Common Stock have been reserved for
issuance. Under the 1997 Option Plan non-qualified and qualified options may be
granted to employees of the Company. Options granted under the Executive Plan
and the 1997 Option Plan will vest and become exercisable upon the earlier of
the date on which a stipulated return (as defined) is achieved by Vestar and
Cabot on their investment in the Company and the tenth anniversary of the date
of grant. The option term will be ten years except that options shall expire in
certain instances of termination of employment and upon the sale of the Company.
As of September 30, 1998, a total of 7,154 options had been granted under the
Executive Plan and 1997 Option Plan and a total of 7,846 options ware available
for grant.

Pro Forma Stock-Based Compensation Expense

In October 1995, the Financial Accounting Standards Board issued SFAS No. 123,
Accounting for Stock-Based Compensation, which sets forth a fair-value-based
method of recognizing stock-based compensation expense. As permitted by SFAS No.
123, the Company has elected to continue to apply APB No. 25 to account for its
stock-based compensation plans. Had compensation cost for awards granted in
fiscal 1996, fiscal 1997 and fiscal 1998 under the Company's stock-based
compensation plans been determined based on the fair value at the grant dates
consistent with the method set forth under SFAS No. 123, reported net income
(loss) and net income (loss) per share would not have been affected for fiscal
1996, fiscal 1997 and fiscal 1998 as the Black-Scholes option pricing model
calculated no value for the options granted in those years.


                                      40
<PAGE>   44
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                               SEPTEMBER 30, 1998


The fair value of each option grant was estimated on the grant date using the
Black-Scholes option pricing model with the following weighted average
assumptions:

<TABLE>
<CAPTION>
                                                             1997        1998
                                                             ----        ----
<S>                                                        <C>          <C>
Risk-free interest rate ..............................        6.10%        5.52%
Expected life of option grants .......................     10 years     10 years
Expected volatility of underlying stock ..............           0%           0%
Dividend yield .......................................           0%           0%
</TABLE>

The Black-Scholes option pricing model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option pricing models require input of highly
subjective assumptions, including expected stock price volatility. Because the
Company's stock options have characteristics significantly different from those
of traded options and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion the existing
models do not necessarily provide a reliable single measure of the fair value of
the Company's stock options.

Stock Option Activity

Stock option data are summarized as follows for the Executive Plan and the 1997 
Option Plan for the years ended September 30, 1996, 1997 and 1998:

<TABLE>
<CAPTION>
                                                   Number       Weighted Average
                                                  of Shares      Exercise Price
<S>                                               <C>           <C>
Outstanding, September 30, 1995                         --                --
Granted                                              5,000          $ 600.00
Exercised                                               --                --
Forfeited                                               --                --
Expired                                                 --                --
                                                  --------          --------
Outstanding, September 30, 1996                      5,000            600.00
Granted                                              1,344            600.00
Exercised                                               --                --
Forfeited                                           (1,319)           600.00
Expired                                                 --                --

Outstanding, September 30, 1997                      5,025            600.00
Granted                                              3,529            600.00
Exercised                                               --                --
Forfeited                                           (1,400)           600.00
Expired                                                 --                --
                                                  --------          --------
Outstanding September 30, 1998                       7,154          $ 600.00
                                                  ========          ========
</TABLE>

The following table sets forth information regarding options outstanding at
September 30, 1998:


<TABLE>
<CAPTION>
                                                                                       Weighted
                                                                     Weighted           Average
                                   Number         Weighted            Average        Exercise Price
Number of                         Currently        Average           Remaining       for Currently
 Options      Exercise Price     Exercisable    Exercise Price    Contractual Life    Exercisable
<S>           <C>                <C>            <C>               <C>                <C>
  7,154           $600.00             0            $600.00           7.99 years           N/A
</TABLE>

At September 30, 1996, 1997 and 1998, none of the shares were currently
exercisable. At September 30, 1998, there were 7,846 options available for 
grant.


                                       41
<PAGE>   45
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                               SEPTEMBER 30, 1998



(13) COMMITMENTS AND CONTINGENCIES

Lease Commitments

The Company leases certain transportation vehicles, warehouse facilities, office
space, and machinery and equipment under cancelable and noncancelable leases,
most of which expire within 10 years and may be renewed by the Company. Rent
expense under such arrangements totaled $4,395,000, $5,315,000 and $5,553,000
for the years ended September 30, 1996, 1997 and 1998, respectively. Future
minimum rental commitments under noncancelable leases in effect at September 30,
1998 are as follows (dollars in thousands):


<TABLE>
       <S>                                                     <C>
       1999                                                     $  3,676
       2000                                                        3,695
       2001                                                        3,584
       2002                                                        2,999
       2003                                                        2,556
       2004 and thereafter                                         4,985
                                                                --------
       Total                                                    $ 21,495
                                                                ========
</TABLE>

Contingencies

The Company is a defendant in various lawsuits and administrative proceedings
which are being handled in the ordinary course of business. In the opinion of
management of the Company, these suits and claims should not result in final
judgments or settlements which, in the aggregate, would have a material adverse
effect on the Company's financial condition or results of operations.


                                       42
<PAGE>   46
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                               SEPTEMBER 30, 1998


During fiscal 1997 the Company received a complaint from Gargoyles, Inc.
alleging that one of the Company's recently introduced plano eyewear products
(Fectoids) infringes a patented lens shape utilized in the plaintiff's sun and
sporting glasses. On October 22, 1998, the Company announced that it had entered
into a settlement agreement with Gargoyles, Inc. Under the terms of the
settlement, in which the Company expressly denies any liability in the lawsuit,
the Company will continue to manufacture its Fectoids line of eyewear for sale
into safety eyewear markets. The Company also will have the right to sell into
such markets other lines of safety eyewear that Gargoyles contended infringe its
patents. The Company agreed to pay Gargoyles $1.2 million in exchange for a
release of all claims relating to Gargoyles' patents and for uncontested rights
to continue manufacturing and selling its Fectoids and other lines of eyewear.

(14) ACQUISITIONS

On May 30, 1996, the Company acquired Peltor Holding AB (the Acquisition) for
approximately $85.6 million. The Acquisition has been accounted for as a
purchase transaction in accordance with Accounting Principles Board Opinion No.
16, and accordingly, the consolidated financial statements for the periods
subsequent to May 30, 1996 reflect the purchase price, including transaction
costs, allocated to tangible and intangible assets acquired and liabilities
assumed, based on their estimated fair values as of May 30, 1996.

The allocation of the $85.6 million purchase price and direct acquisition costs
is summarized as follows (dollars in thousands):

<TABLE>
<S>                                                                     <C>
Cash paid for Peltor ...............................................    $81,100
Acquisition costs ..................................................      4,500
                                                                        -------
          Total consideration and acquisition costs ................     85,600
Historical Cost of Net Assets Acquired .............................     12,516
                                                                        -------
     Excess of consideration paid over historical cost .............    $73,084
                                                                        =======
Allocation of Excess of Consideration Paid over Historical Cost:

     Inventories ...................................................    $ 1,000
     Property, plant and equipment, net ............................      2,500
     Deferred financing costs ......................................      3,500
     Intangible assets .............................................     68,084
     Accrued liabilities ...........................................     (2,000)
                                                                        -------
                                                                        $73,084
                                                                        =======
</TABLE>

Unaudited pro forma operating results of the Company for the year ended
September 30, 1996, as adjusted for the debt financing and estimated effects of
the Acquisition as if it had occurred on October 1, 1995, are as follows:

<TABLE>
<S>                                                                   <C>
Net sales (000's)                                                     $ 273,723
Earnings (loss) applicable to common shareholders (000's)                (7,716)
Earnings (loss) per common share                                         (77.17)
Weighted average  common shares outstanding                              99,980
</TABLE>


                                       43
<PAGE>   47
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                               SEPTEMBER 30, 1998



(15) FINANCIAL INFORMATION BY INDUSTRY SEGMENT AND GEOGRAPHIC AREA

All of Aearo Corporation's operations are included in the Safety and Energy
Absorbing Products industry segment. For the years ended September 30, 1996,
1997, and 1998, no single customer accounted for more than 10% of sales.
Transfers between geographic areas are recorded at cost plus markup or at
market. Financial information by geographic area for the years ended September
30, 1996, 1997, and 1998, is as follows (dollars in thousands):


<TABLE>
<CAPTION>
                                                 YEAR ENDED SEPTEMBER 30,
                                           ------------------------------------
                                             1996         1997          1998
                                           ---------    ---------     ---------
<S>                                        <C>          <C>           <C>
Sales:
   United States --
      Sales, excluding export sales ...    $ 178,682    $ 197,341     $ 204,309
      Export sales ....................       14,973       17,426        15,473
                                           ---------    ---------     ---------
          Total U.S. sales ............      193,655      214,767       219,782
   Canada .............................       14,686       14,727        14,839
   Europe .............................       50,282       78,850        80,104
                                           ---------    ---------     ---------
          Total .......................      258,623      308,344       314,725
   Less -- Eliminations ...............       15,164       22,561        22,266
                                           ---------    ---------     ---------
          Net sales ...................    $ 243,459    $ 285,783     $ 292,459
                                           =========    =========     =========

Operating Profit:
   United States ......................    $  30,412    $  18,744     $  17,207
   Canada .............................          191        1,581         1,213
   Europe .............................        4,919        9,741         8,712
                                           ---------    ---------     ---------
          Total operating profit ......       35,522       30,066        27,132

Interest Expense, net .................       20,703       26,665        26,152
Unallocated corporate expenses (a) ....        8,056        7,259        10,839
Foreign exchange (gain) loss ..........          286        2,101          (617)
                                           ---------    ---------     ---------
           Income (loss) before income
            taxes .....................    $   6,477    $  (5,959)    $  (9,242)
                                           =========    =========     =========

Identifiable Assets:
   United States ......................    $ 212,544    $ 203,489     $ 183,397
   Canada .............................        7,911        6,963         6,787
   Europe .............................      117,981      100,424        96,563
                                           ---------    ---------     ---------
          Total identifiable assets ...    $ 338,436    $ 310,876     $ 286,747
                                           =========    =========     =========
</TABLE>

----------
(a) Unallocated corporate expenses are corporate management costs.


                                       44
<PAGE>   48
                                AEARO CORPORATION

            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
                               SEPTEMBER 30, 1998


(16) RESTRUCTURING CHARGE

During fiscal 1998 the Company recorded a restructuring charge of $11.6 million
related to the restructuring plans announced by the Company during the fiscal
year. On February 3, 1998, the Company announced the appointment of Michael A.
McLain as President and Chief Executive Officer and on March 25, 1998 the
Company announced plans to close the Boston headquarters and relocate it to
Indianapolis, Indiana, where the Company has substantial operations. In
addition, on September 30, 1998 the Company announced plans to improve
profitability through complexity reduction and restructuring. The Company is
eliminating certain product offerings in its Eyewear and Respiratory product
lines, reducing head count in North America through restructuring and
outsourcing, consolidating the branding in its Consumer product line and
reducing selling and manufacturing cost in its Prescription eyewear product
line.

The $11.6 million charge includes a $6.1 million provision for inventories and
product returns for products that are being discontinued. The charge also
provides $1.1 million for certain property, plant and equipment for which the
Company has determined there is no future use, and $0.1 million related to
intangibles on an abandoned product line. In addition, the charge provides $4.3
million to cover mainly employee severance and other contractual obligations.

As of September 30, 1998, there is approximately $3.0 million of remaining
accruals related to cash charges for severance and non-cancelable lease payments
to be substantially paid in fiscal 1999. 

                                       45
<PAGE>   49
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.


                                    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 December 15, 1998.


      NAME                    AGE                      POSITION
      ----                    ---                      --------
Michael A. McLain             48        Chief Executive Officer, President, and
                                        Director

Bryan J. Carey                38        Vice President, Chief Financial Officer,
                                        Treasurer and Assistant Secretary

James D. Hall                 48        Vice President, Product Development

James H. Floyd                43        Vice President, Logistics

Joseph P. Marlette            55        Vice President, Manufacturing

M. Rand Mallitz               56        Vice President and General Manager,
                                        E-A-R Specialty Composites

Daniel P. O'Connor            54        Vice President, Sales - North America

James M. Phillips             46        Vice President, Human Resources

Rahul Kapur                   47        Vice President, Corporate Development

Norman W. Alpert*             40        Chairman of the Board of Directors

Daniel S. O'Connell           44        Director

Arthur J. Nagle               60        Director

Bryan P. Marsal               47        Director

William E. Kassling           54        Director

Robert Rothberg               49        Director

Margaret J. Hanratty*         50        Director

John D. Curtin, Jr.           65        Director


* Member of Audit Committee and  Compensation Committee

Michael A. McLain has been President and Chief Executive Officer of Aearo
Corporation since January 1998. Prior to joining Aearo he was President and
Chief Executive Officer of DowBrands, Inc., a large manufacturer of household
consumer products. Mr. McLain is also a director of Auburn University and Park
Tudor School.

Bryan J. Carey joined the Company as Chief Financial Officer in April 1994 from
Cabot, where he had been Director of Strategic Planning since August 1992. Prior
to joining Cabot, he was a principal with Chase Capital Partners and its
predecessor.


                                       46
<PAGE>   50
James D. Hall joined the Company in October 1994 and served as a consultant to
the Company from July 1994 to October 1994. Mr. Hall was Executive Vice
President of Uvex Safety L.L.C. from 1993 to July 1994 and Vice President-Safety
of Uvex Winter Optical, Inc. from 1990 to 1993.

James H. Floyd joined the Company in April 1998 as Vice President, Logistics.
Prior to April 1998, he was responsible for global logistics and packaging
functions at DowBrands. He began his career at Procter and Gamble where he
worked for seven years.

Joseph P. Marlette joined the Company in April 1998 as Vice President,
Manufacturing. Prior to joining Aearo, he spent 33 years in various
manufacturing positions with the Dow Chemical Company.

M. Rand Mallitz joined the Company in January 1992 as Vice President and General
Manager, E-A-R Specialty Composites. He was Vice President and General Manager
of the Caulk Cartridge Division of Sonoco Products in 1991, and prior to that he
was President/CEO of Roth Office Products.

Daniel P. O'Connor joined the Company in 1991 and has held the positions of Vice
President, Sales & Distribution; Vice President, Global Sales & Marketing; and
Vice President and General Manager, Prescription Eyewear. Prior to joining the
Company in 1991, he was Vice President of Sales and Marketing, Residential and
Small Businesses Services Division, of Northern Telecom.

James M. Phillips joined the Company in May 1998 as Vice President, Human
Resources. He worked for Dow Chemical Company for more than 20 years and has
worked in recruiting, training and compensation for many diverse divisions of
Dow.

Rahul Kapur joined the Company in April 1998 as Vice President of Corporate
Development. He joined DowBrands in 1987 in New Product Development and was
Director of Marketing for Europe. He began his career with Richardson Vicks and
Unilever.

Norman W. Alpert is a Managing Director of Vestar Capital Partners and was a
founding partner of Vestar at its inception in 1988. Mr. Alpert is Chairman of
the Board of Directors of International AirParts Corporation and Advanced
Organics, Inc. and a director of Cluett American Corp., Remington Products
Company, L.L.C. and Russell-Stanley Corporation, all companies in which Vestar
or its affiliates have a significant equity interest. He became a director of
the Company in July 1995 and Chairman in February 1998.

Daniel S. O'Connell is the Chief Executive Officer and founder of Vestar Capital
Partners. Mr. O'Connell is a director of Advanced Organics, Inc., Cluett
American Corp., Remington Products Company, L.L.C. and Russell-Stanley
Corporation, and is a member of the partnership committee of Insight
Communications Company, L.P., all companies in which Vestar or its affiliates
have a significant equity interest. He became a director of the Company in July
1995.

Arthur J. Nagle is a Managing Director of Vestar Capital Partners and was a
founding partner of Vestar at its inception in 1988. Mr. Nagle is a director of
Remington Products Company, L.L.C., and Russell-Stanley Corporation, all
companies in which Vestar or its affiliates have a significant equity interest.
He became a director of the Company in July 1995.

Bryan P. Marsal is Chairman and Chief Executive Officer of Cluett American Corp.
Mr. Marsal is a director of Timex Corporation and Long Manufacturing Corp.
Cluett is an apparel manufacturer of Gold Toe socks and Arrow shirts. Mr. Marsal
has served as Chief Executive Officer for many other companies on a temporary
basis including Republic Health, Anthony Manufacturing, Gitano Corporation and
Alexanders Department Store. He became a director of the Company in October
1998.

William E. Kassling is Chairman and Chief Executive Officer of Westinghouse Air
Brake Company, a manufacturer of value added equipment for locomotives, railway
freight cars and passenger transit vehicles. Prior to joining Westinghouse Air
Brake Company in 1984, Mr. Kassling was with American Standard Incorporated ,
Clark Equipment Company and Boston Consulting Group. Mr. Kassling is a director
of Commercial Intertech, DRAVO Corporation, the Historical Society of Western
Pennsylvania, La Rouche College and Scientific Atlanta, Inc. He became a 
director of the Company in July 1998.


                                       47
<PAGE>   51


Robert Rothberg has been Vice President and General Counsel of Cabot Corporation
since October 1993. Prior to joining Cabot in 1993, Mr. Rothberg was with
Choate, Hall & Stewart from 1976 -1993. He became a director of the Company in
December 1998.

Margaret J. Hanratty has been Vice President and Treasurer of Cabot since
September 1993, and served previously as Director of Corporate Development.
Prior to joining Cabot in 1990, she served as Vice President, Mergers and
Acquisitions for The First Boston Corporation. She became a director of the
Company in July 1995.

John D. Curtin, Jr. joined Cabot in 1989 as Chief Financial Officer. Mr. Curtin
was named Chief Executive Officer of the Company in April 1994, became a
director of the Company in July 1995, and assumed the role as President in
February 1997. Mr. Curtin retired as President and Chief Executive Officer of
the Company in February, 1998. Prior to joining Cabot he was President, Chief
Executive Officer and Director of Curtin & Co., Inc., a private investment
banking firm. Mr. Curtin is also a trustee of Eastern Enterprises and a director
of Imperial Holly Corporation.

The number of directors of the Company is fixed at nine. Under a stockholders'
agreement among Aearo, Vestar, Cabot, and the Management Investors dated July
11, 1995 (the "Stockholders' Agreement"), Vestar has the right to designate five
directors, Cabot has the right to designate two directors, and the Management
Investors have the right to designate two directors. Messrs. Alpert, O'Connell,
Nagle, Kassling and Marsal are the directors designated by Vestar. Mr. Rothberg
and Ms. Hanratty are the directors designated by Cabot. Mr. McLain and Mr.
Curtin are currently the directors designated by the Management Investors. See
Item 13, "Certain Relationships and Related Transactions -- Stock Ownership and
Stockholders' Agreement -- Election and Removal of Directors." The term in
office of each director ends when his or her successor has been elected at the
next following annual meeting of stockholders and qualified or upon his or her
removal or resignation.

The Board of Directors has established an audit committee consisting of Margaret
J. Hanratty and Norman W. Alpert (the "Audit Committee"). The Audit Committee
recommends the firm to be appointed as independent accountants to audit
financial statements and to perform services related to the audit, reviews the
scope and results of the audit with the independent accountants, reviews with
management and the independent accountants the Company's annual operating
results, considers the adequacy of the internal accounting procedures, considers
the effect of such procedures on the accountants' independence and establishes
policies for business values, ethics and employee relations.

Officers and directors of Aearo and the Subsidiary are not subject to Section 16
of the Securities Exchange Act of 1934, as amended (the "Exchange Act").

ITEM 11. EXECUTIVE COMPENSATION

The compensation of executive officers of the Company is determined by the Board
of Directors. The following table sets forth certain information concerning
compensation received by the Chief Executive Officer and the other four most
highly-compensated executive officers of the Company, as well as two former
executive officers of the Company (the "Named Executive Officers") for services
rendered to the Company in all capacities (including service as an officer or
director) in fiscal 1998.


                                       48
<PAGE>   52
                           SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                 ANNUAL COMPENSATION
                                                                                       ALL OTHER
                                                      FISCAL                            ANNUAL
                                                       YEAR     SALARY      BONUS     COMPENSATION
                                                       ----     ------      -----     ------------
<S>                                                   <C>      <C>         <C>        <C>
Michael A. McLain                                      1998    $283,336    $120,000    $ 53,239(1)
   Chief Executive Officer, President, and Director

John D. Curtin, Jr                                     1998    $260,810          --    $479,494(2)
   Formerly Chairman of the Board of Directors,        1997    $393,750          --    $ 29,186
   Chief Executive Officer, and President              1996    $375,000    $200,000    $ 30,791

Daniel P. O'Connor                                     1998    $220,008    $ 79,200    $ 37,333(3)
   Vice President, Sales--North America                1997    $199,333    $ 44,000    $ 19,661
                                                       1996    $178,100    $ 65,000    $ 36,976

M. Rand Mallitz                                        1998    $180,000    $ 64,800    $ 15,641(4)
   Vice President and General Manager,                 1997    $163,666    $ 50,000    $ 17,618
   E-A-R Specialty Composites                          1996    $149,869    $ 40,000    $ 14,124

Bryan J. Carey                                         1998    $197,502    $ 73,800    $ 15,512(5)
   Vice President, Chief Financial Officer,            1997    $177,667    $ 30,000    $ 17,066
   Treasurer and Assistant Secretary                   1996    $159,164    $ 55,000    $ 15,227

James D. Hall                                          1998    $205,008    $ 73,800    $ 18,365(6)
   Vice President, Product Management                  1997    $179,750    $ 41,000    $ 19,740
                                                       1996    $157,080    $ 50,000    $ 14,720
                                                       1998    $110,004

Mark H. Hague                                          1998    $110,004    $     --    $284,506(7)
   Formerly Vice President, Operations                 1997    $196,429    $ 44,000    $  2,650
                                                       
</TABLE>

(1)   Includes contributions made on behalf of Mr. McLain to the Company's
      Supplemental Executive Retirement Plan ($9,281).

(2)   Includes contributions made on behalf of Mr. Curtin to the Company's
      401(k) Savings Plan ($2,500); to the Company's Cash Balance Plan ($6,400);
      and to the Company's Supplemental Executive Retirement Plan ($23,595). In
      addition, and attributed to Mr. Curtin's retirement as President and Chief
      Executive Officer of the Company, Mr. Curtin received a lump sum payment
      of $400,000 as well as accrued vacation pay ($47,000).

(3)   Includes contributions made on behalf of Mr. O'Connor to the Company's
      401(k) Savings Plan ($4,286); to the Company's Cash Balance Plan ($6,627);
      and to the Company's Supplemental Executive Retirement Plan ($8,086). Also
      includes relocation allowance payments associated with the relocation of
      the Corporate Headquarters.($18,334).

(4)   Includes contributions made on behalf of Mr. Mallitz to the Company's
      401(k) Savings Plan ($4,325); to the Company's Cash Balance Plan ($6,733);
      and to the Company's Supplemental Executive Retirement Plan ($4,583).

(5)   Includes contributions made on behalf of Mr. Carey to the Company's 401(k)
      Savings Plan ($2,000); to the Company's Cash Balance Plan ($6,843); and to
      the Company's Supplemental Executive Retirement Plan ($6,668).

(6)   Includes contributions made on behalf of Mr. Hall to the Company's 401(k)
      Savings Plan ($4,286); to the Company's Cash Balance Plan ($6,945); and to
      the Company's Supplemental Executive Retirement Plan ($7,134).

(7)   Includes contributions made on behalf of Mr. Hague to the Company's 401(k)
      Savings Plan ($4,750); and to the Company's Cash Balance Plan ($7,600);
      and to the Company's Supplemental Executive Retirement Plan ($10,460).
      Also includes payments associated with the termination of his employment
      as severance ($249,004) and accrued vacation pay ($12,692).

      The following table sets forth information concerning the individual grant
      of options to purchase Aearo Common Stock to the Named Executive Officers
      during fiscal 1998.


                                       49
<PAGE>   53

                        OPTION GRANTS DURING FISCAL 1998


<TABLE>
<CAPTION>
                                                                                      POTENTIAL
                                                                                      REALIZABLE
                                                                                   VALUES AT ASSUMED
                                                                                   ANNUAL RATES OF
                                           % OF                                      STOCK PRICE
                                       TOTAL OPTIONS                               APPRECIATION FOR
                                        GRANTED TO      EXERCISE                      OPTION TERM
                           OPTIONS     EMPLOYEES IN      PRICE     EXPIRATION         (10 YEARS)(2)
      NAME                GRANTED(1)   FISCAL YEAR     PER SHARE      DATE        5% ($)        10% ($)
      ----                ----------   -----------     ---------      ----        ------        -------
<S>                       <C>          <C>             <C>         <C>            <C>           <C>
Michael A. McLain.....      1,100         31.2%        $600.00      2/20/08      415,068       1,051,871
</TABLE>

----------
(1)   The options will vest and become exercisable upon the earlier of: (i) the
      date on which certain financial performance benchmarks (which depend in
      part on the future market value of the Aearo Common Stock) are achieved by
      the Company and (ii) the tenth anniversary of the date of grant. All 
      options are subject to the employee's continued employment and terminate
      ten years after the grant date, subject to earlier termination in
      accordance with the Company's applicable stock option plan and the
      applicable option agreement.

(2)   This column shows the hypothetical gain or "option spreads" of the options
      granted based on both the fair market value of the Aearo Common Stock for
      financial reporting purposes and assumed annual compound stock
      appreciation rates of 5% and 10% over the term of the options. The 5% and
      10% assumed rates of appreciation are mandated by the rules of the
      Securities and Exchange Commission and do not represent the Company's
      estimate or projection of future Aearo Common Stock prices. The gains
      shown are net of the option exercise price, but do not include deductions
      for taxes or other expenses associated with the exercise of the option or
      the sale of the underlying shares, or reflect nontransferability, vesting
      or termination provisions. The actual gains, if any, on the exercises of
      stock options will depend on the actual future performance of the Aearo
      Common Stock.


                                       50
<PAGE>   54
The following table sets forth information concerning the number and value of
unexercised options to purchase Aearo Common Stock held by the Named Executive
Officers at the end of fiscal 1998. None of the Named Executive Officers
exercised any stock options during fiscal 1998.

<TABLE>
<CAPTION>
                                                                                                         VALUE OF OUTSTANDING
                                                                    NUMBER OF BENEFICIAL                 IN-THE-MONEY OPTIONS
                                    SHARES                       OPTIONS AT FISCAL YEAR-END              AT FISCAL YEAR-END(1)
                                   ACQUIRED         VALUE      --------------------------------     ------------------------------
     NAME                         ON EXERCISE     REALIZED     EXERCISABLE        UNEXERCISABLE     EXERCISABLE      UNEXERCISABLE
--------------                    -----------     --------     -----------        -------------     -----------      -------------
<S>                               <C>             <C>          <C>                <C>               <C>              <C>
Michael A. McLain.............        --             --            --                1,100            $    0            $    0
John D. Curtin, Jr............                       --            --                  325                 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
Mark H. Hague.................        --             --            --                   0                  0                 0
</TABLE>

(1)   There was no public market for the Aearo Common Stock as of September 30,
      1998. Accordingly, these values have been calculated on the basis of an
      assumed fair market value of $200 per share.

DIRECTOR COMPENSATION

Directors (other than two Directors unaffiliated with Cabot or Vestar (the
"Outside Directors")) serve without compensation (other than reimbursement of
expenses) in connection with rendering services as such. The Outside Directors
receive $10,000 annually for their service as Directors and an additional $2,500
per meeting, plus reimbursement of expenses. In connection with their
appointment, Outside Directors were given the opportunity to purchase a limited
amount of shares of Aearo Common Stock; during fiscal 1998, William E.
Kassling, one of the Outside Directors, purchased 250 shares at a price of $200
per share. In connection with such purchases Mr. Kassling became party to the
Stockholders' Agreement. See Item 13, "Certain Relationships and Related
Transactions -- Stock Ownership and Stockholders' Agreement."

EMPLOYEE STOCK AND OTHER BENEFIT PLANS

STOCK PURCHASE PLAN. In connection with the Formation Acquisition, the Company
adopted the Cabot Safety Holdings Corporation 1995 Stock Purchase Plan, as
amended and restated (the "Stock Purchase Plan"), in order to encourage
ownership of Aearo Common Stock by selected officers and employees and
independent directors of the Company. In connection with Mr. Curtin's retirement
as President and Chief Executive Officer, neither the Company nor Mr. Curtin
exercised their right to require repurchase of 3,712.5 of the shares of common
stock owned by Mr. Curtin. Such shares are no longer deemed to be covered by
the Stock Purchase Plan. Under the Stock Purchase Plan, 15,000 shares of Aearo
Common Stock have been reserved for purchase by the Company's executive officers
and other senior members of management as determined by the Board of Directors.
As of December 15, 1998, 13,625 of such shares were issued and outstanding.

Aearo Common Stock acquired under the Stock Purchase Plan is subject to
forfeiture through various puts and calls. In the event of death, permanent
disability or retirement, which retirement occurs at age 65 or older with at
least 3 years of service, such stock may be put to the Company by the holder at
fair market value and the Company has a call on such stock at the same price. In
the event of termination for cause, the Company has a call at the lesser of
initial cost and fair market value. In the event of termination by the Company
other than for cause and in the case of voluntary resignation, the Company has a
call (i) with respect to a percentage of such stock equal to the number of years
elapsed since the Formation Acquisition multiplied by 20% at fair market value,
and (ii) with respect to the remainder of such stock at the lesser of initial
cost and fair market value. Shares repurchased by the Company are held in
reserve, and may be issued to existing and future employees or non-employee
directors. These puts and calls expire (i) on the date on which certain
financial performance benchmarks (which, following an initial public offering of
the Aearo Common Stock, depend in part on the future market value of the Aearo
Common Stock) are achieved by the Company or (ii) the fifth anniversary of the
Formation Acquisition. Each Management Investor is also required to be a party
to the Stockholders' Agreement. See Item 13, "Certain Relationships and Related
Transactions -- Stockholders' Agreement."

STOCK OPTION PLANS. In June 1996, the Company's Board of Directors adopted and
the stockholders subsequently approved the Executive Stock Option Plan (the
"Executive Plan") under which 5,000 shares of Aearo Common Stock have been
reserved for issuance. In July 1997, the Company's Board of Directors adopted
and the stockholders subsequently approved the 1997 Stock Option Plan (the "1997
Option Plan") under which 10,000 shares of Aearo Common Stock have been reserved
for issuance. Under the 1997 Option Plan non-qualified and qualified options may
be granted to employees of the Company.


                                       51
<PAGE>   55
Each of the Executive Plan and the 1997 Option Plan is administered by a
committee of the Board of Directors consisting of all non-employee directors. As
of December 15, 1998, Non-qualified options to acquire 7,922.5 shares at a price
of $600 per share have been granted to officers and key employees of the Company
under the Company's stock option plans and 7,077.5 options remain available for
issuance; of outstanding options, 2,068.75 in the aggregate have been granted to
executive officers, including Mr. McLain (1,100 options), Mr. O'Connor (250
options), Mr. Hall (250 options), Mr. Carey (313 options) and Mr. Mallitz (156
options). The options will vest and become exercisable upon the earlier of: (i)
the date on which certain financial performance benchmarks (which depend in part
on the future market value of the Aearo Common Stock) are achieved by the
Company and (ii) the tenth anniversary of the date of grant. The option term is
10 years; provided, however, that unexercised options expire earlier in certain
instances of termination of employment of the option holder and may expire in
the event of a merger or liquidation of the Company or a sale of substantially
all the assets of the Company. Aearo Common Stock acquired upon exercise of
options granted under the Executive Plan or 1997 Option Plan is subject to the
same restrictions, including puts and calls and drag-along rights as Aearo
Common Stock acquired under the Stock Purchase Plan. See "Stock Purchase Plan."

ANNUAL BONUS. The Company provides performance-based compensation awards to
executive officers and key employees for achievement during each year as part of
an annual bonus plan. Such compensation awards are a function of individual
performance and consolidated corporate results. Business unit performance also
is a factor in determining compensation awards with respect to key employees who
are not executive officers. The specified qualitative and quantitative criteria
employed by the Board of Directors of the Company in determining bonus awards
varies for each individual and from year to year.

SUPPLEMENTAL SEVERANCE PAY PLAN. The Company has adopted a supplemental
severance pay plan providing certain executive officers and key employees with
salary continuation in the event of an eligible termination based on years of
service. The plan provides for one month's base pay for each full year of
service with a minimum amount payable of three months and a maximum amount
payable of twelve months.

SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN. The Company has adopted a supplemental
executive retirement plan, which is a non-qualified plan under the Code, and
which provides unfunded deferred compensation benefits to certain executive
officers and key employees. Pursuant to the plan, participants are credited
annually with amounts representing 4% of compensation in excess of that amount
of compensation subject to social security taxes.

401(K) PLAN. The Company has adopted a savings plan (the "Saving Plan"), which
is qualified under Section 401(a) and 401(k) of the Code. All regular employees
of the Company in the United States are eligible to participate in the Savings
Plan after six months of service. For each employee who elects to participate in
the Savings Plan and makes a contribution thereto, the Company will make a
matching contribution. The Company matches 50.0% of the first 6.0% of
compensation contributed. The maximum contribution for any participant for any
year is 15.0% of such participant's eligible compensation. Contributions to the
Savings Plan will be invested, as the employee directs, in a money market fund,
income fund, growth and income fund, growth fund, or asset allocation fund.

PENSION PLAN. The Company has adopted a cash balance plan. Under such plan, the
Company will provide participants with annual credits of 4% of eligible
compensation. All balances in the accounts of participants will be credited with
interest based on the prior year's U.S. Treasury bill rate. At retirement,
participants eligible for benefits may receive the balance standing in their
account in a lump sum or as a monthly pension having


                                       52
<PAGE>   56
equivalent actuarial value. The following table sets forth, for the Named
Executive Officers, the estimated annual benefits payable upon retirement at
normal retirement age, assuming in each case that such officer elects payment
over time rather than in a lump sum:


<TABLE>
<CAPTION>
NAME AND PRINCIPAL POSITION                              ANNUAL BENEFITS PAYABLE
---------------------------                              -----------------------
<S>                                                      <C>
Michael A. McLain......................................         $ 16,372
  President and Chief Executive Officer

John D. Curtin, Jr. ...................................         $  2,700
  Formerly Chairman, Chief Executive 
  Officer and President

Daniel P. O'Connor.....................................         $ 17,385
  Vice President, Sales

M. Rand Mallitz........................................         $ 15,607
  Vice President and General Manager,
  E-A-R Specialty Composites

Bryan J. Carey.........................................         $ 49,264
  Vice President, Chief Financial
  Officer, Treasurer and Assistant
  Secretary

James D. Hall..........................................         $ 22,584
  Vice President, Product Management

Mark H. Hague..........................................         $  2,755
  Formerly Vice President, Operations
</TABLE>

----------

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

The Company has a compensation committee of the Board of Directors. As of
December 15, 1998 the committee consists of Messrs. Alpert and McLain and Ms.
Hanratty, three directors of the Company. This committee makes all executive
officer compensation decisions, with Mr. McLain abstaining with respect to
decisions affecting his own compensation, and reviews them with the full Board
of Directors of the Company. On March 31, 1998, Mr. McLain acquired 4,050 shares
of Aearo Common Stock under the Stock Purchase Plan at a price of $810,000. Ms.
Hanratty is an officer of Cabot. On July 11, 1995, as part of the Formation
Acquisition, Cabot and its subsidiaries sold assets to the Company for aggregate
consideration of approximately $206.1 million. Messrs. Alpert, O'Connell and
Nagle, three directors of the Company, are officers of Vestar. On July 11, 1995,
as part of the Formation Acquisition, Vestar invested $31.0 million in capital
stock of the Company.


                                       53
<PAGE>   57
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information with respect to the
beneficial ownership of Aearo Common Stock, including beneficial ownership by
each person or entity known by the Company to own beneficially 5% or more of the
Company's voting capital stock, the Directors, the Named Executive Officers and
all of the Company's Directors and executive officers as a group as of December
15, 1998. All of the Subsidiary's issued and outstanding capital stock is owned
by Aearo.

<TABLE>
<CAPTION>
                                                                NUMBER OF
                                                                 SHARES       PERCENTAGE OF
                                                                OF AEARO       OUTSTANDING
NAME AND ADDRESS OF BENEFICIAL OWNER                          COMMON STOCK       SHARES
------------------------------------                          ------------       ------
<S>                                                           <C>             <C>
Vestar Equity Partners, L.P.(1).............................     42,500           41.53%
   245 Park Avenue
   New York, New York  10017

Cabot CSC Corporation(2)....................................     42,500           41.53%
   75 State Street, 13 Floor
   Boston, Massachusetts  02109

Michael A. McLain...........................................      4,050            3.96%
John D. Curtin, Jr..........................................      3,713            3.63%
Bryan J. Carey..............................................      1,500            1.47%
James D. Hall...............................................      1,050            1.02%
Daniel P. O'Connor..........................................      1,050            1.02%
Norman W. Alpert(3).........................................     42,500           41.53%
Daniel S. O'Connell(3)......................................     42,500           41.53%
Arthur J. Nagle(3)..........................................     42,500           41.53%
Robert Rothberg(4)..........................................     42,500           41.53%
Margaret J. Hanratty(4).....................................     42,500           41.53%
Bryan P. Marsal.............................................          0              *
William E. Kassling.........................................        250              *
M. Rand Mallitz.............................................        950              *
Directors and executive officers as a group (14 persons)(5).    101,063            98.8%
</TABLE>

* Less than 1%.

(1)   The general partner of Vestar is Vestar Associates L.P., a limited
      partnership whose general partner is Vestar Associates Corporation
      ("V.A.C."). In such capacity, V.A.C. exercises sole voting and investment
      power with respect to all of the shares held of record by Vestar. Messrs.
      Alpert, O'Connell and Nagle, who are directors of the Company, are
      affiliated with Vestar in the capacities described under "Management --
      Directors and Executive Officers" and are stockholders of V.A.C.
      Individually, no stockholder, director or officer of V.A.C. is deemed to
      have or share such voting or investment power within the meaning of Rule
      13d-3 under the Exchange Act. Accordingly no part of the shares of Aearo
      Common Stock owned of record by Vestar is beneficially owned by Messrs.
      Alpert, O'Connell or Nagle or any other stockholder, director or officer
      of V.A.C.

(2)   The board of directors of Old Cabot Safety Corporation controls the voting
      and investment of the shares of Aearo Common Stock held by Old Cabot
      Safety Corporation. Old Cabot Safety Corporation is a wholly-owned
      subsidiary of Cabot. Cabot appoints the directors of Old Cabot Safety
      Corporation and exercises ultimate voting and investment power with
      respect to all shares held of record by Old Cabot Safety Corporation.
      Cabot is a publicly held company and, accordingly, no single stockholder,
      director or officer of Cabot is deemed to have or share such voting or
      investment power within the meaning of Rule 13d-3 under the Exchange Act.
      Accordingly, no part of the shares of Aearo Common Stock owned of record
      by Old Cabot Safety Corporation is beneficially owned by any stockholder,
      director or officer of Cabot.

(3)   Messrs. Alpert, O'Connell and Nagle are affiliated with Vestar in the
      capacities described under


                                       54
<PAGE>   58
      "Management -- Directors and Executive officers." Ownership of Aearo
      Common Stock for these individuals includes 42,500 shares of Aearo Common
      Stock included in the above table beneficially owned by Vestar, of which
      such persons disclaim beneficial ownership. Each such person's business
      address is c/o Vestar Equity Partners, L.P. at the address set forth
      above.

(4)   Mr. Rothberg and Ms. Hanratty are affiliated with Cabot, the parent of Old
      Cabot Safety Corporation, in the capacities described under "Directors and
      Executive Officers." Ownership of Aearo Common Stock for these individuals
      includes 42,500 shares of Aearo Common Stock included in the above table
      beneficially owned by Old Cabot Safety Corporation, of which such persons
      disclaim beneficial ownership. Each such person's business address is c/o
      Cabot CSC Corporation at the address set forth above.

(5)   Cabot, Vestar and the Management Investors have entered into a
      Stockholders' Agreement, the terms of which are described more fully under
      Item 13, "Certain Relationships and Related Transactions-- Stock Ownership
      and Stockholders' Agreement." Does not include 1,275 shares of Aearo
      Common Stock held by Management Investors who are not executive officers.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

THE ASSET TRANSFER AGREEMENT

The Company is a party to an asset transfer agreement dated as of June 13, 1995
with Cabot and certain of its subsidiaries (including Old Cabot Safety
Corporation) (the "Asset Transfer Agreement") entered into in connection with
the Formation Acquisition. The Asset Transfer Agreement contains customary
representations, warranties and covenants. Cabot and certain of its
subsidiaries, on the one hand, and Aearo and the Subsidiary on the other, have
also agreed to indemnify and hold each other and their affiliates harmless
against certain breaches of representations or covenants and certain other
liabilities.

The Company has the right to pay an annual fee of $400,000 to Old Cabot Safety
Corporation, and has elected to make this payment, with the result that Old
Cabot Safety Corporation will retain responsibility and liability for, and
indemnify the Company against, certain legal claims alleged to arise out of the
use of respirators sold prior to June 1995. The Company has the right to
discontinue the payment of such annual fee at any time, in which case the
Company will assume responsibility for and indemnify Cabot and Old Cabot Safety
Corporation with respect to such claims.

STOCK OWNERSHIP AND STOCKHOLDERS' AGREEMENT

Prior to the Formation Acquisition, Cabot owned 100% of the outstanding shares
of the Subsidiary, which enabled Cabot to elect all of the directors of the
Subsidiary. As of December 15, 1998, (i) Cabot indirectly owns 41.5% of the
Aearo Common Stock outstanding and 50% of the Aearo Preferred Stock outstanding,
(ii) Vestar owns 41.5% of the Aearo Common Stock outstanding and 50% of the
Aearo Preferred Stock outstanding and (iii) 17.0% of the Aearo Common Stock has
been issued to management and certain directors (collectively the Management
Investors). Cabot, Vestar and the Management Investors (the "Stockholders") own
100% of the outstanding shares of Aearo Common Stock and will elect all of the
directors of Aearo and determine the outcome of all matters requiring
stockholder approval, including mergers, consolidations and the sale of all or
substantially all of the assets of Aearo, and to prevent or cause a change in
control of Aearo, in each case subject to such restrictions, limitations and
conditions as may be imposed under the Stockholders' Agreement. There can be no
assurance as to how long any of Cabot, Vestar or the Management Investors will
hold their shares of Aearo Common Stock.

Cabot, Vestar, and the Management Investors have entered into the Stockholders'
Agreement which provides for, among other things, the matters described below.


                                       55
<PAGE>   59
ELECTION AND REMOVAL OF DIRECTORS. The Stockholders' Agreement provides that the
Board of Directors of the Company shall consist of nine members. Currently there
are eight directors serving. The parties agreed to vote all shares of Aearo
Common Stock owned or controlled by them so as to elect as members of the Board
of Directors persons designated as follows: (i) Vestar designates three
directors so long as the Vestar Relative Percentage (as defined below) is at
least 75% or Vestar and its affiliates beneficially own on a fully diluted basis
at least 21,250 shares of Aearo Common Stock (50% of the shares of Aearo Common
Stock acquired by them in the Formation Acquisition), (ii) Cabot may designate
two directors so long as the Cabot Relative Percentage (as defined below) is at
least 75% or Cabot and its affiliates own beneficially on a fully diluted basis
at least 21,250 shares of Aearo Common Stock (50% of the shares of Aearo Common
Stock acquired by them in the Formation Acquisition), (iii) Vestar may designate
two additional directors who are not partners, officers or employees of any of
Vestar or its affiliates so long as the Vestar Relative Percentage is as least
75% or Vestar and its affiliates beneficially own at least 31,875 shares of
Aearo Common Stock (75% of the shares of Aearo Common Stock acquired by them in
the Formation Acquisition), provided that Vestar must notify Cabot in writing in
advance of the identities of these director nominees and obtain Cabot's approval
thereof, which may not be unreasonably withheld, and (iv) the Management
Investors may designate two directors so long as the Management Investors
together own beneficially on a fully diluted basis at least 3,750 shares of
Aearo Common Stock (25% of the shares of Aearo Common Stock acquired by all
Management Investors in the Formation Acquisition), provided that the two
designees of the Management Investors must be the principal executive officer
and the principal operating officer of the Company. Currently only one designee
of the Management Investors is serving on the Board of Directors. The foregoing
provisions relating to the election of directors terminate in the event that
both Cabot and its affiliates, on the one hand, and Vestar and its affiliates,
on the other hand, own on a fully diluted basis fewer than 4,250 shares of Aearo
Common Stock (10% of the shares of Aearo Common Stock acquired by them in the
Formation Acquisition). The term "Vestar Relative Percentage" means a percentage
reflecting (a)(i) $31 million plus (ii) the amount paid for capital stock of
Aearo by Vestar and its Affiliates after the Formation Acquisition less (iii)
the value (based on price per share) of all shares of Aearo Common Stock and
Aearo Preferred Stock acquired by Vestar and its affiliates in the Formation
Transaction and no longer held by them, less (iv) the value of all shares of the
Aearo Common Stock and Aearo Preferred Stock acquired by Vestar and its
affiliates after the Formation Acquisition and no longer held by them, as a
percentage of (b) the amount calculated pursuant to clause (a) for Cabot and its
affiliates for such date. The term "Cabot Relative Percentage" has a correlative
meaning focused on Cabot's remaining investment in Aearo capital stock relative
to Vestar's.

Messrs. Alpert, O'Connell and Nagle were designated by Vestar as described in
clause (i) above, Mr. Rothberg and Ms. Hanratty were designated by Cabot as
described in clause (ii) above, Messrs. Kassling and Marsal were designated by
Vestar as described in clause (iii) above and Mr. McLain and Mr. Curtin were
designated by the Management Investors as described in clause (iv) above. All
directors can be removed, with or without cause, and replaced by the
stockholders who have the right to designate them.

TAG-ALONG RIGHTS. So long as a public offering of Aearo Common Stock shall not
have occurred and subject to certain exceptions, with respect to any proposed
transfer of Aearo Common Stock or Aearo Preferred Stock by Vestar, other than
transfers to affiliates, each other stockholder will have the right to require
that the proposed transferee purchase a certain percentage of the shares owned
by such stockholder at the same price and upon the same terms and conditions.

DRAG-ALONG RIGHTS. The Stockholders' Agreement provides that, so long as Vestar
and its affiliates beneficially own at least 21,250 shares of Aearo Common Stock
(50% of the shares of Aearo Common Stock acquired by them in the Formation
Acquisition) or the Vestar Relative Percentage is at least 75%, if Vestar
receives an offer from a third party to purchase all but not less than all
outstanding shares of Aearo Common Stock and Aearo Preferred Stock and such
offer is accepted by Vestar, then each party to the Stockholders' Agreement will
transfer all shares of Aearo Common Stock and Aearo Preferred Stock owned or
controlled by such party on the terms of the offer so accepted by Vestar,
provided that all such transfers occur on substantially identical terms and the
number of shares to be acquired by the third party after giving effect to all
such transfers would be sufficient under the certificate of incorporation and
by-laws of the Company, any applicable agreements and applicable law to permit
such third party to eliminate all remaining minority interests through a merger
opposed by such minority interests. These so-called "drag-along" rights do not
apply to sales in a public offering or to


                                       56
<PAGE>   60
stock that has been sold by a party to the Stockholders' Agreement in a public
offering or pursuant to Rule 144.

If Vestar intends to transfer Aearo Common Stock to a third party in any
transaction in which these drag-along rights are invoked, Vestar must give Cabot
30 days' advance written notice and, at the request of Cabot must discuss the
possibility of Cabot, in lieu of the third party, acquiring such Aearo Common
Stock, provided that this provision does not obligate Cabot to purchase such
Aearo Common Stock or Vestar to sell such Aearo Common Stock either to Cabot or
to the third party.

OTHER VOTING MATTERS. So long as the drag-along rights are in effect, the
parties to the Stockholders' Agreement are obligated to vote all shares of Aearo
Common Stock owned or controlled by them to ratify, approve and adopt the
following actions to the extent that they are adopted and approved by the Board
of Directors: (i) any merger or consolidation involving the Company that is, in
substance, an acquisition of another company by the Company or a sale of the
Company and in either case does not affect in any way the relative rights of
Cabot and Vestar or result in any benefit to Vestar other than the benefits to
it as a stockholder of the Company equal to the benefits received by other
stockholders, share for share, and (ii) any amendment to the certificate of
incorporation of the Company whereby such amendment does not adversely affect
such stockholder in a manner different from that in which any other stockholder
is affected. In addition, so long as the voting agreements providing for the
election of directors remain in effect, the parties to the Stockholders'
Agreement agreed not to vote to approve, ratify or adopt any amendment to the
by-laws of the Company unless such amendment is expressly authorized by the
Stockholders' Agreement or recommended by the Board of Directors.

TRANSFERS OF COMMON STOCK. Subject to certain limitations, transfers of Aearo
Common Stock and Aearo Preferred Stock by parties to the Stockholders' Agreement
are restricted unless the transferee agrees to become a party to, and be bound
by, the Stockholders' Agreement, provided that such restrictions do not apply to
sales in a public offering or pursuant to Rule 144. In addition, subject to
certain limitations, Cabot and the Management investors agreed not to transfer
their shares of Aearo Common Stock or Aearo Preferred Stock without the prior
written consent of Vestar. Under certain circumstances, the transfer of Aearo
Common Stock or Aearo Preferred Stock by Vestar, Cabot and their affiliates is
permitted.

PARTICIPATION RIGHTS. Under certain circumstances, if Aearo proposes to issue
any capital stock to Vestar, Cabot or any of their respective affiliates, each
other stockholder shall have the opportunity to purchase such capital stock on a
pro rata basis.

APPROVAL OF AFFILIATE TRANSACTIONS. The Stockholders' Agreement provides that
the Company shall not, and shall cause its subsidiaries not to, enter into any
transaction with any affiliate of the Company unless such transaction (i) is on
fair and reasonable terms no less favorable to the Company or such subsidiary
than it could obtain in a comparable arm's length transaction, (ii) is
contemplated by the Stockholders' Agreement, the Asset Transfer Agreement or the
management advisory agreement among the Company and Vestar and Cabot or (iii) is
for the payment of reasonable and customary regular fees to outside directors.
In no event will the Company issue Aearo Common Stock or other equity securities
to Vestar or Cabot or any affiliate of the Company, subject to certain
limitations, below the fair market value of such shares of Aearo Common Stock or
equity securities.

REGISTRATION RIGHTS. The Stockholders' Agreement provides that, subject to
certain limitations, upon a written request by Vestar or a written request by
Cabot (but only in the event that a period of one year or more has elapsed since
a public offering of Aearo Common Stock without Cabot having an opportunity to
participate), the Company will use its best efforts to effect the registration
of all or part of the Aearo Common Stock owned by such requesting stockholder,
provided that (i) the Company will not be required to effect more than one
registration within any 360 day period and (ii) neither Vestar nor Cabot will be
entitled to request more than two registrations. Under certain circumstances, if
the Company proposes to register shares of Aearo Common Stock, it will, upon the
written request of any stockholder, use all reasonable efforts to effect the
registration of such stockholders' Aearo Common Stock.

TERMINATION. The Stockholders' Agreement will terminate as to any Aearo Common
Stock or Aearo Preferred Stock, subject to certain limitations, on the date such
Aearo Common Stock is sold in a public offering or


                                       57
<PAGE>   61
pursuant to Rule 144. The rights of Vestar will terminate under the
Stockholders' Agreement when Vestar and its affiliates own no Aearo Common
Stock, common stock equivalents or Aearo Preferred Stock. The rights of Cabot
under the Stockholders' Agreement will terminate on the earliest date when Cabot
or its affiliates own no Aearo Common Stock, common stock equivalents or Aearo
Preferred Stock.

MANAGEMENT ADVISORY AGREEMENT. In connection with the Formation Acquisition, the
Company became a party to a management advisory agreement with Vestar and Cabot
(the "Management Advisory Agreement"), pursuant to which the Company is
obligated to pay an annual management fee in an aggregate amount with respect to
each fiscal year equal to the greater of (i) $400,000 and (ii) 1.25% of the
consolidated net income of the Company before cash interest, taxes, depreciation
and amortization for such fiscal year to be shared by Cabot and Vestar based on
their relative equity ownership of the Company. Pursuant to the Management
Advisory Agreement, each of Vestar and Cabot received $434,126 (including a
$19,456 reduction to each party as an advisory fee adjustment for fiscal 1997)
with respect to fiscal 1998, $311,949 (including $55,975 to each party as an
advisory fee adjustment relative to fiscal 1996) with respect to fiscal 1997,
and $200,000 to each party with respect to fiscal 1996. Messrs. Alpert,
O'Connell and Nagle, three of the directors of the Company, are affiliated with
Vestar in the capacities described under Item 11, "Management -- Directors and
Executive Officers" and, accordingly, benefit from any payments received by
Vestar. Mr. Rothberg and Ms. Hanratty, two of the directors for the Company, are
affiliated with Cabot in the capacities described under Item 11, "Management --
Directors and Executive Officers" and, accordingly, benefit indirectly from any
payments received by Cabot.

MANAGEMENT LOANS. The Company has made available to certain Management Investors
loans in order to provide such Management Investors with funds to be applied to
a portion of the purchase price of the Common Stock purchased by such Management
Investors under the Stock Purchase Plan. Such loans (i) are secured by the Aearo
Common Stock purchased with the proceeds thereof, (ii) have a term of between 5
and 10 years, (iii) bear interest at an annual rate of 7%, and (iv) are subject
to mandatory prepayment in the event the employment of such Management Investor
terminates. At September 30, 1998, amounts outstanding under such loans to
Messrs. McLain, Kapur, Marlette, Floyd, Carey, O'Connor, Mallitz, Hall, and
Phillips were $607,500, $150,000, $150,000, $150,000, $100,000, $81,000,
$85,305, $75,867 and $75,000, respectively.


                                       58
<PAGE>   62

                                     PART IV

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)  Exhibits

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                          DESCRIPTION
-------                                         -----------
<S>              <C>
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.)                                                                 
</TABLE>


                                       59
<PAGE>   63
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                          DESCRIPTION
-------                                         -----------
<S>              <C>
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 
</TABLE>


                                       60
<PAGE>   64
<TABLE>
<S>              <C>
                 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.                                      
</TABLE>


                                       61
<PAGE>   65
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                          DESCRIPTION
-------                                         -----------
<S>              <C>
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
</TABLE>


                                       62
<PAGE>   66
<TABLE>
<S>              <C>
                 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 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 
</TABLE>


                                       63
<PAGE>   67
<TABLE>
<S>              <C>
                 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 l, 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 l, 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 l, 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 South- bridge,        
                 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.
</TABLE>


                                       64
<PAGE>   68
<TABLE>
<S>              <C>
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.

10.27**   --     Aearo Corporation 1997 Stock Option Plan.

12.1**    --     Statements re: Computation of Ratios.

21.1*     --     List of Subsidiaries.

24.1**    --     Powers of Attorney (see page 68 of this report).

27.1**    --     Financial Data Schedule.
</TABLE>


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

* Incorporated by reference to the same numbered exhibit to the registration
statement on Form S-l, No. 333-05047, of Aearo Corporation (formerly, Cabot
Safety Holdings Corporation).

** Filed herewith.

(b) Financial Statement Schedules
    See next page.

(c) Reports on Form 8-K 

    On October 2, 1998, the Company filed a Current Report on Form 8-K 
    containing its press release regarding certain restructuring charges.

    On October 22, 1998, the Company filed a Current Report on Form 8-K 
    containing its press release regarding settlement of the Gargoyles 
    litigation.




                                       65
<PAGE>   69
                                   SCHEDULE I

                                AEARO CORPORATION

                    VALUATION AND QUALIFYING ACCOUNTS For the
                 years ended September 30, 1996, 1997, and 1998
                             (Dollars in thousands)

<TABLE>
<CAPTION>
                                                                    Additions             
                                                             ----------------------         Net
                                                Balance at   Provisions    Charged       Deductions     Balance
                                                beginning    Charged to    to Other         From        at end
                                                of Period    Operations    Accounts      Allowances    of Period
<S>                                             <C>          <C>           <C>           <C>           <C>
Year ended September 30, 1996
       Bad Debt Reserve                           1,221           620        186 A          (827)        1,200
       Sales Returns & Allowances Reserve             0         1,519                                    1,519
                                                                                                     
Year ended September 30, 1997                                                                        
       Bad Debt Reserve                           1,200           622        100 B          (621)        1,301
       Sales Returns & Allowances Reserve         1,519           203                       (838)          884
                                                                                                     
Year ended September 30, 1998                                                                        
       Bad Debt Reserve                           1,301           497          0            (559)        1,239
       Sales Returns & Allowances Reserve           884             0          0            (285)          599
       Restructure Reserve                            0        11,585          0          (8,595)        2,990
</TABLE>
   NOTES:
            A.   Acquisition date balance at acquired companies.
            B.   Accrued liabilities.


                                       66
<PAGE>   70
                                   SIGNATURES

         Pursuant to the requirements of Section 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.

                            Aearo Corporation


Date:  December 29, 1998           By: /s/ Michael A. McLain               
                                       -----------------------------------------
                                           Michael A. McLain  
                                           President and Chief Executive Officer

                                POWER OF ATTORNEY

         KNOW ALL MEN BY THESE PRESENTS, that we, the undersigned officers and
directors of Aearo Corporation hereby severally constitute Michael A. McLain 
and Bryan J. Carey, and each of them singly, our true and lawful attorney with
full power to him to sign for us and in our names in the capacities indicated
below, the Annual Report on Form 10-K filed herewith and any and all amendments
to said Annual Report on Form 10-K, and generally to do all such things in our
names and in our capacities as officers and directors to enable Aearo
Corporation to comply with the provisions of the Securities Exchange Act of
1934, and all requirements of the Securities and Exchange Commission, hereby
ratifying and confirming our signatures as they may be signed by our said
attorney, to said Annual Report on Form 10-K and any and all amendments thereto.

         Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.


Date: December 29, 1998                    /s/ Michael A. McLain  
                                           ------------------------------------
                                           Michael A. McLain
                                           President, Chief Executive Officer 
                                           and Director
                                           (Principal Executive Officer)

Date: December 29, 1998                    /s/ Bryan J. Carey
                                           ------------------------------------
                                           Bryan J. Carey
                                           Vice President, Chief Financial 
                                           Officer, Treasurer and Assistant 
                                           Secretary (Principal Accounting 
                                           Officer)

Date: December 29, 1998                    /s/ John D. Curtin, Jr.
                                           ------------------------------------
                                           John D. Curtin, Jr., Director

Date: December __, 1998                    
                                           ------------------------------------
                                           Norman W. Alpert, Director


                                       67
<PAGE>   71
Date: December 29, 1998                    /s/ Robert Rothberg               
                                           ------------------------------------
                                           Robert Rothberg, Director

Date: December 29, 1998                    /s/ Margaret J. Hanratty          
                                           ------------------------------------
                                           Margaret J. Hanratty, Director

Date: December __, 1998                    
                                           ------------------------------------
                                           Arthur J. Nagle, Director


Date: December __, 1998                    
                                           ------------------------------------
                                           Daniel S. O'Connell, Director


Date: December __, 1998                    
                                           ------------------------------------
                                           William Kassling, Director


Date: December 29, 1998                    /s/ Bryan Marsal          
                                           ------------------------------------
                                           Bryan Marsal, Director


                                       68
<PAGE>   72
         SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO
SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES
PURSUANT TO SECTION 12 OF THE ACT

         No annual report or proxy material relating to the Registrant's fiscal
year ended September 30, 1998 has been sent to security holders of the
Registrant.


                                       69
<PAGE>   73
                                INDEX OF EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                            DESCRIPTION
-------                                           -----------
<S>                <C>
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 
</TABLE>


                                       70
<PAGE>   74
<TABLE>
<S>                <C>
                   (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.)                                                                 
</TABLE>


                                       71
<PAGE>   75
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                            DESCRIPTION
-------                                           -----------
<S>                <C>
2.11        --     Assumption Agreement, dated as of July 11, 1995, by Aearo Corporation (formerly,   
                   CabotSafety 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 
</TABLE>


                                       72
<PAGE>   76
<TABLE>
<S>                <C>
                   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           
                   SafetyCorporation), 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.                                      
</TABLE>


                                       73
<PAGE>   77
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                                            DESCRIPTION
-------                                           -----------
<S>                <C>
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 
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                   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 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 
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                   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 l, 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 l, 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 l, 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 South- bridge,        
                   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.                                                                           
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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.

10.27**     --     Aearo Corporation 1997 Stock Option Plan.

12.1**      --     Statements re: Computation of Ratios.

21.1*       --     List of Subsidiaries.

24.1**      --     Powers of Attorney (see page 68 of this report).

27.1**      --     Financial Data Schedule.
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----------------

* Incorporated by reference to the same numbered exhibit to the registration
statement on Form S-l, No. 333-05047, of Aearo Corporation (formerly, Cabot
Safety Holdings Corporation).

** Filed herewith.


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