ITEM 1. BUSINESS
COMPANY INTRODUCTION
We are a leading global provider of thermal management solutions for electronic products and the leading developer and marketer of computational fluid dynamics ("CFD") software. We design, manufacture and distribute on a worldwide basis thermal management products that dissipate unwanted heat, which can degrade system performance and reliability, from microprocessors and industrial electronics products. Our products, which include heat sinks, heat pipes, interface materials and attachment accessories, fans, heat spreaders and liquid cooling and phase change devices that we configure to meet customer-specific needs, serve the critical function of conducting, convecting and radiating away unwanted heat. CFD software is used for complex computer modeling of fluid flows, heat and mass transfer and chemical reactions. Our CFD software is used in a variety of industries, including the automotive, aerospace, chemical processing, power generation, material processing, electronics and HVAC industries.
Our thermal management products are used in a wide variety of computer and networking and industrial electronics applications, including computer systems (desktops, laptops, disk drives, printers and peripheral cards), network devices (servers, routers, set top boxes and local area networks), telecommunications equipment (wireless base stations, satellite stations and PBXs), instrumentation (semiconductor test equipment, medical equipment and power supplies), transportation and motor drives (braking and traction systems) and consumer electronics (stereo systems and video games). Our CFD software is used for a wide variety of computer-based analyses, including the design of electronic components and systems, automotive design, combustion systems modeling and process plant troubleshooting. We have longstanding relationships with a highly diversified base of more than 3,500 national and international customers, including original equipment manufacturers (commonly referred to as OEMs), electronics distributors and contract manufacturers. Our customers include 3M, Arrow, Agilent Technologies, Bombardier, Boeing, Cisco Systems, Compaq Computer, Dell, Dow Chemical, Ericsson, Flextronics, Ford, Fujitsu, Gateway, General Electric, General Motors, Hewlett-Packard, IBM, Intel, Lockheed Martin, Lucent, Motorola, NASA, Nortel, Rockwell Automation, Rolls Royce, Sanmina-SCI, Siemens, Solectron and Sun Microsystems.
On February 2, 2000 we were acquired in a merger ("Merger") with Heat Holdings Corp., a corporation newly formed by Willis Stein & Partners II, L.P. (together with affiliated funds, "Willis Stein") and other investors (the "Purchaser"). Pursuant to the Merger, Aavid stockholders received $25.50 in cash for each outstanding share of common stock. In addition, all outstanding stock options and warrants were cashed out. The Merger was accounted for using the purchase method. In connection with the Merger, we consolidated our business into two operating segments: Aavid Thermalloy LLC, which designs, manufacturers and distributes thermal management products that dissipate unwanted heat from microprocessors and industrial electronics products, and includes Applied Thermal Technologies, Inc.'s thermal design, validation and consulting services; and Fluent, which develops and markets CFD software.
INDUSTRY OVERVIEW
THERMAL MANAGEMENT
In today's electronic environment, microprocessors and their associated power supplies, hard drives, advanced video chips and other peripheral devices draw large amounts of power and, consequently, must dissipate a significant amount of heat. The same heat generation occurs in semiconductors and integrated circuits in motor controls, telecommunications switches and other electronics. Because these electronic components can only operate efficiently in narrow temperature bands, heat is an absolute constraint in electronic system design. The excessive heat generated within a component not only degrades semiconductor and system performance and reliability, but can also cause semiconductor and system failure.
Increasingly, neither externally generated off-the-shelf thermal management products nor internally designed and produced parts have been able to effectively address the expanding complexity of thermal management problems resulting from the increasing amount of heat required to be dissipated by electronic products. The complexity of thermal management problems has been intensified by reductions in system size, shorter time-to-market, shorter product life cycles and more demanding operating environments. These factors have led to the development and growth of the thermal management industry.
We believe that future growth of the thermal management products market will be driven by the following factors:
- Inherent unit growth in end-user products, such as desktop computers, laptops and telecommunications equipment. In particular, the volume of microprocessors and support chip units is increasing on an absolute and on a per product basis.
- The wider use of electronic controls in numerous areas due to the general increase in automation.
- The increasing use of microprocessors in industrial electronics applications, fueling the need for thermal management products to manage the different operating temperature characteristics of these devices.
- The increased need for reliable power supplies. The quality of power can be adversely affected by thermal overload arising from ineffective thermal management. This is becoming increasingly important within the industrial, computer and telecommunications sectors where "irregular" power surges can damage equipment and cause productivity loss.
- The complexity of thermal management problems, which has been intensified by the increasing amount of heat to be dissipated, reductions in system size, shorter time-to-market product cycles and more demanding temperature operating environments.
COMPUTATIONAL FLUID DYNAMICS SOFTWARE
CFD software is used in a wide range of industries for complex computer-based analysis of engineering designs involving fluid flows, heat and mass transfer, chemical reaction and other fluid flow phenomena. CFD software tools allow the analysis and evaluation of design modifications without the physical prototyping of each design modification, thereby reducing engineering cost, improving product performance and decreasing time-to-market for new products. Specific uses of CFD-based flow analysis include the design of electronic components and systems, automotive design, combustion systems modeling and process plant troubleshooting.
The CFD software market, which has been growing rapidly over the past decade, continued to grow in 2002, although at a reduced rate. We believe that, through Fluent, we have approximately 35% of the developed market for CFD software applications.
We expect that future growth of the CFD software market will be driven by the following factors:
- The ability of customers using CFD software to reduce their product development costs, minimize time-to-market for their new products and improve product performance.
- The ability to analyze fluid flows is becoming increasingly important across a wide range of industries.
- The development of more powerful and affordable computers that are capable of running CFD software.
- The growing trend among customers to improve the engineering efficiency of product development and improvement through computer-aided analysis and design.
- Expansion of the traditional user base for CFD software beyond Ph.D.-level engineers in corporate research and development centers to the larger base of design engineers.
COMPETITIVE STRENGTHS
We believe that the following competitive strengths have enabled us to become a worldwide leader in both the thermal management market and the CFD software market.
TOTAL INTEGRATED SOLUTIONS PROVIDER
The increasing complexity of heat dissipation problems and the growing trend among manufacturers to outsource development of thermal management solutions has stimulated demand for total integrated solutions. We provide total integrated solutions by analyzing customers' thermal management problems at the device-, board- and system-level, designing, simulating and prototyping thermal management solutions and manufacturing, distributing and supporting these solutions worldwide.
VALUE-ADDED PARTNERING WITH OUR CUSTOMERS
We work closely with our customers to develop customized thermal management solutions. We believe that our close relationships with customers and their design and development teams, as well as our worldwide manufacturing capabilities, allow us to anticipate customers' needs and, through our engineering expertise and experience, provide quality product solutions more quickly than our competitors.
WORLDWIDE LOW COST MANUFACTURER
We have manufacturing operations in the United States, Canada, Mexico, Europe and Asia, including China. As an increasing number of electronics systems are being manufactured outside the United States, our low cost foreign manufacturing operations enable us to supply products directly to our customers at their geographically dispersed manufacturing locations.
LEADERSHIP IN CFD SOFTWARE
We believe that we are the technology leader in CFD software. As a result of our technological leadership, we develop software that enables our customers to generate the increasingly complex computer models they demand for more cost-efficient product design. This factor, as well as the relative ease-of-use and predictive accuracy of our CFD software, are of primary importance to our customers.
RECURRING REVENUES FROM SOFTWARE BUSINESS
Our CFD software business is characterized by high customer retention and recurring revenues. In recent years, approximately 80% of our annual software license revenue was renewed in the following year. This is driven by the significant value added by our CFD software to the design process and the high cost of switching to a competitor's software.
EXPERIENCED MANAGEMENT TEAM
Our senior management team has extensive operating and marketing experience in the thermal management and CFD software markets. This management team has grown our business, both organically and through strategic acquisitions, and has been responsible for improving operating efficiencies. Bharatan R. Patel, our chief executive officer who founded our CFD software business, has 29 years of experience in the area of fluid flows and thermal management and H. Ferit Boysan, president of our CFD software business, has 22 years of experience in the area of fluid flows and CFD software.
BUSINESS STRATEGY
Our business strategy is to continue to be a market leader in both the thermal management and CFD software markets. We intend to continue this business strategy and strengthen our competitive position through the following initiatives:
CAPITALIZE ON THERMAL MANAGEMENT INDUSTRY GROWTH
Despite current economic conditions, we believe that our existing thermal management markets will continue to experience growth in the long term. Growth will be driven by the need to dissipate the increasing amount of heat being generated by electronic products, as well as unit growth in these products. We believe our competitive strengths position us to capitalize on these growth trends.
TAKE ADVANTAGE OF OUTSOURCING TREND
The increasing complexity of heat dissipation problems is driving a trend among manufacturers to outsource the development of thermal management solutions to companies with high levels of expertise in solving these problems. We intend to capitalize on this trend by leveraging our technical expertise in designing thermal management products and through continuing to partner with our customers in creating customized solutions.
EXPAND OUR ADDRESSED THERMAL MANAGEMENT MARKET
We believe we have significant opportunities to expand the portion of the outsourced thermal management market that we address. Our strategy is to expand into the part of the outsourced thermal management market that we do not currently serve by entering into new geographic markets and introducing new products that complement our existing product offerings.
ACCELERATE GROWTH IN COMPUTATIONAL FLUID DYNAMICS SOFTWARE MARKET
Growth in the CFD software market will be driven by customers' needs to reduce product development costs, minimize the time-to-market for their new products and improve product performance, as well as by increasing applications for CFD software. We intend to grow our CFD software business through internal product development and possibly strategic acquisitions to leverage our core technological competence in the development of computerized design and simulation software. Our goal is to further expand this market beyond its traditional user base of Ph.D.-level engineers in corporate research and development centers to the larger base of design engineers by providing them relatively easy-to-use industry-specific software.
PROVIDE TOTAL THERMAL MANAGEMENT SOLUTIONS ON A GLOBAL BASIS
We intend to continue capitalizing on our state-of-the-art worldwide manufacturing capabilities and to further leverage our expertise and technology to offer our customers a complete global solution to their thermal management problems. The increasing number of electronics systems manufactured outside of the United States has forced many electronics manufacturers to seek a highly integrated, worldwide provider of thermal solutions. We plan to continue to expand our quick-ramp, high-volume manufacturing and our design, sales and distribution activities globally as our customers continue to expand their operations overseas.
LEVERAGE OUR TECHNOLOGICAL LEADERSHIP
Our approximately 175 Ph.D.s and 270 engineers focus on new technology initiatives as well as developing new and enhancing existing products, processes and materials to address the evolving needs of our customers. We seek to enhance our internal research and development activities through collaborations with our customers and third parties in order to gain access to, or to pursue the development of, new technologies for thermal management applications and CFD software.
MARKETS AND CUSTOMERS
We sell our thermal management products and services to a highly-diversified base of customers across a wide range of industries and applications. We currently sell our thermal management products and services to over 2,500 customers. The following chart shows our largest customers for thermal management products and services by market sector:
No customer represented more than 10% of our thermal management net sales during 2002, 2001 or 2000.
We currently have more than 2,000 licensees of our CFD software. License revenue is diversified by market sector and geographical market. The following chart shows our largest customers for CFD software applications by market sector:
THERMAL MANAGEMENT PRODUCTS AND SERVICES
We provide total integrated solutions to our thermal management customers. We have the thermal design know-how to first analyze customers' thermal management problems at the device-, board- and system-level, to then design, simulate and prototype thermal management solutions and to finally manufacture, distribute and support these solutions around the world.
We design, manufacture and sell both standard and customized thermal management products. We seek to become a strategic supplier to our customers and to differentiate ourselves from our competitors by offering a higher level of service. We currently offer heat sinks, interface materials and attachment accessories, fans, heat spreaders and liquid cooling and phase change devices that we configure to meet customer-specific needs. The prices for our thermal management products (including attachment devices and interface materials), depend primarily on cost, the technology used to make the part and its value in the customer's application. Because of the continued shrinking time-to-market for most new products and the corresponding contraction of design cycles, we also offer simulation and modeling software and hardware prototyping to assist our customers in handling the complexity of the design of a thermal solution.
The following is a brief description of our thermal management products and services:
COMPUTATIONAL FLUID DYNAMICS SOFTWARE PRODUCTS
We are the leading provider of general purpose CFD software used to predict fluid flow, heat and mass transfer, chemical reaction and related phenomena. We provide CFD-based flow analysis software and consulting services that are used by engineers in corporations worldwide for the design and analysis of products and processes. Our software and services help engineers reduce engineering and product development costs, improve product performance and reduce time-to-market for new products.
We currently license our software products to more than 2,000 licensees worldwide. In North America, we typically license our software products under one year, renewable agreements. In Europe and the Far East, a significant portion of our CFD software sales are derived from licenses of this software for one-time fees; in such situations, we also typically receive annual maintenance and support fees.
We have also introduced CFD-based industry-specific products, such as Icepak, for use by designers and engineers in the electronics cooling industry, Airpak, for use by designers and engineers in the HVAC industry and Mixsim, for use by designers and engineers in the chemical mixing industry. We believe that our relatively easy-to-use, industry-specific products are expanding the CFD total market beyond its traditional user base of Ph.D.-level engineers in corporate research and development centers to the larger base of design engineers.
We also market engineering consulting services. With over 15 years of CFD and engineering consulting experience, our worldwide team of CFD professionals supports clients with senior engineering consultants, experienced CFD analysts, leading CFD software developers and mesh generation experts. Support services include expertise in the physics of heat, fluid flow and related phenomena, in CFD modeling and analysis, and in selection of engineering design solutions. In addition to providing CFD software expertise and access to high-performance computing systems, our CFD software consulting group works under contract to develop software with specific features required by individual clients.
We provide a complete suite of CFD software products, with each product designed for a specific task or for optimal performance on a specific class of problems. The following is a brief description of our CFD software products:
SALES AND SUPPORT
We sell our thermal management products and CFD software primarily through a global network of direct sales personnel, manufacturers' representatives, agents and a network of independent distributors. We provide support services to our customers, particularly in the CFD software area where we believe that high-quality support service is critical to the success of the CFD software business. Aavid Thermalloy (including Applied Thermal Technologies) and Fluent both have their own sales, support and marketing personnel, all of whom cross-sell each other's products and services where appropriate. We currently employ approximately 325 sales, support and marketing personnel.
TECHNOLOGY
We believe that technology leadership is essential to our growth strategy and have focused our approximately 175 Ph.D.s and 270 engineers on the development of technology in two areas:
THERMAL MANAGEMENT TECHNOLOGY
We believe that we are a technology leader in thermal management due to our extensive design expertise, technical manufacturing capabilities and process technology. We intend to develop new technologies and to enhance existing technologies in order to meet our customers' needs for higher performance products on a timely basis.
We have developed proprietary software tools (analytical models) which enable fast approximation answers for a large class of thermal management problems which, in turn, permits quicker design and prototyping of thermal solutions. We have extensive prototyping capabilities and state-of-the-art thermal laboratory facilities, including a wind tunnel which allows us to test and validate the design of thermal solutions.
As part of Aavid Thermalloy, Applied Thermal Technologies leverages Aavid Thermalloy's capabilities and Icepak's technology to assist customers in analyzing their thermal problems at the device-, board- and system-levels and to efficiently design, simulate and prototype thermal management solutions. By entering into the customer relationship at the onset of the product design cycle, Applied Thermal Technologies greatly enhances our knowledge of future industry trends, including technology development and acceptance. Additionally, Applied Thermal Technologies provides a smooth transition from design and validation to outsourced manufacturing with Aavid Thermalloy.
COMPUTATIONAL FLUID DYNAMIC SOFTWARE TECHNOLOGY
We believe that we are the technology leader in CFD software. Fluent's CFD software includes:
- automatic unstructured mesh generation, which allows the automatic creation of meshes,
- numerical algorithms for the accurate solution of fluid flow equations on structured and unstructured meshes,
- solution adaptive mesh which allows for interactive mesh refinement to provide improved solution accuracy,
- state-of-the-art physical models for important fluid flow phenomena such as turbulence, turbulence-chemistry interactions, free surface flows and multiphase flows,
- algorithms for efficient execution on multi-processor computers and distributed computer networks,
- interactive client/server architecture with a flexible and customizable user interface, and
- post-processing and data analysis tools.
PRODUCT DEVELOPMENT
Our thermal management product development activities are focused on lowering production costs, improving thermal characteristics and ease of attachment of conventional heat sinks, and developing new thermal management products and technologies to address the emerging and anticipated thermal management problems of our customers. We are developing new products, both internally as well as through collaborative efforts with third parties. These development efforts are directed toward: heat sink characterization and optimization; fan designs; air flow management; boundary layer optimization and focused flow; re-circulating passive and active cooling systems including heat pipes; thermoelectric coolers, which use electricity to create a temperature difference across an interface between the electronic device and a heat sink; liquid and sub-ambient cooling systems; tab and surface mount heat sink attachment methods; and highly thermally conductive adhesive and interface systems.
Our CFD product development activities are focused on enhancing the capabilities of its solvers, implementing new physical models to increase the range of applications and developing front-end user interfaces that are easy to use for engineers in specific industries. We are also focusing on various application and industry-specific CFD software projects which we believe will enable us to penetrate the design engineering market.
SUPPLIERS
We purchase raw aluminum, aluminum extrusion, aluminum coil and various components from a limited number of outside sources. We purchase substantially all of our aluminum coil stock from a single supplier. We believe that purchasing aluminum extrusion and coil stock from a limited number of suppliers is necessary to obtain lower prices and to consistently achieve the tolerances and design and delivery flexibility that we require.
For raw aluminum extrusion and coil stock, we typically make a purchasing commitment to a key supplier of up to 24 months. In return, this supplier commits to maintaining local inventory and to reserving run-time on critical machines. The cost of aluminum extrusion is generally negotiated annually, with the price adjusted monthly, based upon the changes in the price of aluminum ingot, which has historically been highly cyclical.
COMPETITION
Our thermal management products business competes with a number of major providers of thermal management products throughout the world. In addition, there are a large number of smaller heat sink companies, as well as hundreds of machine shops, that fabricate heat sinks, usually under subcontract with an OEM customer. Further, some aluminum die casters offer cast heat sinks, and a number of aluminum extruders sell heat sink products and fabrication capability, including aluminum extruders serving the automotive industry and the power conversion market.
Fluent currently competes with a number of privately held companies, primarily on the basis of product performance. To the extent that Fluent expands into additional application and industry-specific markets, it will encounter additional competition from software companies already serving such specific markets. In addition, certain CFD software is available in the public domain.
BACKLOG AND LICENSE RENEWAL
Our hardware products typically are produced and shipped within 30 days of the receipt of orders and, accordingly, we operate with little backlog. As a result, net sales in any quarter generally are dependent on orders booked and shipped in that quarter. All orders are subject to cancellation or rescheduling by customers. Because of our quick turn of orders to shipments, the timing of orders, delivery intervals, customer and product mix and the possibility of customer changes in delivery schedules, we do not believe our backlog at a particular date is a reliable indicator of actual sales for any succeeding period.
Our software products are typically sold under annual license agreements or with annual maintenance agreements. In recent years, approximately 80% of our annual software license revenue was renewed in the following year.
EMPLOYEES
As of December 31, 2002, we had a total of 1,834 employees including approximately 400 contract employees in China. Except for the employees in our manufacturing facility in Mexico, none of our employees are represented by labor unions or collective bargaining units. We believe that our relationship with our employees is good.
RISK FACTORS
This Annual Report on Form 10-K contains certain 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. All statements regarding our expected future financial position, results of operations, cash flows, financing plans, business strategy, competitive position, plans and objectives and words such as "anticipate," "believe," "estimate," "expect," "intend," "plan" and other similar expressions are forward-looking statements. Such forward looking statements are inherently uncertain, and holders of our securities must recognize that actual results could differ materially from those projected or contemplated in the forward-looking statements as a result of a variety of factors, including the factors set forth below. Holders of our securities should not place undue reliance on these forward-looking statements.
The forward-looking statements speak only as of the date on which they are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, we cannot assess the effect of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
RISKS RELATING TO OUR BUSINESS
WE MAY NOT BE ABLE TO EFFECTIVELY MANAGE OUR INTERNAL GROWTH.
We intend to increase our thermal products and software businesses overseas, expand the products and services we offer, and possibly make selective acquisitions as the economy improves. This growth and expansion may place a significant strain on our production, technical, financial and other management resources. To manage any growth effectively, we must maintain a high level of manufacturing quality, efficiency, delivery and performance and must continue to enhance our operational, financial and management systems, and attract, train, motivate and manage our employees. We may not be able to effectively manage this expansion, and any failure to do so could have a material adverse effect on our business and financial condition.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.
Our quarterly and annual operating results are affected by a wide variety of factors, many of which are outside our control, that have in the past and could in the future materially and adversely affect our net sales, gross margins and profitability. These factors include:
- the volume and timing of orders received;
- competitive pricing pressures;
- the availability and cost of raw materials;
- changes in the mix of products and services sold;
- potential cancellation or rescheduling of orders;
- general economic conditions;
- changes in the level of customer inventories of our products;
- the timing of new product and manufacturing process technology introductions by us or our competitors;
- the availability of manufacturing capacity; and
- market acceptance of new or enhanced products introduced by us.
Additionally, our growth and results of operations have in the past been, are currently being and would in the future be, adversely affected by downturns in the semiconductor or electronics industries. Our ability to reduce costs quickly in response to revenue shortfalls is limited, and this limitation will be exacerbated to the extent we continue to add additional manufacturing capacity. The need for continued investment in research and development could also limit our ability to reduce expenses accordingly. As a result of these factors, we expect our operating results to continue to fluctuate. Results of operations in any one quarter should not be considered indicative of results to be expected for any future period, and fluctuations in operating results may also cause fluctuations in the market price of the senior subordinated notes. We cannot provide assurance that the overall thermal management market, the segments of the market served by us or we will continue to grow in the future. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."
OUR BUSINESS IS DEPENDENT ON THE SEMICONDUCTOR MARKET.
A significant portion of our net sales has been, and is expected to continue to be, dependent upon sales of thermal management products for industrial electronics applications, consisting primarily of integrated circuits and for computer and networking applications, consisting primarily of microprocessors and related chip sets. The thermal management market for computer and networking applications is characterized by rapid technological change, short product life cycles, greater pricing pressure and increasing foreign and domestic competition as compared to the thermal management market for industrial electronics applications.
Future growth will, to a significant extent, depend upon increased demand for semiconductor devices and products that require thermal solutions. The semiconductor industry (both computer and networking and industrial) has historically been cyclical and subject to significant economic downturns characterized by diminished product demand and eroding average selling prices. A decrease in demand for semiconductor products would reduce demand for our products and have an adverse impact on our results of operations. Further, semiconductor manufacturers and their customers, in developing and designing new products, typically seek to eliminate or minimize thermal problems, and such efforts could have the effect of reducing or eliminating demand for certain of our products. Additionally, we believe that many of our OEM customers compete in intensely competitive markets characterized by declining prices and low margins. These OEMs apply continued pricing pressure on their component suppliers, including us. We cannot provide assurance that we will not be adversely affected by cyclical conditions in the semiconductor and electronics industries.
The semiconductor industry continues to be in an economic slump and demand for industrial and consumer electronics contracted significantly during 2001 and 2002. This situation adversely affected our results of operation for 2001 and 2002, and will likely adversely affect our results of operation into at least the second half of 2003.
CHANGES IN THE AVAILABILITY OR PRICE OF ALUMINUM CAN SIGNIFICANTLY AFFECT OUR BUSINESS AND RESULTS OF OPERATIONS.
Aluminum is the principal raw material used in our products and represents a significant portion of our cost of goods sold. We purchase raw aluminum, aluminum extrusion, aluminum coil and various components from a limited number of outside sources. During the years ended December 31, 2002, 2001 and 2000, we purchased a significant portion of our aluminum coil stock from a single supplier. We believe that purchasing aluminum extrusion and coil stock from a limited number of suppliers is necessary in order to obtain lower prices and to achieve, consistently, the tolerances and design and delivery flexibility that we require. If the available supply of aluminum declines, or if one or more of our current suppliers is unable for any reason to meet our requirements, is acquired by a competitor or determines to compete with us, we could experience cost increases, a deterioration of service from our suppliers, or interruptions, delays or a reduction in raw material supply that may cause us to fail to meet delivery schedules to customers. Although we believe that viable alternate suppliers exist for the aluminum coil stock and components, any unanticipated interruption of supply would have a short-term material adverse effect on us.
In addition, our ability to pass price increases for aluminum or other raw materials along to our customers may be limited by competitive pressures, customer resistance and price adjustment limitations in our product purchase contracts with our customers. Even if we are able to pass along all or a portion of raw material price increases, there is typically a lag of three to twelve months between the actual cost increase of raw material and the corresponding increase in the prices of our products. We cannot provide assurance that in the future we will be able to recover increased aluminum or other raw material costs through higher prices to our customers. Market prices for raw aluminum, which have historically been cyclical and highly volatile, have a significant effect on our gross margin. An increase in the market price for aluminum could have a material adverse effect upon our results of operations and business. See "Our operating results may fluctuate significantly."
WE SUPPLY PRODUCTS AND SERVICES TO INDUSTRIES THAT EXPERIENCE RAPID TECHNOLOGICAL CHANGE, WHICH MAY MAKE OUR PRODUCTS OBSOLETE.
The markets for our products are characterized by rapidly changing technology, frequent new product introductions and enhancements and rapid product obsolescence. Our future success will be highly dependent upon our ability to continually enhance or develop new thermal and software products, materials, manufacturing processes and services in order to keep pace with the technological advancements of our customers and their corresponding increasingly complex thermal management and computational fluid dynamics software needs. We may not be able to identify new product trends or opportunities, develop and bring to market new products or respond effectively to new technological changes or product announcements by others, develop or obtain access to advanced materials, or achieve commercial acceptance of our products. In addition, other companies, including our customers, may develop products or technologies which render our products or technologies noncompetitive or obsolete.
WE FACE INTENSE COMPETITION, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO MAINTAIN OR INCREASE SALES OF OUR PRODUCTS.
The markets for thermal management products and computational fluid dynamics software are highly competitive. Certain of our competitors, which include divisions or subsidiaries of large companies, may have greater technical, financial, research and development and marketing resources than we do. Further, we expect that as the trend toward outsourcing continues, a number of new competitors may emerge, some of which may have greater technical, financial, research and development and marketing resources than we do. Our ability to compete successfully depends upon a number of factors, including price, customer acceptance of our products, cost effective high-volume manufacturing, proximity to customers, lead times, ease of installation of our products, new product and manufacturing process technology introductions by us and our competitors, access to new technologies and general market and economic conditions. We cannot provide assurance that we will be able to compete successfully in the future against existing or potential competitors, or that our operating results will not be adversely affected by increased price competition. In addition, our customers for thermal management and software products may manufacture or develop such products internally or actively support new entrants into our market rather than purchase thermal products from us. Further, many of our customers like to maintain dual sources for thermal management products.
OUR BUSINESS EXPERIENCES SEASONAL VARIATIONS.
Our CFD software business has experienced and is expected to continue to experience significant seasonality due to, among other things, the second and third quarter slowdown in software billings primarily due to the purchasing and budgeting patterns of Fluent's software customers. In addition, our thermal management business has experienced slight seasonal variations due to the slowdown during the third quarter's summer months which historically has occurred in the electronics industry. Typically, our billings are lowest during the second and third quarters of the fiscal year, which ends in December.
WE DEPEND ON KEY PERSONNEL AND SKILLED EMPLOYEES WHO MAY NOT REMAIN WITH US IN THE FUTURE.
Our success depends to a large extent upon the continued services of our senior management and technical personnel. Our business also depends upon our ability to retain skilled and semi-skilled employees. There is intense competition for qualified management and skilled and semi-skilled employees and our failure to recruit, train and retain such employees could adversely affect our business.
OUR INTERNATIONAL OPERATIONS EXPOSE US TO ADDITIONAL RISKS.
We currently have multiple international manufacturing locations to better service our customers, many of whom have moved their manufacturing operations and expanded their business overseas. International operations are subject to a number of risks, including:
- greater difficulties in controlling and administering business;
- less familiarity with business customs and practices;
- increased reliance on key local personnel;
- the imposition of tariffs and import and export controls;
- changes in governmental policies (including U.S. policy toward these countries);
- difficulties caused by language barriers;
- increased difficulty in collecting receivables;
- availability of, and time required for, the transportation of products to and from foreign countries;
- political instability;
- foreign currency fluctuations; and
- expropriation and nationalization.
The occurrence of any of these or other factors may have a material adverse effect on our results of operations and could have an adverse effect on our relationships with our customers. Furthermore, the occurrence of certain of these factors in countries in which we operate could result in the impairment or loss of our investment in such countries. The trend by our customers to move manufacturing operations and expand their business overseas may have an adverse impact on our sales of domestically manufactured products.
A part of our net sales is currently derived from products manufactured at our manufacturing facility in Guang Dong Province in The People's Republic of China. We commenced manufacturing at this facility in early 1998 and currently maintain 140,000 square feet of manufacturing space. We have limited experience in managing operations in China and, although we have focused significant management resources on this operation, we cannot provide assurance that this business will be successful. An inability to successfully manage this business or an interruption in the operations at this facility could have a material adverse effect on our overall financial performance until we are able to obtain substitute production capability with similar low operating costs. We have additional manufacturing facilities in North America and Europe.
WE MAY BE UNABLE TO PROTECT OUR PROPRIETARY TECHNOLOGY.
Our success depends in part on our proprietary technology. We attempt to protect our proprietary technology through patents, copyrights, trademarks, trade secrets and license agreements. We believe, however, that our success will depend to a greater extent upon innovation, technological expertise and distribution strength. We cannot provide assurance that we will be able to protect our technology, or that our competitors will not be able to develop similar technology independently. We cannot provide assurance that the claims allowed on any patents held by us will be sufficiently broad to protect our technology. In addition, no assurance can be given that any patents issued to us will not be challenged, invalidated or circumvented, or that the rights granted thereunder will provide competitive advantages to us. In addition, effective patent, copyright and trade secret protection may be unavailable or limited in certain foreign countries in which we conduct business. Although we believe that our products and technology do not infringe upon proprietary rights of others, there can be no assurance that third parties will not assert infringement claims in the future. Moreover, litigation may be necessary in the future to enforce our patents, copyrights and other intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our financial condition and results of operations.
WE ARE SUBJECT TO EXTENSIVE ENVIRONMENTAL AND OTHER REGULATIONS.
We are subject to a variety of United States and foreign environmental laws and regulations, including those relating to the use, storage, treatment, discharge and disposal of hazardous materials, substances and wastes used to manufacture our products and remediation of soil and groundwater contamination. Public attention has increasingly been focused on the environmental impact of operations that use hazardous materials. Some of the environmental laws impose strict, and in certain cases joint and several, liability for response costs at contaminated properties on their owners or operators, or on persons who arranged for the disposal of regulated materials at these properties. Our operations are also governed by laws and regulations relating to workplace safety and worker health, principally the Occupational Safety and Health Act and regulations thereunder which, among other requirements, establish noise and dust standards. We believe we are in material compliance with applicable environmental, health and safety requirements. Our failure to comply with present or future laws or regulations could result in substantial liability to us. We cannot predict the nature, scope or effect of legislation or regulatory requirements that could be imposed or how existing or future laws or regulations will be administered or interpreted with respect to products or activities to which they have not previously applied. Enactment of more stringent laws or regulations, as well as more vigorous enforcement policies of regulatory agencies or discovery of previously unknown conditions requiring remediation, could require substantial expenditures by us and could adversely affect our results of operations.
RISKS RELATED TO OUR INDEBTEDNESS
OUR SUBSTANTIAL DEBT COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION AND PREVENT US FROM FULFILLING OUR OBLIGATIONS UNDER THE SENIOR SUBORDINATED NOTES.
We have a substantial amount of debt. The following chart shows certain important credit statistics:
Our substantial indebtedness could have important consequences to holders of our senior subordinated notes. For example, it could:
- make it difficult for us to satisfy our obligations with respect to the senior subordinated notes and our obligations under our current senior credit facility (the "loan and security agreement");
- require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, which will reduce amounts available for working capital, capital expenditures, research and development and other general corporate purposes;
- limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
- increase our vulnerability to general adverse economic and industry conditions;
- place us at a competitive disadvantage compared to our competitors with less debt; and
- limit our ability to borrow additional funds.
The terms of the indenture governing our senior subordinated notes do not fully prohibit us or our subsidiaries from incurring substantial additional debt in the future. Our loan and security agreement also permits additional borrowing. All of the borrowings under loan and security agreement are senior to the senior subordinated notes. If new debt is added to our current debt levels, the related risks that we now face could intensify.
In addition, a portion of our debt, including debt incurred under our loan and security agreement, bears interest at variable rates. An increase in the interest rates on our debt will reduce the funds available to repay the senior subordinated notes and our other debt and for operations and future business opportunities and will intensify the consequences of our leveraged capital structure. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" for a description of our loan and security agreement and the senior subordinated notes.
TO SERVICE OUR DEBT, WE WILL REQUIRE A SIGNIFICANT AMOUNT OF CASH, WHICH DEPENDS ON MANY FACTORS BEYOND OUR CONTROL.
Our ability to make payments on and to refinance our debt, including the senior subordinated notes and the loan and security agreement, will depend on our ability to generate cash in the future. This, to an extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.
We cannot provide assurance that our business will generate sufficient cash flow or that future borrowings will be available to us in an amount sufficient to enable us to pay our debt, including the senior subordinated notes, or to fund our other liquidity needs. If our future cash flow from operations and other capital resources are insufficient to pay our obligations as they mature or to fund our liquidity needs, we may be forced to reduce or delay our business activities and capital expenditures, sell assets, obtain additional equity capital or restructure or refinance all or a portion of our debt, including the senior subordinated notes, on or before maturity. We cannot assure noteholders that we will be able to refinance any of our debt, including the senior subordinated notes, on a timely basis or on satisfactory terms if at all. In addition, the terms of our existing debt, including the senior subordinated notes and the loan and security agreement, and other future debt may limit our ability to pursue any of these alternatives.
OUR LOAN AND SECURITY AGREEMENT AND THE INDENTURE IMPOSE OPERATIONAL AND FINANCIAL RESTRICTIONS ON US.
Our loan and security agreement and the indenture under which our senior subordinated notes were issued include restrictive covenants that, among other things, restrict our ability to:
- incur more debt;
- pay dividends and make distributions;
- issue stock of subsidiaries;
- make certain investments;
- repurchase stock;
- create liens;
- enter into transactions with affiliates;
- enter into sale-leaseback transactions;
- merge or consolidate; and
- transfer and sell assets.
Our loan and security agreement also requires us to maintain financial ratios. All of these restrictive covenants may restrict our ability to expand or to pursue our business strategies. Our ability to comply with these and other provisions of our indenture and loan and security agreement may be affected by changes in our business condition or results of operations, adverse regulatory developments or other events beyond our control.
RISKS RELATED TO THE SENIOR SUBORDINATED NOTES
OUR CONTROLLING STOCKHOLDER, WILLIS STEIN, MAY HAVE INTERESTS THAT CONFLICT WITH HOLDERS OF THE SENIOR SUBORDINATED NOTES.
We are a wholly owned subsidiary of Heat Holdings Corp., whose equity securities are held by Willis Stein and some co-investors. Through its controlling interest in Aavid and pursuant to the terms of the security holders' agreement among the equity investors, Willis Stein has the ability to control the operations and policies of Aavid. Circumstances may occur in which the interests of Willis Stein, as the controlling equity holder, could be in conflict with the interests of the holders of the senior subordinated notes. In addition, the equity investors may have an interest in pursuing acquisitions, divestitures or other transactions that, in their judgment, could enhance their equity investment, even though such transactions might involve risks to the holders of the senior subordinated notes.
THE SENIOR SUBORDINATED NOTES ARE CONTRACTUALLY SUBORDINATED IN RIGHT OF PAYMENT TO OUR SENIOR DEBT.
The senior subordinated notes are senior subordinated obligations of Aavid ranking junior to all of our existing and future senior debt, equal in right of payment with all of our existing and future senior subordinated debt and senior in right of payment to any of our subordinated debt. The senior subordinated notes are contractually subordinated in right of payment to borrowings under our loan and security agreement.
As of December 31, 2002, we had $19.2 million of senior debt outstanding, all of which was secured debt. The indenture limits, and in some (but not all) instances prohibits, the incurrence of additional debt.
In addition, all payments on the senior subordinated notes will be blocked in the event of a payment default under the loan and security agreement and may be blocked for up to 179 consecutive days in any given year in the event of non-payment defaults on senior debt. In the event of a default on the senior subordinated notes and any resulting acceleration of the senior subordinated notes, the holders of senior debt then outstanding will be entitled to payment in full in cash of all obligations in respect of such senior debt before any payment or distribution may be made with respect to the senior subordinated notes.
In a bankruptcy, liquidation or reorganization or similar proceeding relating to us, holders of the senior subordinated notes will participate with trade creditors and all other holders of subordinated debt in the assets remaining after we have paid all of the senior debt. However, because the indenture requires that amounts otherwise payable to holders of the senior subordinated notes in a bankruptcy or similar proceeding be paid to holders of senior debt instead, holders of the senior subordinated notes may receive proportionately less than holders of trade payables in any such proceeding. In any of these cases, we cannot provide assurance that sufficient assets will remain to make any payments on the senior subordinated notes.
WE ARE A HOLDING COMPANY AND OUR ONLY SOURCE OF CASH TO PAY INTEREST ON AND THE PRINCIPAL OF THE SENIOR SUBORDINATED NOTES IS DISTRIBUTIONS FROM OUR SUBSIDIARIES.
We are a holding company with no business operations of our own. Our only significant asset is and will be our equity interests in our subsidiaries. We conduct all of our business operations through our subsidiaries. Accordingly, our only source of cash to make payments of interest on and principal of the senior subordinated notes is distributions with respect to our ownership interest in our subsidiaries from the net earnings and cash flows generated by such subsidiaries.
WE MAY NOT HAVE THE ABILITY TO RAISE THE FUNDS NECESSARY TO FINANCE THE CHANGE OF CONTROL OFFER REQUIRED BY THE INDENTURE.
If we undergo a "change of control," as defined in the indenture under which the senior subordinated notes were issued, we must offer to buy back the senior subordinated notes for a price equal to 101% of the principal amount, plus interest that has accrued but has not been paid as of the repurchase date. We cannot assure note holders that we will have sufficient funds available to make the required repurchases of the senior subordinated notes in that event, or that we will have sufficient funds to pay our other debts. In addition, our loan and security agreement prohibits us from repurchasing the senior subordinated notes after a change of control until we have repaid in full our debt under such credit facility. If we fail to repurchase the senior subordinated notes upon a change of control, we will be in default under both the senior subordinated notes and our loan and security agreement. Any future debt that we incur may also contain restrictions on repurchases in the event of a change of control or similar event.
THE SENIOR SUBORDINATED NOTES AND THE GUARANTEES COULD BE VOIDED OR SUBORDINATED TO OUR OTHER DEBT IF THE ISSUANCE OF THE SENIOR SUBORDINATED NOTES OR THE GUARANTEES CONSTITUTED A FRAUDULENT CONVEYANCE.
If a bankruptcy case or lawsuit is initiated by our unpaid creditors, the debt represented by the senior subordinated notes and the guarantees of the senior subordinated notes by certain of our subsidiaries may be reviewed under the federal bankruptcy laws and comparable provisions of state fraudulent transfer laws. Under these laws, the debt could be voided, or claims in respect of the senior subordinated notes and the guarantees could be subordinated to all other debts of Aavid or its subsidiaries if, among other things, the court found that, at the time we incurred the debt represented by the senior subordinated notes and the subsidiaries incurred the debt represented by the guarantee, we or any subsidiary:
- received less than reasonably equivalent value or fair consideration for the incurrence of such debt; and
- were insolvent or rendered insolvent by reason of such incurrence; or
- were engaged in a business or transaction for which the remaining assets constituted unreasonably small capital; or
- intended to incur, or believed that we or a subsidiary executing a guarantee thereof would incur, debts beyond the ability to pay such debts as they matured; or
- intended to hinder, delay or defraud creditors.
The measure of insolvency for purposes of fraudulent transfer laws varies depending on the law applied. Generally, however, a debtor would be considered insolvent if:
- the sum of its debts, including contingent liabilities, were greater than the fair saleable value of all of its assets; or
- the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or
- it could not pay its debts as they become due.
EFFECT OF ORIGINAL ISSUE DISCOUNT ON HOLDERS OF THE SENIOR SUBORDINATED NOTES.
The senior subordinated notes are considered to have been issued with original issue discount. Holders of the senior subordinated notes are required to include the accretion of the original issue discount in gross income for U.S. federal income tax purposes in advance of receipt of the cash payments to which such income is attributable. If a bankruptcy case is commenced by or against us under the United States Bankruptcy Code, the claim of a holder of senior subordinated notes with respect to the principal amount thereof may be limited to an amount equal to the sum of (i) the purchase price and (ii) that portion of the original issue discount which has been amortized as of the date of any such bankruptcy filing.
ITEM 2.
ITEM 2. PROPERTIES
Aavid Thermalloy has a total of approximately 510,000 square feet of manufacturing space with locations in Laconia, New Hampshire; Monterrey, Mexico; the United Kingdom; Italy; Singapore; Taiwan; China; and Toronto, Canada. We employ a broad range of aluminum and copper fabrication and processing capabilities. Manufacturing operations consist of cutting, stamping, machining, joining, brazing, soldering, assembling and finishing, including anodizing capabilities. We have a substantial in-house tool and die capability that enables us to create our own extrusion and progressive stamping dies and other production tooling. A key element of our business strategy has been to expand internationally. Many of our customers have short product cycles that demand facilities to support quick-ramp, high-volume, high-quality manufacturing at their geographically dispersed manufacturing locations. We plan to continue to build or acquire additional manufacturing facilities overseas to better service our customers, many of whom have moved manufacturing operations and expanded their business overseas. Fluent's total sales, marketing, development, and support facilities consist of approximately 185,000 square feet.
There can be no assurance that our expansion of our foreign operations will be successful. Foreign operations are subject to a number of risks including: work stoppages; transportation delays and interruptions; expropriation; nationalization; misappropriation of intellectual property; imposition of tariffs, foreign currency fluctuations and import and export controls; changes in governmental policies (including U.S. policy toward these countries); and other factors which could have an adverse effect on our business. In addition, we may be subject to risks associated with the availability of, and time required for, the transportation of products to and from foreign countries. The occurrence of any of these factors may delay or prevent the delivery of goods ordered by customers, and such delay or inability to meet customers' requirements would have a materially adverse effect our results of operations and could have an adverse effect on the our relationships with our customers. Furthermore, the occurrence of certain of these factors in countries where we own or operate manufacturing facilities could result in the impairment or loss of our investment in such countries.
We currently operate in the following locations:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are involved in various other legal proceedings that are incidental to the conduct of our business, none of which we believe could reasonably be expected to have a materially adverse effect on our financial condition.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET PRICES OF AAVID COMMON STOCK
Our Common Stock traded on the Nasdaq National Market under the symbol "AATT" until February 2, 2000, the date we were acquired by Heat Holdings. As a result of the merger, our Common Stock is no longer publicly traded.
We have never paid a cash dividend on our Common Stock, and we currently intend to retain all earnings for use in our business and do not anticipate paying cash dividends in the foreseeable future. Our current loan and security agreement and senior subordinated notes indenture contain restrictive covenants which, among other things, impose limitations on the payment of dividends.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA(1)
The following tables set forth selected statement of operations and balance sheet data derived from the consolidated financial statements of the Company and the Predecessor for the periods indicated. The following tables should be read in conjunction with "Management Discussion and Analysis of Financial Condition and Results of Operations," the Consolidated Financial Statements, and related Notes thereto of the Company and the Predecessor included elsewhere herein.
The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying financial statements of the Predecessor and the Company are not comparable in all material respects since those financial statements report financial position, results of operations, and cash flows for these two separate entities.
Certain items have been reclassified to reflect the exclusion of curamik electronics GmbH from our results from continuing operations as a result of the sale of Curamik in July, 2002. See Note 8 below and Note D of Notes to our Consolidated Financial Statements.
NOTES TO SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA (AMOUNTS IN THOUSANDS)
(1) This financial data reflects the consolidated financial position of the Company as of December 31, 2002, 2001 and 2000, and of the Predecessor as of December 31, 1999 and 1998, and the consolidated results of operations of the Company for the years ended December 31, 2002 and 2001 and the period February 2, 2000 through December 31, 2000 and of the Predecessor for the period from January 1, 2000 to February 1, 2000 and the years ended December 31, 1999 and 1998. The Predecessor financial statements have been prepared using the historical cost of the Company's assets and have not been adjusted to reflect the merger with Heat Holdings Corp. on February 2, 2000. The accompanying financial data as of and for the years ended December 31, 2002 and 2001 and as of December 31, 2000 and for the period from February 2, 2000 to December 31, 2000 reflect the consolidated financial position and results of operations of the Company subsequent to the date of the merger and include adjustments required under the purchase method of accounting.
(2) Includes the results of operations of Thermalloy and Curamik from October 21, 1999 (the date of acquisition of Thermalloy).
(3) In the fourth quarter of 2001 and in accordance with SFAS 121, we recorded an impairment charge related to goodwill and intangible assets acquired in connection with the Merger.
(4) Represents the charges in 1998 related to (i) the estimated restructuring costs incurred with our closure of our Manchester, New Hampshire facility, (ii) the termination of the management agreement with Sterling Ventures Limited and (iii) a bonus due a former President and Chief Executive Officer, based on profits in excess of certain thresholds. The 1999 credit of $630 relates to the reversal of excess restructuring reserves which were no longer required upon the completion of the Manchester restructuring in the fourth quarter of 1999. Restructuring charges of $16,885 in 2001 were recorded in connection with the cessation of manufacturing activities at the Dallas, Texas, Terrell, Texas and Loudwater, United Kingdom facilities, reduction of the New Hampshire workforce and reduction of China workforce including closure of the fan factory and write-off of associated fixed assets. Restructuring charges of $858 in 2002 were recorded in the fourth quarter of 2002 in connection with the reduction in workforce and cessation of manufacturing activities in Singapore and Malaysia.
(5) Represents loss realized on sale of Franklin, New Hampshire extrusion plant that occurred in the fourth quarter of 2001.
(6) The $15,000 charge in 2000 represents the amount of the purchase price allocated to technology acquired by Heat Holdings related to Fluent, Inc., which was not fully commercially developed and had no alternative future use at the time of acquisition.
(7) Represents gain related to early retirement of debt, net of related tax effect.
(8) On July 17, 2002, the Company sold all of the outstanding shares of Aavid Thermalloy Holdings, GmbH, which in turn owned approximately 89.5% of the outstanding shares of curamik electronics GmbH, pursuant to a Share Sale and Purchase Agreement between the Company and Electrovac Fabrikation Electrotechnischer Spezialartikel GesmbH dated July 10, 2002 (the "Sale Agreement"). The sale of Curamik and its related operating results have been excluded from income (losses) from continuing operations and is classified as a discontinued operation for all periods presented, in accordance with the requirements of Statement of Financial Accounting Standards (SFAS) No. 144 "Accounting for Impairment or Disposal of Long-Lived Assets".
(9) On December 31, 2000, 2001 and 2002, the Company's common stock was not publicly traded; therefore, earnings per share information is not presented.
(10) See Notes C and D to the consolidated financial statements for a discussion of restatements to the Company's financial results.
(11) Represents net income before interest, income taxes, depreciation and amortization and extraordinary items. Adjusted EBITDA for 2000 also includes the following add-backs, as defined by our senior credit facility, to net income: non-cash charge to cost of sales related to the write-up of inventory to fair value associated with purchase accounting, minority interest, non-cash write-off of in-process technology, one-time accruals related to increases in inventory and receivables reserves related to the Thermalloy acquisition and severance associated with a senior executive. Adjusted EBITDA in 2001 and 2002 also includes add-backs for restructuring charges, change in deferred revenue from the beginning of the year to the end of the year, minority interest, intangible asset impairment charge and loss on sale of division, and excludes both the gain on extinguishments of debt and the gain on sale of discontinued operations. Each of these components of Adjusted EBITDA can significantly affect our results of operations and liquidity and should be considered in evaluating our financial performance. Adjusted EBITDA is included because we understand that such information is considered to be an additional basis on which to evaluate our ability to pay interest, repay debt and make capital expenditures. Adjusted EBITDA is not intended to represent and should not be considered more meaningful than, or as an alternative to, measures of performance, profitability or liquidity determined in accordance with generally accepted accounting principles.
(12) Represents Adjusted EBITDA as a percentage of net sales.
(13) Minority interest included in "Other Financial Data" differs from minority interest recorded within the statements of operations due to the fact that within the statement of operations, minority interest associated with Curamik has been reclassified to income(loss) from discontinued operations. Within "Other Financial Data" minority interest has been presented on a gross basis, including the component related to Curamik.
ITEM 7.
ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion of our financial condition and results of operations together with the financial statements and the notes to such statements included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements based on our current expectations, assumptions, estimates and projections about us and our industries. These forward-looking statements involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements, as more fully described in "Item 1. Business - Risk Factors". We undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.
OVERVIEW
We are a leading global provider of thermal management solutions for electronic products and the leading developer and marketer of CFD software. Historically, we were organized as three operating segments: Aavid Thermal Products, Fluent and Applied Thermal Technologies; however, in connection with the merger, we consolidated our business into two operating units: Aavid Thermal Products (including Applied Thermal Technologies), which following the merger is known as Aavid Thermalloy, and Fluent. Aavid Thermalloy designs, manufactures and distributes thermal management products that dissipate unwanted heat from microprocessors and industrial electronics products. Fluent develops and markets CFD software that is used in complex computer-generated modeling of fluid flows, heat and mass transfer and chemical reactions for a variety of industries including, among others, the automotive, aerospace, chemical processing, power generation, material processing, electronics and HVAC industries.
We and our predecessors have been engaged in the development and manufacture of heat sinks and related thermal management products since 1964. In August 1995, we acquired all the outstanding capital stock of Fluent for $12.8 million. In February 1996, we completed our initial public offering, whereby we sold an aggregate of 2,645,000 shares of common stock at a price of $9.50 per share, from which we received net proceeds of approximately $21.7 million. During 1996, we further expanded our operations through the acquisitions of (1) Fluid Dynamics International, Inc., a provider of computational fluid dynamics software, (2) an aluminum extrusion manufacturing facility located in Franklin, New Hampshire and (3) Beaver Industries, a manufacturer of heat sinks and related thermal management products for electrical and electronics parts, components, ensembles and systems in Toronto, Canada.
On October 21, 1999, the Company purchased all of the stock of the Thermalloy Division of Bowthorpe plc ("Thermalloy") and 85.4% of the stock of curamik electronics Gmbh ("Curamik") (the "Thermalloy acquisition") for a cash purchase price of $84.6 million, including transaction costs of $2.8 million. Thermalloy designs, manufactures and sells a wide variety of standard and proprietary heat sinks and associated products, similar to those produced by Aavid Thermal Products, our thermal management business, within the computer and networking and industrial electronics (including telecommunications) industries. Curamik is a German corporation that manufactures direct bonded copper ceramic substrates that are used in the power semiconductor and other industrial electronics industries. As further discussed below, Curamik was sold on July 17, 2002. Aavid used $12.6 million of its cash on hand and $84.6 million of borrowings under its new credit facility to complete the Thermalloy acquisition, repay $12.6 million of outstanding debt, and pay transaction costs. The acquisition of Thermalloy created significant opportunities to realize cost savings through certain plant closings, the elimination of duplicative selling, general and administrative functions and the reduction of unnecessary corporate expenses. The increased goodwill amortization and other purchase accounting adjustments resulting from our acquisition of Thermalloy decreased our net income in the fourth quarter of 1999 and in 2000 as compared to the respective prior year periods. Following the acquisition of Thermalloy, we changed the name of Aavid Thermal Products to Aavid Thermalloy.
On February 2, 2000, we were acquired in a merger by Heat Holdings Corp., a corporation newly formed by Willis Stein and other investors. Pursuant to the merger, Aavid stockholders received $25.50 in cash for each outstanding share of common stock, and outstanding stock options and warrants were cashed out. The merger was accounted for using the purchase method.
RESTATEMENT OF FINANCIAL RESULTS
See Notes C and D to the consolidated financial statements for a discussion of restatements to the Company's financial results. The most significant restatements, software revenue recognition and discontinued operations, are discussed below.
Restatement of Software Revenue
The Company's software subsidiary, Fluent, has historically recognized software revenue in accordance with Statement of Position (SOP) 97-2, "Software Revenue Recognition" and SOP 98-9, "Modification of SOP 97-2 Software Revenue Recognition, With Respect to Certain Transactions." These statements provide specific industry guidance and stipulate that revenue recognized from software arrangements is to be allocated to each element of the arrangement based on the relative fair values of the elements, such as software products, upgrades, enhancements, post-contract customer support ("PCS"), installation or training. Under the terms of Fluent's arrangements, the software is delivered upon signing and the bundled PCS is available to the customer over the term of the contract. SOP 97-2 requires a seller of software with bundled PCS to establish vendor specific objective evidence ("VSOE") of the value of the undelivered element of the contract (in Fluent's case the PCS) in order to account separately for the PCS revenue.
In order to establish VSOE, there needs to be specific instances in which a customer purchases the PCS separately from the software such that a true market value can be determined. Prior to 2001, Fluent's product offerings consisted of both perpetual licenses and annual licenses that included bundled PCS. Purchasers of perpetual licenses would renew their PCS each year for a specific price, thereby establishing VSOE for the PCS. Fluent used this VSOE of the value of PCS for both perpetual and annual licenses.
SOP 98-9 modified SOP 97-2 to require the use of the "residual method" in situations where VSOE of value exists for all undelivered elements, but does not exist for one or more of the delivered elements. Under the residual method, the undiscounted VSOE of fair value of the undelivered elements (PCS) is deferred and the difference (residual) between the total fee and the amount deferred for the undelivered elements is recognized immediately as revenue. In sum, revenue related to the software element is recognized upon signing of the contract and delivery of the product. Revenue related to PCS is recognized ratably over the life of the contract. Using the residual method methodology, Fluent, with the concurrence of Arthur Andersen LLP, its auditors at the time, determined that 36% of the annual license fee was attributable to PCS, using the price charged for PCS on a perpetual license as VSOE of value of PCS for an annual license. Therefore, upon delivery of software under an annual software license, 64% of the license fee was recognized immediately and the remaining 36% was deferred and amortized to revenue over the 12 month life of the license.
On December 29, 2000, the American Institute of Certified Public Accountants (AICPA) issued Technical Practice Aid (TPA) 5100.68. TPA 5100.68 dealt with the issue of whether a perpetual license with separately priced PCS established VSOE of value for shorter term software licenses with bundled PCS. The AICPA specifically stated in TPA 5100.68 that PCS services for a perpetual license and PCS services for a shorter term license are two different elements. Therefore, the renewal rate charged for PCS on a perpetual license does not provide VSOE of value for PCS on the shorter term license. Due to the issuance of this TPA, the Company and its auditors at the time, Arthur Andersen LLP, concluded that under Fluent's bundled contract business practice the Company could no longer establish VSOE of the value of PCS related to its annual licenses based on the PCS used for perpetual licenses.
In order to maintain a consistent revenue recognition methodology and to more definitely confirm VSOE of value on the individual elements of the contract, the Company elected to change its annual license agreements and proposals in 2001 to offer PCS as a separately priced item from the software (the "unbundled method"), that could be purchased at the customer's election. In other words, customers could license Fluent's software, which no longer included PCS, and either separately contract for PCS or elect not to take PCS. The Company, along with Arthur Andersen LLP, believed at that time that the unbundled method would establish VSOE of value on the PCS such that the Company could continue to recognize the software revenue upon contract signing and shipment of the software, and defer only the PCS portion of the revenue ratably over the term of the contract. This change had minimal impact on revenue recognition when compared to prior periods, but did clearly identify separate prices for the software and service elements of the contract.
On July 10, 2002, the Company announced it had changed auditors from Arthur Andersen LLP to Ernst & Young LLP. Arthur Andersen LLP's fate has been widely publicized and the firm is no longer available to the Company. Based on discussions with Ernst & Young LLP and the guidance in TPA 5100.68, issued December 29, 2000, the Company determined that the VSOE of value that it was relying upon to support the portion of the license fee attributed to the PCS during 2001, even in the unbundled state, may not have been sufficient to support such treatment. As a result, the Company
concluded that it should recognize revenue for the entire software license, and not just the PCS portion of the agreement, ratably over the 12 month term of the license.
Accordingly, the Company has restated its financial statements as of December 31, 2001, and for the year then ended, to reflect this change in revenue recognition. The Company also restated its financial statements for the first quarter of 2002 and conformed the financial statements for the remainder of 2002 to this revenue recognition methodology. While this change has a significant impact on recorded revenues within the statements of operations, and consequently on net loss and EBITDA, this change does not affect the Company's statements of cash flows for the year ended December 31, 2001, and the three month period ended March 30, 2002, other than re-allocating certain changes in balance sheet accounts within the cash flow from operations section of the statement. For the year ended December 31, 2001, the amount of revenue originally recognized but now deferred is $15.8 million. However, Fluent continues to be paid by its customers upon commencement of the execution of the non-cancelable license agreement.
Restatement from Discontinued Operations
As discussed under "Discontinued Operations" below, the Company sold its German subsidiary, Aavid Thermalloy Holdings, GmbH ("Curamik") on July 17, 2002. Due to the sale, the Company must treat Curamik as a discontinued operation, which requires all prior periods presented to be restated to remove the results of Curamik's operations from "continuing" operations and, instead, reflect Curamik's results of operations as "discontinued" operations.
All affected amounts in this Form 10-K have been restated to reflect the change in software revenue recognition and discontinued operations as discussed above. Arthur Andersen LLP was not available to reissue their report on the restated fiscal year 2001 and 2000 results. Therefore, the Company's financial statements for fiscal year 2001 have been reaudited by Ernst & Young, LLP. The Company's financial statements for fiscal year 2000 were not reaudited. As such, the fiscal year 2000 financial statements have been labeled as "unaudited" throughout these financial statements.
DISCONTINUED OPERATIONS
On July 17, 2002, the Company sold all of the outstanding shares of Aavid Thermalloy Holdings, GmbH, which in turn owned approximately 89.5% of the outstanding shares of curamik electronics GmbH, pursuant to a Share Sale and Purchase Agreement between the Company and Electrovac Fabrikation Electrotechnischer Spezialartikel GesmbH dated July 10, 2002 (the "Sale Agreement"). Under the Sale Agreement, the Company received consideration of $31.5 million, subject to possible adjustment based upon the level of consolidated net assets of Curamik and certain indemnification obligations of the Company. The Company recorded a gain on the sale of $7.1 million in the accompanying statements of operations for the third quarter of 2002. $27.7 million of the sale proceeds was used to pay down senior debt. The sale of Curamik and its related operating results have been excluded from the results from continuing operations and are classified as a discontinued operation for all periods presented, in accordance with the requirements of Statement of Financial Accounting Standards (SFAS) No. 144 "Accounting for Impairment or Disposal of Long-Lived Assets".
RESULTS OF OPERATIONS
The following table is derived from our consolidated statements of operations and sets forth the percentage relationship of certain items to net sales for the periods indicated. The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying financial statements of the Predecessor and the Company are not comparable in all material respects since those financial statements report financial position, results of operations, and cash flows for these two separate entities. The 2000 results include the combined results of the Predecessor for the period January 1, 2000 through February 1, 2000 and the Company from February 2, 2000 through December 31, 2000.
2002 COMPARED WITH 2001
Net sales for 2002 were $161.9 million, a decrease of 5.3% compared with $170.9 million for 2001. The overall decrease in sales stems from Aavid Thermalloy and is primarily the result of the continued decline experienced by the semiconductor and electronics industries during 2002. Fluent's sales increased $21.4 million and consulting and design services decreased $0.5 million.
Aavid Thermalloy's net sales were $89.6 million for 2002, a decrease of $30.5 million, or 25.4%, compared with $120.1 million for 2001. This decrease, as discussed above, was primarily the result of the significant decline experienced by the semiconductor and electronics industries in 2002.
Fluent's net sales were $72.2 million for 2002, an increase of $21.4 million, or 42.1%, over 2001 sales of $50.8 million. The majority of the increase was due to the change in the way Fluent recognizes revenue, which occurred in the first quarter of 2001. Fluent changed to a ratable recognition methodology for software license revenue, as discussed above in the section titled "Restatement of Financial Results". Beginning in 2001, following the guidance in TPA 5100.68, issued on December 29, 2000, all revenue related to a software contract is deferred and recognized ratably over 12 months. Prior to 2001, Fluent had only deferred that portion of the contract that the Company had determined related to post-contract support (approximately 36%) and recognized the remaining 64% immediately upon delivery of the software. This change caused a significant drop in revenue during 2001 due to an increase in the amount of revenue deferred upon signing and delivery of a software contract. Fluent's revenue in 2001 was significantly less than what can be expected in future years due to the fact that, at January 1, 2001, there was not a significant "backlog" of deferred revenue already in place to generate revenues in 2001 from contract signings that occurred in 2000. In 2000, 64% of the contract was immediately recognized upon contract signing and delivery and so was not available for recognition in 2001. Fluent's contract bookings increased 14% in 2002 compared with 2001. The increase in bookings was spread among all product offerings due primarily to increased sales to new customers for computational fluid dynamics software, as well as the success of application-specific products.
International net sales (which include North American exports) increased to 57.5% of net sales for the year ended December 31, 2002 as compared with 53.5% for the year ended December 31, 2001.
Our gross profit in 2002 was $73.4 million, an increase of $26.5 million, or 56.6% higher than 2001 gross profit of $46.9 million. Our gross margin in 2002 was 45.3%, which compares with 27.4% in 2001. Aavid Thermalloy saw a significant improvement in gross profit and gross margin in 2002 primarily due to the restructuring activities that occurred over the prior two years. Additionally, Fluent's revenue and gross profit continued to become a larger percentage of the overall Company's revenue and gross profit in 2002. As Fluent's gross margin tends to be much greater than the gross margin of Aavid Thermalloy, the increase of Fluent as a percentage of overall Company revenues also serves to increase the overall gross margin of the Company.
Our selling, general and administrative expenses, excluding amortization of intangibles, were $55.4 million, or 34.2% of sales for 2002, as compared with $58.5 million, or 34.2% of net sales, for 2001. The net decrease in selling, general and administrative expenses in dollars resulted primarily from S,G&A expense reductions at Aavid Thermalloy. Aavid Thermalloy's 2002 S,G&A expenses were down $6.9 million from 2001 levels. Fluent's 2002 S,G&A increased $3.1 million from 2001 levels as Fluent continued to enhance its sales and support infrastructure to support its revenue growth. Lastly, the Company's corporate offices also experienced a $0.6 million increase primarily related to increased legal and accounting costs associated with a re-audit of fiscal 2001 financial statements, debt refinancings (indirectly) and foreign corporate reorganizations. On a percentage of net sales basis, S,G&A in 2002 was flat at 34.2%.
During the fourth quarter of 2002 the Company ceased manufacturing operations in Malaysia and Singapore. In connection with these actions, the Company recorded a restructuring charge within the statement of operations during 2002. This restructuring charge totaled $0.9 million and included amounts related to employee severance, facility costs/lease terminations and write-off of fixed assets. Approximately 57 individuals were terminated under the restructuring plan.
During 2001, in response to the global slowdown in the semi-conductor and electronics industries, we took significant steps to reduce our cost structure and appropriately size our business to match current revenue levels. These cost reduction activities included the cessation of manufacturing activities at the Dallas, Texas, Terrell, Texas and Loudwater, United Kingdom facilities and the reduction of our New Hampshire workforce, which included a reduction of both direct labor and S,G&A personnel. The total number of personnel reduced due to 2001 restructuring activities was 524. In connection with these actions, we recorded restructuring charges totaling $16.9 million over the course of 2001. These restructuring charges consisted of the following components: (1) severance of $5.6 million, (2) write-off of fixed assets of $7.1 million, (3) write-off of a prepaid rent asset of $3.8 million related to the Dallas facility and (4) lease termination and other accruals of $0.4 million.
Intangible asset amortization of $3.4 million was recorded in 2002 compared with $34.2 million recorded in 2001, primarily related to intangible assets established as part of the acquisition of Aavid by Heat Holdings Corp. The decrease in 2002 is a result of the cessation of goodwill amortization beginning in the first quarter of 2002 due to the adoption of SFAS 142.
Our research and development expenses consist primarily of funding for internal product development activities as well as product development activities conducted by third parties on our behalf. Research and development expenses also include the costs of obtaining patents on the technology developed in research and development activities. Research and development expenses were $12.5 million, or 7.7% of net sales, which compares with $10.8 million, or 6.3% of net sales, in 2001. The increase in research and development expenses was primarily due to increased expenditures at Fluent in connection with the development of next generation software.
In connection with the Merger in February, 2000, the Company allocated $15.0 million of the purchase price to in-process research and development projects. This allocation represented the estimated fair value based on risk-adjusted cash flows related to the incomplete software research and development projects of Fluent, Inc. At the date of the merger, the development of these projects had not yet reached technological feasibility and the research and development in progress had no alternative future uses. Accordingly, these costs were expensed as of the merger date.
The Company allocated values to the in-process research and development based on an in-depth assessment of the R&D projects. The value assigned to these assets was limited to significant research projects for which technological feasibility had not been established, including development, engineering and testing activities associated with the introduction of the acquired in-process technologies.
The value assigned to purchased in-process technology was determined by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting net cash flows from the projects, and discounting the net cash flows to their present value. The revenue projection used to value the in-process research and development was based on historical results, estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by the Company and its competitors. The resulting net cash flows
from such projects are based on management's estimates of cost of sales, operating expenses, and income taxes from such projects.
The nature of the efforts to develop the acquired in-process technologies into commercially viable products and services principally related to the completion of certain planning, designing, coding, prototyping, and testing activities that were necessary to establish that the developmental software technologies met their design specifications including functional, technical, and economic performance requirements. At the merger date, the technologies under development were between 40% and 80% complete, based upon project man-month and cost data. Anticipated completion dates ranged from 6 to 18 months, at which times the Company expected to begin selling the developed products. Development costs to complete the R&D were estimated at approximately $4.0 million.
Fluent's primary in-process R&D projects involved developing: (i) Fluent version 6.0; (ii) Gambit version 2.0; (iii) materials processing functionality; and (iv) advanced infrastructure technology. Fluent 6.0 represented the Company's next-generation computational fluid dynamics (CFD) software engine. Gambit 2.0 includes new pre-processor CFD technologies. The development of materials processing technologies is designed to address CFD needs in new markets. The advanced infrastructure technology establishes a new platform upon which future products will be more efficiently and rapidly developed.
Aggregate revenues for the developmental Fluent products were estimated to peak within three years of acquisition and then decline steadily as other new products and technologies are expected to enter the market. Operating expenses were estimated based on historical results and management's analysis of Fluent's cost structure. Projected operating expenses as a percentage of revenues were expected to be stable for the foreseeable future.
The rates utilized to discount the net cash flows to their present value were based on estimated cost of capital calculations. A discount rate of 18 percent was considered appropriate for the in-process R&D, and a discount rate of 15 percent was appropriate for the existing products and technologies. These discount rates were commensurate with the Fluent's long history and market leadership position. The discount rate utilized for the in-process technology was higher than Aavid's cost of capital due to the inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of such technology and the uncertainty of technological advances that are unknown at this time.
With respect to the acquired in-process technology, the calculations of value were adjusted to reflect the development efforts of Fluent prior to the close of the merger. In doing so, consideration was given to each major project's stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred, and the projected cost to complete the projects.
As of December 31, 2002 the majority of these projects had been successfully completed.
Our income from continuing operations in 2002 was $1.2 million, an increase of $194.3 million from the operating loss in 2001 of $193.0 million. The operating loss in 2001 includes a write-off of intangible assets of $115.2 million discussed below, restructuring charges of $16.9 million and loss on disposal of a division (further discussed below) of $4.3 million. Aavid Thermalloy, excluding intangible write-offs, loss on sale of division, amortization and restructuring charges, had an operating loss of $6.2 million in 2002 compared with an operating loss of $19.6 million in 2001. Fluent's operating income, excluding intangible write-offs and amortization, increased to $14.1 million compared with an operating loss of $1.2 million in 2001. Fluent's operating margins increased primarily due to the significant increase in revenue as discussed above that resulted from the change in revenue recognition methodology that occurred in 2001.
In the fourth quarter of 2001, the Company recognized a loss on disposal of a division of $4.3 million. This loss was related to the sale of our aluminum extrusion facility located in Franklin, NH. The facility was sold for $3.0 million. Of this amount, $2.5 million was paid in cash and the remainder was taken as a note due the Company and payable in 12 equal installments of principal and interest beginning March 1, 2002. The note bears interest at 8%. The $2.5 million in cash proceeds was remitted to our senior lending group as required by the amended and restated credit agreement that was in effect at the time.
Our net interest charges were $20.1 million in 2002 compared with $22.2 million in 2001. This decrease in interest expense was a combination of lower interest rates in 2002, a full year's benefit from a reduction in the face amount of our Senior Subordinated Notes that occurred in May, 2001 as well as a reduction in outstanding balances of senior debt in 2002 compared with 2001.
The Company recorded a tax provision of $0.8 million in 2002 compared to a tax benefit of $11.0 million in 2001. The Company incurred a tax provision in 2002 despite having significant operating losses because of state tax provisions on applicable state components of U.S. income and foreign tax provisions on foreign earnings. We had to record a tax provision on foreign earnings which are expected to be repatriated into the U.S. to service debt. Because the Company is in a net operating loss carryforward position for U.S. tax purposes, the Company will not receive any tax benefit from foreign tax credits. These repatriated earnings will therefore incur both foreign income taxes and U.S. income taxes, effectively doubling up the tax rate on the foreign earnings. The significant net operating loss carryforwards in the U.S. will help offset the actual cash paid for taxes in the U.S. when the foreign earnings are repatriated.
2001 COMPARED WITH 2000
Net sales for 2001 were $170.9 million, a decrease of 38.0% compared with $275.9 million for 2000. The overall decrease in sales stems primarily from Aavid Thermalloy whose revenues decreased as a result of the significant decline experienced by the semi-conductor and electronics industries during 2001. Fluent's sales decreased $6.9 million while consulting and design services were down $0.4 million. Fluent experienced a decline in revenues solely due to the change in revenue recognition methodology in 2001 to a ratable methodology as discussed above. Prior to 2001, Fluent's methodology was to recognize a significant portion of a signed license agreement immediately upon delivery of the software and only defer that revenue which was deemed attributable to the post contract support portion of the contract. Beginning in 2001, following the guidance in TPA 5100.68, issued on December 29, 2000, Fluent changed to a ratable method whereby revenue from the entire software license is deferred and recognized ratably over the term of the license. Foreign exchange rates in 2001 also had a negative impact on revenues. Had foreign exchange rates over the course of 2001 remained consistent with the exchange rates at the end of 2000, the Company's revenues would have been approximately $4.2 million higher than reported.
Aavid Thermalloy's net sales were $120.1 million for 2001, a decrease of $98.1 million, or 45.0%, compared with $218.2 million for 2000. This decrease, as discussed above, was primarily the result of the significant decline experienced by the semi-conductor and electronics industries in 2001.
Fluent's net sales were $50.8 million for 2001, a decrease of $6.9 million, or 12.0%, from 2000 sales of $57.7 million. As discussed above, this decrease was solely the result of a change in revenue recognition methodology. Actual billings in 2001 increased approximately 15% over 2000 billings.
International net sales (which include North American exports) increased to 53.5% of net sales for the year ended December 31, 2001 as compared with 39.4% for the year ended December 31, 2000.
Our gross profit in 2001 was $46.9 million, a decrease of $47.3 million, or 50.2% lower than 2000 gross profit of $94.2 million. Our gross margin in 2001 was 27.4%, which compares with 34.1% in 2000. Aavid Thermalloy saw a significant decrease in gross profit in 2001 which was caused primarily by excess factory capacity in the U.S. and abroad due to the significant slowdown in the semi-conductor and electronic industries. This underutilization has been addressed through the shut-down in 2001 of the Loudwater, U.K. facility and the Dallas and Terrell, Texas facilities. Fluent also saw a decrease in gross margin due to the change in revenue recognition methodology as discussed above. Lastly, our gross margin in the first quarter of 2000 was negatively impacted by certain purchase accounting and acquisition related adjustments which decreased gross profit by $4.5 million in acquisition related charges. Our gross margin in 2000 would have been 35.8% without these charges.
Our selling, general and administrative expenses, excluding amortization of intangibles, were $58.5 million, or 34.2% of sales for 2001, as compared with $66.3 million, or 24.0% of net sales, for 2000. The net decrease in selling, general and administrative expenses in dollars resulted primarily from S,G&A expense reductions at Aavid Thermalloy, including personnel reductions in the Concord, New Hampshire headquarters as well as personnel reductions associated with the closure of the Dallas, Texas facility which was completed during the second quarter of 2001. Aavid Thermalloy's S,G&A expenses were down $11.2 million from 2000 levels. Fluent's 2001 S,G&A increased $2.6 million from 2000 levels as Fluent
continued to enhance its sales and support infrastructure to support its growth. Lastly, the Company's corporate offices also experienced an $0.6 million increase primarily related to increased legal costs associated with debt refinancings and foreign corporate reorganizations. On a percentage of net sales basis, S,G&A in 2001 was 10.2% higher than in 2000. Much of this increase relates to Aavid Thermalloy as their overall S,G&A rate as a percentage of sales increased in 2001 due to the significant reduction in revenues from the previous year. The remaining increase in percentage is primarily the result of Fluent becoming a much larger component of the consolidated results of the Company. Fluent in general has a higher S,G&A rate than Aavid Thermalloy.
Intangible asset amortization of $34.2 million was recorded in 2001 compared with $31.5 million recorded in 2000, primarily related to intangible assets established as part of the acquisition of Aavid by Heat Holdings Corp. The increase in 2001 is due to the fact that in 2001, the Company recorded a full 12 months of amortization. In 2000, the merger occurred on February 2nd and, therefore, the Company only recorded approximately 11 months of amortization in 2000.
Our research and development expenses consist primarily of funding for internal product development activities as well as product development activities conducted by third parties on our behalf. Research and development expenses also include the costs of obtaining patents on the technology developed in research and development activities. Research and development expenses were $10.8 million, or 6.3% of net sales, which compares with $9.1 million, or 3.3% of net sales in 2000. The increase in research and development expenses was primarily due to increased expenditures at Fluent.
In connection with the Merger in February, 2000, the Company allocated $15.0 million of the purchase price to in-process research and development projects. This allocation represented the estimated fair value based on risk-adjusted cash flows related to the incomplete software research and development projects of Fluent. At the date of the merger, the development of these projects had not yet reached technological feasibility and the research and development in progress had no alternative future uses. Accordingly, these costs were expensed as of the merger date.
The Company allocated values to the in-process research and development based on an in-depth assessment of the R&D projects. The value assigned to these assets was limited to significant research projects for which technological feasibility had not been established, including development, engineering and testing activities associated with the introduction of the acquired in-process technologies.
The value assigned to purchased in-process technology was determined by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting net cash flows from the projects, and discounting the net cash flows to their present value. The revenue projection used to value the in-process research and development was based on historical results, estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by the Company and its competitors. The resulting net cash flows from such projects are based on management's estimates of cost of sales, operating expenses, and income taxes from such projects.
The nature of the efforts to develop the acquired in-process technologies into commercially viable products and services principally related to the completion of certain planning, designing, coding, prototyping, and testing activities that were necessary to establish that the developmental software technologies met their design specifications including functional, technical, and economic performance requirements. At the merger date, the technologies under development were between 40% and 80% complete, based upon project man-month and cost data. Anticipated completion dates ranged from 6 to 18 months, at which times the Company expected to begin selling the developed products. Development costs to complete the R&D were estimated at approximately $4.0 million.
Fluent's primary in-process R&D projects involved developing: (i) Fluent version 6.0; (ii) Gambit version 2.0; (iii) materials processing functionality; and (iv) advanced infrastructure technology. Fluent 6.0 represented the Company's next-generation computational fluid dynamics (CFD) software engine. Gambit 2.0 includes new pre-processor CFD technologies. The development of materials processing technologies is designed to address CFD needs in new markets. The advanced infrastructure technology establishes a new platform upon which future products will be more efficiently and rapidly developed.
Aggregate revenues for the developmental Fluent products were estimated to peak within three years of acquisition and then decline steadily as other new products and technologies are expected to enter the market. Operating expenses were estimated based on historical results and management's analysis of Fluent's cost structure. Projected operating expenses as a percentage of revenues were expected to be stable for the foreseeable future.
The rates utilized to discount the net cash flows to their present value were based on estimated cost of capital calculations. A discount rate of 18 percent was considered appropriate for the in-process R&D, and a discount rate of 15 percent was
appropriate for the existing products and technologies. These discount rates were commensurate with the Fluent's long history and market leadership position. The discount rate utilized for the in-process technology was higher than Aavid's cost of capital due to the inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of such technology and the uncertainty of technological advances that are unknown at this time.
With respect to the acquired in-process technology, the calculations of value were adjusted to reflect the development efforts of Fluent prior to the close of the merger. In doing so, consideration was given to each major project's stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred, and the projected cost to complete the projects.
During 2001, global macroeconomic conditions weakened and the demand for industrial and consumer electronics contracted significantly. Coupled with the closing of three manufacturing facilities in the U.S. and abroad as discussed below, we determined that our ability to achieve our original long term financial forecast had been negatively impacted. We determined that a triggering event, as defined by SFAS 121, had occurred related to the intangible assets initially acquired in connection with the Merger. Based on cash flow projections related to the acquired assets, we concluded that all of the acquired intangible assets related to Aavid Thermalloy and certain intangible assets related to Fluent had been impaired. During the fourth quarter of 2001, upon completion of our analysis of the impairment, we wrote down the assets, along with any allocated goodwill, to fair value based on the related discounted cash flow. In order to measure the impairment loss related to goodwill, the difference between the carrying value and the fair value of goodwill was calculated using a business enterprise methodology. This method of goodwill measurement entails calculating the total enterprise value of each of Aavid's business units. Goodwill and intangible assets were then estimated by subtracting the allocated tangible assets (normal levels of working capital and fixed assets) from the total enterprise value. The total impairment charge recorded in 2001 totaled $115.2 million and is recorded in the accompanying statement of operations as a component of loss from operations.
A breakout of this charge by asset type and by business unit is as follows:
During 2001, in response to the global slowdown in the semi-conductor and electronics industries, we took significant steps to reduce our cost structure and appropriately size our business to match current revenue levels. These cost reduction activities included the cessation of manufacturing activities at the Dallas, Texas, Terrell, Texas and Loudwater, United Kingdom facilities and the reduction of our New Hampshire workforce, which included a reduction of both direct labor and S,G&A personnel. The total number of personnel reduced due to 2001 restructuring activities was 524. In connection with these actions, we recorded restructuring charges totaling $16.9 million over the course of 2001. These restructuring charges consisted of the following components: (1) severance of $5.6 million, (2) write-off of fixed assets of $7.1 million, (3) write-off of a prepaid rent asset of $3.8 million related to the Dallas facility and (4) lease termination and other accruals of $0.4 million.
Our loss from continuing operations in 2001 was $193.0 million, an increase of $165.2 million from the operating loss in 2000 of $27.8 million. The operating loss in 2001 includes a write-off of intangible assets of $115.2 million as discussed above, restructuring charges of $16.9 million, loss on disposal of a division (further discussed below) of $4.3 million and increased intangible amortization of $2.7 million related to having a full twelve months of amortization in 2001 results, compared with 11 months of amortization in 2000. In 2000, as mentioned above, the Company wrote-off $15.0 million of in-process technology related to Fluent acquired in the Merger. Aavid Thermalloy (exclusive of Curamik), excluding intangible write-offs, loss on sale of division, amortization and restructuring charges, had an operating loss of $19.6 million in 2001 compared with operating income of $11.5 million in 2000. This decline is related to the significant reduction in revenues that occurred during 2001 associated with the global semiconductor and electronics industry slow down. Fluent's operating loss, excluding intangible write-offs and amortization decreased $2.1 million in 2001 compared with 2000.
In the fourth quarter of 2001, the Company recognized a loss on disposal of a division of $4.3 million. This loss was related to the sale of our aluminum extrusion facility located in Franklin, NH. The facility was sold for $3.0 million. Of this amount, $2.5 million was paid in cash and the remainder was taken as a note due the Company and payable in 12 equal
installments of principal and interest beginning March 1, 2002. The note bears interest at 8%. The $2.5 million in cash proceeds was remitted to our senior lending group as required by the amended and restated credit agreement that was in effect at the time.
Our net interest charges were $22.2 million in 2001 compared with $24.0 million in 2000. This decrease in interest expense resulted primarily from lower interest rates in 2001, as well as a reduction in the face amount of our Senior Subordinated Notes. The savings from lower interest rates and lower debt balances was partially offset by the fact, that in 2001, we recorded a full twelve months of interest expense related to the 12 3/4% senior subordinated notes. In 2000, the notes initially were offered on February 2, 2000 and, therefore, only eleven months of interest expense related to the Notes was included in 2000 net interest expense.
The Company recorded a tax benefit of $11.0 million in 2001 compared to a tax provision of $0.5 million in 2000. The net tax benefit recorded in 2001 is a result of an increased tax benefit from domestic federal net operating loss carryforwards, partially offset by an increase in the valuation allowance on net deferred tax assets, combined with a reduced tax provision on lower foreign earnings in 2001 compared to 2000. The Company incurred a tax provision in 2000 despite having significant operating losses because of significant non-deductible goodwill amortization and in-process R&D charges and a foreign tax provision of $3.9 million on foreign earnings. We had to record a tax provision on foreign earnings which are expected to be repatriated into the U.S. to service debt. Because the Company is in a net operating loss carryforward position for U.S. tax purposes, the Company will not receive any tax benefit from foreign tax credits. These repatriated earnings will therefore incur both foreign income taxes and U.S. income taxes, effectively doubling up the tax rate on the foreign earnings. The significant net operating loss carryforwards in the U.S. will help offset the actual cash paid for taxes in the U.S. when the foreign earnings are repatriated.
CRITICAL ACCOUNTING POLICIES
We prepare the consolidated financial statements of Aavid Thermal Technologies, Inc. in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgements and assumptions that we believe are reasonable based on the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies which we believe are the most critical to aid in fully understanding and evaluating our financial reporting results include the following:
REVENUE RECOGNITION AND SALES RETURNS AND ALLOWANCES
Thermal Products
Revenue is recognized when products are shipped. We offer certain distributors limited rights of return and stock rotation rights. Due to these return rights, we continuously monitor and track product returns and we record a provision for the estimated future amount of such future returns, based on historical experience and any notification we receive of pending returns. While such returns have historically been within our expectations and provisions established, we cannot guarantee that we will continue to experience the same return rates that we have in the past. Any significant decrease in product demand experienced by our distributor customers and the resulting credit returns could have a material adverse impact on our operating results for the period or periods in which such returns materialize.
Software
Our software subsidiary, Fluent, has historically recognized software revenue in accordance with Statement of Position (SOP) 97-2, "Software Revenue Recognition" and SOP 98-9, "Modification of SOP 97-2 Software Revenue Recognition, With Respect to Certain Transactions." These statements provide specific industry guidance and stipulate that revenue recognized from software arrangements is to be allocated to each element of the arrangement based on the relative fair values of the elements, such as software products, upgrades, enhancements, post-contract customer support ("PCS"), installation or training. Under the terms of Fluent's arrangements, the software is delivered upon signing and the bundled PCS is available to the customer over the term of the contract. SOP 97-2 requires a seller of software with bundled PCS to establish vendor specific objective evidence ("VSOE") of the value of the undelivered element of the contract (in Fluent's case the PCS) in order to account separately for the PCS revenue.
In order to establish VSOE, there needs to be specific instances in which a customer purchases the PCS separately from the software such that a true market value can be determined. Prior to 2001, Fluent's product offerings consisted of both perpetual licenses and annual licenses that included bundled PCS. Purchasers of perpetual licenses would renew their PCS
each year for a specific price thereby establishing VSOE for the PCS. Fluent used this VSOE of the value of PCS for both perpetual and annual licenses.
SOP 98-9 modified SOP 97-2 to require the use of the "residual method" in situations where VSOE of value exists for all undelivered elements, but does not exist for one or more of the delivered elements. Under the residual method, the undiscounted VSOE of fair value of the undelivered elements (PCS) is deferred and the difference (residual) between the total fee and the amount deferred for the undelivered elements is recognized immediately as revenue. In sum, revenue related to the software element is recognized upon signing of the contract and delivery of the product. Revenue related to PCS is recognized ratably over the life of the contract. Using the residual method methodology, Fluent, with the concurrence of Arthur Andersen LLP, its auditors at the time, determined that 36% of the annual license fee was attributable to PCS, using the price charged for PCS on a perpetual license as VSOE of value of PCS for an annual license. Therefore, upon delivery of software under an annual software license, 64% of the license fee was recognized immediately and the remaining 36% was deferred and amortized to revenue over the 12 month life of the license.
On December 29, 2000, the American Institute of Certified Public Accountants (AICPA) issued Technical Practice Aid (TPA) 5100.68. TPA 5100.68 dealt with the issue of whether a perpetual license with separately priced PCS established VSOE of value for shorter term software licenses with bundled PCS. The AICPA specifically stated in TPA 5100.68 that PCS services for a perpetual license and PCS services for a shorter term license are two different elements. Therefore, the renewal rate charged for PCS on a perpetual license does not provide VSOE of value for PCS on the shorter term license. Due to the issuance of this TPA, we concluded, along with our auditors at the time, Arthur Andersen LLP, that under Fluent's bundled contract business practice the Company could no longer establish VSOE of the value of PCS related to its annual licenses based on the PCS used for perpetual licenses.
In order to maintain a consistent revenue recognition methodology and to more definitely confirm VSOE of value on the individual elements of the contract, we elected to change our annual license agreements and proposals in 2001 to offer PCS as a separately priced item from the software (the "unbundled method"), that could be purchased at the customer's election. In other words, customers could license Fluent's software, which no longer included PCS, and either separately contract for PCS or elect not to take PCS. We believed, along with Arthur Andersen LLP, at that time that the unbundled method would establish VSOE of value on the PCS such that the Company could continue to recognize the software revenue upon contract signing and shipment of the software, and defer only the PCS portion of the revenue ratably over the term of the contract. This change had minimal impact on revenue recognition when compared to prior periods, but did clearly identify separate prices for the software and service elements of the contract.
On July 10, 2002, we announced that we had changed auditors from Arthur Andersen LLP to Ernst & Young LLP. Arthur Andersen LLP's fate has been widely publicized and the firm is no longer available to us. Based on discussions with Ernst & Young LLP and the guidance in TPA 5100.68, issued December 29, 2000, we determined that the VSOE of value that we were relying upon to support the portion of the license fee attributed to the PCS during 2001, even in the unbundled state, may not have been sufficient to support such treatment. As a result, we concluded that we should recognize revenue for the entire software license, and not just the PCS portion of the agreement, ratably over the 12 month term of the license.
Accordingly, we have restated our financial statements as of December 31, 2001,and for the year then ended, to reflect this change in revenue recognition. We have also restated our financial statements for the first quarter of 2002 and conformed the financial statements for the remainder of 2002 to this revenue recognition methodology. While this change has a significant impact on recorded revenues within the statements of operations, and consequently on net loss and EBITDA, this change does not affect our statements of cash flows for the year ended December 31, 2001, and the three month period ended March 30, 2002, other than re-allocating certain changes in balance sheet accounts within the cash flow from operations section of the statement. For the year ended December 31, 2001, the amount of revenue originally recognized but now deferred is $15.8 million. However, Fluent continues to be paid by its customers upon commencement of the execution of the non-cancellable license agreement.
ACCOUNTS RECEIVABLE
We perform ongoing credit evaluations of our customers and adjust credit limits based on payment history and the customer's current credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based on our historical experience and any specific customer collection issues we have identified. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates we have in the past. In the event that economic or other conditions cause a change in liquidity or financial condition in multiple customers, there could be a material adverse effect on our collection of receivables and future results of operations.
INVENTORIES
We value our inventory, which consists of materials, labor and overhead, at the lower of the actual cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production demand for the next twelve months. As demonstrated in 2002 and 2001, demand for our products can fluctuate significantly. A significant increase in demand for our products could result in a short-term increase in the cost of inventory purchases and production costs while a significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand. In addition, our industry is characterized by rapid technological change, frequent new product development and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Additionally, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess or obsolete inventory. In the future, if our inventory is determined to be overvalued, we would be required to recognize such costs in our cost of goods sold at the time of determination. Likewise, if our inventory is determined to be undervalued, we may have over-reported our cost of sales in previous periods and would be required to recognize such additional operating income at the time of sale. Therefore, although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and reported operating results.
VALUATION OF LONG-LIVED ASSETS AND INTANGIBLE ASSETS AND GOODWILL
During 2001 and prior periods, we assessed the impairment of identifiable intangibles, long-lived assets and related goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable as required under SFAS 121. Factors we considered important which could trigger an impairment review included the following:
- significant underperformance relative to expected historical or projected future operating results;
- significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
- significant negative industry or economic trends.
Under SFAS 121, when we determine that the carrying value of intangibles, long-lived assets and related goodwill may not be recoverable based on the existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cashflow method using a discount rate determined by our management to be commensurate with the risk inherent in our business model. During 2001, global macroeconomic conditions weakened and the demand for industrial and consumer electronics contracted significantly and as a result we determined that our ability to achieve our long term financial forecast had been negatively impacted. We determined that a triggering event, as defined by SFAS 121, had occurred related to the intangible assets initially acquired in connection with the Merger. Based on cash flow projections related to the acquired assets, we concluded that all of the acquired intangible assets related to Aavid Thermalloy and certain intangible assets related to Fluent had been impaired. During the fourth quarter of 2001, upon completion of our analysis of the impairment, we wrote down the assets, along with any allocated goodwill, to fair value based on the related discounted cash flow. In order to measure the impairment loss related to goodwill, the difference between the carrying value and the fair value of goodwill was calculated using a business enterprise methodology. This method of goodwill measurement entails calculating the total enterprise value of each of Aavid's business units. Goodwill and intangible assets were then estimated by subtracting the allocated tangible assets (normal levels of working capital and fixed assets) from the total enterprise value.
The total impairment charge recorded in 2001 totaled $115.2 million and is recorded in the accompanying statement of operations as a component of loss from operations.
Effective January 1, 2002, SFAS 142, "Goodwill and Other Intangible Assets" became effective and, as a result, we ceased amortizing approximately $45.1 million of goodwill (the amount remaining after the impairment charge discussed above). Under SFAS 142, goodwill and indefinite-lived assets are no longer amortized but are reviewed annually, or more frequently if impairment indications arise, for impairment. Intangible assets with finite lives continue to be amortized over their estimated useful lives. We have performed the initial and annual impairment tests required by SFAS 142 and have concluded that no further impairment exists as of January 1, 2002 and December 31, 2002. We computed fair value of our operating units based on a discounted cash flow model and compared the results to the book value of each unit. The fair value exceeded book value for each operating unit as of our valuation dates of January 1, 2002 and December 31, 2002. Significant estimates included in our valuation included future business results and the discount rate. Material changes in our estimated future operating results or discount rate could significantly impact our carrying value of goodwill and other intangible assets.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have used internally generated funds and proceeds from financing activities to meet our working capital and capital expenditure requirements. As a result of the Thermalloy acquisition and the merger, we have significantly increased our cash requirements for debt service relating to the notes and our senior credit facility. We intend to use amounts available under our senior credit facility, future debt and equity financings and internally generated funds to finance our working capital requirements, capital expenditures and potential acquisitions.
Net cash used in operating activities for the year ended December 31, 2002 was $3.5 million compared to $9.7 million used in operating activities for the year ended December 31, 2001. We had $19.4 million in negative working capital as of December 31, 2002 compared with $153.0 million in negative working capital at December 31, 2001. The Company's working capital at December 31, 2001 was adversely affected due to the Company classifying all debt related to its senior credit facility and 12 3/4% bond Indenture as current within the December 31, 2001 balance sheet. This classification was due to an event of non-compliance with a financial ratio covenant found within the senior credit facility agreement. As further discussed below, the credit facility was subsequently refinanced and the appropriate classification of debt into short-term and long- term portions occurred at December 31, 2002. At December 31, 2002, accounts receivable days sales outstanding ("DSO") were 66.3 days, compared with 64.5 days at December 31, 2001. At December 31, 2002, inventory turns were 9.7, which compares with 7.4 times at December 31, 2001.
During the year ended December 31, 2002, we made capital expenditures of $4.7 million compared with $5.7 million in 2001. In addition, $0.4 million and $0.7 million of assets were acquired under capital leases in 2002 and 2001, respectively.
On January 29, 2002, the Company's owners contributed $12.0 million of additional equity as part of a forbearance agreement entered into with its lenders at the time. The forbearance agreement allowed the Company to pay its semi-annual interest payment that was due February 1, 2002 on its 12-3/4% Senior Subordinated Notes. The forbearance agreement also required the Company to accelerate a principal payment of $1,985 on the term loan that was originally due on March 31, 2002. This payment of $1,985 was made at the time of the signing of the forbearance agreement.
On August 1, 2002, the Company refinanced its Amended and Restated Credit Facility with two of the four banks that were party to the Amended and Restated Credit Facility. The new credit facility (the "Loan and Security Agreement") is a $27.5 million asset based facility. The facility consists of a term loan component secured by certain United States real estate and machinery and equipment, and requires quarterly principal payments of $0.4 million commencing November 1, 2002. The Loan and Security Agreement also consists of a revolving line of credit component secured by inventory in the United States and accounts receivable in the United States and the United Kingdom. Availability under the line of credit component is determined by a borrowing base of 85% of eligible accounts receivable and 50% of eligible inventory, as defined in the Loan and Security Agreement. Debt outstanding under the Loan and Security Agreement bears interest at a rate equal to, at the Company's option, either (1) in the case of LIBOR rate loans, the sum of the offered rate for deposits in United States dollars for a period equal to such interest period as it appears on Telerate page 3750 as of 11:00am London time and a margin of between 2.5% and 2.85%, or (2) the sum of LaSalle Business Credit's prime rate plus a margin of between ..25% and .50%. At December 31, 2002, the interest rates on the Loan and Security Agreement ranged from 3.92% to 4.75%. Total availability under the line of credit at December 31, 2002 was $15.2 million, of which $7.0 million was outstanding.
On February 2, 2000, as part of the transactions relating to the Merger, we issued 150,000 units (the "Units"), consisting of $150 million aggregate principal amount of our 12 3/4 % Senior Subordinated Notes due 2007 (the "Senior Subordinated Notes") and warrants (the "Warrants") to purchase an aggregate of 60 shares of our Class A Common Stock, par value $0.01
per share, and 60 shares of our Class H Common Stock, par value $0.01 per share. The Senior Subordinated Notes are fully and unconditionally guaranteed on a joint and several basis by each of our domestic subsidiaries. The senior subordinated notes were issued pursuant to an Indenture (the "Indenture") among us, the subsidiary guarantors and Bankers Trust Company, as trustee. Approximately $4.6 million of the proceeds from the sale of the Units was allocated to the fair value of the Warrants and approximately $143.7 million was allocated to the Senior Subordinated Notes, net of original issue discount of approximately $1.7 million. In May, 2001 certain of the Company's stockholders purchased $26.2 million principal amount of Senior Subordinated Notes and contributed them to the Company for cancellation in satisfaction of their obligations resulting from the Company's failure to achieve their required leverage ratio as of December 31, 2000.
The Indenture limits our ability to incur additional debt, to pay dividends or make other distributions, to purchase or redeem our stock or make other investments, to sell or dispose of assets, to create or incur liens, and to merge or consolidate with any other person. The Indenture provides that upon a change in control of Aavid, we must offer to repurchase the Notes at 101% of the face value thereof, together with accrued and unpaid interest. The Notes are subordinated in right of payment to amounts outstanding under our senior credit facility and certain other permitted indebtedness.
The Company has an obligation to purchase from one of its key suppliers a minimum quantity of aluminum coil stock. The Company believes that purchasing aluminum coil stock from this supplier is necessary to achieve consistently low tolerances, design, delivery flexibility, and price stability. Under the terms of this agreement the Company has agreed to purchase certain minimum quantities which approximates $1.8 million at December 31, 2002; however, there are no required dates within which these quantities may be purchased, as such, this purchase commitment is not included in the table below. Additionally, the Company has entered into various long-term debt, capital lease and operating lease arrangements. The future payments required by these arrangements are as follows:
Further expansion of our business or the completion of any material strategic acquisitions may require additional funds which, to the extent not provided by internally generated sources, could require us to seek access to debt and equity markets. There can be no assurance that such funds would be available to the Company at favorable terms or at all.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Upward or downward changes in market interest rates and their impact on the reported interest expense of the Company's variable rate borrowings will affect the our future earnings; however, a ten percent change in 2002 effective interest rates would have an approximate $0.08 million impact on our earnings for 2003, based on debt composition and rates in effect at December 31, 2002.
The Company is exposed to certain foreign currency risks in connection with its foreign operations. The Company does not currently engage in foreign currency hedging activities.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements and supplementary data required pursuant to this Item begin on page 48 of this Report.
This Report contains unaudited consolidated financial statements for 2000. The consolidated financial statements for 2000 were originally audited by Arthur Andersen LLP, but have been modified in this Report by the Company to reflect the treatment of curamik electronics GmbH as a discontinued operation (due to its sale in July, 2002) and to make an adjustment to the Company's cumulative translation adjustment. These restatements are further discussed in Notes C and D to the consolidated financial statements. The 2000 financial statements of curamik electronics GmbH which formed the basis for the discontinued operations computations had been audited by an independent German accounting firm. The Company concluded that a re-audit by Ernst & Young of the 2000 consolidated financial statements, which encompassed many extraordinary events, including the Company's acquisition by Willis Stein & Partners in February 2000 and significant worldwide workforce and facility reductions by Aavid Thermalloy, would place a significant administrative and financial burden on the Company while adding minimal benefit. Accordingly, the Company did not consider the assumption of this burden to be in the best interests of the Company or its debt holders, and did not conduct the re-audit of 2000.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The following table sets forth the names of each of the our directors as of March 15, 2003, their ages, the year in which each became a director and their principal occupations during the past five years:
MEETINGS OF THE BOARD OF DIRECTORS
Our business affairs are managed under the direction of the Board of Directors. Members of the Board are kept informed through various reports and documents sent to them, through operating and financial reports routinely presented at Board and committee meetings by the Chairman and other officers, and through other means. In addition, our directors discharge their duties throughout the year not only by attending Board meetings, but also through personal meetings and other communications, including considerable telephone contact, with the Chief Executive Officer and others regarding matters of interest and concern to Aavid.
During the fiscal year ended December 31, 2002, our Board of Directors held 5 formal meetings. Each director attended at least 75% of the meetings of the Board of Directors held during 2002.
BOARD COMMITTEES
Our Board of Directors formed an audit committee in 2002 comprised of Daniel Blumenthal and David Steadman.
EXECUTIVE OFFICERS
Our executive officers are as follows:
BHARATAN R. PATEL, PH.D. became our and Aavid Thermalloy's Chief Executive Officer on January 1, 2000. He served as one of our directors since April 1996, our President since October 15, 1997 and Chief Executive Officer of Fluent since he helped form it in 1988 as a subsidiary of Creare, Inc. He served as our Chief Operating Officer from October 15, 1997 until December 31, 1999. Dr. Patel worked at Creare, Inc., an engineering consulting firm, from 1976 to 1988, serving in various capacities including Principal Engineer and Vice President. From 1971 to 1976, Dr. Patel was employed as a Senior Engineer in the Power Systems Group of Westinghouse Electric Corporation.
BRIAN A. BYRNE joined Aavid Thermal Technologies, Inc. in April, 2000 as its Chief Financial Officer. Mr. Byrne comes to Aavid from Jabil Circuits, Inc., where he served as Operations Manager. Prior to his position at Jabil, Mr. Byrne served as the Vice President Business Development for Altron Incorporated's (subsequently Sanmina Corporation) and its Massachusetts' printed circuit assembly division for 3 years. Prior to that, he spent 20 years at Compangnie Des Machines Bull in increasingly senior financial and executive positions, most recently as Division General Manager of Bull Electronics.
JOHN W. MITCHELL joined us in December 1995 as Vice President and General Counsel. From 1979 until he joined us, Mr. Mitchell was a corporate and business attorney at Sulloway & Hollis, a Concord, New Hampshire law firm, where he served as our principal outside legal counsel since May 1985.
H. FERIT BOYSAN, PH.D. became Chief Operating Officer of Fluent in July 1997 and President of Fluent in December 1998. Since 1991, he had been Managing Director of Fluent's European operations, headquartered in Sheffield, England. From 1986 to 1991, Dr. Boysan was the Managing Director of Flow Simulations, Ltd., the European distributor of Fluent products until the formation of Fluent Europe in 1991. Dr. Boysan was one of the original developers of Fluent's CFD software.
PETER L. CHRISTIE joined Fluent in 1998 as its Vice President and Chief Financial Officer. From 1984 to 1998, Mr. Christie held several senior management positions, including President and Chief Financial Officer, at Verax Corporation, a bioprocessing company. Prior to joining Verax, Mr. Christie was employed at Creare Inc., an engineering consulting firm, where he held the position of Chief Financial Officer from 1973 to 1978 and was President and founder of Creare Products Inc., a medical instruments manufacturer, from 1978 to 1984.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION OF EXECUTIVE OFFICERS
The following table summarizes all compensation earned by or paid to our Chief Executive Officer and the four other most highly paid executive officers whose annual salary and bonus exceeded $100,000 (collectively, the "Named Executive Officers") for services rendered in all capacities to Aavid during the fiscal years indicated.
(1) Mr. Patel became President and Chief Operating Officer of Aavid in October 1997, and became Chief Executive Officer of Aavid on January 1, 2000.
(2) Mr. Byrne became joined the Company as Chief Financial Officer in April, 2000.
(3) Mr. Boysan became President of Fluent in December 1998.
EMPLOYMENT AGREEMENTS
Aavid has entered into an employment agreements with Messrs. Patel, Byrne and Mitchell, which currently expire on July 1, 2005 and Fluent has entered into an employment agreement with Mr. Boysan, which currently expires on July 1, 2005.
The employment agreements require each employee to devote his full business time and best efforts, business judgment, skill and knowledge exclusively to the advancement of the business and interests of Aavid. The employment agreements currently provide for the payment of a base salary to Messrs. Patel, Boysan, Mitchell and Byrne equal to $350,000, $200,000, $210,000, and $210,000, respectively, subject to increase at the discretion of the board of directors of their respective employers. The board of directors did increase base compensation of Messrs. Patel, Mitchell and Byrne as set forth in the Summary Compensation Table above. Each employment agreement provides that the employee will continue to receive his base salary, benefits and other compensation for a specified period in the event their respective employers terminate their employment other than for "cause" or under certain other circumstances.
Each of Messrs. Byrne, Mitchell, and Patel is entitled to an annual bonus of 30%, 33.33% and 50% of base salary, respectively, based on Aavid's performance. Mr. Boysan is entitled to an annual bonus based on our actual performance against budgeted performance. We may renegotiate our obligation to make the payments under those employment agreements in connection with certain public offering or acquisition transactions.
The employment agreements contain non-competition covenants.
COMPENSATION OF DIRECTORS
Each of Messrs. Steadman and Dickinson receives an annual fee of $15,000 and $1,000 for each Board of Directors meeting attended. In addition, each of Mr. Steadman and Mr. Dickinson purchased 0.05% of the non-voting common equity of Aavid Thermalloy LLC.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
BENEFICIAL OWNERSHIP OF COMMON STOCK
Heat Holdings Corp. currently owns all of the issued and outstanding common and preferred stock of Aavid. Aavid also has issued detachable warrants, sold to noteholders in connection with the sale of the senior subordinated notes, to acquire, in the aggregate, 60 shares of Aavid's Class A common stock, representing 3% of the common stock of Aavid (on a fully diluted basis) and 60 shares of Aavid's Class H common stock (representing rights to less than 1% of the equity securities of Aavid Thermalloy, LLC). Holdings currently owns a portion of such warrants.
The following table sets forth certain information regarding the beneficial ownership of the issued and outstanding common stock of Holdings as of March 1, 2003.
(1) "Beneficial ownership" means any person who, directly or indirectly, has or shares voting or investment power with respect to a security or has the right to acquire such power within 60 days. Unless otherwise indicated, we believe that each holder has sole voting and investment power with regard to the equity interests listed as beneficially owned.
(2) Each share of Series A preferred stock is convertible into approximately .9346 shares of Class A common stock and each share of Series B preferred stock is convertible into approximately .9346 shares of Class B common stock. Each share of Series C preferred stock is convertible into approximately 2.817 shares of Class A common stock, and each share of Series D preferred stock is convertible into approximately 2.817 shares of Class B common stock.
(3) Consists of 4,096,770.66 shares of each of Class A common stock and Class B common stock directly beneficially held by Willis Stein & Partners II, L.P. and 262,075.91 shares of each of Class A common stock and Class B common stock directly beneficially held by Willis Stein & Partners Dutch, L.P. Willis Stein & Partners Management II, L.L.C. is the general partner of the general partner of both partnerships and may be deemed to beneficially own such shares. John R. Willis and Daniel H. Blumenthal, as managing directors of Willis Stein & Partners Management II, L.L.C., may be deemed to beneficially own the shares of common stock beneficially owned by the partnerships and their general partner. Messrs. Willis and Blumenthal disclaim beneficial ownership of any of such shares. The address of Willis Stein & Partners Management II, L.L.C. and each partnership is One North Wacker Drive, Suite 4800, Chicago, IL 60606.
(4) Consists of (a) 972,735.80 shares of each of Series A preferred stock and Series B preferred stock and 445,655.86 shares of each of Series C preferred stock and Series D preferred stock directly beneficially held by Willis Stein & Partners III, L.P., (b) 29,288.68 shares of each of Series A preferred stock and Series B preferred stock and 13,418.52 shares of each of Series C preferred stock and Series D preferred stock directly beneficially held by Willis Stein & Partners Dutch III-A, L.P., (c) 29,288.68 shares of each of Series A preferred stock and Series B preferred stock and 13,418.52 shares of each of Series C preferred stock and Series D preferred stock directly beneficially held by Willis Stein & Partners Dutch III-B, L.P. and (d) 8,435.15 shares of each of Series A preferred stock and Series B preferred stock and 3,864.54 shares of each of Series C preferred stock and Series D preferred stock directly beneficially held by Willis Stein & Partners III-C, L.P. Willis Stein & Partners Management III, L.L.C. is the general partner of the general partner of each partnership and may be deemed to beneficially own such shares. John R. Willis and Daniel H. Blumenthal, as managing directors of Willis Stein & Partners Management III, L.L.C., may be deemed to beneficially own the shares of common stock beneficially owned by the partnerships and their general partner. Messrs. Willis and Blumenthal disclaim beneficial ownership of any of such shares. The address of Willis Stein & Partners Management III, L.L.C. and each partnership is One North Wacker Drive, Suite 4800, Chicago, IL 60606.
(5) The Chase Manhattan Bank acts as the trustee for the First Plaza Group Trust, a trust under and for the benefit of certain employee benefit plans of General Motors Corporation ("GM"), its subsidiaries and unrelated employers. These shares may be deemed to be owned beneficially by General Motors Investment Management Corporation ("GMIMCo"), a wholly-owned subsidiary of GM. GMIMCo's principal business is providing investment advice and investment management services with respect to the assets of certain employee benefit plans of GM, its subsidiaries and unrelated employers, and with respect to the assets of certain direct and indirect subsidiaries of GM and associated entities. GMIMCo is serving as the trust's investment manager with respect to these shares and in that capacity it has the sole power to direct the trustee as to the voting and disposition of these shares. Because of the trustee's limited role, beneficial ownership of the shares by the trustee is disclaimed. First Plaza Group Trust's address is c/o GMIMCo, 767 Fifth Ave., 16th Floor, New York, NY 10153.
(6) Consists of (a) 333,857.73 shares of each of Class A common stock and Class B common stock directly beneficially held by Abbott Capital 1330 Investors II, L.P., (b) 66,771.55 shares of each of Class A common stock and Class B common stock, 93,163.66 shares of each of Series A preferred stock and Series B preferred stock, and 31,804.53 shares of each of Series C preferred stock and Series D preferred stock directly beneficially held by Abbott Capital Private Equity Fund III, L.P. and (c) 26,708.62 shares of each of Class A common stock and Class B common stock and 1,741.76 shares of each of Series C preferred stock and Series D preferred stock directly beneficially held by BNY Partners Fund, L.L.C. The address of such funds is c/o Abbott Capital Management, LLC, 1211 Avenue of the Americas, Suite 4300, New York, New York 10036.
(7) Consists of (a) 424,061.76 shares of each of Class A common stock and Class B common stock, and 49,881.15 shares of each of Series A preferred stock and Series B preferred stock directly beneficially held by Nassau Capital Partners III, L.P., and (b) 3,276.14 shares of each of Class A common stock and Class B common stock and 385.36 shares of each of Series A preferred stock and Series B preferred stock directly beneficially held by NAS Partners I L.L.C. Such funds' address is 22 Chambers Street, Princeton, New Jersey 08542.
(8) BancBoston's address is 175 Federal Street, 10th Floor, Boston, Massachusetts 02110. Each of the stockholders listed in the table above currently holds Class A and Class B common stock and Series A, Series B, Series C and Series D preferred stock of Heat Holdings II Corp. in a percentage equal to such stockholder's ownership of the corresponding class and series of Holdings shares. Heat Holdings II Corp. holds or has the rights to acquire approximately 98% of the outstanding common and convertible preferred membership interests in Aavid Thermalloy, LLC. Our executive officers and certain of our employees currently own approximately 1.5% of the non-voting common equity of Aavid Thermalloy, LLC and approximately 9.5% of the non-voting common equity of Fluent Holdings, Inc.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
NONE
PART IV
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
(1) Evaluation of disclosure controls and procedures. Based on their evaluation of our disclosure controls and procedures (as defined in Rules 13a-14( c) and 15d-14( c) under the Securities Exchange Act of 1934) as of a date within 90 days of the filing of this Annual Report on Form 10-K, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within time periods specified in the SEC's rules and forms and are operating in an effective manner.
(2) Changes in internal controls. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluation.
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K
(a) Financial Statements and Financial Schedules
(1) and (2) See "Index to Consolidated Financial Statements" beginning on page 48. Schedule II - Valuation and Qualifying Accounts and the Financial Data Schedule are filed herewith. All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.
(3) The following exhibits are filed or incorporated by reference as part of this Annual Report are management contracts, compensatory plans or arrangements: Exhibits 10.1, 10.2, 10.5, 10.6 and 10.7.
(1) Incorporated by reference to Exhibits to the Company's Current Report on Form 8-K dated August 23, 1999.
(2) Incorporated by reference to Exhibits to the Company's Registration Statement on Form S-4 (No. 333-33126).
(3) Incorporated by reference to Exhibits to the Company's Current Report on Form 8-K dated February 2, 2000.
(4) Incorporated by reference to Exhibits to the Company's Registration Statement on Form S-1 (No. 33-99232).
(5) Incorporated by reference to Exhibits to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001.
(6) Incorporated by reference to Exhibits to the Company's Current Report on Form 8-K dated October 21, 1999.
SIGNATURES
Pursuant to the requirements of Section 13 or 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.
AAVID THERMAL TECHNOLOGIES, INC.
By: /s/ Bharatan R. Patel -------------------------------- Bharatan R. Patel, President and Chief Executive Officer March 28, 2003
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 in the capacities and on the dates indicated.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AAVID THERMAL TECHNOLOGIES, INC.
REPORT OF INDEPENDENT AUDITORS
Stockholders and Board of Directors Aavid Thermal Technologies, Inc.
We have audited the accompanying consolidated balance sheets of Aavid Thermal Technologies, Inc. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, changes in stockholders' (deficit) equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of Curamik GmbH (which, through July 16, 2002, was an 89.4%-owned subsidiary) as of December 31, 2001 and for the year then ended, which statements reflect total assets and total revenues of 15.0% and 11.5%, respectively, of the related consolidated totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for that entity, is based solely on the report of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits, and the report of other auditors, provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Aavid Thermal Technologies, Inc. and subsidiaries at December 31, 2002 and 2001, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.
As discussed in Note B to the consolidated financial statements, in 2002 the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets".
Our audits were conducted for the purpose of forming an opinion of the basic financial statements taken as a whole. The schedule listed in the Index To Consolidated Financial Statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a required part of the basic financial statements. This schedule has been subject to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
/s/ ERNST & YOUNG LLP
MANCHESTER, NEW HAMPSHIRE February 21, 2003
AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA)
The accompanying notes are an integral part of these consolidated financial statements.
AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS)
The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company in the Merger. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying consolidated financial statements of the Predecessor and the Company are not comparable in all material respects since those consolidated financial statements report results of operations and cash flows for these two separate entities.
The accompanying notes are an integral part of these consolidated financial statements.
AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' (DEFICIT) EQUITY (IN THOUSANDS, EXCEPT SHARE DATA)
The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company in the Merger. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying consolidated financial statements of the Predecessor and the Company are not comparable in all material respects since those consolidated financial statements report results of operations and cash flows for these two separate entities.
The accompanying notes are an integral part of these consolidated financial statements.
AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' (DEFICIT) EQUITY (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA)
The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company in the Merger. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying consolidated financial statements of the Predecessor and the Company are not comparable in all material respects since those consolidated financial statements report results of operations and cash flows for these two separate entities.
The accompanying notes are an integral part of these consolidated financial statements.
AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' (DEFICIT) EQUITY (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA)
The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company in the Merger. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying financial statements of the Predecessor and the Company are not comparable in all material respects since those financial statements report results of operations and cash flows for these two separate entities.
The accompanying notes are an integral part of these consolidated financial statements.
AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company in the Merger. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying consolidated financial statements of the Predecessor and the Company are not comparable in all material respects since those consolidated financial statements report results of operations and cash flows for these two separate entities.
The accompanying notes are an integral part of these consolidated financial statements.
AAVID THERMAL TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (ALL AMOUNTS PRESENTED FOR THE PERIOD JANUARY 1, 2000 THROUGH FEBRUARY 1, 2000 AND FOR THE PERIOD FEBRUARY 2, 2000 THROUGH DECEMBER 31, 2000 ARE "UNAUDITED")
A. OPERATIONS AND MERGER
Aavid Thermal Technologies, Inc. (the "Company" or "Aavid") is a leading global provider of thermal management solutions for electronic products and the leading developer and marketer of computational fluid dynamic ("CFD") software. Each of these businesses has an established reputation for high product quality, service excellence and engineering innovation in its market. Aavid designs, manufactures and distributes on a worldwide basis thermal management products that dissipate unwanted heat, which can degrade system performance and reliability, from microprocessors and industrial electronics products. Aavid's products, which include heat sinks, interface materials and attachment accessories, fans, heat spreaders and liquid cooling and phase change devices that it configures to meet customer-specific needs, serve the critical function of conducting, convecting and radiating away unwanted heat. CFD software is used in complex computer-generated modeling of fluid flows, heat and mass transfer and chemical reactions. Aavid's CFD software is used in a variety of industries, including the automotive, aerospace, chemical processing, power generation, material processing, electronics and HVAC industries.
Overall, the Company services a highly diversified base of more than 3,500 national and international customers including OEMs, distributors, and contract manufacturers through a highly integrated network of software, development, manufacturing, sales and distribution locations throughout North America, Europe, and the Far East.
On February 2, 2000, the Company was acquired by Heat Holdings Corp., a corporation newly formed by Willis Stein & Partners II, L.P. Pursuant to the Merger, Aavid stockholders received $25.50 in cash for each outstanding share of common stock. In addition, all outstanding stock options and warrants were cashed out. The Merger was accounted for using the purchase method.
The Merger and related transaction costs were funded by a cash contribution from Heat Holdings and an affiliate of $152,000, proceeds of $148,312, net of original issue discount, from the sale by the Company of 12 3/4% senior subordinated notes and warrants due 2007, $54,700 pursuant to a senior credit facility entered into by the Company, and approximately $4,653 of cash on hand. Additionally, the Company used $7,085 of cash on hand to pay financing fees associated with the senior credit facility and 12 3/4% senior subordinated notes. Net assets on the date of acquisition were $156,560. Based upon fair value of assets acquired and liabilities assumed, goodwill of $183,676 was established. Approximately $113,705 of this goodwill is attributable to Aavid Thermalloy, the hardware business, and was being amortized over 20 years. The remainder, $69,971, is attributable to Fluent, the CFD software business, and was being amortized over 4 years.
The fair value of assets acquired and liabilities assumed at February 2, 2000 (unaudited) was as follows:
Of the $152,000 cash contribution, $4,811 was invested by Heat Holdings II Corp., an affiliate of Heat Holdings, to acquire 95% of the common equity of Aavid Thermalloy, LLC, the thermal management hardware business. The Company controls Aavid Thermalloy, LLC through a preferred equity interest, and holds a 5% common equity interest and thus consolidates Aavid Thermalloy LLC in its results within the accompanying financial statements. The investment by Heat Holdings II Corp. has been recorded as minority interest within the accompanying financial statements. Based on the allocation methodology as defined within the Aavid Thermalloy LLC Agreement, $3,294 and $1,519 of the losses at Aavid Thermalloy, LLC were allocated to the minority interest held by Heat Holdings II Corp. for the year ended December 31, 2001 and 2000, respectively. There were no losses allocated in 2002.
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
These financial statements reflect the consolidated results of operations and cash flows of the Company for the period from January 1, 2000 to February 1, 2000 ("Predecessor financial statements"). The Predecessor financial statements have been prepared using the historical cost of the Company's assets and have not been adjusted to reflect the merger with Heat Holdings Corp. The accompanying financial statements as of December 31, 2002 and 2001 and for the periods subsequent to February 1, 2000 reflect the consolidated financial position, results of operations, and cash flows of the Company subsequent to the date of the merger and include adjustments required under the purchase method of accounting. The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying financial statements of the Predecessor and the Company are not comparable in all material respects since those financial statements report financial position, results of operations, and cash flows for these two separate entities. The 2000 amounts (unaudited) included in the following notes include the combined results of the Predecessor for the period from January 1, 2000 through February 1, 2000 and the Company from February 2, 2000 through December 31, 2000.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All material intercompany transactions have been eliminated.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to significant concentration of credit risk consist principally of trade accounts receivable. The risk is limited due to the relatively large number of customers comprising the Company's customer base and their dispersion across many industries within the United States, Europe, and Asia. The Company performs ongoing credit evaluations of its customers' financial condition and generally requires no collateral from its customers. The Company maintains an allowance for uncollectible accounts receivable based upon expected collectibility of all accounts receivable, considering historical losses, existing economic conditions and individual customers' credit worthiness. The Company's write-offs of accounts receivable have not been significant during the periods presented. At December 31, 2002 and 2001, there were no individual customer accounts receivable balances greater than 10% of total accounts receivable. The Company's sales have been primarily denominated in U.S. dollars, and the effects of foreign exchange fluctuations are not considered to be material.
INCOME TAXES
The Company accounts for income taxes under Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." Under this method, the amount of deferred tax liabilities or assets is calculated by applying the provisions of enacted tax laws to determine the amount of taxes payable or refundable currently or in future years. SFAS No. 109 requires a valuation allowance against deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realizable.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations as incurred. SFAS No. 86, "Accounting for the Costs of Computer Software To Be Sold, Leased, or Otherwise Marketed," requires capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on the Company's product development process, technological feasibility is established upon completion of a working model. Costs incurred by the Company between completion of the working model and the point at which the product is ready for general release have not been material. Accordingly, all research and software development costs have been expensed.
IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with the merger, the Company allocated $15,000 of the purchase price to in-process research and development projects. This allocation represented the estimated fair value based on risk-adjusted cash flows related to the incomplete software research and development projects of Fluent, Inc. At the date of the merger, the development of these projects had not yet reached technological feasibility and the research and development in progress had no alternative future uses. Accordingly, these costs were expensed as of the merger date.
The Company allocated values to the in-process research and development based on an in-depth assessment of the R&D projects. The value assigned to these assets was limited to significant research projects for which technological feasibility had not been established, including development, engineering and testing activities associated with the introduction of the acquired in-process technologies.
The value assigned to purchased in-process technology was determined by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting net cash flows from the projects, and discounting the net cash flows to their present value. The revenue projection used to value the in-process research and development was based on historical results, estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by the Company and its competitors. The resulting net cash flows from such projects are based on management's estimates of cost of sales, operating expenses, and income taxes from such projects.
The nature of the efforts to develop the acquired in-process technologies into commercially viable products and services principally related to the completion of certain planning, designing, coding, prototyping, and testing activities that were necessary to establish that the developmental software technologies met their design specifications including functional, technical, and economic performance requirements. At the merger date, the technologies under development were between 40% and 80% complete, based upon project man-month and cost data. Anticipated completion dates ranged from 6 to 18 months, at which times the Company expects to begin selling the developed products. Development costs to complete the R&D were estimated at approximately $4,000.
Fluent's primary in-process R&D projects involved developing: (i) Fluent version 6.0; (ii) Gambit version 2.0; (iii) materials processing functionality; and, (iv) advanced infrastructure technology. Fluent 6.0 represents the Company's latest computational fluid dynamics (CFD) software engine. Gambit 2.0 includes new pre-processor CFD technologies. The development of materials processing technologies is designed to address CFD needs in new markets. The advanced infrastructure technology establishes a new platform upon which future products will be more efficiently and rapidly developed.
Aggregate revenues for the developmental Fluent products were estimated to peak within three years of acquisition and then decline steadily as other new products and technologies are expected to enter the market. Operating expenses were estimated based on historical results and management's analysis of Fluent's cost structure. Projected operating expenses as a percentage of revenues were expected to be stable for the foreseeable future.
The rates utilized to discount the net cash flows to their present value were based on estimated cost of capital calculations. A discount rate of 18 percent was considered appropriate for the in-process R&D, and a discount rate of 15 percent was appropriate for the existing products and technologies. These discount rates were commensurate with the Fluent's long history and market leadership position. The discount rate utilized for the in-process technology was higher than Aavid's cost of capital due to the inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of such technology and the uncertainty of technological advances that are unknown at this time.
With respect to the acquired in-process technology, the calculations of value were adjusted to reflect the development efforts of Fluent prior to the close of the merger. In doing so, consideration was given to each major project's stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred, and the projected cost to complete the projects.
As of December 31, 2002, the majority of the projects had been successfully completed.
CASH AND CASH EQUIVALENTS AND FINANCIAL INSTRUMENTS
For purposes of the consolidated statements of cash flows, cash and cash equivalents consist of highly liquid investments with original maturities at date of purchase of three months or less.
The estimated fair value of the Company's financial instruments including accounts receivable, accounts payable and cash equivalents approximates carrying value. The fair value of the Company's long-term debt instruments under the Company's senior credit facilities also approximates carrying value due to their variable interest rates and relatively short maturities. The fair value of the Company's 12 3/4% senior subordinated notes was $92,238 at December 31, 2002 and $74,285 at December 31, 2001.
INVENTORIES
Inventories are valued at the lower of the actual cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory, using the first-in, first-out (FIFO) method of accounting, and consists of materials, labor and overhead. The Company regularly reviews its inventory quantities on hand and records a provision for excess and obsolete inventory based primarily on the estimated forecast of product demand and production demand for the next twelve months. As demonstrated in 2002 and 2001, demand for the Company's products can fluctuate significantly. A significant increase in demand for the Company's products could result in a short-term increase in the cost of inventory purchases and production costs while a significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand. In addition, the Company's industry is characterized by rapid technological change, frequent new product development and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Additionally, the Company's estimates of future product demand may prove to be inaccurate, in which case the Company may have understated or overstated the provision required for excess or obsolete inventory. In the future, if the Company's inventory is determined to be overvalued, the Company would be required to recognize such costs in our cost of goods sold at the time of determination. Likewise, if the Company's inventory is determined to be undervalued, the Company may have over-reported our cost of sales in previous periods and would be required to recognize such additional operating income at the time of sale. Therefore, although the Company makes every effort to ensure the accuracy of its forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of the Company's inventory and reported operating results.
PROPERTY, PLANT AND EQUIPMENT
Property, plant, and equipment are stated at cost. The Company depreciates property, plant and equipment over their estimated remaining useful lives (buildings -- 30 to 40 years; machinery and equipment, -- 1 to 10 years; and vehicles -- 4 to 5 years) using both the straight-line and accelerated methods of depreciation.
Repairs and maintenance are charged against income when incurred; renewals and betterments are capitalized. When property, plant, and equipment are retired or sold, their cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized.
INTANGIBLE ASSETS
Costs incurred in connection with the issuance of the Company's debt obligations have been deferred and are being amortized over the term of the respective debt obligations. Other intangible assets consist principally of goodwill and developed technology. Intangibles are being amortized on a straight-line basis over the following estimated useful lives:
SFAS No. 121, "Accounting For the Impairment of Long-Lived Assets and For Long-Lived Assets To Be Disposed Of", requires that long-lived assets, including intangibles, be reviewed for impairment whenever events or changes in circumstances, such as a change in market value, indicate that the asset carrying amounts may not be recoverable. In performing the review for recoverability, if future undiscounted cash flows (without interest charges) from the use and ultimate disposition of the assets are less than their carrying values, an impairment loss is recognized. Impairment losses are to be measured based on the fair value of the asset.
During 2001 and prior periods, we assessed the impairment of identifiable intangibles, long-lived assets and related goodwill whenever events or changes in circumstances indicated that the carrying value may not be recoverable as required under SFAS No. 121. Factors we considered important which could trigger an impairment review included the following:
- - significant underperformance relative to historical or projected future operating results;
- - significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
- - significant negative industry or economic trends.
Under SFAS No. 121, when we determined that the carrying value of intangibles, long-lived assets and related goodwill may not be recoverable based on the existence of one or more of the above indicators of impairment, we measured any impairment based on a projected discounted cashflow method using a discount rate determined by our management to be commensurate with the risk inherent in our business model. During 2001, global macroeconomic conditions weakened and the demand for industrial and consumer electronics contracted significantly. Coupled with the closing of three manufacturing facilities in the U.S. and abroad, the Company determined that its ability to achieve its original long-term financial forecast had been negatively impacted. The Company determined that a triggering event, as defined by SFAS No. 121, had occurred related to the intangible assets initially acquired in connection with the Merger. Based on cash flow projections related to the acquired assets, the Company concluded that all of the acquired intangible assets related to Aavid Thermalloy and certain intangible assets related to Fluent had been impaired. During the fourth quarter of 2001, the Company wrote down the assets, along with any allocated goodwill, to fair value based on the related discounted cash flow. In order to measure the impairment loss related to goodwill, the difference between the Company's carrying value and the fair value of goodwill was calculated using a business enterprise methodology. This method of goodwill measurement entails calculating the total enterprise value of each of the Company's business units. Goodwill and intangible assets were then estimated by subtracting the allocated tangible assets (normal levels of working capital and fixed assets) from the total enterprise value. The impairment charge recorded in 2001 totaled $115,210 (restated - Note C) and is recorded in the accompanying consolidated statement of operations as a component of income from operations.
A breakout of this charge by asset type and by business unit is as follows:
Effective January 1, 2002, the Company adopted the provisions of SFAS No. 142 "Goodwill and Other Intangible Assets". SFAS No. 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. The Statement requires that these assets be reviewed for impairment at least annually. Intangible assets with finite lives will continue to be amortized over their estimated useful lives.
Information regarding intangible assets at December 31 follows:
Aggregate amortization expense for the year ended December 31, 2002, 2001 and 2000, excluding the impairment charge of $115,210 taken in 2001, was $5,189, $35,660 and $33,162 (unaudited), respectively. Estimated amortization expense for the next five years is estimated to be $4,299 annually.
A reconciliation of reported net income to adjusted net income for each year follows:
REVENUE RECOGNITION
THERMAL PRODUCTS
Revenue is recognized when products are shipped. We offer certain distributors limited rights of return and stock rotation rights. Due to these return rights, we continuously monitor and track product returns and we record a provision for the estimated future amount of such future returns, based on historical experience and any notification we receive of pending returns. While such returns have historically been within our expectations and provisions established, we cannot guarantee that we will continue to experience the same return rates that we have in the past. Any significant decrease in product demand experienced by our distributor customers and the resulting credit returns could have a material adverse impact on our operating results for the period or periods in which such returns materialize.
SOFTWARE
The Company's software subsidiary, Fluent, has historically recognized software revenue in accordance with Statement of Position (SOP) 97-2, "Software Revenue Recognition" and SOP 98-9, "Modification of SOP 97-2 Software Revenue Recognition, With Respect to Certain Transactions." These statements provide specific industry guidance and stipulate that revenue recognized from software arrangements is to be allocated to each element of the arrangement based on the relative fair values of the elements, such as software products, upgrades, enhancements, post-contract customer support ("PCS"), installation or training. Under the terms of Fluent's arrangements, the software is delivered upon signing and the bundled PCS is available to the customer over the term of the contract. SOP 97-2 requires a seller of software with bundled PCS to establish vendor specific objective evidence ("VSOE") of the value of the undelivered element of the contract (in Fluent's case the PCS) in order to account separately for the PCS revenue.
In order to establish VSOE, there needs to be specific instances in which a customer purchases the PCS separately from the software such that a true market value can be determined. Prior to 2001, Fluent's product offerings consisted of both perpetual licenses and annual licenses that included bundled PCS. Purchasers of perpetual licenses would renew their PCS each year for a specific price, thereby establishing VSOE for the PCS. Fluent used this VSOE of the value of PCS for both perpetual and annual licenses.
SOP 98-9 modified SOP 97-2 to require the use of the "residual method" in situations where VSOE of value exists for all undelivered elements, but does not exist for one or more of the delivered elements. Under the residual method, the undiscounted VSOE of fair value of the undelivered elements (PCS) is deferred and the difference (residual) between the total fee and the amount deferred for the undelivered elements is recognized immediately as revenue. In sum, revenue related to the software element is recognized upon signing of the contract and delivery of the product. Revenue related to PCS is recognized ratably over the life of the contract. Using the residual method methodology, Fluent determined that 36% of the annual license fee was attributable to PCS, using the price charged for PCS on a perpetual license as VSOE of value of PCS for an annual license. Therefore, upon delivery of software under an annual software license, 64% of the license fee was recognized immediately and the remaining 36% was deferred and amortized to revenue over the 12 month life of the license.
On December 29, 2000, the American Institute of Certified Public Accountants (AICPA) issued Technical Practice Aid (TPA) 5100.68. TPA 5100.68 dealt with the issue of whether a perpetual license with separately priced PCS established VSOE of value for shorter term software licenses with bundled PCS. The AICPA specifically stated in TPA 5100.68 that PCS services for a perpetual license and PCS services for a shorter term license are two different elements. Therefore, the renewal rate charged for PCS on a perpetual license does not provide VSOE of value for PCS on the shorter term license. Due to the issuance of this TPA, the Company concluded that under Fluent's bundled contract business practice the Company could no longer establish VSOE of the value of PCS related to its annual licenses based on the PCS used for perpetual licenses.
In order to maintain a consistent revenue recognition methodology and to more definitely confirm VSOE of value on the individual elements of the contract, the Company elected to change its annual license agreements and proposals in 2001 to offer PCS as a separately priced item from the software (the "unbundled method"), that could be purchased at the customer's
election. In other words, customers could license Fluent's software, which no longer included PCS, and either separately contract for PCS or elect not to take PCS. The Company believed at that time that the unbundled method would establish VSOE of value on the PCS such that the Company could continue to recognize the software revenue upon contract signing and shipment of the software, and defer only the PCS portion of the revenue ratably over the term of the contract. This change had minimal impact on revenue recognition when compared to prior periods, but did clearly identify separate prices for the software and service elements of the contract.
During 2002, based upon further consideration of the guidance in TPA 5100.68, issued on December 29, 2000, the Company determined that the VSOE of value that it was relying upon to support the portion of the license fee attributed to the PCS during 2001, even in the unbundled state, was not sufficient to support such treatment. As a result, the Company concluded that it should recognize revenue for the entire software license, and not just the PCS portion of the agreement, ratably over the 12 month term of the license.
Accordingly, the Company has restated its financial statements as of December 31, 2001, and for the year then ended, to reflect this change in revenue recognition. While this change has a significant impact on recorded revenues within the statements of operations, and consequently on net loss, this change does not affect the Company's statements of cash flows other than re-allocating certain changes in balance sheet accounts within the cash flow from operations section of the statement. For the year ended December 31, 2001, the amount of revenue originally recognized but now deferred is $15,806 (Note C). However, Fluent continues to be paid by its customers upon commencement of the execution of the non-cancellable license agreement.
COMPREHENSIVE INCOME
Statement of Financial Accounting Standards No. 130 "Reporting Comprehensive Income", requires reporting and display of comprehensive income and its components. SFAS No. 130 requires companies to report all changes in stockholders' equity during a period, except those resulting from investment by owners and distribution to owners, in comprehensive income (loss) in the period in which they are recognized. Accordingly, the foreign currency translation adjustments are included in other comprehensive income (loss).
USE OF ACCOUNTING ESTIMATES
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the reported amounts of revenues and expenses during the reporting period, and to disclose contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates.
TRANSLATION OF FOREIGN CURRENCY
The financial statements of the Company's foreign subsidiaries are translated in accordance with SFAS No. 52, "Foreign Currency Translation". The financial statements of the Company's subsidiaries are translated from their functional currency into U.S. dollars utilizing the current rate method.
Accordingly, assets and liabilities are translated at exchange rates in effect at the end of the year, and revenues and expenses are translated at the weighted average exchange rate during the year. All cumulative translation gains and losses from the translation into U.S. dollars are included as a separate component of stockholders' equity in the consolidated balance sheets. Transaction gains and losses are included in the consolidated statements of operations. Foreign currency gains (losses) included in the consolidated statement of operations were $465, ($933) and ($954) (unaudited) for the years ended December 31, 2002, 2001 and 2000, respectively.
C. RESTATEMENTS
Retained earnings (deficit) at December 31, 2000 (unaudited) and December 31, 2001 have been restated in connection with changes made to the consolidated statements of operations for the period February 2, 2000 through December 31, 2000 (unaudited) and the year ended December 31, 2001 as follows:
The above-noted changes relating to the cumulative translation adjustment reflected in comprehensive loss for the period February 2, 2000 through December 31, 2000 (unaudited) and the year ended December 31, 2001 resulted in a corresponding correction to the cumulative translation adjustment reflected in the consolidated statements of changes in stockholders' equity (deficit) for the respective periods.
D. SALE OF BUSINESSES AND DISCONTINUED OPERATION
In the fourth quarter of 2001, the Company recognized a loss on disposal of a division of $4,322 (restated - Note C). This loss was related to the sale of the Company's aluminum extrusion facility located in Franklin, NH. The facility was sold for $2,980. Of this amount, $2,500 was paid in cash and the remainder was taken as a note due the Company and payable in 12 equal installments of principal and interest in the amount of $42 beginning March 1, 2002. The note bears interest at 8.0%. The $2,500 in cash proceeds were remitted to our Senior Lending group as required by the Amended and Restated Credit Agreement that was in effect at the time.
On July 17, 2002, the Company sold all of the outstanding shares of Aavid Thermalloy Holdings, GmbH, which in turn owned approximately 89.4% of the outstanding shares of curamik electronics GmbH, pursuant to a Share Sale and Purchase Agreement between the Company and Electrovac Fabrikation Electrotechnischer Spezialartikel GesmbH dated July 10, 2002 (the "Sale Agreement"). Under the Sale Agreement, the Company received consideration of $31,524, subject to possible adjustment based upon the level of consolidated net assets of Curamik and certain indemnification obligations of the Company. The Company recorded a pre-tax gain on the sale of $7,082 in the accompanying statements of operations for the year ended December 31, 2002. $27,683 of the sale proceeds was used to pay down senior debt. The sale of Curamik and its related operating results have been excluded from the results from continuing operations and is classifed as a discontinued operation for all periods presented, in accordance with the requirements of Statement of Financial Accounting Standards (SFAS) No. 144 "Accounting for Impairment or Disposal of Long-Lived Assets".
The following is a summary of the results of discontinued operations for the period January 1, 2000 through February 1, 2000 (unaudited), the period February 2, 2000 through December 31, 2000 (unaudited) and the years ended December 31, 2001 and 2002:
The table that follows presents a breakdown of the major components of assets and liabilities of discontinued operations at December 31, 2001:
E. ACCOUNTS RECEIVABLE
The components of accounts receivable at December 31, 2002 and 2001 are as follows:
F. INVENTORIES
The components of inventories at December 31, 2002 and 2001 are as follows:
G. PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment, recorded at cost, by major classification as of December 31, 2002 and 2001 consist of the following:
Substantially all property, plant, and equipment serve as collateral under the Company's borrowing arrangements.
H. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Included in accrued expenses and other current liabilities at December 31, 2002 and 2001 are the following:
I. DEBT OBLIGATIONS
Debt obligations as of December 31, 2002 and 2001 consist of the following:
On February 2, 2000, as part of the transactions relating to the Merger, the Company issued 150,000 units (the "Units"), consisting of $150,000 aggregate principal amount of its 12 3/4% Senior Subordinated Notes due 2007 (the "Notes") and warrants (the "Warrants") to purchase an aggregate of 60 shares of the Company's Class A Common Stock, par value $0.0001 per share, and 60 shares of the Company's Class H Common Stock, par value $0.0001 per share. The Notes are fully and unconditionally guaranteed on a joint and several basis by each of the Company's domestic subsidiaries (the "Subsidiary Guarantors") (see note (Q) for selected consolidating financial statements of parent, guarantors and non-guarantors). The Notes were issued pursuant to an Indenture (the "Indenture") among the Company, the Subsidiary Guarantors and Bankers Trust Company, as trustee. $4,560 of the proceeds from the sale of the Units was allocated to the fair value of the Warrants and $143,752 was allocated to the Notes, net of original issue discount of $1,688. The total discount of $6,248 is being accreted over the term of the notes, using the effective interest rate method. This accretion is recorded as interest expense within the accompanying statements of operations for the years ended December 31, 2002 and 2001 and the period February 2, 2000 to December 31, 2000 (unaudited). In May, 2001 certain of the Company's stockholders purchased $26,191 principal amount of Senior Subordinated Notes and contributed them to the Company for cancellation in satisfaction of their obligations resulting from the Company's failure to achieve their required leverage ratio as of December 31, 2000.
In connection with the Merger, the Company entered into an amended and restated credit facility (the "Amended and Restated Credit Facility"). The Amended and Restated Credit Facility provided for a $22,000 revolving credit facility (the "Revolving Facility") and a $53,000 term loan facility (the "Term Facility"). On May 4, 2001, in response to the Company not being in compliance with a leverage ratio covenant at December 31, 2000, certain of the Company's stockholders and their affiliates made an equity contribution of $8,000 in cash which was used to reduce outstanding borrowings under the credit facility. At December 31, 2001, the interest rates on the Term Facility and the Revolving Facility were 6.5%.
As of December 31, 2001 and continuing through June 29, 2002, the Company was not in compliance with certain financial covenants under the Amended and Restated Credit Facility. The Company notified its lenders concerning the noncompliance. The resulting event of default was not waived by the Company's lenders at December 31, 2001; accordingly, the lenders could have demanded full payment of all amounts outstanding under the Amended and Restated Credit Facility. On January 29, 2002, the Company and its Senior lenders entered into a forbearance agreement with an expiration date of May 31, 2002. The forbearance agreement, among other things, required the Company's owners to contribute $12.0 million of additional equity and allowed the Company to pay its semi-annual interest payment due February 1, 2002 on its 12-3/4% Senior Subordinated Notes. The forbearance agreement also required the Company to accelerate a principal payment of $1,985 on the term loan that was originally due on March 31, 2002. This payment of $1,985 was made at the time of the signing of the forbearance agreement. As a result of the event of default, the Company classified $17,000 outstanding under the revolving credit facility, $38,192 outstanding under the term facility and $119,653 of 12 3/4% Senior Subordinated notes as current within the consolidated balance sheet at December 31, 2001.
On January 30, 2002, as part of the equity contribution required under the forbearance agreement discussed above, Heat Holdings Corp. contributed to Aavid Thermal Technologies, Inc. an aggregate of $12,000 in cash in exchange for: (a) a warrant to purchase 174,389 Series B Preferred Units of Aavid Thermalloy, LLC held beneficially and of record by Aavid Thermal Technologies, Inc., and (b) 67.71 shares of Aavid Thermal Technologies, Inc. Series A Preferred Stock, par value $.0001 per share and 67.71 shares of Aavid Thermal Technologies, Inc. Series B Preferred Stock, par value $.0001 per share. The portion of the equity contribution related to the warrant has been recorded in additional paid-in capital.
On August 1, 2002, the Company refinanced its Amended and Restated Credit Facility with two of the four banks that were party to the Amended and Restated Credit Facility. The new credit facility (the "Loan and Security Agreement") is a $27,500 asset based facility. The facility consists of a term loan component which requires quarterly principal payments of $359 commencing November 1, 2002. The Loan and Security Agreement also consists of a revolving line of credit component. All borrowings under the new credit facility are secured by substantially all assets of the Company. Availability under the line of credit component is determined by a borrowing base of 85% of eligible accounts receivable and 50% of eligible inventory, as defined in the Loan and Security Agreement. At August 1, 2002, the available borrowing base was $23,880, of which $22,620 was drawn at closing. Debt outstanding under the Loan and Security Agreement bears interest at a rate equal to, at the Company's option, either (1) in the case of LIBOR rate loans, the sum of the offered rate for deposits in United states dollars for a period equal to such interest period as it appears on Telerate page 3750 as of 11:00am London time and a margin of between 2.5% and 2.85%, or (2) the sum of LaSalle Business Credit's prime rate plus a margin of between .25% and .50%. At December 31, 2002, the interest rates on the Loan and Security Agreement ranged from 3.92% to 4.75%. Availability under the revolving line of credit was $15,216 at December 31, 2002, of which $6,992 had been drawn.
The Company incurred costs for underwriting, legal and other professional fees in connection with the issuance of the Notes and the establishment of other credit facilities. These costs have been capitalized as deferred financing fees and are
being amortized over the respective terms of the related debt. This amortization is recorded in interest expense in the accompanying statements of operations for the years ended December 31, 2002 and 2001 and the period February 2, 2000 through December 31, 2000 (unaudited).
The Company had no letters of credit outstanding at December 31, 2002 or 2001.
Debt maturities payable for the five years subsequent to December 31, 2002 are as follows:
J. EQUITY
COMMON AND PREFERRED STOCK
The Company's amended and restated certificate of incorporation authorizes the Company to issue 1400 shares of Class A Common Stock, par value $0.0001 per share; 1,400 shares of Class B Common Stock, par value $0.0001 per share; 200 shares of Class H Common Stock, par value $0.0001 per share; 100 shares of Series A Preferred Stock, par value $0.0001 per share; and 100 shares of Series B Preferred Stock, par value $0.0001 per share. As of December 31, 2002, the Company had issued and outstanding 1,019 shares of Class A Common Stock, 1,079 shares of Class B Common Stock, 40 shares of Class H Common Stock, 68 shares of Series A Preferred Stock and 68 shares of Series B Preferred Stock.
Common Stock
In the election of directors, the holders of Class B Common Stock will be entitled to elect two directors or a greater number established in our Bylaws (the "Class B Directors") and the Class A Common Stock and the Class H Common Stock, voting together as a single class, will be entitled to elect the number of directors established in our Bylaws (the "Class A Directors").
Except as otherwise provided by law, the vote of any class of Common Stock, voting as a separate class, will be necessary to approve a merger of Aavid into another corporation if the merger would adversely affect the rights of the class. In addition, except as otherwise provided by law, the vote of the holders of at least 66 2/3% of the holders of Class H Common Stock, voting as a separate class, is necessary for certain transactions, including dividends made with proceeds from the disposition of Aavid Thermalloy, LLC in any of our businesses other than a business operated by Aavid Thermalloy, LLC or its successors.
The Company is permitted to pay dividends on the Class A and B Common Stock out of our funds legally available and on the Class H Common Stock only out of the lesser of (a) our funds legally available therefor and (b) the Available Hardware Dividend Amount, as defined in the amended and restated certificate of incorporation. Dividends payable in a class or series of our capital stock may be paid only in the same class or series.
If the Company disposes of all of its assets and liabilities to a wholly-owned subsidiary (a "Corporate Subsidiary"), the Company's board of directors may declare that all of the outstanding shares of Class A Common Stock and/or Class B Common Stock will be exchanged on a pro rata basis for all of the outstanding shares of the common stock of the Corporate Subsidiary having substantially similar rights, qualifications, limitations and restrictions to the Class A Common Stock and Class B Common Stock, respectively. Any share of Class A Common Stock or Class B Common Stock that is issued on conversion or exercise of any convertible securities will immediately upon issuance pursuant to such conversion or exercise be redeemed for $0.0001 in cash.
If the Company consummates a disposition of Aavid Thermalloy, LLC to any person, the Company will, on or prior to the first business day following the 60th day following the consummation of the disposition (a) declare and pay a dividend in cash and/or in securities or other property received as proceeds of the disposition to the holders of Class H Common Stock in any amount equal to the net proceeds of the disposition; or (b) exchange the number of whole shares of outstanding Class H Common Stock that have an aggregate average market value of the net proceeds of such disposition, for the property received as proceeds of such disposition in an amount equal to such net proceeds; or (c) exchange each outstanding share of Class H Common Stock for a number of shares of Class A Common Stock or, if there are no shares of Class A Common Stock outstanding, Class B Common Stock, equal to the average daily ratio of the market value of the Class H Common Stock to the market value of the Class A Common Stock or Class B Common Stock, as the case may be.
The Company's board of directors may, at any time after a dividend or redemption, declare that each of the remaining outstanding shares of Class H Common Stock will be exchanged for a number of shares of Class A Common Stock or, if there are no shares of Class A Common Stock outstanding and shares of Class B Common Stock are then outstanding, of Class B Common Stock, equal to the market value ratio of one share of Class H Common Stock to one share of Class A Common Stock or one share of Class B Common Stock, as the case may be. If all of the Company's indirect or directly owned common membership interest in Aavid Thermalloy, LLC (and no other assets or liabilities) is held, directly or indirectly, by a wholly-owned subsidiary of Aavid (the "Aavid Thermalloy Subsidiary"), the Company's board of directors may declare that all of the outstanding shares of Class H Common Stock will be exchanged for all of the outstanding shares of common stock of the Aavid Thermalloy Subsidiary, on a pro rata basis.
After any exchange date or redemption date on which all outstanding Class H Common Stock was exchanged or redeemed, any share of Class H Common Stock that is issued on conversion or exercise of any convertible securities will be (a) exchanged for the kind and amount of shares of capital stock and other securities and property that the holder would have received had the convertible security been converted immediately prior thereto; or (b) redeemed for $0.001 in cash.
In the event the Company dissolves, liquidates or winds up, the holders of the outstanding shares of each class of Common Stock will be entitled to receive a fraction of the funds remaining based on the Market Value of each class of stock.
Preferred Stock
Dividends on the Company's Series A and Series B Preferred Stock (Preferred Stock) shall be paid at the rate of 12% per annum, compounded annually, of the liquidation value of such shares (plus any accrued and unpaid dividends as of the end of the previous anniversary of the date of issuance of such shares) from and including the date of issuance of such shares of Preferred Stock to and including the first to occur of: (i) the date on which the liquidation value (plus all accrued and unpaid dividends thereon) of such shares of Preferred Stock is paid to the holder thereof in connection with the liquidation of the Corporation or the redemption of such shares of Preferred Stock by the Company or; (ii) the date on which such shares are otherwise acquired by the Company. Such dividends shall accrue whether or not they have been declared and whether or not there are profits, surplus or other funds of the Company legally available for the payment of dividends, and such dividends shall be cumulative such that all accrued and unpaid dividends shall be fully paid or declared with funds irrevocably set apart for payment thereof and shall be paid before any dividends, distributions, redemptions or other payments may be made with respect to any Junior Securities, other than Participating Dividends.
If any dividend or other distribution in cash or other property is paid with respect to the Common Stock, a dividend or other distribution in cash or other property shall also be paid with respect to shares of Preferred Stock, in an amount equal to the amount a holder of a share of Preferred Stock would have received had such holder converted such holder's Preferred Stock into Common Stock immediately prior to the record date (or if no record date is declared, the payment date) for the dividend.
On all matters submitted to a vote of the stockholders, each holder of outstanding shares of Preferred Stock shall have the number of votes such holder would have had if such holder had converted such holder's Preferred Stock into Common Stock on the record date of such vote (or, if no record date is established, immediately prior to such vote).
Upon any liquidation, dissolution or winding up of the Company, each holder of Preferred Stock shall be entitled to be paid, before any distribution or payment is made upon any Junior Securities, an amount in cash equal to the greater of (i) the aggregate liquidation value of all Shares of Preferred Stock held by such holder (plus any accrued and unpaid dividends) or (ii) the amount such holder of Preferred Stock would receive if the holder converted all of such holder's shares of Preferred Stock into shares of Common Stock immediately prior to such liquidation, dissolution or winding up of the Company.
At any time after April 13, 2022, the Company may redeem the Preferred Stock by delivering a written notice of such redemption at least thirty days prior to the redemption date. For each share of Preferred Stock which is to be redeemed, the Company shall be obligated on the redemption date to pay the holder of such share an amount equal to the liquidation value of such share (plus any accrued and unpaid dividends).
At any time and from time to time, any holder of Preferred Stock may convert all or any portion of the Preferred Stock (including a fraction of a share) held by such holder into a number of shares of Common Stock computed by multiplying the number of shares to be converted by $10.00 and dividing the result by the applicable conversion price then in effect ($3.55 is the initial conversion price). The initial conversion price may be adjusted from time to time for certain dilutive events.
The Preferred Stock also contains automatic conversion features whereby upon the closure of a qualifying public offering or upon the vote of a majority of Preferred Stockholders each share of Preferred Stock is converted to Common Stock as described above.
The liquidation value of any share of Preferred Stock as of any particular date shall be $75,738.83 per share, as such amount is adjusted for stock splits, stock dividends and similar transactions. The total liquidation value of the Preferred Stock is $11,384 at December 31, 2002. Total cumulative unpaid dividends at December 31, 2002 were $1,128.
WARRANTS AND ADDITIONAL EQUITY CONTRIBUTIONS
In connection with the issuance of the 12 3/4% Senior Subordinated Notes, the Company issued warrants to purchase 60 shares of Class A common stock and 60 shares of Class H common stock. The warrants are exercisable on or after an exercise event, as defined, and will expire on February 1, 2007. Each warrant entitles its holder to purchase 0.0004 shares of Class A common stock and 0.0004 shares of Class H common stock, subject to adjustment, as defined, at an exercise price of $0.01 per share.
On May 4, 2001 certain of the Company's stockholders and their affiliates made an equity contribution of $8,000 in cash and $26,191 in principal amount of senior subordinated notes in order to cure an event of non-compliance with certain financial ratio covenants related to the Company's senior credit facility. As part of the equity contribution discussed above, Heat Holdings contributed to Aavid Thermal Technologies, Inc. an aggregate of $8,000 in cash and $26,191 in principal amount of Aavid Thermal Technologies, Inc.'s 12 -3/4% senior subordinated notes due 2007 in exchange for: (a) a warrant to purchase 2,224,472.5 Series B Preferred Units of Aavid Thermalloy, LLC held beneficially and of record by Aavid Thermal Technologies, Inc. and (b) 78.871 shares of Aavid Thermal Technologies, Inc. Class A Common Stock and 78.871 shares of Aavid Thermal Technologies, Inc. Class B Common Stock, par value $.01 per share. The portion of the equity contribution related to the warrants has been recorded in additional paid-in capital. The Company recognized a gain, prior to the allocation of the write-off of unamortized deferred financing fees of $1,381, on the retirement of senior subordinated notes of $3,286, which is recorded as an extraordinary gain on extinguishment of debt, net of the related tax effect, in the accompanying statement of operations for the year ended December 31, 2001.
On January 30, 2002, as part of the equity contribution required under the forbearance agreement discussed in Note I above, Heat Holdings contributed to Aavid Thermal Technologies, Inc. an aggregate of $12.0 million in cash in exchange for: (a) a warrant to purchase 174,389 Series B Preferred Units of Aavid Thermalloy, LLC held beneficially and of record by Aavid Thermal Technologies, Inc., and (b) 67.71 shares of Aavid Thermal Technologies, Inc. Series A Preferred Stock, par value $.0001 per share, and 67.71 shares of Aavid Thermal Technologies, Inc. Series B Preferred Stock, par value $.0001 per share. The portion of the equity contribution related to the warrant has been recorded in additional paid-in capital.
MANAGEMENT INCENTIVE PURCHASE PROGRAM
During 2000, the Board of Directors approved the Management Incentive Purchase Program (the "Program"). The Program provides for the grant and purchase of non-voting restricted stock of Fluent, Aavid Thermalloy and Enductive Solutions to and by certain employees and directors of the Company. Shares acquired pursuant to the Program are subject to a right of repurchase by the Company, which lapses as the stock vests. In the event of termination of services, the Company has the right to repurchase unvested shares at the original issuance price.
The vesting is generally five years. The Board of Directors set aside approximately 10% of the common equity ownership in Aavid Thermalloy, Fluent and Enductive Solutions for the Program. The 10% of common equity in each company is equal to approximately 56,296 shares in Aavid Thermalloy, LLC, 28,149 shares in Fluent, Inc. and 500 shares in Enductive Solutions, Inc.
As of December 31, 2002, the Company held notes receivable for stock in the amount of $589 from employees in consideration for the purchase of common stock. The notes bear interest at 7%. Notes issued in connection with Aavid Thermalloy shares are due October 1, 2007 or upon termination of employment and are collateralized by the underlying common stock. Notes issued in connection with Fluent and Enductive Solutions shares are due November 1, 2007 or upon termination of employment and are collateralized by the underlying common stock. In addition, the interest due and the 60% of the note balance are full recourse to the employee. These notes are recorded in other long term assets in the accompanying consolidated balance sheets.
K. INCOME TAXES
Income (loss) from continuing operations, before income taxes, minority interest and extraordinary item for domestic and foreign operations are as follows:
The income tax provision (benefit) included in the consolidated statements of operations consists of the following:
The Company has approximately $78,000 of U.S. federal net operating loss carryforwards available to reduce future taxable income, if any. These net operating loss carryforwards expire through 2022, and are subject to the review and possible adjustment by the Internal Revenue Service. Section 382 of the Internal Revenue Code also contains provisions that could place annual limitations on the utilization of these net operating loss carryforwards in the event of a change in ownership, as defined. These loss carryforwards have an annual limitation of approximately $13,000 per year as a result of the Merger described in Note A. A reconciliation of the income tax provision (benefit) at the statutory federal income tax rate to the Company's actual income tax provision (benefit) is as follows:
Deferred tax assets and liabilities are measured as the difference between the financial statement and the tax bases of assets and liabilities at the applicable enacted tax rates. In 2002, 2001 and 2000, the Company provided for U.S. income taxes on undistributed earnings from its foreign subsidiaries as it is the Company's intention to repatriate those earnings from its foreign operations in future years.
The components of the net deferred asset consist of the following:
SFAS No. 109 "Accounting for Income Taxes", requires a valuation allowance against deferred tax assets if it is more likely than not that some or all of the deferred tax assets will not be realized. Due to the uncertainty surrounding the Company's ability to realize the full benefit of the deferred tax assets, a valuation allowance in the amount of $13,286 and $10,022 has been established at December 31, 2002 and 2001, respectively.
L. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases various equipment and facilities under the terms of non-cancelable operating leases. Future lease commitments are as follows:
Lease expense was approximately $6,978, $7,328 and $6,625 (unaudited) for the years ended December 31, 2002, 2001 and 2000, respectively.
In 2001, the Company entered into a sub-lease agreement for its vacated Corby, U.K. facility. The initial term of the lease was from May, 2001 to May, 2004 with an annual rent of approximately $185,000. The lease allowed the tenant to cancel the lease upon three months' notice. The tenant has notified the Company that it will be vacating the property effective June, 2003.
LITIGATION
The Company is involved in various other legal proceedings that are incidental to the conduct of its business, none of which it believes could reasonably be expected to have a materially adverse effect on the Company's financial condition.
PURCHASE COMMITMENT
The Company has an obligation to purchase from one of its key suppliers a minimum quantity of aluminum coil stock. The Company believes that purchasing aluminum coil stock from this supplier is necessary to achieve consistently low tolerances, design, delivery flexibility, and price stability. Under the terms of this agreement the Company has agreed to purchase certain minimum quantities which approximates $1,832 at December 31, 2002.
MEXICO LABOR AGREEMENT
The Company is currently operating its Monterrey, Mexico facility under an annual collective bargaining agreement with its manufacturing employees. The contract covered 67 employees on December 31, 2002 and expires in March, 2003.
M. 401(K) PROFIT SHARING PLAN
The Company has profit sharing plans, which permit participants to make contributions by salary reduction pursuant to Section 401(k) of the Internal Revenue Code. Employee eligibility is based on a minimum age and employment requirement. Annual employer contributions are determined by the Board of Directors, but cannot exceed the amount allowable for federal income tax purposes. The Company's contribution was approximately $555, $692 and $823 (unaudited) for the years ended December 31, 2002, 2001 and 2000, respectively.
N. SEGMENT REPORTING
Aavid provides thermal management solutions for microprocessors and integrated circuits ("ICs") for digital and power applications. In connection with the merger, we consolidated our business into two operating segments: thermal management products and computational fluid dynamics ("CFD") software. Aavid's thermal management products consist of products and services that solve problems associated with the dissipation of unwanted heat in electronic and electrical components and systems. The Company develops and offers CFD software for computer modeling and fluid flow analysis of products and processes that reduce time and expense associated with physical models and the facilities to test them. The Company also provides thermal design services to customers who choose to outsource their thermal design needs.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies.
The Company accounts for inter-segment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices.
Aavid's reportable segments are strategic business units that offer different products and services. They are managed separately because each segment requires different marketing and sales strategies. Most of the businesses were acquired as a unit and the management at the time of acquisition has generally been retained.
The following summarizes the continuing operations of each reportable segment for the years ending December 31, 2002, 2001 and 2000. Results for 2000, which are unaudited, include the combined operations of the Company (February 2, 2000 through December 31, 2000) and the Predecessor (January 1, 2000 through February 1, 2000):
(1) Does not include amortization associated with deferred financing fees and accretion of bond discount as these amounts are included in "Interest Expense, net".
The following table provides geographic information about the Company's continuing operations. Revenues are attributable to an operation based on the location the product was shipped from. Long-lived assets are attributable to a location based on physical location.
There were no individual customers who made up more than 10% of consolidated revenues for the years ended December 31, 2002, 2001 or 2000 (unaudited).
O. RESTRUCTURING CHARGES AND RESERVES
Approximately $2,130 of restructuring charges were recorded in connection with the Company's October 1999 acquisition of Thermalloy, the thermal management business of Bowthorpe plc. The restructuring plan included initiatives to integrate the operations of the Company and Thermalloy and reduce overhead. The primary components of these plans related to (a) the closure of duplicative Thermalloy operations in Hong Kong and the United Kingdom, (b) the elimination of duplicative selling, general and administration functions of Thermalloy on a global basis and (c) the termination of certain contractual obligations. During the year ended December 31, 2000, 136 individuals were terminated under the restructuring plan. The following amounts have been charged against the Thermalloy restructuring reserves during the years ended December 31, 2002 and 2001:
Approximately $716 of restructuring charges were recorded in connection with the Merger. The restructuring plans included initiatives to integrate the operations of the Company and reduce overhead. The primary components of these plans related to (a) the closure of operations in California and the United Kingdom and (b) the termination of certain contractual obligations. During the year ended December 31, 2000, 89 individuals were terminated under the restructuring plan. The following amounts have been charged against the merger restructuring reserves during the year ended December 31, 2001:
During 2001, the Company ceased manufacturing operations in Dallas and Terrell, Texas, Loudwater, United Kingdom and its fan factory in China. Additionally, the Company reduced its workforce in New Hampshire, Europe and Asia, including both selling general and administrative and manufacturing personnel. In connection with these actions, the Company recorded a restructuring charge within the statement of operations during 2001. This restructuring charge totaled $16,885 and included amounts related to employee severance, lease terminations, write-off of fixed assets and write-off of a prepaid lease intangible asset that was originally recorded as part of the Thermalloy acquisition. Approximately 524 individuals were terminated under the restructuring plan. The following amounts have been charged against these reserves during the years ended December 31, 2002 and 2001:
During 2002, the Company ceased manufacturing operations in Malaysia and reduced its workforce in Singapore. In connection with these actions, the Company recorded a restructuring charge within the statement of operations during 2002. This restructuring charge totaled $858 and included amounts related to employee severance, facility costs/lease terminations and write-off of fixed assets. Approximately 57 individuals were terminated under the restructuring plan. The following amounts have been charged against these reserves during the years ended December 31, 2002:
P. QUARTERLY DATA (UNAUDITED)
Following is a summary of the quarterly results of continuing operations for the years ended December 31, 2002, and 2001:
(1) Amounts may differ from amounts previously reported in Form 10-Q due to the quarterly impact of restatements discussed in Note C.
(2) During the third quarter of 2002, the Company recorded a gain on the sale of Curamik of approximately $7,100.
Q. SELECTED CONSOLIDATING FINANCIAL STATEMENTS OF PARENT, GUARANTORS AND NON-GUARANTORS
The Company's wholly-owned domestic subsidiaries have jointly and severally guaranteed, on a senior subordinated basis, the principal amount of the Company's 12 3/4% Senior Subordinated Notes, due 2007. The guarantors include the combined domestic operations of Aavid Thermalloy, LLC, which directly or indirectly owns all of the Company's thermal management operations, and Fluent, Inc., which directly or indirectly owns all of the Company's CFD operations, and the Company's subsidiary Applied Thermal Technologies, Inc. The non-guarantors include the combined foreign operations of Aavid Thermalloy, LLC and Fluent, Inc. The consolidating condensed financial statements of the Company depict Aavid Thermal Technologies, Inc., the Parent, carrying its investment in subsidiaries under the equity method and the guarantor and non-guarantor subsidiaries are presented on a combined basis. Management believes that there are no significant restrictions on the Parent's and guarantors' ability to obtain funds from their subsidiaries by dividend or loan. The principal elimination entries eliminate investment in subsidiaries and intercompany balances and transactions.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
THERMALLOY RESTRUCTURING RESERVES:
WILLIS STEIN RESTRUCTURING RESERVES:
2002 RESTRUCTURING RESERVES
2001 RESTRUCTURING RESERVES