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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED JUNE 29, 2002 COMMISSION FILE NO. 000-27308.
AAVID THERMAL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 02-0466826
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE EAGLE SQUARE, SUITE 509, CONCORD, NH 03301
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (603) 224-1117
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [x] No [ ]
Aggregate market value of the Registrant's common stock held by non-affiliates:
N/A. The number of outstanding shares of the registrant's Common Stock as of
August 19, 2002 was 1,019 shares of Class A, 1,079 shares of Class B and 40
shares of Class H, all of which are owned by Heat Holdings Corp. The
Registrant's Common Stock is no longer publicly traded; however, the
Registrant's Senior Subordinated Notes are publicly traded.
AAVID THERMAL TECHNOLOGIES, INC.
INDEX TO FORM 10-Q
PAGE
Part I. Financial Information
Item 1. Financial Statements
a.) Consolidated Balance Sheets as of June 29, 2002 and
December 31, 2001........................................ 3
b.) Consolidated Statements of Operations for the quarter
and six months ended June 29, 2002 and the quarter
and six months ended June 30, 2001....................... 4
c.) Consolidated Statements of Cash Flows for the six
months ended June 29, 2002 and June 30, 2001............. 5
d.) Notes to Consolidated Financial Statements............... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................. 21
Part II. Other Information
Item 1. Legal Proceedings................................................ 32
Item 5. Other Information................................................ 32
Item 6. Exhibits and Reports on Form 8-K................................. 32
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AAVID THERMAL TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
JUNE 29, DECEMBER 31,
2002 2001*
--------- ------------
ASSETS
Cash and cash equivalents $ 19,045 $ 14,538
Accounts receivable-trade, net 32,374 30,460
Notes receivable 284 480
Inventories 8,404 10,530
Refundable taxes 59 118
Deferred income taxes 163 192
Deferred financing fees 908 5,385
Prepaid and other current assets 5,173 3,567
Assets of discontinued operations 27,312 26,321
--------- ---------
Total current assets 93,722 91,591
Property, plant and equipment, net 32,150 34,147
Goodwill, net 39,433 36,445
Developed technology and assembled workforce, net 5,548 9,783
Other assets, net 5,430 1,584
--------- ---------
Total assets $ 176,283 $ 173,550
========= =========
LIABILITIES, MINORITY INTERESTS AND STOCKHOLDERS' DEFICIT
Accounts payable-trade $ 12,198 $ 13,851
Current portion of debt obligations 40,654 175,382
Income taxes payable 4,294 3,211
Restructuring charges 953 2,255
Deferred revenue 31,214 24,080
Accrued expenses and other current liabilities 23,338 21,798
Liabilities of discontinued operations 3,263 2,673
--------- ---------
Total current liabilities 115,914 243,250
Term loan 10,403 --
12 3/4% senior subordinated notes 119,961 --
Other long term debt obligations 732 450
Deferred income taxes 230 222
--------- ---------
Total liabilities 247,240 243,922
--------- ---------
Commitments and Contingencies
Minority interests in consolidated subsidiaries 1,437 1,464
Stockholders' deficit:
Series A Preferred Stock, $.0001 par value; authorized 100 shares;
67.71 shares issued and outstanding at June 29, 2002, none at
December 31, 2001; liquidation preference $5,384 at June 29,
2002, none at December 31, 2001 -- --
Series B Preferred Stock, $.0001 par value; authorized 100 shares;
67.71 shares issued and outstanding at June 29, 2002, none at
December 31, 2001; liquidation preference $5,384 at June 29,
2002, none at December 31, 2001 -- --
Class A Common Stock, $.0001 par value; authorized 1,400 shares;
1,018.87 shares issued and outstanding -- --
Class B Common Stock, $.0001 par value; authorized
1,400 shares; 1,078.87 shares issued and outstanding -- --
Class H Common Stock, $.0001 par value; authorized
200 shares; 40 shares issued and outstanding -- --
Warrants to purchase 49.52 shares of Class A common stock
and 49.52 shares of Class H common stock 3,764 3,764
Additional paid-in capital 188,007 176,007
Cumulative translation adjustment (1,145) (2,512)
Accumulated deficit (263,020) (249,095)
--------- ---------
Total stockholders' deficit (72,394) (71,836)
--------- ---------
Total liabilities, minority interests and
stockholders' deficit $ 176,283 $ 173,550
========= =========
* Restated. See Note 2.
The accompanying notes are an integral part of these
consolidated financial statements.
3
AAVID THERMAL TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
(UNAUDITED)
QUARTER QUARTER* SIX MONTHS* SIX MONTHS*
ENDED ENDED ENDED ENDED
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
2002 2001 2002 2001
-------- -------- ---------- ----------
Net sales $ 40,423 $ 43,154 $ 78,855 $ 90,772
Cost of goods sold 22,137 31,654 44,671 66,855
-------- -------- -------- --------
Gross profit 18,286 11,500 34,184 23,917
Selling, general and administrative expenses 14,169 13,092 27,456 30,290
Amortization of intangible assets 663 8,559 1,326 17,119
Research and development 3,557 3,093 6,699 5,549
Restructuring charge -- 408 -- 12,865
-------- -------- -------- --------
Loss from operations (103) (13,652) (1,297) (41,906)
Interest expense, net (5,136) (6,903) (10,361) (13,189)
Other income (expense), net 130 27 169 (118)
-------- -------- -------- --------
Loss from continuing operations
before income taxes, minority
interests and extraordinary item (5,109) (20,528) (11,489) (55,213)
Income tax expense (1,036) (1,112) (2,079) (999)
-------- -------- -------- --------
Loss from continuing operations before
minority interest and extraordinary
item (6,145) (21,640) (13,568) (56,212)
Minority interest in loss of
consolidated subsidiaries -- -- -- 3,294
-------- -------- -------- --------
Loss from continuing operations before
extraordinary item (6,145) (21,640) (13,568) (52,918)
Income (loss) from discontinued operation (16) 475 (357) 1,221
-------- -------- -------- --------
Loss before extraordinary item (6,161) (21,165) (13,925) (51,697)
Gain on extinguishment of debt -- 4,979 -- 4,979
-------- -------- -------- --------
Net loss $ (6,161) $(16,186) $(13,925) $(46,718)
======== ======== ======== ========
* Restated. See Note 2.
The accompanying notes are an integral part of these
consolidated financial statements.
4
AAVID THERMAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE FOR THE
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 29, 2002* JUNE 30, 2001*
-------------- --------------
Cash flows (used in) provided by operating activities:
Loss from continuing operations before extraordinary item $(13,568) $(52,918)
Income (loss) from discontinued operations (357) 1,221
Extraordinary gain -- 4,979
-------- --------
Net loss (13,925) (46,718)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation and amortization 6,031 25,113
Loss on sale of property, plant and equipment 325 73
Accretion of discount on 12 3/4% senior
subordinated notes to interest expense 308 310
Minority interest in loss of consolidated subsidiaries -- (3,294)
Restructuring charges -- 12,865
Extraordinary gain on early extinguishment of debt -- (4,979)
Changes in assets and liabilities:
Accounts receivable - trade (458) 10,459
Inventories 2,379 3,334
Prepaid and other current assets (1,267) (1,592)
Notes receivable 196 --
Net assets of discontinued operations 748 (1,601)
Other long term assets 243 289
Accounts payable - trade (2,158) (4,234)
Income taxes payable 858 (92)
Deferred revenue 5,831 13,421
Accrued expenses and other current liabilities (621) (4,671)
-------- --------
Total adjustments 12,415 45,401
-------- --------
Net cash used in operating activities (1,510) (1,317)
Cash flows (used in) provided by investing activities:
Purchases of property, plant & equipment (2,992) (3,583)
Proceeds from sale of property, plant and equipment 1,403 126
Purchase of minority interest in Curamik -- (882)
-------- --------
Net cash used in investing activities (1,589) (4,339)
Cash flows provided by (used in) financing activities:
Issuance of preferred stock and warrant 12,000 --
Advances under line of credit 497 9,300
Repayments of line of credit -- (396)
Principal payments under debt obligations (5,433) (10,218)
Advances under other debt obligations 131 --
Make-well contribution -- 34,028
Retirement of 12 3/4% senior subordinated notes and warrants -- (26,028)
-------- --------
Net cash provided by financing activities 7,195 6,686
Foreign exchange rate effect on cash and cash equivalents 411 (615)
Net increase in cash and cash equivalents 4,507 415
Cash and cash equivalents, beginning of period 14,538 22,850
-------- --------
Cash and cash equivalents, end of period $ 19,045 $ 23,265
======== ========
Supplemental disclosure of cash flow information:
Interest paid $ 9,613 $ 11,462
======== ========
Income taxes paid $ 1,757 $ 1,704
======== ========
* Restated. See Note 2.
The accompanying notes are an integral part of these
consolidated financial statements.
5
AAVID THERMAL TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA)
(1) ORGANIZATION AND MERGER
Aavid Thermal Technologies, Inc. (the "Company" or "Aavid") is the leading
global provider of thermal management solutions for electronic products and the
leading developer and marketer of Computational Fluid Dynamics (CFD) software.
On February 2, 2000, the Company was acquired by Heat Holdings Corp., a
corporation newly formed by Willis Stein & Partners II, L.P. (the "Merger").
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 new 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 through
December 31, 2001. The remainder, $69,971, is attributable to Fluent, the CFD
software business, and was being amortized over 4 years through December 31,
2001. During the fourth quarter of 2001, the Company wrote off the goodwill
attributable to Aavid Thermalloy after performing a review for impairment under
Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of."
The impairment charge recorded in the fourth quarter of 2001 related to the
goodwill attributable to Aavid Thermalloy was $94,233. The Company adopted SFAS
142, "Goodwill and Other Intangible Assets," on January 1, 2002. Under the
provisions of SFAS 142, the remaining goodwill attributable to Fluent is no
longer amortized, but instead will be tested for impairment at least annually.
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 interests within the
accompanying financial statements.
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 12 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
statement of operations for the quarter and six months ended June 29, 2002 and
June 30, 2001.
In connection with the Merger, the Company repaid all of the outstanding
term loan and revolving line of credit under its then existing credit facility,
which aggregated approximately $88,200 at December 31, 1999, and 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") (of which $1,700 was drawn
at the closing of the Merger) and a $53,000 term loan facility (the "Term
Facility") (which was fully drawn at the closing of the Merger). Subject to
compliance with the terms of the Amended and Restated Credit Facility,
borrowings under the Revolving Facility were available for working capital
purposes, capital expenditures and future acquisitions. The Revolving Facility
was to terminate, and all amounts outstanding thereunder were to be payable, on
March 31, 2005. Principal on the Term Facility was required to be repaid in
quarterly installments commencing December 31, 2000 and ending March 31, 2005 as
follows: five installments of $2,000; four installments of $2,500; four
installments of $2,750; two installments of $3,200; two installments of $3,900;
and a final installment of $7,800.
6
In addition, commencing with our fiscal year ending December 31, 2001, the
Company was required to apply 50% of excess cash flow, as defined, to
permanently reduce the Term Facility. The Amended and Restated Credit Facility
bore interest at a rate equal to, at the Company's option, either (1) in the
case of Eurodollar loans, the sum of (x) the interest rate in the London
interbank market for loans in an amount substantially equal to the amount of
borrowing and for the period of borrowing selected by Aavid and (y) a margin of
between 1.50% and 2.25% (depending on the Company's consolidated leverage ratio
(as defined in the Amended and Restated Credit Facility)) or (2) the sum of the
higher of (x) Canadian Imperial Bank of Commerce's prime or base rate or (y)
one-half percent plus the latest overnight federal funds rate plus (z) a margin
of between .25% and 1.00% (depending on the Company's consolidated leverage
ratio). At June 29, 2002, the interest rates on the Term Facility and the
Revolving Facility were 6.50%.
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
and $26,191 in principal amount of 12-3/4% senior subordinated notes. In
addition, the Company and the lenders amended the facility to provide that the
last three required quarterly principal payments in 2001 under the facility were
prepaid with $6,000 of the proceeds of the equity contribution, and the four
required principal payments in 2002 were reduced by $500 each, reflecting
application of the remaining cash equity contribution. Further, certain covenant
ratios and ratio definitions were amended and the available line of credit was
reduced to $17,000 from $22,000.
The Amended and Restated Credit Facility may be prepaid at any time in
whole or in part without penalty, and must be prepaid to the extent of certain
equity or asset sales. The Amended and Restated Credit Facility limits the
Company's ability to incur additional debt, to sell or dispose of assets, to
create or incur liens, to make additional acquisitions, to pay dividends, to
purchase or redeem its stock and to merge or consolidate with any other party.
In addition, the Amended and Restated Credit Facility requires that the Company
meet certain financial ratios, and provides the lenders with the right to
require the payment of all amounts outstanding under the facility, and to
terminate all commitments thereunder, if there is a change in control of Aavid.
The Amended and Restated Credit Facility is guaranteed by each of Heat Holdings
Corp. and Heat Holdings II Corp., and all of the Company's domestic subsidiaries
and secured by the Company's assets (including the assets and stock of its
domestic subsidiaries and a portion of the stock of its foreign subsidiaries).
The Company incurred approximately $7,085 in underwriting, legal and other
professional fees in connection with the issuance of the Notes and the
establishment of the Amended and Restated Credit Facility. These costs, in
addition to the $1,624 of unamortized costs associated with the original Credit
Facility, 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 statement of operations for the
quarters and six months ended June 29, 2002 and June 30, 2001.
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. 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 December 31, 2001 balance sheet. 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 $12,000 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.
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
secured by certain United States real estate and machinery and equipment and
requires quarterly principal payments of $359 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 receivables 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. 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
..50%.
7
Debt classified as long term in the accompanying balance sheet as of June
29, 2002 consists of the long term portion of the term loan component of the new
Loan and Security Agreement and all of the 12 3/4% senior subordinated notes.
These amounts have been classified as long term due to the refinancing of the
Amended and Restated Credit Agreement which occurred on July 31, 2002.
On January 30, 2002, as part of the equity contribution required under the
forbearance agreement discussed above, Heat Holdings 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 in the accompanying balance sheet as of June 29, 2002.
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.
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 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 $10,768 at June 29, 2002.
(2) RESTATEMENT OF FINANCIAL RESULTS
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
8
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 could 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 therefore 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, 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 their 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, determined 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, the Company has 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, Ernst & Young LLP
advised the Company 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. Ernst & Young LLP further advised the Company to
restate its financial results for the year ended December 31, 2001 to reflect
this change.
Accordingly, the Company has restated its financial statements as of
December 31, 2001,and for the year then ended, and for the three and six month
periods ended June 30, 2001, included herein, to reflect this change in revenue
recognition. The Company has also restated its financial statements for the
first quarter of 2002 and has conformed its second quarter 2002 financial
statements to this revenue recognition methodology. While this change has a
significant impact on recorded revenues within the statements of operations, and
consequently net loss and EBITDA, this change does not affect the Company's
statements of cash flows for the three and six month periods ended June 30,
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 three and six months ended June 30, 2001, the
amount of revenue originally recognized but now deferred is $4,579 and $12,885,
respectively. For the three month period ended June 29, 2002, the amount of
revenue originally recognized but now deferred was $4,627. Regardless Fluent
continues to be paid by its customers upon commencement of the execution of the
non-cancellable license agreement.
9
An additional restatement matter arises from the Company's sale of its
German subsidiary, Aavid Thermalloy Holdings, GmbH ("Curamik") (see Note 3) 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 from earnings from continuing operations and instead,
reflect Curamik's results as earnings from discontinued operations.
All amounts in this Form 10-Q have been restated to reflect the change in
revenue recognition and discontinued operation as discussed above. As a result
of the unavailability of Arthur Andersen LLP to reissue their report on the
restated fiscal year 2001 results, the Company's financial statements for fiscal
year 2001 will have to be reaudited. Accordingly, all periods presented in this
Form 10-Q have been marked as "unaudited". It is also possible that periods
prior to 2001 may also need to be reaudited due to the discontinued operation
restatement related to Curamik. Although the Company is not presently aware of
any other matters that could give rise to changes in prior period financial
statements, it is possible that the reaudit of the Company's financial
statements may result in additional changes to the consolidated financial
statements as of December 31, 2001, and for the year then ended, and for the
three and six months ended June 30, 2001 and 2002, included herein.
Ernst & Young LLP, the Company's independent accountants, have not
performed a review of the consolidated financial statements included in this
Quarterly Report on Form 10-Q in accordance with Statement on Auditing Standards
No. 71, "Interim Financial Information," and as required by Rule 10-01(d) of
Regulation S-X, because the Company's consolidated financial statements for the
fiscal year ended December 31, 2001 will have to be reaudited as discussed
above. Upon completion of the fiscal year 2001 reaudit by Ernst & Young LLP and
completion of the SAS 71 review, amended Form 10-Q's and an amended Form 10-K
will be filed for all applicable periods.
(3) DISCONTINUED OPERATION
On July 17, 2002, the Company sold all of the outstanding shares of Aavid
Thermalloy Holdings, GmbH, which in turn owns 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
31,290 euros, subject to possible adjustment based upon consolidated net
assets of Curamik and certain indemnification obligations of the Company. The
Company will record a pre-tax gain on the sale of $6,102 in the third quarter of
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 losses 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". See Note 2 above.
The following is a summary of the results of discontinued operations for
the quarter and six months ended June 29, 2002 and June 30, 2001:
QUARTER QUARTER SIX MONTHS SIX MONTHS
ENDED ENDED ENDED ENDED
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
2002 2001 2002 2001
-------- -------- ----------- ----------
Net sales $ 5,111 $ 5,586 $ 9,314 $ 11,272
-------- -------- -------- --------
Income (loss) before taxes and minority
interests 234 780 (64) 2,338
Income tax expense (234) (249) (320) (937)
-------- -------- -------- --------
Loss before minority interest -- 531 (384) 1,401
Minority interest in (income) loss of
consolidated subsidiaries (16) (56) 27 (180)
-------- -------- -------- --------
Income (loss) from discontinued operations $ (16) $ 475 $ (357) $ 1,221
======== ======== ======== ========
10
The table that follows presents a breakdown of the major components of
assets and liabilities of discontinued operations at June 29, 2002 and December
31, 2001:
JUNE 29, DECEMBER 31,
2002 2001
-------- ------------
ASSETS
Cash $ 1,777 $ 1,521
Accounts receivable -- trade, net 3,491 2,469
Inventories 1,958 2,030
Prepaid and other current assets 814 614
Property, plant and equipment, net 5,221 5,122
Goodwill, net 9,336 8,610
Developed technology, net 4,715 5,955
-------- --------
Total assets of discontinued operations $ 27,312 $ 26,321
======== ========
LIABILITIES
Accounts payable -- trade $ 518 $ 654
Accrued expenses and other current liabilities 1,878 1,271
Accrued taxes payable 1,053 970
Long-term deferred income taxes (186) (222)
-------- --------
Total liabilities of discontinued operations $ 3,263 $ 2,673
======== ========
(4) BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited consolidated
financial statements reflect all adjustments, consisting only of normal
adjustments, necessary to present fairly the financial position of Aavid Thermal
Technologies, Inc. and its consolidated subsidiaries at June 29, 2002 and
December 31, 2001, and the results of operations and cash flows for the quarters
and six months ended June 29, 2002 and June 30, 2001. Interim results are not
necessarily indicative of results for a full year.
As previously discussed in Note 2 above, the financial statements as of
December 31, 2001 and for the three and six month periods ended June 30, 2001,
included herein, have been restated to reflect a change in revenue recognition
at the Company's software subsidiary, Fluent. While this change has a
significant impact on recorded revenues within the statements of operations, and
consequently net loss and EBITDA, this change does not affect the Company's
statements of cash flows for the three and six month periods ended June 30, 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.
Ernst & Young LLP, the Company's independent accountants, have not
performed a review of the consolidated financial statements included in this
Quarterly Report on Form 10-Q in accordance with Statement on Auditing Standards
No. 71, "Interim Financial Information," and as required by Rule 10-01(d) of
Regulation S-X, because the Company's consolidated financial statements for the
fiscal year ended December 31, 2001 will have to be reaudited as discussed
above. Upon completion of the fiscal year 2001 reaudit by Ernst & Young LLP and
completion of the SAS 71 review, as discussed in Note 2 above, amended Form
10-Q's and an amended Form 10-K will be filed for all applicable periods.
(5) RECLASSIFICATIONS
Certain reclassifications have been made to the 2001 financial statements
to conform to the 2002 presentation.
(6) ACCOUNTS RECEIVABLE
The components of accounts receivable at June 29, 2002 and December 31,
2001 are as follows:
JUNE 29, DECEMBER 31,
2002 2001
----------- ------------
(UNAUDITED) (UNAUDITED)
Accounts receivable $ 35,702 $ 33,659
Allowance for doubtful accounts (3,328) (3,199)
-------- --------
Net accounts receivable $ 32,374 $ 30,460
======== ========
11
(7) INVENTORIES
Inventories are valued at the lower of cost or market (first-in,
first-out), and consist of materials, labor and overhead. The components of
inventories at June 29, 2002 and December 31, 2001 are as follows:
JUNE 29, DECEMBER 31,
2002 2001
----------- ------------
(UNAUDITED) (UNAUDITED)
Raw materials $ 2,975 $ 4,277
Work-in-process 1,571 1,407
Finished goods 3,858 4,846
------- --------
$ 8,404 $ 10,530
======= ========
(8) COMPREHENSIVE INCOME
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," which specifies the presentation and
disclosure requirements for comprehensive income. The following details
comprehensive income for the periods reported herein:
QUARTER ENDED QUARTER ENDED SIX MONTHS SIX MONTHS
JUNE 29, JUNE 30, ENDED ENDED
2002 2001 JUNE 29, 2002 JUNE 30, 2001
------------- ------------- ------------- -------------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
Net loss $(6,161) $(16,186) $(13,925) $(46,718)
Foreign currency translation
adjustment, net of taxes 982 (323) 820 (1,252)
------- -------- -------- --------
Comprehensive loss $(5,179) $(16,509) $(13,105) $(47,970)
======= ======== ======== ========
(9) NON-RECURRING CHARGES AND RESTRUCTURING RESERVES
Approximately $2,130 of restructuring charges have been recorded in
connection with the Company's October 1999 acquisition of Thermalloy, the
thermal management business of Bowthorpe plc. The restructuring plan includes
initiatives to integrate the operations of the Company and Thermalloy and reduce
overhead. The primary components of these plans relate 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. The following amounts have been charged against the Thermalloy
restructuring reserves during the quarter ended June 29, 2002:
CHARGES AGAINST
RESERVES FOR THE RESTRUCTURING
RESTRUCTURING QUARTER ENDED RESERVES BALANCE
RESERVES BALANCE AT JUNE 29, AT JUNE 29,
MARCH 30, 2002 2002 2002
------------------- ---------------- ---------------
Lease terminations and
leasehold improvements reserve $301 $ -- $301
Employee separation 139 -- 139
---- ------ ----
Total $440 $ -- $440
==== ====== ====
During the first half of 2001, the Company ceased manufacturing activities
at its Dallas, Texas facility and reduced its New Hampshire workforce. In
connection with these actions, the Company recorded a restructuring charge
within the statement of operations for the first quarter of 2001. This
restructuring charge totaled $12,073 and included estimated amounts related to
employee severance, write-off of fixed assets and write-off of a prepaid lease
intangible asset that was originally recorded as part of the Thermalloy
acquisition. 81 individuals were terminated under the restructuring plan. The
following amounts have been charged against these restructuring reserves during
the second quarter of 2002:
CHARGES AGAINST RESTRUCTURING
RESERVES FOR THE RESERVES
RESTRUCTURING QUARTER ENDED BALANCE
RESERVES BALANCE JUNE 29, AT JUNE 29,
AT MARCH 30, 2002 2002 2002
----------------- ---------------- -------------
Employee separation $90 $ (43) $ 47
Fixed asset reserve -- 226 226
Prepaid rent write-off -- -- --
--- ----- ----
Total $90 $ 183 $273
=== ===== ====
12
During the third quarter of 2001 the Company made the decision to cease
manufacturing operations at its Terrell, Texas facility and further reduce its
New Hampshire workforce. In connection with this action, the Company recorded a
restructuring charge within the statement of operations for the third quarter of
2001. This restructuring charge totals $1,222 and includes estimated amounts
related to employee severance and the write-off of fixed assets. During the
quarter ended September 29, 2001, 105 individuals were terminated under the
restructuring plan. The following amounts have been charged against these
restructuring reserves during the second quarter of 2002:
CHARGES AGAINST RESTRUCTURING
RESERVES FOR THE RESERVES
RESTRUCTURING QUARTER ENDED BALANCE
RESERVES BALANCE JUNE 29, AT JUNE 29,
AT MARCH 30, 2002 2002 2002
----------------- ---------------- -------------
Employee separation $76 $(33) $43
Fixed asset reserve -- -- --
Prepaid rent write-off -- -- --
--- ---- ---
Total $76 $(33) $43
=== ==== ===
During the fourth quarter of 2001 the Company made the decision to cease
manufacturing operations at its fan facility in China and reduce its workforce
in North America, Europe and Asia. In connection with this action, the Company
recorded a restructuring charge within the statement of operations for the
fourth quarter of 2001. This restructuring charge totals $3,314 and includes
estimated amounts related to employee severance, the write-off of fixed assets
and charges related to certain contractual obligations. During the quarter ended
December 31, 2001, 253 individuals were terminated under this restructuring
plan. The following amounts have been charged against these restructuring
reserves during the second quarter of 2002:
CHARGES AGAINST RESTRUCTURING
RESERVES FOR THE RESERVES
RESTRUCTURING QUARTER ENDED BALANCE
RESERVES BALANCE JUNE 29, AT JUNE 29,
AT MARCH 30, 2002 2002 2002
----------------- ----------------- -------------
Employee separation $ 328 $(211) $ 117
Fixed asset reserve 1,393 -- 1,393
Lease obligations 120 (40) 80
------ ----- ------
Total $1,841 $(251) $1,590
====== ===== ======
(10) RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) 141, "Business Combinations" and SFAS 142,
"Goodwill and Other Intangible Assets." SFAS 141 requires business combinations
initiated after June 30, 2001 to be accounted for using the purchase method of
accounting. It also specifies the types of acquired intangible assets that are
required to be recognized and reported separately from goodwill. SFAS 142
requires that goodwill and certain intangibles, including assembled workforce,
no longer be amortized, but instead tested for impairment at least annually. The
Company adopted SFAS 142 on January 1, 2002. The Company completed its initial
review during the first quarter of 2002 and determined its intangible assets
were not impaired. Because goodwill and some intangible assets are no longer
being amortized, the reported amounts of goodwill and intangible assets (as well
as total assets) will not decrease at the same time and in the same manner as
under previous standards. There may be more volatility in future earnings of the
Company than under previous standards because impairment losses are likely to
occur irregularly and in varying amounts. Additionally, the Company was required
to reclassify the net balance of its assembled workforce intangible asset of
$3,714 to goodwill upon adoption of the statement. In the second quarter of
2001, the Company recorded $6,420 of amortization related to goodwill that was
not recorded in the second quarter 2002 under the provisions of SFAS No. 142.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets and
supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
Long-Lived Assets to be Disposed Of" and the accounting and reporting provisions
of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" for the disposal of a segment of
a business (as previously defined in that Opinion). The Company adopted SFAS No.
144 on January 1, 2002. The adoption of SFAS No. 144 did not have a material
effect on the Company's financial position or results of operations.
13
(11) SEGMENT REPORTING
Aavid provides thermal management solutions for microprocessors and
integrated circuits ("ICs") for computer and network and industrial
applications. The Company consists of two distinct reportable segments: (1)
thermal management products and (2) 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 accounting policies of the segments are the same as those described in
the summary of significant accounting policies as disclosed in the Company's
Form 10-K for the year ended December 31, 2001, with the exception of software
revenue recognition which is further discussed in footnote (2) to these
financial statements.
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.
The following summarizes the operations of each reportable segment for the
quarters and six months ending June 29, 2002 and June 30, 2001:
SEGMENT
REVENUES INCOME (LOSS)
FROM BEFORE TAXES ASSETS (NET OF
EXTERNAL AND MINORITY INTERCOMPANY
CUSTOMERS* INTERESTS* BALANCES)*
---------- ------------- --------------
Quarter Ending June 29, 2002
Thermal Products $22,085 $ (4,261) $ 61,091
CFD Software 18,338 1,640 91,386
Corporate Office -- (2,488) 23,806
------- -------- --------
Total $40,423 $ (5,109) $176,283
======= ======== ========
Quarter Ending June 30, 2001
Thermal Products $31,328 $(14,161) $213,385
CFD Software 11,826 (8,213) 95,517
Corporate Office -- 1,846 33,475
------- -------- --------
Total $43,154 $(20,528) $342,377
======= ======== ========
Six Months Ending June 29, 2002
Thermal Products $44,396 $(10,596)
CFD Software 34,459 1,726
Corporate Office -- (2,619)
------- --------
Total $78,855 $(11,489)
======= ========
Six Months Ending June 30, 2001
Thermal Products $69,540 $(35,231)
CFD Software 21,232 (19,551)
Corporate Office -- (431)
------- --------
Total $90,772 $(55,213)
======= ========
* Restated. See Note 2.
14
The following table provides geographic information about the Company's
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.
FOR THE QUARTER ENDED
FOR THE SIX MONTHS ENDED FOR THE SIX MONTHS ENDED JUNE 29, JUNE 30,
JUNE 29, 2002 JUNE 30, 2001 2002 2001
-------------------------- -------------------------- -------------------------
LONG-LIVED LONG-LIVED
ASSETS ASSETS
AS OF PERIOD AS OF PERIOD
REVENUES* END* REVENUES* END* REVENUES REVENUES*
--------- ------------ --------- ------------ -------- ---------
United States $ 42,618 $ 69,434 $ 62,464 $ 225,546 $ 22,523 $ 29,580
Taiwan 4,462 1,369 5,036 1,448 1,494 2,356
China 6,099 1,557 5,862 3,604 3,351 2,763
United Kingdom 9,544 1,899 10,424 1,615 4,542 5,040
Other International 33,181 8,367 30,011 7,461 16,952 15,341
Intercompany eliminations (17,049) (65) (23,025) (65) (8,439) (11,926)
-------- -------- -------- --------- -------- --------
Total $ 78,855 $ 82,561 $ 90,772 $ 239,609 $ 40,423 $ 43,154
======== ======== ======== ========= ======== ========
* Restated. See Note 2.
15
(12) SELECTED CONSOLIDATING FINANCIAL STATEMENTS OF PARENT, GUARANTORS AND
NON-GUARANTORS (UNAUDITED)
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 and Fluent, Inc. 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.
CONDENSED CONSOLIDATING BALANCE SHEET AS OF JUNE 29, 2002 (UNAUDITED)
--------------------------------------------------------------------------
U.S. GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- -------------- ------------- ------------ ------------
ASSETS
Cash and cash equivalents ........ $ 925 $ 7,616 $ 10,504 $ -- $ 19,045
Accounts receivable-trade, net ... -- 12,194 19,967 213 32,374
Notes receivable ................. -- 284 -- -- 284
Inventories ...................... -- 2,891 5,391 122 8,404
Due (to) from affiliate, net ..... 100,038 (56,299) (10,162) (33,577) --
Refundable taxes ................. (239) -- 118 180 59
Deferred income taxes ............ 11,687 (3,065) 496 (8,955) 163
Prepaid and other current assets . 137 1,676 3,371 (11) 5,173
Deferred financing fees .......... -- 908 -- -- 908
Assets of discontinued operations -- 966 26,346 -- 27,312
--------- -------- -------- -------- --------
Total current assets ............. 112,548 (32,829) 56,031 (42,028) 93,722
Property, plant and equipment, net 22 20,155 11,989 (16) 32,150
Investment in subsidiaries ....... (54,161) -- -- 54,161 --
Deferred taxes ................... 974 -- 429 (1,384) 19
Other assets, net ................ 23,801 48,876 645 (22,930) 50,392
--------- -------- -------- -------- --------
Total assets ..................... $ 83,184 $ 36,202 $ 69,094 $(12,197) $176,283
========= ======== ======== ======== ========
CONDENSED CONSOLIDATING BALANCE SHEET AS OF JUNE 29, 2002 (UNAUDITED)
---------------------------------------------------------------------------
U.S. GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- -------------- ------------- ------------ ------------
LIABILITIES, MINORITY INTERESTS
AND STOCKHOLDERS' DEFICIT
Accounts payable-trade ........... $ 175 $ 2,981 $ 9,042 $ -- $ 12,198
Current portion of debt obligations 39,661 484 509 -- 40,654
Income taxes payable ............. (12,440) 15,982 1,455 (703) 4,294
Deferred revenue ................. -- 15,998 15,216 -- 31,214
Accrued expenses and other
current liabilities ............ 8,009 9,126 7,124 32 24,291
Liabilities of discontinued
operations ..................... -- 30 3,233 -- 3,263
--------- -------- -------- -------- --------
Total current liabilities ........ 35,405 44,601 36,579 (671) 115,914
--------- -------- -------- -------- --------
Debt obligations, net of current
portion ........................ 130,363 205 528 -- 131,096
Deferred income taxes ............ (10,769) 15,463 172 (4,636) 230
--------- -------- -------- -------- --------
Total liabilities ................ 154,999 60,269 37,279 (5,307) 247,240
--------- -------- -------- -------- --------
Commitments and contingencies
Minority interests ............... 579 77 1,482 (701) 1,437
Stockholders' equity:
Preferred stock, par value ....... -- -- -- -- --
Common stock, par value .......... -- -- 6 (6) --
Warrants ......................... 3,764 -- -- -- 3,764
Additional paid-in capital ....... 188,007 207,604 4,079 (211,683) 188,007
Cumulative translation adjustment (1,145) 1,931 (820) (1,111) (1,145)
Retained earnings (deficit) ...... (263,020) (233,679) 27,068 206,611 (263,020)
--------- -------- -------- -------- --------
Total stockholders' (deficit) equity (72,394) (24,144) 30,333 (6,189) (72,394)
--------- -------- -------- -------- --------
Total liabilities, minority
interests and stockholders'
(deficit) equity ............... $ 83,184 $ 36,202 $ 69,094 $(12,197) $176,283
========= ======== ======== ======== ========
16
CONDENSED CONSOLIDATING BALANCE SHEET AS OF DECEMBER 31, 2001*
---------------------------------------------------------------------------
U.S. GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- -------------- ------------- ------------ ------------
ASSETS
Cash and cash equivalents ........ $ 849 $ 5,594 $ 8,095 $ -- $ 14,538
Accounts receivable-trade, net ... -- 13,038 17,054 368 30,460
Notes receivable ................. -- 480 -- -- 480
Inventories ...................... -- 4,015 6,473 42 10,530
Due (to) from affiliate, net ..... 95,281 (48,374) (13,091) (33,816) --
Refundable taxes ................. (180) -- 118 180 118
Deferred income taxes ............ 11,687 (3,065) 525 (8,955) 192
Prepaid and other current assets . 151 6,250 2,562 (11) 8,952
Assets of discontinued operations. -- 1,068 25,253 -- 26,321
--------- -------- -------- -------- --------
Total current assets ............. 107,788 (20,994) 46,989 (42,192) 91,591
Property, plant and equipment,
net............................. 33 22,838 11,292 (16) 34,147
Investment in subsidiaries ....... (41,596) -- -- 41,596 --
Deferred taxes ................... 974 -- 410 (1,384) --
Other assets, net ................ 23,801 46,376 627 (22,992) 47,812
--------- -------- -------- -------- --------
Total assets ..................... $ 91,000 $ 48,220 $ 59,318 $(24,988) $173,550
========= ======== ======== ======== ========
LIABILITIES, MINORITY INTERESTS
AND STOCKHOLDERS' (DEFICIT) EQUITY
Accounts payable-trade ........... $ 834 $ 5,388 $ 7,629 $ -- $ 13,851
Current portion of debt
obligations..................... 174,845 444 93 -- 175,382
Income taxes payable ............. (10,240) 13,122 1,032 (703) 3,211
Deferred revenue ................. -- 14,010 10,070 -- 24,080
Accrued expenses and other
current liabilities ........... 7,668 10,125 6,228 32 24,053
Liabilities of discontinued
operations...................... -- 31 2,642 -- 2,673
--------- -------- -------- -------- --------
Total current liabilities ........ 173,107 43,120 27,694 (671) 243,250
--------- -------- -------- -------- --------
Debt obligations, net of
current portion ............... -- 221 229 -- 450
Deferred income taxes ............ (10,849) 15,463 244 (4,636) 222
--------- -------- -------- -------- --------
Total liabilities ................ 162,258 58,804 28,167 (5,307) 243,922
--------- -------- -------- -------- --------
Commitments and contingencies
Minority interests ............... 578 85 1,502 (701) 1,464
Stockholders' equity:
Common stock, par value .......... -- -- -- -- --
Warrants ......................... 3,764 -- -- -- 3,764
Additional paid-in capital ....... 176,007 207,604 4,021 (211,625) 176,007
Cumulative translation adjustment (2,512) 1,954 (3,065) 1,111 (2,512)
Retained earnings (deficit) ...... (249,095) (220,227) 28,693 191,534 (249,095)
--------- -------- -------- -------- --------
Total stockholders' equity
(deficit)........................ (71,836) (10,669) 29,649 (18,980) (71,836)
--------- -------- -------- -------- --------
Total liabilities, minority
interests and stockholders'
(deficit) equity ............... $ 91,000 $ 48,220 $ 59,318 $(24,988) $173,550
========= ======== ======== ======== ========
* Restated. See Note 2.
17
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE QUARTER ENDED JUNE 29, 2002 (UNAUDITED)
---------------------------------------------------------------------------
U.S. GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- -------------- ------------- ------------ ------------
Net sales ........................ $ -- $ 22,724 $ 26,338 $ (8,639) $ 40,423
Cost of goods sold ............... -- 10,565 16,210 (4,638) 22,137
--------- -------- -------- -------- --------
Gross profit ..................... -- 12,159 10,128 (4,001) 18,286
Selling, general and
administrative expenses ........ 319 9,083 6,763 (1,333) 14,832
Research and development ......... -- 3,442 2,642 (2,527) 3,557
--------- -------- -------- -------- --------
Income (loss) from operations .... (319) (366) 723 (141) (103)
Interest income (expense), net ... (2,156) (2,978) 14 (16) (5,136)
Other income (expense), net ...... 3 (16) 136 7 130
Equity in income (loss) of
subsidiaries ................... (4,095) -- -- 4,095 --
--------- -------- -------- -------- --------
Income (loss) before income
taxes and minority interests ... (6,567) (3,360) 873 3,945 (5,109)
Income tax benefit (expense) ..... 406 (1,250) (192) -- (1,036)
--------- -------- -------- -------- --------
Income (loss) before minority
interests ...................... (6,161) (4,610) 681 3,945 (6,145)
Minority interests in (income)
loss of consolidated
subsidiaries ................... -- -- -- -- --
--------- -------- -------- -------- --------
Loss from continuing operations .. (6,161) (4,610) 681 3,945 (6,145)
Income (loss) from discontinued
operations ..................... -- (22) 6 -- (16)
--------- -------- -------- -------- --------
Net income (loss) ................ $ (6,161) $ (4,632) $ 687 $ 3,945 $ (6,161)
========= ======== ======== ======== ========
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE QUARTER ENDED JUNE 30, 2001 (UNAUDITED)*
----------------------------------------------------------------------------
U.S. GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- -------------- ------------- ------------ ------------
Net sales ........................ $ -- $ 29,582 $ 25,500 $(11,928) $ 43,154
Cost of goods sold ............... (1,000) 22,632 18,118 (8,096) 31,654
--------- -------- -------- -------- --------
Gross profit ..................... 1,000 6,950 7,382 (3,832) 11,500
Selling, general and
administrative expenses ........ (510) 17,803 5,973 (1,615) 21,651
Restructuring charges ............ -- 232 176 -- 408
Research and development ......... -- 2,768 2,603 (2,278) 3,093
--------- -------- -------- -------- --------
Income (loss) from operations .... 1,510 (13,853) (1,370) 61 (13,652)
Interest income (expense), net ... 354 (7,224) (38) 5 (6,903)
Other income (expense), net ...... -- 97 15 (85) 27
Equity in income (loss) of
subsidiaries ................... (22,103) -- -- 22,103 --
--------- -------- -------- -------- --------
Income (loss) before income
taxes and minority interests ... (20,239) (20,980) (1,393) 22,084 (20,528)
Income tax benefit (expense) ..... (926) (345) 159 -- (1,112)
--------- -------- -------- -------- --------
Income (loss) before minority
interests ...................... (21,165) (21,325) (1,234) 22,084 (21,640)
Minority interests in (income)
loss of consolidated
subsidiaries ................... -- -- -- -- --
--------- -------- -------- -------- --------
Loss from continuing operations .. (21,165) (21,325) (1,234) 22,084 (21,640)
Income (loss) from discontinued
operations ..................... -- 56 419 -- 475
--------- -------- -------- -------- --------
(Income) loss before extraordinary
item ........................... (21,165) (21,269) (815) 22,084 (21,165)
Gain on extinguishment of debt ... 4,979 -- -- -- 4,979
--------- -------- -------- -------- --------
Net income (loss) ................ $ (16,186) $(21,269) $ (815) $ 22,084 $(16,186)
========= ======== ======== ======== ========
* Restated. See Note 2.
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 29, 2002 (UNAUDITED)*
----------------------------------------------------------------------------
U.S. GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- -------------- ------------- ------------ ------------
Net sales ........................ $ -- $ 43,644 $ 53,286 $(18,075) $ 78,855
Cost of goods sold ............... -- 20,944 33,643 (9,916) 44,671
--------- -------- -------- -------- --------
Gross profit ..................... -- 22,700 19,643 (8,159) 34,184
Selling, general and
administrative expenses ........ 872 17,833 12,931 (2,854) 28,782
Restructuring charges ............ -- -- -- -- --
Research and development ......... -- 6,613 5,293 (5,207) 6,699
--------- -------- -------- -------- --------
Income (loss) from operations .... (872) (1,746) 1,419 (98) (1,297)
Interest income (expense), net ... (1,744) (8,642) 37 (12) (10,361)
Other income (expense), net ...... 9 (21) 146 35 169
Equity in income (loss) of
subsidiaries ................... (13,241) -- -- 13,241 --
--------- -------- -------- -------- --------
Income (loss) before income taxes
and minority interests ......... (15,848) (10,409) 1,602 13,166 (11,489)
Income tax benefit (expense) .... 1,923 (2,978) (1,024) -- (2,079)
--------- -------- -------- -------- --------
Income (loss) before minority
interests ...................... (13,925) (13,387) 578 13,166 (13,568)
Minority interests in (income)
loss of consolidated
subsidiaries ................... -- -- -- -- --
--------- -------- -------- -------- --------
Loss from continuing operations .. (13,925) (13,387) 578 13,166 (13,568)
Income (loss) from discontinued
operations ..................... -- (64) (293) -- (357)
--------- -------- -------- -------- --------
Net income (loss) ................ $ (13,925) $(13,451) $ 285 $ 13,166 $(13,925)
========= ======== ======== ======== ========
* Restated. See Note 2.
18
CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2001 (UNAUDITED)*
---------------------------------------------------------------------------
U.S. GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- -------------- ------------- ------------ ------------
Net sales ......................... $ -- $ 62,467 $ 51,333 $(23,028) $ 90,772
Cost of goods sold ................ -- 47,464 35,179 (15,788) 66,855
--------- -------- -------- -------- --------
Gross profit ...................... -- 15,003 16,154 (7,240) 23,917
Selling, general and
administrative expenses ......... 289 38,007 11,808 (2,695) 47,409
Restructuring charges ............. -- 12,689 176 -- 12,865
Research and development .......... -- 5,037 5,176 (4,664) 5,549
--------- -------- -------- -------- --------
Income (loss) from operations ..... (289) (40,730) (1,006) 119 (41,906)
Interest income (expense), net .... (98) (12,983) (100) (8) (13,189)
Other income (expense), net ....... 6 25 (92) (57) (118)
Equity in income (loss) of
subsidiaries .................... (51,390) -- -- 51,390 --
--------- -------- -------- -------- --------
Income (loss) before income taxes
and minority interests .......... (51,771) (53,688) (1,198) 51,444 (55,213)
Income tax benefit (expense) ...... 74 (261) (812) -- (999)
--------- -------- -------- -------- --------
Income (loss) before minority
interests ....................... (51,697) (53,949) (2,010) 51,444 (56,212)
Minority interests in (income) loss
of consolidated subsidiaries .... -- 3,294 -- -- 3,294
--------- -------- -------- -------- --------
Loss from continuing operations ... (51,697) (50,655) (2,010) 51,444 (52,918)
Income (loss) from discontinued
operations ...................... -- 202 1,019 -- 1,221
--------- -------- -------- -------- --------
Income (loss) before extraordinary
item ............................ (51,697) (50,453) (991) 51,444 (51,697)
Gain on extinguishment of debt .... 4,979 -- -- -- 4,979
--------- -------- -------- -------- --------
Net income (loss) ................. $ (46,718) $(50,453) $ (991) $ 51,444 $(46,718)
========= ======== ======== ======== ========
* Restated. See Note 2.
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 29, 2002 (UNAUDITED)*
---------------------------------------------------------------------------
U.S. GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- -------------- ------------- ------------ ------------
Net cash (used in) provided by
operating activities ........... $ (6,795) $ 2,088 $ 3,197 $ -- $ (1,510)
Cash flows used in investing
activities:
Purchases of property, plant and
equipment ...................... -- (1,174) (1,818) -- (2,992)
Proceeds from sale of property,
plant and equipment ............ -- 1,401 2 -- 1,403
--------- -------- -------- -------- --------
Net cash used in investing
activities ..................... -- 227 (1,816) -- (1,589)
Cash flows provided by (used in)
financing activities:
Issuance of preferred stock
and warrant .................... 12,000 -- -- -- 12,000
Advances under line of credit .... -- -- 497 -- 497
Principal payments on debt
obligations .................... (5,129) (293) (11) -- (5,433)
Advances under other debt
obligations .................... -- -- 131 -- 131
--------- -------- -------- -------- --------
Net cash provided by (used in)
financing activities ........... 6,871 (293) 617 -- 7,195
Foreign exchange effect on cash
and cash equivalents ........... -- -- 411 -- 411
--------- -------- -------- -------- --------
Net (decrease) increase in cash
and cash equivalents ........... 76 2,022 2,409 -- 4,507
Cash and cash equivalents,
beginning of period ............ 849 5,594 8,095 -- 14,538
--------- -------- -------- -------- --------
Cash and cash equivalents, end
of period ...................... $ 925 $ 7,616 $ 10,504 $ -- $ 19,045
========= ======== ======== -------- ========
* Restated. See Note 2.
19
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2001 (UNAUDITED)*
---------------------------------------------------------------------------
U.S. GUARANTOR NON-GUARANTOR
PARENT SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
--------- -------------- ------------- ------------ ------------
Net cash provided by (used in)
operating activities ........... $ (5,057) $ 611 $ 3,130 $ (1) $ (1,317)
Cash flows used in investing
activities:
Proceeds from sale of property,
plant and equipment ............ -- -- 126 -- 126
Purchase of minority interest in
Curamik ........................ (882) -- -- -- (882)
Purchases of property, plant and
equipment....................... -- (1,681) (1,902) -- (3,583)
--------- -------- -------- -------- --------
Net cash used in investing
activities ..................... (882) (1,681) (1,776) -- (4,339)
Cash flows provided by (used in)
financing activities:
Advances under line of credit .... 9,300 -- -- -- 9,300
Repayments of line of credit ..... -- -- (396) -- (396)
Principal payments on debt
obligations .................... (10,000) (211) (7) -- (10,218)
Make-well contribution ........... 34,028 -- -- -- 34,028
Retirement of 12 3/4% senior
subordinated notes and warrants (26,028) -- -- -- (26,028)
--------- -------- -------- -------- --------
Net cash provided by (used in)
financing activities ........... 7,300 (211) (403) -- 6,686
Foreign exchange effect on cash
and cash equivalents ........... -- -- (615) -- (615)
--------- -------- -------- -------- --------
Net increase (decrease) in cash
and cash equivalents ........... 1,361 (1,281) 336 (1) 415
Cash and cash equivalents,
beginning of period ............ 9,443 3,936 9,470 1 22,850
--------- -------- -------- -------- --------
Cash and cash equivalents,
end of period .................. $ 10,804 $ 2,655 $ 9,804 $ -- $ 23,265
========= ======== ======== ======== ========
* Restated. See Note 2.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Statements in this Quarterly Report on Form 10-Q concerning the Company's
business outlook or future economic performance; anticipated profitability,
revenues, expenses or other financial items; introductions and advancements in
development of products, and plans and objectives related thereto; and
statements concerning assumptions made or expectations as to any future events,
conditions, performance or other matters, are "forward-looking statements" as
that term is defined under the Federal Securities Laws. Forward-looking
statements are subject to risks, uncertainties and other factors that could
cause actual results to differ materially from those stated in such statements.
Such risks, uncertainties and factors include, but are not limited to, changes
in the Company's markets, particularly the potentially volatile semiconductor
market, changes in and delays in product development plans and schedules,
customer acceptance of new products, changes in pricing or other actions by
competitors, patents owned by the Company and its competitors, risk of foreign
operations and markets, the Company's substantial indebtedness and general
economic conditions, as well as other risks detailed in the Company's filings
with the Securities and Exchange Commission, including the Company's Annual
Report on Form 10-K for the year ended December 31, 2001.
The Company undertakes 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
Aavid Thermal Technologies, Inc. (the "Company" or "Aavid") is a leading
global provider of thermal management solutions for electronics products and the
leading developer and marketer of computational fluid dynamics ("CFD") software.
Each of these businesses has a leading 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 heat from microprocessors and industrial electronics products.
Aavid's products include heat sinks, interface and attachment accessories, fans,
heat spreaders and liquid cooling and phase change devices that can be
configured to meet customer-specific needs. 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, electronics
and bio-medical industries.
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 the Purchaser of $152.0 million, proceeds of $148.3 million, net of
original issue discount, from the sale by the Company of 12 3/4% senior
subordinated notes and warrants due 2007, $54.7 million pursuant to a new credit
facility entered into by the Company, and approximately $4.7 million of cash on
hand. Net stockholders' equity on the date of acquisition was $156.6 million.
Based upon fair value of assets acquired and liabilities assumed, goodwill of
$183.7 million was established. Approximately $113.7 million of this goodwill is
attributable to Aavid Thermalloy, the hardware business, and was being amortized
over 20 years through December 31, 2001. The remainder, $70.0 million, is
attributable to Fluent, the CFD software business, and was being amortized over
4 years through December 31, 2001. During the fourth quarter of 2001, the
Company wrote off the goodwill attributable to Aavid Thermalloy after performing
a review for impairment under Statement of Financial Accounting Standards (SFAS)
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of." The impairment charge recorded in the fourth quarter
of 2001 related to the goodwill attributable to Aavid Thermalloy was $94.2
million. The Company adopted SFAS 142, "Goodwill and Other Intangible Assets,"
on January 1, 2002. Under the provisions of SFAS 142, the remaining goodwill
attributable to Fluent is no longer amortized, but instead will be tested for
impairment at least annually. The Company completed its initial review for
impairment during the first quarter of 2002 and determined its intangible assets
were not impaired. Because goodwill and some intangible assets are no longer
being amortized, the reported amounts of goodwill and intangible assets (as well
as total assets) will not decrease at the same time and in the same manner as
under previous standards. There may be more volatility in future earnings of the
Company than under previous standards because impairment losses are likely to
occur irregularly and in varying amounts. Additionally, the Company was required
to reclassify the net balance of its assembled workforce intangible asset of
$3.7 million to goodwill upon adoption of the statement. In the second quarter
of 2001, the Company recorded $6.4 million and $12.8 million, respectively, of
amortization related to goodwill that was not recorded in the second quarter and
first half of 2002 under the provisions of SFAS No. 142.
21
Of the $152.0 million cash contribution, $4.8 million 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.
On February 2, 2000, as part of the transactions relating to the Merger,
the Company issued 150,000 units (the "Units"), consisting of $150,000,000
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").
The Notes were issued pursuant to an Indenture (the "Indenture") among the
Company, 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 $143.8 million was
allocated to the Notes, net of original issue discount of approximately $1.7
million. The total discount of $6.2 million 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 statement of operations for the
quarter and six months ended June 29, 2002 and June 30, 2001.
The Indenture limits the Company's 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 also contained
provisions requiring additional equity investments by Willis Stein & Partners in
the event the Company does not achieve certain leverage to EBITDA ratios, as
defined, in years 2000 and 2001. As described below, Willis Stein made the
maximum required equity investment in 2001 in respect of year 2000 and is not
required to make an additional equity investment even if the Company does not
achieve the required ratios in 2002. The Indenture provides that upon a change
in control of Aavid, the Company 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 the Amended and
Restated Credit Facility and certain other permitted indebtedness.
In connection with the Merger, the Company repaid all of the outstanding
term loan and revolving line of credit under its then existing credit facility
and entered into an amended and restated credit facility (the "Amended and
Restated Credit Facility"). The Amended and Restated Credit Facility provided
for a $22.0 million revolving credit facility (the "Revolving Facility") (of
which $1.7 million was drawn at the closing of the Merger) and a $53.0 million
term loan facility (the "Term Facility") (which was fully drawn at the closing
of the Merger). Subject to compliance with the terms of the Amended and Restated
Credit Facility, borrowings under the Revolving Facility were available for
working capital purposes, capital expenditures and future acquisitions. The
Revolving Facility was to terminate, and all amounts outstanding thereunder were
to be payable, on March 31, 2005. Principal on the Term Facility was required to
be repaid in quarterly installments commencing December 31, 2000 and ending
March 31, 2005 as follows: five installments of $2.0 million; four installments
of $2.5 million; four installments of $2.75 million; two installments of $3.2
million; two installments of $3.9 million; and a final installment of $7.8
million. In addition, commencing with our fiscal year ending December 31, 2001,
the Company is required to apply 50% of our excess cash flow, as defined in the
credit agreement, to permanently reduce the Term Facility. The Amended and
Restated Credit Facility bears interest at a rate equal to, at the Company's
option, either (1) in the case of Eurodollar loans, the sum of (x) the interest
rate in the London interbank market for loans in an amount substantially equal
to the amount of borrowing and for the period of borrowing selected by Aavid and
(y) a margin of between 1.50% and 2.25% (depending on the Company's consolidated
leverage ratio (as defined in the Amended and Restated Credit Facility)) or (2)
the sum of the higher of (x) Canadian Imperial Bank of Commerce's prime or base
rate or (y) one-half percent plus the latest overnight federal funds rate plus
(z) a margin of between .25% and 1.00% (depending on the Company's consolidated
leverage ratio). At June 29, 2002 the interest rates on the Term Facility and
the Revolving Facility were 6.5%.
The Amended and Restated Credit Facility may be prepaid at any time in
whole or in part without penalty, and must be prepaid to the extent of certain
equity or asset sales. The Amended and Restated Credit Facility limits the
Company's ability to incur additional debt, to sell or dispose of assets, to
create or incur liens, to make additional acquisitions, to pay dividends, to
purchase or redeem its stock and to merge or consolidate with any other person.
In addition, the Amended and Restated Credit Facility requires that the Company
meet certain financial ratios, and provides the lenders with the right to
require the payment of all amounts outstanding under the facility, and to
terminate all commitments thereunder, if there is a change in control of Aavid.
22
The Amended and Restated Credit Facility is guaranteed by each of Holdings
Corp. and Heat Holdings II Corp., and all of the Company's domestic subsidiaries
and secured by the Company's assets (including the assets and stock of its
domestic subsidiaries and a portion of the stock of its foreign subsidiaries).
The Company incurred approximately $7.1 million in underwriting, legal and
other professional fees in connection with the issuance of the Notes and the
obtainment of the Amended and Restated Credit Facility. These costs, in addition
to the $1.6 million of unamortized costs associated with the original Credit
Facility, 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 statement of operations.
At December 31, 2000 the Company was not in compliance with the leverage
ratio covenant required by the Amended and Restated Credit Facility. As a
result, the Company's stockholders were required to make an equity contribution
sufficient to allow the Company to pay down enough debt to achieve a 4.5 to 1
leverage ratio based on total leverage at December 31, 2000. On May 4, 2001
certain of the Company's stockholders and their affiliates made an equity
contribution of $8.0 million in cash and $26.2 million in principal amount of
Senior Subordinated Notes in full satisfaction of this obligation. In addition,
the Company and the lenders amended the Amended and Restated Credit Facility
(Amendment No. 1) to provide that the last three required quarterly principal
payments in 2001 under the facility be prepaid with $6.0 million of the proceeds
of the equity contribution, and the four required principal payments in 2002 be
reduced by $0.5 million each, reflecting application of the remaining cash
equity contribution. Further, certain covenant ratios and ratio definitions were
amended and the available line of credit was reduced to $17.0 million from $22.0
million. Based on the equity contribution, the Company's events of
non-compliance with its debt covenants at December 31, 2000 and March 31, 2001
were cured.
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 $2.0 million on the term loan that was originally due on March 31,
2002. This payment of $2.0 million 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. At August 1, 2002 the available borrowing base was $23.9
million, of which $22.6 million 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 .50%.
On January 30, 2002, as part of the equity contribution required under the
forbearance agreement discussed 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 in the accompanying balance sheet as of June 29,
2002.
23
RESTATEMENT OF FINANCIAL RESULTS
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 could 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 therefore 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, 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 their 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, determined 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, the Company has 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, Ernst & Young LLP
advised the Company 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. Ernst & Young LLP further advised the Company to
restate its financial results for the year ended December 31, 2001 to reflect
this change.
24
Accordingly, the Company has restated its financial statements as of
December 31, 2001,and for the year then ended, and for the three and six month
periods ended June 30, 2001, included herein, to reflect this change in revenue
recognition. The Company has also restated its financial statements for the
first quarter of 2002 and has conformed its second quarter 2002 financial
statements to this revenue recognition methodology. While this change has a
significant impact on recorded revenues within the statements of operations, and
consequently net loss and EBITDA, this change does not affect the Company's
statements of cash flows for the three and six month periods ended June 30,
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 three and six months ended June 30, 2001, the
amount of revenue originally recognized but now deferred is $4.6 million and
$12.9 million, respectively. For the three month period ended June 29, 2002, the
amount of revenue originally recognized but now deferred was $4.6 million.
Regardless, Fluent continues to be paid by its customers upon commencement of
the execution of the non-cancellable license agreement.
An additional restatement matter arises from the Company's sale of its
German subsidiary, Aavid Thermalloy Holdings, GmbH ("Curamik") (see
"Discontinued Operation" below) 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 from earnings from
continuing operations and instead, reflect Curamik's results as earnings from
discontinued operations.
All amounts in this Form 10-Q have been restated to reflect the change in
revenue recognition and discontinued operation as discussed below. As a result
of the unavailability of Arthur Andersen LLP to reissue their report on the
restated fiscal year 2001 results, the Company's financial statements for fiscal
year 2001 will have to be reaudited. Accordingly, all periods presented in this
Form 10-Q have been marked as "unaudited". It is also possible, that periods
prior to 2001 may also need to be reaudited due to the discontinued operation
restatement related to Curamik. Although the Company is not presently aware of
any other matters that could give rise to changes in prior period financial
statements, it is possible that the reaudit of the Company's financial
statements may result in additional changes to the consolidated financial
statements as of December 31, 2001, and for the year then ended, and for the
three and six months ended June 30, 2001 and 2002, included herein.
Ernst & Young LLP, the Company's independent accountants, have not
performed a review of the consolidated financial statements included in this
Quarterly Report on Form 10-Q in accordance with Statement on Auditing Standards
No. 71, "Interim Financial Information," and as required by Rule 10-01(d) of
Regulation S-X, because the Company's consolidated financial statements for the
fiscal year ended December 31, 2001 will have to be reaudited as discussed
above. Upon completion of the fiscal year 2001 reaudit by Ernst & Young LLP and
completion of the SAS 71 review, amended Form 10-Q's and an amended Form 10-K
will be filed for all applicable periods.
DISCONTINUED OPERATION
On July 17, 2002, the Company sold all of the outstanding shares of Aavid
Thermalloy Holdings, GmbH, which in turn owns 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
31,290,000 euros, subject to possible adjustment based upon consolidated net
assets of Curamik and certain indemnification obligations of the Company. The
Company will record a pre-tax gain on the sale of $6.1 million in 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 losses 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".
RESULTS OF OPERATIONS
For The Quarter and Six Months Ended June 29, 2002 Compared With The
Quarter and Six Months Ended June 30, 2001
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
---------------------------- -----------------------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
SALES (DOLLARS IN MILLIONS) 2002 2001 CHANGE 2002 2001 CHANGE
- ---------------------------------- -------- -------- ------ -------- -------- ------
Computer, network and industrial
electronic thermal solutions 21.8 30.8 (29.2)% 43.7 68.5 (36.2)%
Consulting and design services
(Applied) 0.3 0.5 (40.0)% 0.7 1.0 (30.0)%
------- ------- ------- -------
Total Aavid Thermalloy 22.1 31.3 (29.4)% 44.4 69.5 (36.1)%
Total Fluent 18.3 11.9 53.8% 34.5 21.3 62.0%
------- ------- ----- ------- ------- -----
Total Company $ 40.4 $ 43.2 (6.5)% $ 78.9 $ 90.8 (13.1)%
======= ======= ===== ======= ======= =====
25
Sales in the second quarter of 2002 were $40.4 million, a decrease of $2.8
million, or 6.5% from the comparable period of 2001. Sales for the six months
ended June 29, 2002 were $78.9 million, a decrease of $11.9 million or 13.1%
from the comparable period of 2001. The overall decrease in sales stems from
Aavid Thermalloy and is primarily the result of the significant decline
experienced by the semi-conductor and electronics industries during 2001 and
which has extended through the first half of 2002. The decline experienced by
Aavid Thermalloy was in part offset by an increase in sales experienced at
Fluent. Part of this increase results from a revenue recognition change made by
Fluent in 2001 as discussed below.
Fluent software sales of $18.3 million in the second quarter of 2002 were
$6.4 million, or 53.8%, higher, than the second quarter of 2001. 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, all revenue
related to a software contract is deferred and recognized ratably over 12
months. Prior to 2001, Fluent had only deferred a portion of the contract
(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. Because 2001 is the transition year, revenue is
significantly less in 2001 than what can be expected in future years due to the
fact that at January 1, 2001 there was not a signficant "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. Had Fluent continued to recognize revenue in 2001 and 2002 consistent with
how it was recognized in prior years, Fluent's revenue for the quarter and six
months ended June 29, 2002 and June 30, 2001 would have been as follows:
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
----------------------------- ----------------------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
SALES (DOLLARS IN MILLIONS) 2002 2001 CHANGE 2002 2001 CHANGE
- --------------------------- ------- -------- -------- -------- -------- ------
Net sales $20.6 $16.4 25.6% $41.3 $34.1 21.1%
As can be seen above, under the revenue recognition methodology used by
Fluent through the year 2000, Fluent experienced solid year over year growth,
however, the magnitude of the growth is distorted when looking at the restated
revenue due to the changes discussed above.
Aavid Thermalloy's sales were $22.1 million in the second quarter of 2002,
a decrease of $9.2 million, or 29.4%, over the second quarter of 2001. Aavid
Thermalloy's sales for the first six months of 2002 were $44.4 million, a
decrease of $25.1 million or 36.1%. As discussed above, this was the result of a
significant decline in the overall industry in which Aavid Thermalloy's
customers operate in. However, Aavid Thermalloy has experienced an improvement
in its book-to-bill ratio which became positive at the beginning of the first
quarter of 2002. Based on the current booking activity, management expects to
see an environment of flat revenues on a sequential basis in the third and
fourth quarters when compared with the second quarter of 2002.
Additionally, at the end of the second quarter of 2002, Jason Huang, Aavid
Thermalloy's President of Asian Operations resigned his position. The position
has been taken over directly by Bart Patel, CEO with assistance by George
Davision, Vice President of Sales and Marketing.
International sales (which include U.S. exports) increased to 56.8% of
sales for the second quarter of 2002 compared with 52.7% in the second quarter
of 2001.
No customer generated greater than 10% of the Company's revenues in the
second quarter and first half of 2002 or 2001.
26
The Company's gross profit for the second quarter of 2002 was $18.3 million
compared with $11.5 million in the comparable period from 2001. Gross margin as
a percentage of sales increased from 26.6% in the second quarter of 2001 to
45.2% for the comparable period of 2002. Gross profit for the six months ended
June 29, 2002 increased to $34.2 million from $23.9 million in the comparable
period of 2001. Gross margin improved to 43.4% for the six months ended June 29,
2002 from 26.3% for the comparable period of 2001. Gross margin at Aavid
Thermalloy has improved through significant improvements in manufacturing
efficiency and utilization as a result of the consolidation of manufacturing
facilities (including the shut-down of the Loudwater, U.K. facility and the
Dallas and Terrell, Texas facilities) that occurred during 2001. Aavid
Thermalloy's gross margin has increased approximately 10.5 percentage points
from the second quarter of 2001 to the second quarter of 2002. Additionally, due
to the restatement of Fluent's revenue as discussed above, Fluent's gross margin
was much less in 2001 than what would normally be expected due to the decreased
revenue level. As Fluent's cost of sales was not impacted by the restatement in
2001, gross profit decreased dollar for dollar by the amount of the sales
decrease.
In the second quarter of 2002 the Company's operating loss of $0.1 million
compares with an operating loss of $13.7 million in the second quarter of 2001.
For the first six months of 2002, the Company's operating loss was $1.3 million
compared with and operating loss of $41.9 million for the comparable period of
2001. For the quarter, operating loss saw a large improvement over the second
quarter of 2001 due to several factors. First, amortization of intangible assets
in the second quarter of 2002 was $0.7 million, a decrease of $7.9 million, over
the $8.6 million of amortization recorded in the comparable quarter of 2001.
This decrease in amortization expense is a result of the cessation of goodwill
amortization beginning in the first quarter of 2002 due to the adoption of SFAS
142. Second, Fluent's operating income, excluding the effect of decreased
amortization, improved $4.4 million from the second quarter of 2001 to the
second quarter of 2002 due to the revenue restatement effect of the change in
revenue recognition discussed above. Aavid Thermalloy saw a $2.1 million dollar
improvement from the second quarter of 2001 to the second quarter of 2002 due to
the improvement in manufacturing utilization and cost savings achievements
discussed above. Corporate headquarters experienced an increase in operating
loss of $0.8 million from the second quarter of 2001 to the second quarter of
2002 due to increased legal and administrative costs.
The magnitude of the operating loss in the first six months of 2001 was
primarily impacted by a one-time restructuring charge of $12.9 million that was
recorded in connection with the cessation of manufacturing activities at the
Dallas facility and the reduction of the New Hampshire workforce. Aavid
Thermalloy's selling, general and administrative expenses, excluding
amortization of intangibles, declined $4.0 million, from $13.8 million in the
first half of 2001 to $9.8 million in the first half of 2002 due to cost savings
resulting from facility consolidations and workforce reductions in 2001.
Fluent's S,G&A expenses, exclusive of intangible asset amortization, increased
by $0.4 million in the first half of 2002 compared to the first half of 2001.
Amortization of intangible assets in the first half of 2002 was $1.3 million, a
decrease of $15.8 million over the $17.1 million of amortization recorded in
the comparable period of 2001. This decrease in amortization expense is a result
of the cessation of goodwill amortization beginning in the first quarter of 2002
due to the adoption of SFAS 142.
Net interest charges for the Company were $5.1 million in the second
quarter and $10.4 million in the first half of 2002 which compares with $6.9
million for the second quarter and $13.2 million for the first half of 2001. The
decrease in interest expense is due to the lower debt levels in the second
quarter of 2002 compared to the second quarter of 2001 resulting from the
retirement of $26.2 million of Senior Subordinated Notes that occurred in the
second quarter of 2001, combined with lower interest rates on the senior credit
facility in 2002 compared to 2001.
The Company incurred a tax provision in the second quarter of 2002 despite
having significant operating losses in the United States because of significant
foreign tax provisions on foreign earnings. The Company's tax provision in 2002
represents the foreign tax provision on foreign earnings. The Company incurred
significant losses in the United States and the Company only benefits the U.S.
losses to the extent of foreign earnings which are expected to be repatriated in
the United States. Because the Company is in a net operating loss position for
U.S. tax purposes, the Company will not receive any tax benefit from foreign tax
credits. Accordingly, there is no net benefit recorded for the United States
losses, resulting in an overall tax provision for foreign taxes.
The Company's net loss was $6.2 million for the second quarter and $13.9
million for the second half of 2002, versus a net loss for the comparable
periods of 2001 of $16.2 million and $46.7 million, respectively. The primary
reasons for the improvement in net loss from 2001 to 2002 have been discussed
above but include the following: First, Fluent revenue restatement caused an
unusually high net loss in 2001 versus 2002. Fluent's net loss decreased $4.5
million from the second quarter 2001 to the second quarter 2002 and $10.2
million from the first half of 2001 compared with the first half of 2002
(excluding impact of amortization). Second, restructuring charges of $12.9
million were recorded in the first quarter of 2001 at Aavid Thermalloy. Third,
amortization expense decreased significantly both on a quarterly and half year
basis from 2001 to 2002 as discussed above. Fourth, Aavid Thermalloy experienced
significant improvements in manufacturing efficiency through plant shut-downs
and other cost savings initiatives.
27
FINANCIAL CONDITION
Historically, the Company has used internally generated funds and proceeds
from financing activities to meet its working capital and capital expenditure
requirements. As a result of the Thermalloy acquisition and the Merger, the
Company has significantly increased its cash requirements for debt service
relating to the Notes and its Bank debt described in footnote (1) in the
accompanying financial statements. The Company intends to use amounts available
under its new Loan and Security Agreement, future debt and equity financings and
internally generated funds to finance its working capital requirements, capital
expenditures and potential acquisitions. See "Overview" for a discussion of the
Notes and Loan and Security Agreement.
During the first six months of 2002, the Company used $1.5 million of cash
for operations, versus using $1.3 million of cash for operations in the first
six months of 2001. Of the $1.5 million of cash used for operations, $9.6
million related to interest payments made during the period. During the period,
the Company was provided with $7.2 million of cash in connection with financing
activities versus $6.7 million in the comparable period of 2001. The Company
used $3.0 million for capital expenditures in the first half of 2002 versus $3.6
million in the comparable period of 2001.
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 $2.0 million on the term loan that was originally due on March 31,
2002. This payment of $2.0 million 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. At August 1, 2002 the available borrowing base was $23.9
million, of which $22.6 million 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 .50%.
Debt classified as long term in the accompanying balance sheet as of June
29, 2002 consists of the long term portion of the term loan component of the new
Loan and Security Agreement and all of the 12 3/4% senior subordinated notes.
These amounts have been classified as long term due to the refinancing of the
Amended and Restated Credit Agreement which occurred on July 31, 2002.
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 $0.7 million at June 29, 2002.
At June 29, 2002 inventory turns were 7.8, which compare with 7.4 at
December 31, 2001.
At June 29, 2002 accounts receivable days sales outstanding ("DSO") were
68, which compare with 65 days at December 31, 2001.
28
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, judgments 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
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 could 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 therefore 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
29
and its auditors, 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 their 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, determined 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, the Company has 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, Ernst & Young LLP
advised the Company 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. Ernst & Young LLP further advised the Company to
restate its financial results for the year ended December 31, 2001 to reflect
this change.
Accordingly, the Company has restated its financial statements as of
December 31, 2001,and for the year then ended, and for the three and six month
periods ended June 30, 2001, included herein, to reflect this change in revenue
recognition. The Company has also restated its financial statements for the
first quarter of 2002 and has conformed its second quarter 2002 financial
statements to this revenue recognition methodology. While this change has a
significant impact on recorded revenues within the statements of operations, and
consequently net loss and EBITDA, this change does not affect the Company's
statements of cash flows for the three and six month periods ended June 30,
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 three and six months ended June 30, 2001, the
amount of revenue originally recognized but now deferred is $4,579 and $12,885,
respectively. Regardless, Fluent continues to be paid by its customers upon
commencement of the execution of the non-cancellable license agreement.
Ernst & Young LLP, the Company's independent accountants, have not
performed a review of the consolidated financial statements included in this
Quarterly Report on Form 10-Q in accordance with Statement on Auditing Standards
No. 71, "Interim Financial Information," and as required by Rule 10-01(d) of
Regulation S-X, because the Company's consolidated financial statements for the
fiscal year ended December 31, 2001 will have to be reaudited as discussed
above. Upon completion of the fiscal year 2001 reaudit by Ernst & Young LLP and
completion of the SAS 71 review, amended Form 10-Q's and an amended Form 10-K
will be filed for all applicable periods.
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.
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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 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
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets and
supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
Long-Lived Assets to be Disposed Of" and the accounting and reporting provisions
of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" for the disposal of a segment of
a business (as previously defined in that Opinion). The Company adopted SFAS No.
144 on January 1, 2002. The application of SFAS No. 144 did not have a material
effect on the Company's financial position or results of operations.
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.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in various other legal proceedings that are
incidental to the conduct of the Company's business, none of which the Company
believes could reasonably be expected to have a materially adverse effect on the
Company's financial condition.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.27 Loan and Security Agreement dated as of July 31, 2002
(b) Reports on Form 8-K
None.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SIGNATURES
DATE: August 19, 2002 AAVID THERMAL TECHNOLOGIES, INC.
By: /s/ Brian A. Byrne
------------------------------------
Vice President and Chief Financial
Officer (Principal Financial Officer)
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