ITEM 1. BUSINESS
COMPANY INTRODUCTION
We are the leading global provider of thermal management solutions for electronic products and the leading developer and marketer of computational fluid dynamic ("CFD") software. Each of these businesses has an established reputation for high product quality, service excellence and engineering innovation in its market. We design, manufacture and distribute on a worldwide basis thermal management products that dissipate unwanted heat, which can degrade system performance and reliability, from microprocessors and industrial electronics products. Our products, which include heat sinks, interface materials and attachment accessories, fans, heat spreaders and liquid cooling and phase change devices that we configure to meet customer-specific needs, serve the critical function of conducting, convecting and radiating away unwanted heat. CFD software is used in complex computer-generated modeling of fluid flows, heat and mass transfer and chemical reactions. Our CFD software is used in a variety of industries, including the automotive, aerospace, chemical processing, power generation, material processing, electronics and HVAC industries.
We believe the demand for thermal management products and CFD software is growing. The increase in unwanted heat generated in electronic and other products is primarily a result of more powerful semiconductors and the growing number of semiconductors being used in individual products. The growing demand for our thermal management products is driven by the need to dissipate the increasing amount of heat generated by electronic products, as well as strong unit growth. The increase in heat requires more complex thermal solutions, which in turn is driving the trend among our customers and other electronics manufacturers to outsource development of thermal management solutions. Through our product design capabilities and customer relationships, we lead the thermal management industry in meeting this growing demand. The demand for CFD software is driven by the need to reduce product development costs, minimize time-to-market for new products and improve product performance. Through our technological leadership in CFD software, we will continue to develop software to meet the needs of our customers and others in this growing market. These trends have contributed to the growth in our net sales.
Our thermal management products are used in a wide variety and growing number of computer and networking and industrial electronics applications, including computer systems (desktops, laptops, disk drives, printers and peripheral cards), network devices (servers, routers, set top boxes and local area networks), telecommunications equipment (wireless base stations, satellite stations and PBXs), instrumentation (semiconductor test equipment, medical equipment and power supplies), transportation and motor drives (braking and traction systems) and consumer electronics (stereo systems and video games). Our CFD software is used for a wide variety of computer-based analyses, including the design of electronic components and systems, automotive design, combustion systems modeling and process plant troubleshooting. We have longstanding relationships with a highly diversified base of more than 3,500 national and international customers, including original equipment manufacturers (commonly referred to as OEMs), electronics distributors and contract manufacturers. Our customers include Acer, Apple, Arrow, AT&T, Cisco Systems, Compaq Computer, DaimlerChrysler, Dell, Dow Chemical, Ericsson, Flextronics, Ford, Fujitsu, General Electric, Harmon-Kardon, Hewlett-Packard, IBM, Intel, Lockheed Martin, Lucent, Motorola, Nortel, Rockwell Automation, Rolls Royce, SCI Systems, Siemens, Silicon Graphics, Solectron and Sun Microsystems.
On February 2, 2000 we were acquired in a merger with Heat Holdings Corp., a corporation newly formed by Willis Stein & Partners II, L.P. ("the Purchaser"). Pursuant to the merger, Aavid stockholders received $25.50 in cash for each outstanding share of common stock. In addition, all outstanding stock options and warrants were cashed out. The merger was accounted for using the purchase method. In connection with the merger, we consolidated our business into two operating segments: Aavid Thermalloy LLC, which designs, manufacturers and distributes thermal management products that dissipate unwanted heat from microprocessors and industrial electronics products, and include Applied Thermal Technologies, Inc.'s thermal design, validation and consulting services; and Fluent, which develops and markets CFD software.
INDUSTRY OVERVIEW(1)
THERMAL MANAGEMENT
In today's electronic environment, microprocessors and their associated power supplies, hard drives, advanced video chips and other
- ---------------------------- (1) Unless otherwise indicated, all industry data and statistics relating to the thermal management industry and its segments contained in this Annual Report on Form 10-K are management estimates that are based on its experience and independent reports on the electronics industry periodically issued by Electronics Industry Outlook, together with a study on thermal content in electronics products conducted by International Interconnection Intelligence for Aavid in 1996. Information relating to the existing computational fluid dynamics, or CFD, software market is based on publicly available information about our key competitors and internal management estimates; and information relating to the potential CFD software market is based on a study we conducted at the time we acquired our CFD software business. Although we believe the information on which we have based our estimates is reliable, we cannot guarantee the accuracy or completeness of such information and have not independently verified any of it.
peripheral devices draw large amounts of power and, consequently, must dissipate a significant amount of heat. The same heat generation occurs in semiconductors and integrated circuits in motor controls, telecommunications switches and other electronics. Because these electronic components can only operate efficiently in narrow temperature bands, heat is an absolute constraint in electronic system design. The excessive heat generated within a component not only degrades semiconductor and system performance and reliability, but can also cause semiconductor and system failure.
Increasingly, neither externally generated off-the-shelf thermal management products nor internally designed and produced parts have been able to effectively address the expanding complexity of thermal management problems resulting from the increasing amount of heat required to be dissipated by electronic products. The complexity of thermal management problems has been intensified by reductions in system size, shorter time-to-market, shorter product life cycles and more demanding operating environments. These factors have led to the development and growth of the thermal management industry.
The worldwide electronic thermal management market is divided between solutions that are internally designed and produced by OEMs (i.e., "in-house" thermal solutions) and those that are externally supplied by thermal management companies (i.e., "outsourced" thermal solutions). Based on our experience in the industry and industry data, we estimate that the size of the in-house thermal solutions market is approximately $0.8 billion and the size of the outsourced thermal solutions market is approximately $2.9 billion, or 78.4% of the worldwide electronic thermal management market. As thermal management problems become increasingly complex, we believe that manufacturers will increasingly outsource their thermal management design and production in order to focus on their core competencies. We further believe that the market for the types of thermal management products and services we offer in our existing geographic locations comprises only 45% of the $2.9 billion outsourced thermal solutions market. We believe that, as the market leader, we will benefit from the expected growth in the worldwide electronic thermal management market and that, through geographic and product expansion, we have an opportunity to address a larger portion of the outsourced segment of this market than we currently address.
Electronics manufacturers seek to respond to end user demands and increasing competition by offering new products with improved performance (functionality and speed) and greater reliability in smaller forms and at lower prices. This greater functionality, speed and the miniaturization of component housing has resulted in an increase in unwanted heat generated by electronics products. The demand for thermal management products is driven by the need to dissipate the increasing amount of heat generated by electronic products.
We believe that future growth of the thermal management products market will be driven by the following factors:
- Inherent unit growth in end-user products, such as desktop computers, laptops and telecommunications equipment. In particular, the volume of microprocessors and support chip units is increasing on an absolute and on a per product basis.
- The wider use of electronic controls in numerous areas due to the general increase in automation.
- The increasing use of microprocessors in industrial electronics applications, fueling the need for thermal management products to manage the different operating temperature characteristics of these devices.
- The increased need for reliable power supplies. The quality of power can be adversely affected by thermal overload arising from ineffective thermal management. This is becoming increasingly important within the industrial, computer and telecommunications sectors where "irregular" power surges can damage equipment and cause productivity loss.
- The complexity of thermal management problems, which has been intensified by the increasing amount of heat to be dissipated, reductions in system size, shorter time-to-market product cycles and more demanding temperature operating environments.
COMPUTATIONAL FLUID DYNAMICS SOFTWARE
CFD software is used in a wide range of industries for complex computer-based analysis of engineering designs involving fluid flows, heat and mass transfer, chemical reaction and other fluid flow phenomena. CFD software tools allow the analysis and evaluation of design modifications without the physical prototyping of each design modification, thereby reducing engineering cost, improving product performance and decreasing time-to-market for new products. Specific uses of CFD-based flow analysis include the design of electronic components and systems, automotive design, combustion systems modeling and process plant troubleshooting.
Over the past decade, increases in computing power have made CFD-based computer analysis of complex fluid flows feasible on computers that are readily available to research and development and engineering departments. Development of CFD software technology is expanding that market beyond its traditional user base of Ph.D-level engineers in corporate research and development centers to the larger base of design engineers working in product development. Finally, CFD software tools are part of the growing trend toward improved engineering efficiency through computer-aided analysis and design by integrating CFD software with geometric modeling and design.
The CFD software market has been growing rapidly during the past decade. Based on publicly available information from a number of our key competitors and internal management estimates, we believe that in 1998 the size of the developed market for CFD software applications was approximately $100 million. We further believe that this market has grown approximately 20% annually since 1992 and we expect to benefit from the anticipated continued growth of this market. Based on a market study we conducted in connection with our acquisition of Fluent, we estimate that the size of the potential market for CFD software products is currently approximately $500 million. We also believe that, through Fluent, we have approximately 40% of the developed market for CFD software applications.
We expect that future growth of the CFD software market will be driven by the following factors:
- The ability of customers using CFD software to reduce their product development costs, minimize time-to-market for their new products and improve product performance.
- The ability to analyze fluid flows is becoming increasingly important across a wide range of industries.
- The development of more powerful and affordable computers that are capable of running CFD software.
- The growing trend among customers to improve the engineering efficiency of product development and improvement through computer-aided analysis and design.
- Expansion of the traditional user base for CFD software beyond Ph.D.-level engineers in corporate research and development centers to the larger base of design engineers.
COMPETITIVE STRENGTHS
We believe that the following competitive strengths have enabled us to become a worldwide leader in both the thermal management market and the CFD software market.
TOTAL INTEGRATED SOLUTIONS PROVIDER
The increasing complexity of heat dissipation problems and the growing trend among manufacturers to outsource development of thermal management solutions has stimulated demand for total integrated solutions. We provide total integrated solutions by analyzing customers' thermal management problems at the device-, board- and system-level, designing, simulating and prototyping thermal management solutions and manufacturing, distributing and supporting these solutions worldwide.
VALUE-ADDED PARTNERING WITH OUR CUSTOMERS
We work closely with our customers to develop customized thermal management solutions. We believe that our close relationships with customers and their design and development teams, as well as our worldwide manufacturing capabilities, allow us to anticipate customers' needs and, through our engineering expertise and experience, provide quality product solutions more quickly than our competitors.
WORLDWIDE LOW COST MANUFACTURER
We have manufacturing operations in the United States, Canada, Mexico, Europe and Asia, including China. As an increasing number of electronics systems are being manufactured outside the United States, our low cost foreign manufacturing operations enable us to supply products directly to our customers at their geographically dispersed manufacturing locations.
LEADERSHIP IN CFD SOFTWARE
We believe that we are the technology leader in CFD software. As a result of our technological leadership, we develop software that enables our customers to generate the increasingly complex computer models they demand for more cost-efficient product design. This factor, as well as the relative ease-of-use and predictive accuracy of our CFD software, are of primary importance to our customers.
RECURRING REVENUES FROM SOFTWARE BUSINESS
Our CFD software business is characterized by high customer retention and recurring revenues. In recent years, approximately 80% of our annual software license revenue was renewed in the following year. This is driven by the significant value added by our CFD software to the design process and the high cost of switching to a competitor's software.
EXPERIENCED MANAGEMENT TEAM
Our senior management team has extensive operating and marketing experience in the thermal management and CFD software markets. This management team has grown our business, both organically and through strategic acquisitions, and has been responsible for improving operating efficiencies. Bharatan R. Patel, our chief executive officer who founded our CFD software business, has 28 years of experience in the area of fluid flows and thermal management and H. Ferit Boysan, president of our CFD software business, has 21 years of experience in the area of fluid flows and CFD software.
BUSINESS STRATEGY
Our business strategy is to continue to be the market leader in both the thermal management and CFD software markets. We intend to continue this business strategy and strengthen our competitive position through the following initiatives:
CAPITALIZE ON STRONG THERMAL MANAGEMENT INDUSTRY GROWTH
We believe that our existing thermal management markets will continue to experience growth in the long term. Growth will be driven by the need to dissipate the increasing amount of heat being generated by electronic products, as well as unit growth in these products. We believe our competitive strengths position us to capitalize on these growth trends.
TAKE ADVANTAGE OF OUTSOURCING TREND
The increasing complexity of heat dissipation problems is driving a trend among manufacturers to outsource the development of thermal management solutions to companies with high levels of expertise in solving these problems. We intend to capitalize on this trend by leveraging our technical expertise in designing thermal management products and through continuing to partner with our customers in creating customized solutions.
EXPAND OUR ADDRESSED THERMAL MANAGEMENT MARKET
We believe we have significant opportunities to expand the portion of the outsourced thermal management market that we address. Our strategy is to expand into the $1.6 billion part of the outsourced thermal management market that we do not currently serve by entering into new geographic markets and introducing new products that complement our existing product offerings.
ACCELERATE GROWTH IN COMPUTATIONAL FLUID DYNAMICS SOFTWARE MARKET
Growth in the CFD software market will be driven by customers' needs to reduce product development costs, minimize the time-to-market for their new products and improve product performance, as well as by increasing applications for CFD software. We intend to grow our CFD software business through internal product development and possibly strategic acquisitions to leverage our core technological competence in the development of computerized design and simulation software. Our goal is to further expand this market beyond its traditional user base of Ph.D.-level engineers in corporate research and development centers to the larger base of design engineers by providing them relatively easy-to-use industry-specific software.
PROVIDE TOTAL THERMAL MANAGEMENT SOLUTIONS ON A GLOBAL BASIS
We intend to continue capitalizing on our state-of-the-art worldwide manufacturing capabilities and to further leverage our expertise and technology to offer our customers a complete global solution to their thermal management problems. The increasing number of electronics systems manufactured outside of the United States has forced many electronics manufacturers to seek a highly integrated, worldwide provider of thermal solutions. We plan to continue to expand our quick-ramp, high-volume manufacturing and our design, sales and distribution activities globally as our customers continue to expand their operations overseas.
LEVERAGE OUR TECHNOLOGICAL LEADERSHIP
Our approximately 146 Ph.D.s and 210 engineers focus on new technology initiatives as well as developing new and enhancing existing products, processes and materials to address the evolving needs of our customers. We seek to enhance our internal research and development activities through collaborations with our customers and third parties in order to gain access to, or to pursue the development of, new technologies for thermal management applications and CFD software.
MARKETS AND CUSTOMERS
We sell our thermal management products and services to a highly-diversified base of customers across a wide range of industries and applications. We currently sell our thermal management products and services to over 2,500 customers. The following chart shows our largest customers for thermal management products and services by market sector:
No customer represented more than 10% of our thermal management net sales during 2000 or 1999. Intel accounted for approximately 22% of net sales during 1998.
We currently have more than 2,000 licensees of our CFD software. License revenue is diversified by market sector and geographical market. The following chart shows our largest customers for CFD software applications by market sector:
THERMAL MANAGEMENT PRODUCTS AND SERVICES
We provide total integrated solutions to our thermal management customers. We have the thermal design know-how to first analyze customers' thermal management problems at the device-, board- and system-level, to then design, simulate and prototype thermal management solutions and to finally manufacture, distribute and support these solutions around the world.
Our design and applications engineers work concurrently with our customers' design teams to develop optimal thermal solutions, which are increasingly being outsourced by our customers. Working as an extension of the product design team, Applied Thermal Technologies' engineers give customers easy access to our system design expertise in thermal management on a time-and-materials consulting basis. Additionally, Applied Thermal Technologies provides for a smooth transition from system design and validation to complete outsourced product solutions provided by Aavid Thermalloy.
We design, manufacture and sell both standard and customized thermal management products. We seek to become a strategic supplier to our customers and to differentiate ourselves from our competitors by offering a higher level of service. We currently offer heat sinks, interface materials and attachment accessories, fans, heat spreaders and liquid cooling and phase change devices that we configure to meet customer-specific needs. The prices for our thermal management products (including attachment devices and interface materials), depend primarily on cost, the technology used to make the part and its value in the customer's application. Because of the continued shrinking time-to-market for most new products and the corresponding contraction of design cycles, we also offer simulation and modeling software to assist our customers in handling the complexity of the design of a thermal solution. The following is a brief description of our thermal management products and services:
COMPUTATIONAL FLUID DYNAMICS SOFTWARE PRODUCTS
We are the leading provider of general purpose CFD software used to predict fluid flow, heat and mass transfer, chemical reaction and related phenomena. We provide CFD-based flow analysis software and consulting services that are used by engineers in corporations worldwide for the design and analysis of products and processes. Our software and services help engineers reduce engineering and product development costs, improve product performance and reduce time-to-market for new products.
We currently license our software products to more than 2,000 licensees worldwide. In North America, we typically license our software products under one year, renewable agreements. In Europe and the Far East, a significant portion of our CFD software sales are derived from licenses of this software for one-time fees; in such situations, we also typically receive annual maintenance and support fees.
We have also introduced CFD-based industry-specific products, such as Icepak, for use by designers and engineers in the electronics cooling industry, Airpak, for use by designers and engineers in the HVAC industry and Mixsim, for use by designers and engineers in the
chemical mixing industry. We believe that our relatively easy-to-use, industry-specific products are expanding the CFD total market beyond its traditional user base of Ph.D.-level engineers in corporate research and development centers to the larger base of design engineers.
We also market engineering consulting services. With over 15 years of CFD and engineering consulting experience, our worldwide team of CFD professionals supports clients with senior engineering consultants, experienced CFD analysts, leading CFD software developers and mesh generation experts. Support services include expertise in the physics of heat, fluid flow and related phenomena, in CFD modeling and analysis, and in selection of engineering design solutions. In addition to providing CFD software expertise and access to high-performance computing systems, our CFD software consulting group works under contract to develop software with specific features required by individual clients.
We provide a complete suite of CFD software products, with each product designed for a specific task or for optimal performance on a specific class of problems. The following is a brief description of our CFD software products:
SALES AND SUPPORT
We sell our thermal management products and CFD software primarily through a global network of direct sales personnel, manufacturers' representatives, agents and a network of independent distributors. We provide support services to our customers, particularly in the CFD software area where we believe that high-quality support service is critical to the success of the CFD software business. Aavid Thermalloy (including Applied Thermal Technologies) and Fluent both have their own sales, support and marketing personnel, all of whom cross-sell each other's products and services where appropriate. We currently employ approximately 240 sales, support and marketing personnel.
TECHNOLOGY
We believe that technology leadership is essential to our growth strategy and have focused our approximately 146 Ph.D.s and 210 engineers on the development of technology in two areas:
THERMAL MANAGEMENT TECHNOLOGY
We believe that we are a technology leader in thermal management due to our extensive design expertise, technical manufacturing capabilities and process technology. We intend to develop new technologies and to enhance existing technologies in order to meet our customers' needs for higher performance products on a timely basis.
We have developed proprietary software tools (analytical models) which enable fast approximation answers for a large class of thermal management problems which, in turn, permits quicker design and prototyping of thermal solutions. We have extensive prototyping capabilities and state-of-the-art thermal laboratory facilities, including a wind tunnel which allows us to test and validate the design of thermal solutions.
As part of Aavid Thermalloy, Applied Thermal Technologies leverages Aavid Thermalloy's capabilities and Icepak's technology to assist customers in analyzing their thermal problems at the device-, board- and system-levels and to efficiently design, simulate and prototype thermal management solutions. By entering into the customer relationship at the onset of the product design cycle, Applied Thermal Technologies greatly enhances our knowledge of future industry trends, including technology development and acceptance. Additionally, Applied Thermal Technologies provides a smooth transition from design and validation to outsourced manufacturing with Aavid Thermalloy.
COMPUTATIONAL FLUID DYNAMIC SOFTWARE TECHNOLOGY
We believe that we are the technology leader in CFD software. Fluent's CFD software includes:
- automatic unstructured mesh generation, which allows the automatic creation of meshes,
- numerical algorithms for the accurate solution of fluid flow equations on structured and unstructured meshes,
- solution adaptive mesh which allows for interactive mesh refinement to provide improved solution accuracy,
- state-of-the-art physical models for important fluid flow phenomena such as turbulence, turbulence-chemistry interactions, free surface flows and multiphase flows,
- algorithms for efficient execution on multi-processor computers and distributed computer networks,
- interactive client/server architecture with a flexible and customizable user interface, and
- post-processing and data analysis tools.
PRODUCT DEVELOPMENT
Our thermal management product development activities are focused on lowering production costs, improving thermal characteristics and ease of attachment of conventional heat sinks, and developing new thermal management products and technologies to address the emerging and anticipated thermal management problems of our customers. We are developing new products, both internally as well as through collaborative efforts with third parties. These development efforts are directed toward: heat sink characterization and optimization; fan designs; air flow management; boundary layer optimization and focused flow; re-circulating passive and active cooling systems including heat pipes; thermoelectric coolers, which use electricity to create a temperature difference across an interface between the electronic device and a heat sink; liquid and sub-ambient cooling systems; tab and surface mount heat sink attachment methods; vacuum die casting; engineered materials and net shape part manufacturing technology; direct chip mounting to extruded heat sinks; and highly thermally conductive adhesive and interface systems.
Our CFD product development activities are focused on enhancing the capabilities of its solvers, implementing new physical models to increase the range of applications and developing front-end user interfaces that are easy to use for engineers in specific industries. We are also focusing on various application and industry-specific CFD software projects which we believe will enable us to penetrate the design engineering market.
SUPPLIERS
We purchase raw aluminum, aluminum extrusion, aluminum coil and various components from a limited number of outside sources. We purchase substantially all of our aluminum coil stock from a single supplier. We believe that purchasing aluminum extrusion and coil stock
from a limited number of suppliers is necessary to obtain lower prices and to consistently achieve the tolerances and design and delivery flexibility that we require.
For raw aluminum extrusion and coil stock, we typically make purchasing commitments to key suppliers of up to 24 months. In return, these suppliers commit to maintaining local inventory and to reserving run-time on their critical machines. The cost of aluminum extrusion is generally negotiated annually, with the price adjusted monthly, based upon the changes in the price of aluminum ingot, which has historically been highly cyclical. In addition, we produce approximately 50% of our domestic aluminum extrusion requirements at our extrusion facility in Franklin, New Hampshire, which has two extrusion presses.
COMPETITION
Our thermal management products business competes with a number of major providers of thermal management products located in the United States, Asia and Europe. Two of our most significant competitors are Hon Hai Precision Components Manufacturing (d/b/a Foxconn) and Wakefield Engineering, Inc. Foxconn is a Taiwan-based company that sells thermal management products as part of its broader electronic components products portfolio. Wakefield is a subsidiary of publicly traded Alpha Technologies Group, Inc. and mainly focuses on thermal management products for industrial electronics applications.
In addition, there are a large number of smaller heat sink companies, as well as hundreds of machine shops, that fabricate heat sinks, usually under subcontract with an OEM customer. Further, some aluminum die casters offer cast heat sinks, and a number of aluminum extruders sell heat sink products and fabrication capability, including aluminum extruders serving the automotive industry and the power conversion market.
Fluent currently competes with a number of privately held companies, primarily on the basis of product performance. To the extent that Fluent expands into additional application and industry-specific markets, it will encounter additional competition from software companies already serving such specific markets. In addition, certain CFD software is available in the public domain.
BACKLOG AND LICENSE RENEWAL
Our hardware products typically are produced and shipped within two months of the receipt of orders and, accordingly, we operate with little backlog. As a result, net sales in any quarter generally are dependent on orders booked and shipped in that quarter. All orders are subject to cancellation or rescheduling by customers. Because of our quick turn of orders to shipments, the timing of orders, delivery intervals, customer and product mix and the possibility of customer changes in delivery schedules, we do not believe our backlog at a particular date is a reliable indicator of actual sales for any succeeding period.
Our software products are typically sold under annual license agreements. In recent years, approximately 80% of our annual software license revenue was renewed in the following year.
EMPLOYEES
As of December 31, 2000 we had a total of 3,219 employees including approximately 816 contract employees in China. Except for the employees in our manufacturing facility in Mexico, none of our employees is represented by labor unions or collective bargaining units. We believe that our relationship with our employees is good.
RISK FACTORS
This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements regarding our expected future financial position, results of operations, cash flows, financing plans, business strategy, competitive position, plans and objectives and words such as "anticipate," "believe," "estimate," "expect," "intend," "plan" and other similar expressions are forward-looking statements. Such forward looking statements are inherently uncertain, and holders of our securities must recognize that actual results could differ materially from those projected or contemplated in the forward-looking statements as a result of a variety of factors, including the factors set forth below. Holders of our securities should not place undue reliance on these forward-looking statements.
The forward-looking statements speak only as of the date on which they are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, we cannot assess the effect of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
RISKS RELATING TO OUR BUSINESS
WE MAY NOT BE ABLE TO EFFECTIVELY MANAGE OUR INTERNAL GROWTH.
We have recently experienced substantial growth in our thermal management products business and have significantly expanded our operations through manufacturing capacity additions, the acquisition of Thermalloy and geographic expansion. We intend to continue to increase our thermal products and software businesses overseas, expand the products and services we offer, and possibly make selective acquisitions. This growth and expansion has placed, and will continue to place, a significant strain on our production, technical, financial and other management resources. To manage growth effectively, we must maintain a high level of manufacturing quality, efficiency, delivery and performance and must continue to enhance our operational, financial and management systems, and attract, train, motivate and manage our employees. We may not be able to effectively manage this expansion, and any failure to do so could have a material adverse effect on our business and financial condition.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.
Our quarterly and annual operating results are affected by a wide variety of factors, many of which are outside our control, that have in the past and could in the future materially and adversely affect our net sales, gross margins and profitability. These factors include:
- the volume and timing of orders received; - competitive pricing pressures; - the availability and cost of raw materials; - changes in the mix of products and services sold; - potential cancellation or rescheduling of orders; - general economic conditions; - changes in the level of customer inventories of our products; - the timing of new product and manufacturing process technology introductions by us or our competitors; - the availability of manufacturing capacity; and - market acceptance of new or enhanced products introduced by us.
Additionally, our growth and results of operations have in the past been, are currently being and would in the future be, adversely affected by downturns in the semiconductor or electronics industries. Our ability to reduce costs quickly in response to revenue shortfalls is limited, and this limitation will be exacerbated to the extent we continue to add additional manufacturing capacity. The need for continued investment in research and development could also limit our ability to reduce expenses accordingly. As a result of these factors, we expect our operating results to continue to fluctuate. Results of operations in any one quarter should not be considered indicative of results to be expected for any future period, and fluctuations in operating results may also cause fluctuations in the market price of the senior notes. We cannot provide assurance that the overall thermal management market, the segments of the market served by us or we will continue to grow in the future. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."
OUR BUSINESS IS DEPENDENT ON THE SEMICONDUCTOR MARKET.
A significant portion of our net sales has been, and is expected to continue to be, dependent upon sales of thermal management products for industrial electronics applications, consisting primarily of integrated circuits. However, a significant portion of our net sales has been, and is expected to continue to be, dependent upon sales of thermal management products for computer and networking applications, consisting primarily of microprocessors and related chip sets. Our sales for industrial electronics applications accounted for approximately 51%, 34% and 37% of our net sales (excluding sales of a special product we manufactured for Intel (the "Intel Special Product")), in 2000, 1999 and 1998, respectively. Our sales for computer and networking applications (excluding sales of the Intel Special Product) accounted for approximately 29%, 41% and 38% of our net sales in 2000, 1999 and 1998, respectively. The thermal management market for computer and networking applications is characterized by rapid technological change, short product life cycles, greater pricing pressure and increasing foreign and domestic competition as compared to the thermal management market for industrial electronics applications.
Our continued growth will, to a significant extent, depend upon increased demand for semiconductor devices and products that require thermal solutions. The semiconductor industry (both computer and networking and industrial) has historically been cyclical and subject to significant economic downturns characterized by diminished product demand and eroding average selling prices. A decrease in demand for semiconductor products would reduce demand for our products and have an adverse impact on our results of operations. Further, semiconductor manufacturers and their customers, in developing and designing new products, typically seek to eliminate or minimize thermal problems, and such efforts could have the effect of reducing or eliminating demand for certain of our products. Additionally, we believe that many of our OEM customers compete in intensely competitive markets characterized by declining prices and low margins.
These OEMs apply continued pricing pressure on their component suppliers, including us. We cannot provide assurance that we will not be adversely affected by cyclical conditions in the semiconductor and electronics industries.
The semiconductor industry is currently in a downward cycle marked by decreasing product demand which adversely affected our results of operation for the fourth quarter and full year 2000, and will likely adversely affect our results of operation into at least the second half of 2001.
CHANGES IN THE AVAILABILITY OR PRICE OF ALUMINUM CAN SIGNIFICANTLY AFFECT OUR BUSINESS AND RESULTS OF OPERATIONS.
Aluminum is the principal raw material used in our products and represents a significant portion of our cost of goods sold. We purchase raw aluminum, aluminum extrusion, aluminum coil and various components from a limited number of outside sources. During the years ended December 31, 2000, 1999 and 1998, we purchased a significant portion of our aluminum coil stock from a single supplier. We believe that purchasing aluminum extrusion and coil stock from a limited number of suppliers is necessary in order to obtain lower prices and to achieve, consistently, the tolerances and design and delivery flexibility that we require. If the available supply of aluminum declines, or if one or more of our current suppliers is unable for any reason to meet our requirements, is acquired by a competitor or determines to compete with us, we could experience cost increases, a deterioration of service from our suppliers, or interruptions, delays or a reduction in raw material supply that may cause us to fail to meet delivery schedules to customers. Although we believe that viable alternate suppliers exist for the aluminum coil stock and components, any unanticipated interruption of supply would have a short-term material adverse effect on us.
In addition, our ability to pass price increases for aluminum or other raw materials along to our customers may be limited by competitive pressures, customer resistance and price adjustment limitations in our product purchase contracts with our customers. Even if we are able to pass along all or a portion of raw material price increases, there is typically a lag of three to twelve months between the actual cost increase of raw material and the corresponding increase in the prices of our products. We cannot provide assurance that in the future we will be able to recover increased aluminum or other raw material costs through higher prices to our customers. Market prices for raw aluminum, which have historically been cyclical and highly volatile, have a significant effect on our gross margin. An increase in the market price for aluminum could have a material adverse effect upon our results of operations and business. See "Our operating results may fluctuate significantly."
WE SUPPLY PRODUCTS AND SERVICES TO INDUSTRIES THAT EXPERIENCE RAPID TECHNOLOGICAL CHANGE, WHICH MAY MAKE OUR PRODUCTS OBSOLETE.
The markets for our products are characterized by rapidly changing technology, frequent new product introductions and enhancements and rapid product obsolescence. Our future success will be highly dependent upon our ability to continually enhance or develop new thermal and software products, materials, manufacturing processes and services in order to keep pace with the technological advancements of our customers and their corresponding increasingly complex thermal management and computational fluid dynamics software needs. We may not be able to identify new product trends or opportunities, develop and bring to market new products or respond effectively to new technological changes or product announcements by others, develop or obtain access to advanced materials, or achieve commercial acceptance of our products. In addition, other companies, including our customers, may develop products or technologies which render our products or technologies noncompetitive or obsolete.
WE FACE INTENSE COMPETITION, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO MAINTAIN OR INCREASE SALES OF OUR PRODUCTS.
The markets for thermal management products and computational fluid dynamics software are highly competitive. Certain of our competitors, which include divisions or subsidiaries of large companies, may have greater technical, financial, research and development and marketing resources than we do. Further, we expect that as the trend toward outsourcing continues, a number of new competitors may emerge, some of which may have greater technical, financial, research and development and marketing resources than we do. Our ability to compete successfully depends upon a number of factors, including price, customer acceptance of our products, cost effective high-volume manufacturing, proximity to customers, lead times, ease of installation of our products, new product and manufacturing process technology introductions by us and our competitors, access to new technologies and general market and economic conditions. We cannot provide assurance that we will be able to compete successfully in the future against existing or potential competitors, or that our operating results will not be adversely affected by increased price competition. In addition, our customers for thermal management and software products may manufacture or develop such products internally or actively support new entrants into our market rather than purchase thermal products from us. Further, many of our customers like to maintain dual sources for thermal management products.
OUR BUSINESS EXPERIENCES SEASONAL VARIATIONS.
Our CFD software business has experienced and is expected to continue to experience significant seasonality due to, among other things, the second and third quarter slowdown in software revenues primarily due to the purchasing and budgeting patterns of Fluent's software customers. In addition, our thermal management business has experienced slight seasonal variations due to the slowdown during the third quarter's summer months which historically has occurred in the electronics industry. Typically, our revenues are lowest during the second and third quarters of the fiscal year, which ends in December.
WE DEPEND ON KEY PERSONNEL AND SKILLED EMPLOYEES WHO MAY NOT REMAIN WITH US IN THE FUTURE.
Our success depends to a large extent upon the continued services of our senior management and technical personnel. Our business also depends upon our ability to retain skilled and semi-skilled employees. There is intense competition for qualified management and skilled and semi-skilled employees and our failure to recruit, train and retain such employees could adversely affect our business.
OUR INTERNATIONAL OPERATIONS EXPOSE US TO ADDITIONAL RISKS.
We have been expanding our manufacturing capacity internationally to better service our customers, many of whom have moved their manufacturing operations and expanded their business overseas. Our acquisition of Thermalloy significantly increased the scope of our international operations. We cannot provide assurance that the expansion of our international operations will be successful. International operations are subject to a number of risks, including:
- greater difficulties in controlling and administering business; - less familiarity with business customs and practices; - increased reliance on key local personnel; - the imposition of tariffs and import and export controls; - changes in governmental policies (including U.S. policy toward these countries); - difficulties caused by language barriers; - increased difficulty in collecting receivables; - availability of, and time required for, the transportation of products to and from foreign countries; - political instability; - foreign currency fluctuations; and - expropriation and nationalization.
The occurrence of any of these or other factors may have a material adverse effect on our results of operations and could have an adverse effect on our relationships with our customers. Furthermore, the occurrence of certain of these factors in countries in which we operate could result in the impairment or loss of our investment in such countries. The trend by our customers to move manufacturing operations and expand their business overseas may have an adverse impact on our sales of domestically manufactured products.
WE DEPEND ON A LIMITED NUMBER OF MANUFACTURING FACILITIES.
A significant part of our net sales is currently derived from products manufactured at our manufacturing facility in Guang Dong Province in The People's Republic of China. We commenced manufacturing at this facility in early 1998 and have expanded this facility to 120,000 square feet. This facility has grown to generate significant revenues for us, representing 14.0% of net sales in 1999 and 8.3% of net sales in 2000. We only have limited experience in managing operations in China and, although we have focused significant management resources on this operation, we cannot provide assurance that this business will be successful. Because of the growth of our operations in China and the increasing percentage of net sales from China, an inability to successfully manage this business or an interruption in the operations at this facility could have a material adverse effect on our overall financial performance until we are able to obtain substitute production capability with similar low operating costs.
We produce approximately 50% of our domestic aluminum extrusion requirements on two presses at our extrusion facility in Franklin, New Hampshire. Any extended interruptions to the operation of the presses could have a material adverse on our business and results of operations.
WE MAY BE UNABLE TO PROTECT OUR PROPRIETARY TECHNOLOGY.
Our success depends in part on our proprietary technology. We attempt to protect our proprietary technology through patents, copyrights, trademarks, trade secrets and license agreements. We believe, however, that our success will depend to a greater extent upon innovation, technological expertise and distribution strength. We cannot provide assurance that we will be able to protect our technology, or that our competitors will not be able to develop similar technology independently. We cannot provide assurance that the claims allowed on any patents held by us will be sufficiently broad to protect our technology. In addition, no assurance can be given that any patents issued to us will not be challenged, invalidated or circumvented, or that the rights granted thereunder will provide competitive advantages to us. In addition, effective patent, copyright and trade secret protection may be unavailable or limited in certain foreign countries in which we conduct business. Although we believe that our products and technology do not infringe upon proprietary rights of others, there can be no assurance that third parties will not assert infringement claims in the future. Moreover, litigation may be necessary in the future to enforce our patents, copyrights and other intellectual property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our financial condition and results of operations.
WE ARE SUBJECT TO EXTENSIVE ENVIRONMENTAL AND OTHER REGULATIONS.
We are subject to a variety of United States and foreign environmental laws and regulations, including those relating to the use, storage, treatment, discharge and disposal of hazardous materials, substances and wastes used to manufacture our products and remediation of soil and groundwater contamination. Public attention has increasingly been focused on the environmental impact of operations that use hazardous materials. Some of the environmental laws impose strict, and in certain cases joint and several, liability for response costs at contaminated properties on their owners or operators, or on persons who arranged for the disposal of regulated materials at these properties. Our operations are also governed by laws and regulations relating to workplace safety and worker health, principally the Occupational Safety and Health Act and regulations thereunder which, among other requirements, establish noise and dust standards. We believe we are in material compliance with applicable environmental, health and safety requirements. Our failure to comply with present or future laws or regulations could result in substantial liability to us. We cannot predict the nature, scope or effect of legislation or regulatory requirements that could be imposed or how existing or future laws or regulations will be administered or interpreted with respect to products or activities to which they have not previously applied. Enactment of more stringent laws or regulations, as well as more vigorous enforcement policies of regulatory agencies or discovery of previously unknown conditions requiring remediation, could require substantial expenditures by us and could adversely affect our results of operations.
RISKS RELATED TO OUR INDEBTEDNESS
OUR SUBSTANTIAL DEBT COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION AND PREVENT US FROM FULFILLING OUR OBLIGATIONS UNDER THE SENIOR NOTES.
We have a substantial amount of debt. The following chart shows certain important credit statistics:
Our substantial indebtedness could have important consequences to holders of our senior notes. For example, it could:
- make it more difficult for us to satisfy our obligations with respect to the senior notes and our obligations under our amended and restated credit facility; - require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, which will reduce amounts available for working capital, capital expenditures, research and development and other general corporate purposes; - limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; - increase our vulnerability to general adverse economic and industry conditions; - place us at a competitive disadvantage compared to our competitors with less debt; and - limit our ability to borrow additional funds.
The terms of the indenture governing our senior notes do not fully prohibit us or our subsidiaries from incurring substantial additional debt in the future. Our amended and restated credit facility also permits additional borrowing. All of the borrowings under the amended and restated credit facility are senior to the senior notes. If new debt is added to our current debt levels, the related risks that we now face could intensify.
In addition, a portion of our debt, including debt incurred under our amended and restated credit facility, bears interest at variable rates. An increase in the interest rates on our debt will reduce the funds available to repay the senior notes and our other debt and for operations and future business opportunities and will intensify the consequences of our leveraged capital structure. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" for a description of our amended and restated credit facility and the senior notes.
TO SERVICE OUR DEBT, WE WILL REQUIRE A SIGNIFICANT AMOUNT OF CASH, WHICH DEPENDS ON MANY FACTORS BEYOND OUR CONTROL.
Our ability to make payments on and to refinance our debt, including the senior notes and the amended and restated credit facility, will depend on our ability to generate cash in the future. This, to an extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.
We cannot provide assurance that our business will generate sufficient cash flow or that future borrowings will be available to us in an amount sufficient to enable us to pay our debt, including the senior notes, or to fund our other liquidity needs. If our future cash flow from operations and other capital resources are insufficient to pay our obligations as they mature or to fund our liquidity needs, we may be forced to reduce or delay our business activities and capital expenditures, sell assets, obtain additional equity capital or restructure or refinance all or a portion of our debt, including the senior notes, on or before maturity. We cannot assure noteholders that we will be able to refinance any of our debt, including the senior notes, on a timely basis or on satisfactory terms if at all.
In addition, the terms of our existing debt, including the senior notes and the amended and restated credit facility, and other future debt may limit our ability to pursue any of these alternatives.
OUR AMENDED AND RESTATED CREDIT FACILITY AND THE INDENTURE IMPOSE OPERATIONAL AND FINANCIAL RESTRICTIONS ON US.
Our amended and restated credit facility and the indenture under which our senior notes were issued include restrictive covenants that, among other things, restrict our ability to:
- - incur more debt; - - pay dividends and make distributions; - - issue stock of subsidiaries; - - make certain investments; - - repurchase stock; - - create liens; - - enter into transactions with affiliates; - - enter into sale-leaseback transactions; - - merge or consolidate; and - - transfer and sell assets.
Our amended and restated credit facility also requires us to maintain financial ratios. All of these restrictive covenants may restrict our ability to expand or to pursue our business strategies. Our ability to comply with these and other provisions of our indenture and amended and restated credit facility may be affected by changes in our business condition or results of operations, adverse regulatory developments or other events beyond our control. The breach of any of these covenants would result in a default under our debt. If we default, we could be prohibited from making payments with respect to the senior notes until the default is cured or all debt under the amended and restated credit facility or other senior debt is paid in full. This default could allow our creditors to accelerate the related debt, as well as any other debt to which a cross-acceleration or cross-default provision applies. If our indebtedness were to be accelerated, we cannot provide assurance that we would be able to repay it. In addition, a default could give the lenders the right to terminate any commitments they had made to provide us with further funds.
At December 31, 2000, the Company was not in compliance with the leverage ratio covenant required by the amended and restated credit facility and the indenture under which our senior notes were issued. As a result, the Company's stockholders are required to make an equity contribution of up to $25.0 million 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. Subsequent to December 31, 2000, certain of the Company's stockholders and their affiliates agreed, subject to definitive documentation, to make an equity contribution of $8.0 million in cash and up to $25.0 million in principal amount of senior notes in full satisfaction of this obligation. This contribution is required to be made by May 15, 2001. In addition, the Company and the lenders under the amended and restated credit facility have agreed, subject to definitive documentation, to amend the facility such that the last three required quarterly principal payments in 2001 under the facility will be prepaid with $6 million of the proceeds of the equity contribution, and the four required principal payments in 2002 will be reduced by $0.5 million each, reflecting application of the remaining cash equity contribution. Further, certain covenant ratios and ratio definitions will be amended to levels which the Company expects to meet through December 31, 2001 and the available line of credit will be reduced to $17.0 million from $22.0 million. Based on the equity contribution, the Company's event of non-compliance with the leverage ratio covenant at December 31, 2000 will be cured.
RISKS RELATED TO THE SENIOR NOTES
OUR CONTROLLING STOCKHOLDER, WILLIS STEIN, MAY HAVE INTERESTS THAT CONFLICT WITH HOLDERS OF THE SENIOR NOTES.
We are a wholly owned subsidiary of Heat Holdings Corp., whose equity securities are held by Willis Stein and some co-investors. Through its controlling interest in Aavid and pursuant to the terms of the security holders' agreement among the equity investors, Willis Stein has the ability to control the operations and policies of Aavid. Circumstances may occur in which the interests of Willis Stein, as the controlling equity holder, could be in conflict with the interests of the holders of the senior notes. In addition, the equity investors may have an interest in pursuing acquisitions, divestitures or other transactions that, in their judgment, could enhance their equity investment, even though such transactions might involve risks to the holders of the senior notes.
THE SENIOR NOTES ARE CONTRACTUALLY SUBORDINATED IN RIGHT OF PAYMENT TO OUR SENIOR DEBT.
The senior notes are senior subordinated obligations of Aavid ranking junior to all of our existing and future senior debt, equal in right of payment with all of our existing and future senior subordinated debt and senior in right of payment to any of our subordinated debt. The senior notes are contractually subordinated in right of payment to borrowings under our amended and restated credit facility.
As of December 31, 2000, we had $58.7 million of senior debt outstanding, all of which was secured debt. The indenture limits, and in some (but not all) instances prohibits, the incurrence of additional debt.
In addition, all payments on the senior notes will be blocked in the event of a payment default under the amended and restated credit facility and may be blocked for up to 179 consecutive days in any given year in the event of non-payment defaults on senior debt. In the event of a default on the senior notes and any resulting acceleration of the senior notes, the holders of senior debt then outstanding will be entitled to payment in full in cash of all obligations in respect of such senior debt before any payment or distribution may be made with respect to the senior notes.
In a bankruptcy, liquidation or reorganization or similar proceeding relating to us, holders of the senior notes will participate with trade creditors and all other holders of subordinated debt in the assets remaining after we have paid all of the senior debt. However, because the indenture requires that amounts otherwise payable to holders of the senior notes in a bankruptcy or similar proceeding be paid to holders of senior debt instead, holders of the senior notes may receive proportionately less than holders of trade payables in any such proceeding. In any of these cases, we cannot provide assurance that sufficient assets will remain to make any payments on the senior notes.
WE ARE A HOLDING COMPANY AND OUR ONLY SOURCE OF CASH TO PAY INTEREST ON AND THE PRINCIPAL OF THE SENIOR NOTES IS DISTRIBUTIONS FROM OUR SUBSIDIARIES.
We are a holding company with no business operations of our own. Our only significant asset is and will be our equity interests in our subsidiaries. We conduct all of our business operations through our subsidiaries. Accordingly, our only source of cash to make payments of interest on and principal of the senior notes is distributions with respect to our ownership interest in our subsidiaries from the net earnings and cash flows generated by such subsidiaries.
WE MAY NOT HAVE THE ABILITY TO RAISE THE FUNDS NECESSARY TO FINANCE THE CHANGE OF CONTROL OFFER REQUIRED BY THE INDENTURE.
If we undergo a "change of control," as defined in the indenture under which the senior notes were issued, we must offer to buy back the senior notes for a price equal to 101% of the principal amount, plus interest that has accrued but has not been paid as of the repurchase date. We cannot assure note holders that we will have sufficient funds available to make the required repurchases of the senior notes in that event, or that we will have sufficient funds to pay our other debts. In addition, our amended and restated credit facility prohibits us from repurchasing the senior notes after a change of control until we have repaid in full our debt under such credit facility. If we fail to repurchase the senior notes upon a change of control, we will be in default under both the senior notes and our amended and restated credit facility. Any future debt that we incur may also contain restrictions on repurchases in the event of a change of control or similar event.
THE SENIOR NOTES AND THE GUARANTEES COULD BE VOIDED OR SUBORDINATED TO OUR OTHER DEBT IF THE ISSUANCE OF THE SENIOR NOTES OR THE GUARANTEES CONSTITUTED A FRAUDULENT CONVEYANCE.
If a bankruptcy case or lawsuit is initiated by our unpaid creditors, the debt represented by the senior notes and the guarantees of the senior notes by certain of our subsidiaries may be reviewed under the federal bankruptcy laws and comparable provisions of state fraudulent transfer laws. Under these laws, the debt could be voided, or claims in respect of the senior notes and the guarantees could be subordinated to all other debts of Aavid or its subsidiaries if, among other things, the court found that, at the time we incurred the debt represented by the senior notes and the subsidiaries incurred the debt represented by the guarantee, we or any subsidiary:
- received less than reasonably equivalent value or fair consideration for the incurrence of such debt; and - were insolvent or rendered insolvent by reason of such incurrence; or - were engaged in a business or transaction for which the remaining assets constituted unreasonably small capital; or - intended to incur, or believed that we or a subsidiary executing a guarantee thereof would incur, debts beyond the ability to pay such debts as they matured; or - intended to hinder, delay or defraud creditors.
The measure of insolvency for purposes of fraudulent transfer laws varies depending on the law applied. Generally, however, a debtor would be considered insolvent if:
- - the sum of its debts, including contingent liabilities, were greater than the fair saleable value of all of its assets; or - - the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or - - it could not pay its debts as they become due.
EFFECT OF ORIGINAL ISSUE DISCOUNT ON HOLDERS OF THE SENIOR NOTES.
The senior notes are considered to have been issued with original issue discount. Holders of the senior notes are required to include the accretion of the original issue discount in gross income for U.S. federal income tax purposes in advance of receipt of the cash payments to which such income is attributable. If a bankruptcy case is commenced by or against us under the United States Bankruptcy Code, the claim of a holder of senior notes with respect to the principal amount thereof may be limited to an amount equal to the sum of (i) the purchase price and (ii) that portion of the original issue discount which has been amortized as of the date of any such bankruptcy filing.
ITEM 2.
ITEM 2. PROPERTIES
A key element of our business strategy has been to expand internationally. Many of our customers have short product cycles that demand facilities to support quick-ramp, high-volume, high-quality manufacturing at their geographically dispersed manufacturing locations. Our acquisition of Thermalloy, which has manufacturing facilities in Italy, Malaysia, Mexico and the United Kingdom, significantly expands our manufacturing operations outside the United States. We plan to continue to build or acquire additional manufacturing facilities overseas to better service our customers, many of whom have moved manufacturing operations and expanded their business overseas.
There can be no assurance that our expansion of our foreign operations will be successful. Foreign operations are subject to a number of risks including: work stoppages; transportation delays and interruptions; expropriation; nationalization; misappropriation of intellectual property; imposition of tariffs and import and export controls; changes in governmental policies (including U.S. policy toward these countries); and other factors which could have an adverse effect on our business. In addition, we may be subject to risks associated with the availability of, and time required for, the transportation of products to and from foreign countries. The occurrence of any of these factors may delay or prevent the delivery of goods ordered by customers, and such delay or inability to meet customers' requirements would have a materially adverse effect our results of operations and could have an adverse effect on the our relationships with our customers. Furthermore, the occurrence of certain of these factors in countries where we own or operate manufacturing facilities could result in the impairment or loss of our investment in such countries.
Aavid Thermalloy has a total of approximately 860,000 square feet of manufacturing space with locations in Laconia and Franklin, New Hampshire; Dallas and Terrell, Texas; Mexico; the United Kingdom; Italy; Germany (Curamik facility); Malaysia; Singapore; Taiwan; China; and Toronto, Canada. We employ a broad range of aluminum fabrication and processing capabilities. Manufacturing operations consist of extrusion, cutting, stamping, machining, assembling and finishing, including anodizing capabilities. We have a substantial in-house tool and die capability that enables us to create our own extrusion and progressive stamping dies and other production tooling. Fluent's total sales, marketing, development, and support facilities consist of approximately 145,000 square feet.
Aavid Thermalloy closed down its manufacturing facility in Manchester, New Hampshire at the end of 1998 due to a change in product mix at a major customer. In addition, in connection with the consolidation of Aavid with Thermalloy following the acquisition of Thermalloy, we closed facilities in Santa Ana, California; Hong Kong; Corby, U.K. and High Wycombe, U.K. and are closing our Dallas, Texas facility in the first half of 2001.
We operate in the following locations:
* Facility to be closed in 2001
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Following the public announcement of the merger with Heat Merger Corp., lawsuits were filed against us, Willis Stein, our directors, and one former director in the Court of Chancery of the State of Delaware by certain of our stockholders. The complaints alleged, among other things, that our directors breached their fiduciary duties and sought to enjoin, preliminarily and permanently, the merger and also sought compensatory damages. The stockholder plaintiffs, on behalf of our public stockholders, also sought class action certification for their lawsuits. On March 11, 2001 the stockholders plaintiffs filed to dismiss the class action without prejudice. We are awaiting a final court order approving the dismissal.
We are involved in various other legal proceedings that are incidental to the conduct of our business, none of which we believe could reasonably be expected to have a materially adverse effect on our financial condition.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET PRICES OF AAVID COMMON STOCK
Our Common Stock traded on the Nasdaq National Market under the symbol "AATT" until February 2, 2000, the date we were acquired by Heat Holdings. As a result of the merger, our Common Stock is no longer publicly traded.
We have never paid a cash dividend on our Common Stock, and we currently intend to retain all earnings for use in our business and do not anticipate paying cash dividends in the foreseeable future. Our current amended and restated credit facility and senior notes indenture contain restrictive covenants which, among other things, impose limitations on the payment of dividends.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA(1)
The following tables set forth selected statement of operations and balance sheet data derived from the consolidated financial statements of the Company for the periods indicated. The following tables should be read in conjunction with "Management Discussion and Analysis of Financial Condition and Results of Operations," the Consolidated Financial Statements, and related Notes thereto of the Company included elsewhere herein.
The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying financial statements of the Predecessor and the Company are not comparable in all material respects since those financial statements report financial position, results of operations, and cash flows for these two separate entities.
NOTES TO SELECTED HISTORICAL CONSOLIDATED FINANCIAL DATA (amounts in thousands)
(1) This financial data reflects the consolidated financial position of the Company as of December 31, 1999 and the consolidated results of operations of the Predecessor for the period from January 1, 2000 to February 1, 2000 and the years ended December 31, 1999, 1998, 1997 and 1996 (collectively "Predecessor financial statements"). The Predecessor financial statements have been prepared using the historical cost of the Company's assets and have not been adjusted to reflect the merger with Heat Holdings Corp on February 2, 2000. The accompanying financial data as of December 31, 2000 and for the period from February 2, 2000 to December 31, 2000 reflect the consolidated financial position and results of operations of the Company subsequent to the date of the merger and include adjustments required under the purchase method of accounting.
(2) Includes the results of operations of Fluid Dynamics International from May 16, 1996 (the date of the acquisition of Fluid Dynamics International).
(3) Includes the results of operations of Thermalloy and Curamik from October 21, 1999 (the date of acquisition of Thermalloy).
(4) Represents the charges in 1998 related to (i) the estimated restructuring costs incurred with our closure of our Manchester, New Hampshire facility, (ii) the termination of the management agreement with Sterling Ventures Limited and (iii) a bonus due Mr. Beane, our former President and Chief Executive Officer, based on profits in excess of certain thresholds. The 1999 credit of $630 relates to the reversal of excess restructuring reserves which were no longer required upon the completion of the Manchester restructuring in the fourth quarter of 1999.
(5) The $3,446 non-recurring charge in 1996 represents the amount of the purchase price allocated to technology acquired in the acquisition of Fluid Dynamics International in 1996, which was not fully commercially developed and had no alternative future use at the time of acquisition. The $15,000 charge in 2000 represents the amount of the purchase price allocated to technology acquired by Heat Holdings related to Fluent, Inc., which was not fully commercially developed and had no alternative future use at the time of acquisition.
(6) Represents charge related to early retirement of debt, net of related tax effect.
(7) On December 31, 2000, the Company's common stock was not publicly traded; therefore, earnings per share information is not presented.
(8) Represents net income before interest, income taxes, depreciation and amortization and extraordinary items. Adjusted EBITDA for 2000 also includes the following add-backs, as defined in the amended and restated credit facility, to net income: non-cash charge to cost of sales related to the write-up of inventory to fair value associated with purchase accounting, minority interest, non-cash write-off of in-process technology, one-time accruals related to increases in inventory and receivables reserves and severance associated with a senior executive. Each of these components of Adjusted EBITDA can significantly affect our results of operations and liquidity and should be considered in evaluating our financial performance. Adjusted EBITDA is included because we understand that such information is considered to be an additional basis on which to evaluate our ability to pay interest, repay debt and make capital expenditures. Adjusted EBITDA is not intended to represent and should not be considered more meaningful than, or as an alternative to, measures of performance, profitability or liquidity determined in accordance with generally accepted accounting principles.
(9) Represents Adjusted EBITDA as a percentage of net sales.
ITEM 7.
ITEM 7. MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion of our financial condition and results of operations together with the financial statements and the notes to such statements included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements based on our current expectations, assumptions, estimates and projections about us and our industries. These forward-looking statements involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements, as more fully described in "Item 1. Business - Risk Factors". We undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future.
OVERVIEW
We are the leading global provider of thermal management solutions for electronic products and the leading developer and marketer of CFD software. Historically, we were organized as three operating segments: Aavid Thermal Products, Fluent and Applied Thermal Technologies; however, in connection with the merger, we consolidated our business into two operating units: Aavid Thermal Products (including Applied Thermal Technologies), which following the merger is known as Aavid Thermalloy, and Fluent. Aavid Thermalloy designs, manufactures and distributes thermal management products that dissipate unwanted heat from microprocessors and industrial electronics products. Fluent develops and markets CFD software that is used in complex computer-generated modeling of fluid flows, heat and mass transfer and chemical reactions for a variety of industries including, among others, the automotive, aerospace, chemical processing, power generation, material processing, electronics and HVAC industries.
We and our predecessors have been engaged in the development and manufacture of heat sinks and related thermal management products since 1964. In August 1995, we acquired all the outstanding capital stock of Fluent for $12.8 million. In February 1996, we completed our initial public offering, whereby we sold an aggregate of 2,645,000 shares of common stock at a price of $9.50 per share, from which we received net proceeds of approximately $21.7 million. During 1996, we further expanded our operations through the acquisitions of (1) Fluid Dynamics International, Inc., a provider of computational fluid dynamics software, (2) an aluminum extrusion manufacturing facility located in Franklin, New Hampshire and (3) Beaver Industries, a manufacturer of heat sinks and related thermal management products for electrical and electronics parts, components, ensembles and systems in Toronto, Canada.
On October 21, 1999, the Company purchased all of the stock of the Thermalloy Division of Bowthorpe plc (Thermalloy) and 85.4% of the stock of Curamik Electronics Gmbh (Curamik) (the Thermalloy acquisition) for a cash purchase price of $84.6 million, including transaction costs of $2.8 million. Thermalloy designs, manufactures and sells a wide variety of standard and proprietary heat sinks and associated products, similar to those produced by Aavid Thermal Products, our thermal management business, within the computer and networking and industrial electronics (including telecommunications) industries. Curamik is a German corporation that manufactures direct bonded copper ceramic substrates that are used in the power semiconductor and other industrial electronics industries. Aavid used $12.6 million of its cash on hand and $84.6 million of borrowings under its new credit facility to complete the Thermalloy acquisition, repay $12.6 million of outstanding debt, and pay transaction costs. The acquisition of Thermalloy created significant opportunities to realize cost savings through certain plant closings, the elimination of duplicative selling, general and administrative functions and the reduction of unnecessary corporate expenses. The increased goodwill amortization and other purchase accounting adjustments resulting from our acquisition of Thermalloy decreased our net income in the fourth quarter of 1999 and in 2000 as compared to the respective prior year periods. Following the acquisition of Thermalloy, we changed the name of Aavid Thermal Products to Aavid Thermalloy. See Note C. of notes to our consolidated financial statements for pro forma information for the acquisition.
On February 2, 2000, we were acquired in a merger by Heat Holdings Corp., a corporation newly formed by Willis Stein & Partners II, L.P. (the "Purchaser"). Pursuant to the merger, Aavid stockholders received $25.50 in cash for each outstanding share of common stock, and outstanding stock options and warrants were cashed out. The merger was accounted for using the purchase method.
RESULTS OF OPERATIONS
The following table is derived from our consolidated statements of operations and sets forth the percentage relationship of certain items to net sales for the periods indicated. The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying financial statements of the Predecessor and the Company are not comparable in all material respects since those financial statements report financial position, results of operations, and cash flows for these two separate entities. The 2000 results include the combined results of the Predecessor for the period January 1, 2000 through February 1, 2000 and the Company from February 2, 2000 through December 31, 2000.
2000 COMPARED WITH 1999
Our results of operations in 1999 include the operations of Thermalloy and Curamik from October 21, 1999, the date of acquisition of the business.
Net sales for 2000 were $293.6 million, an increase of $79.4 million, or 37.1%, compared with $214.2 million for 1999. The increase in sales was primarily the result of having a full year's worth of results from the Thermalloy Division, which contributed approximately $99.4 million in sales in 2000, versus the $19.4 million contributed in 1999 (from October 21 through December 31). Additionally, Fluent's sales increased $8.8 million and consulting services increased $0.4 million. Sales to the Computer and Network industry segment experienced a decline from 1999 levels of $2.5 million ($9.8 million after excluding the increase of revenues from the acquisition of Thermalloy). This decrease was primarily due to a decline in the semi-conductor industry as a whole, which adversely impacted 2000 performance and which will likely adversely impact the first half of 2001 and may adversely impact the second half of 2001. In addition, the Company has deferred expansion of a new fan business in Asia and does not anticipate significant revenues to be generated from this business until the second half of 2001. Foreign exchange rates in 2000 also had a negative impact on revenues. Had foreign exchange rates in 2000 remained consistent with 1999 exchange rates, the Company's revenues would have been approximately $5.3 million higher than reported.
Aavid Thermalloy's net sales were $235.6 million for 2000, an increase of $70.6 million million, or 42.8%, compared with $165.0 million for 1999. This increase was primarily the result of having 12 months of Thermalloy sales included in 2000 results which contributed an additional $80 million of sales and an increase of $0.4 million of consulting services sales, offset by a reduction of approximately $9.8 million in Computer and Networking sales as mentioned above. Industrial electronics net sales increased 103.2% for the year ended December 31, 2000 compared to the year ended December 31, 1999, primarily due to the inclusion of Thermalloy revenues for an entire year. 1999 sales included Thermalloy sales from October 22, 1999 through December 31, 1999.
Fluent's net sales were $58.0 million for 2000, an increase of $8.8 million, or 17.9%, over $49.2 million for 1999. The increase was spread among all product offerings due primarily to increased sales to new customers for computational fluid dynamics software, as well as the success of application-specific products.
Excluding net sales for the Intel Special Product, international net sales (which include North American exports) increased to 42.2% of net sales for the year ended December 31, 2000 as compared with 37.7% for the year ended December 31, 1999.
Our gross profit in 2000 was $101.1 million, an increase of $25.4 million, or 33.6% higher than $75.7 million in 1999. Our gross margin decreased from 35.3% in 1999 to 34.4% in 2000. Our gross margin in the fourth quarter of 1999 was negatively impacted by certain purchase accounting and acquisition related adjustments which decreased gross profit by $3.8 million. Excluding these purchase accounting and acquisition related adjustments, gross margin for 1999 was 37.1%. Our gross margin in the first quarter of 2000 was similarly impacted and was reduced by $4.5 million in acquisition related charges. Our gross margin in 2000 would have been 36.0% without these charges. A small part of the decrease in gross margin resulted from the acquisition of Thermalloy which caused Fluent's higher gross margin business to become a smaller percentage of the overall Company's gross profit. Furthermore, underutilization of factories contributed to the decrease in margins; however, this is being addressed through the on-going integration process which has included the shut-down of duplicative operations in Santa Ana, California; Hong Kong, China; Corby, U.K.; and High Wycombe, U.K. and will be substantially complete once the Dallas facility is shut-down as of June 30, 2001.
Our selling, general and administrative expenses were $71.4 million, or 24.3% of net sales, for 2000 as compared to $52.0 million, or 24.3% of net sales, for 1999. The increase in selling, general and administrative expenses in gross dollars resulted primarily from S,G&A expenses related to Thermalloy which was included in our results for an entire year, whereas in 1999 we only included the S,G&A of Thermalloy from October 22, 1999 through December 31, 1999. Also, Fluent's S,G&A has increased $4.4 million as Fluent enhanced their
sales and support infrastructure to accommodate their revenue growth. On a percentage of net sales basis, S,G&A in 2000 remained consistent with 1999.
$31.3 million of intangible asset amortization recorded in 2000 related to intangible assets established as part of the acquisition of Aavid by Heat Holdings Corp.
Our research and development expenses consist primarily of funding for internal product development activities as well as product development activities conducted by third parties on our behalf. Research and development expenses also include the costs of obtaining patents on the technology developed in research and development activities. Research and development expenses were $10.7 million, or 3.6% of net sales, in 2000 as compared to $7.5 million, or 3.5% of net sales, in 1999. The increase in research and development expenses was primarily due to increased expenditures at Fluent.
In connection with the Merger, the Company allocated $15.0 million of the purchase price to in-process research and development projects. This allocation represented the estimated fair value based on risk-adjusted cash flows related to the incomplete software research and development projects of Fluent, Inc. At the date of the merger, the development of these projects had not yet reached technological feasibility and the research and development in progress had no alternative future uses. Accordingly, these costs were expensed as of the merger date.
The Company allocated values to the in-process research and development based on an in-depth assessment of the R&D projects. The value assigned to these assets was limited to significant research projects for which technological feasibility had not been established, including development, engineering and testing activities associated with the introduction of the acquired in-process technologies.
The value assigned to purchased in-process technology was determined by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting net cash flows from the projects, and discounting the net cash flows to their present value. The revenue projection used to value the in-process research and development was based on historical results, estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by the Company and its competitors. The resulting net cash flows from such projects are based on management's estimates of cost of sales, operating expenses, and income taxes from such projects.
The nature of the efforts to develop the acquired in-process technologies into commercially viable products and services principally related to the completion of certain planning, designing, coding, prototyping, and testing activities that were necessary to establish that the developmental software technologies met their design specifications including functional, technical, and economic performance requirements. At the merger date, the technologies under development were between 40% and 80% complete, based upon project man-month and cost data. Anticipated completion dates ranged from 6 to 18 months, at which times the Company expects to begin selling the developed products. Development costs to complete the R&D were estimated at approximately $4.0 million.
Fluent's primary in-process R&D projects involved developing: (i) Fluent version 6.0; (ii) Gambit version 2.0; (iii) materials processing functionality; and, (iv) advanced infrastructure technology. Fluent 6.0 represents the Company's next-generation computational fluid dynamics (CFD) software engine. Gambit 2.0 includes new pre-processor CFD technologies. The development of materials processing technologies is designed to address CFD needs in new markets. The advanced infrastructure technology establishes a new platform upon which future products will be more efficiently and rapidly developed.
Aggregate revenues for the developmental Fluent products were estimated to peak within three years of acquisition and then decline steadily as other new products and technologies are expected to enter the market. Operating expenses were estimated based on historical results and management's analysis of Fluent's cost structure. Projected operating expenses as a percentage of revenues were expected to be stable for the foreseeable future.
The rates utilized to discount the net cash flows to their present value were based on estimated cost of capital calculations. A discount rate of 18 percent was considered appropriate for the in-process R&D, and a discount rate of 15 percent was appropriate for the existing products and technologies. These discount rates were commensurate with the Fluent's long history and market leadership position. The discount rate utilized for the in-process technology was higher than Aavid's cost of capital due to the inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of such technology and the uncertainty of technological advances that are unknown at this time.
With respect to the acquired in-process technology, the calculations of value were adjusted to reflect the development efforts of Fluent prior to the close of the merger. In doing so, consideration was given to each major project's stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred, and the projected cost to complete the projects.
The Company believes that the foregoing assumptions used in the forecasts were reasonable at the time of the merger. No assurance can be given, however, that the underlying assumptions used to estimate sales, development costs or profitability, or the events associated with such projects, will transpire as estimated. For these reasons, actual results may vary from projected results. The most significant and uncertain assumptions relating to the in-process projects relate to the projected timing of completion of, and revenues attributable to, each project.
If these projects are not successfully developed, the sales and profitability of the Fluent division may be adversely affected in future periods. Additionally, the value of other acquired intangible assets may become impaired
Our loss from operations in 2000 was $25.5 million, a decline of $41.7 million from operating income of $16.2 million in 1999 (excluding non-recurring charges (credits)). The decrease in income from operations is primarily the due to amortization related to goodwill and other intangible assets resulting from the Merger of $31.2 million. In addition, as mentioned above, the Company wrote-off $15.0 million of in-process technology related to Fluent. These two charges were partially off-set by an increase in income from operations at Fluent of $4.2 million. Fluent's income from operations as a percentage of net sales increased to 20.1% in 2000, compared with 15.3% in 1999. Fluent's operating margins increased primarily because selling, general and administrative expenditures grew at a slower rate than sales.
Our net interest charges were $23.9 million in 2000, a $22.3 million increase over interest charges of $1.6 million in 1999. This increase in interest charges resulted from significantly higher levels of indebtedness incurred in connection with the Willis Stein merger and the acquisition of Thermalloy in October of 1999.
The Company incurred a tax provision in 2000 despite having significant operating losses because of significant non-deductible goodwill amortization and in-process R&D charges and a foreign tax provision of $5.1 million on foreign earnings. We had to record a tax provision on foreign earnings which are expected to be repatriated into the U.S. to service debt incurred subsequent to year end. Because the Company is in a net operating loss carryforward position for U.S. tax purposes, the Company will not receive any tax benefit from foreign tax credits. These repatriated earnings will therefore incur both foreign income taxes and U.S. income taxes, effectively doubling up the tax rate on the foreign earnings. The significant net operating loss carryforwards in the U.S. will help offset the actual cash paid for taxes in the U.S. when the foreign earnings are repatriated.
1999 COMPARED WITH 1998
Our results of operations in 1999 include the operations of Thermalloy and Curamik from October 21, 1999, the date of acquisition of the business.
Net sales for 1999 were $214.2 million, an increase of $5.1 million, or 2.4%, compared with $209.1 million for 1998. This increase in net sales was the result of $19.4 million from Thermalloy's operations for the period October 21, 1999 (the date of acquisition) through December 31, 1999 which are included in our 1999 results and organic revenue growth of approximately $30.1 million offset in large part by the result of the impact of the one-time reduction in sales volume of $44.4 million for the Intel Special Product.
Aavid Thermalloy's net sales were $165.0 million for 1999, a decrease of $5.8 million, or 3.4%, compared with $170.8 million for 1998. This decrease was the result of the one-time reduction in sales volume of $44.4 million for the Intel Special Product, which was offset by revenues of $19.4 million from Thermalloy's operations for the period October 21, 1999 through December 31, 1999 which are included in Aavid Thermalloy's 1999 results, as well as $19.2 million of organic revenue growth.
Net sales from computer and networking products (excluding the Intel Special Product) showed strong growth in the year ended December 31, 1999, increasing 41.0% over the year ended December 31, 1998. Of the increase, $11.5 million, or 45% resulted from revenues from the Thermalloy division from the date of acquisition through year end. Industrial electronics net sales increased 21.3% for the year
ended December 31, 1999 compared to the year ended December 31, 1998. Industrial electronics net sales were significantly impacted in the third quarter and fourth quarters of 1998 and to a lesser extent in the first quarter of 1999 by the Asian economic slowdown.
Fluent's net sales were $49.2 million for 1999, an increase of $10.9 million, or 28.5%, over $38.3 million for 1998. Of this increase, approximately 28% was the result of net sales by Fluent's new subsidiary in Japan, which became operational in the first quarter of 1999. The remaining 72% increase was spread among all product offerings due primarily to increased sales to new customers for computational fluid dynamics software, as well as the success of application-specific products.
Excluding net sales for the Intel Special Product, international net sales (which include North American exports) increased to 37.7% of net sales for the year ended December 31, 1999 as compared with 36.4% for the year ended December 31, 1998.
Our gross profit in 1999 was $75.7 million, an increase of $5.1 million, or 7.1% higher than $70.6 million in 1998. Our gross margin increased from 33.8% in 1998 to 35.3% in 1999. Our gross margin in the fourth quarter of 1999 was negatively impacted by certain purchase accounting and acquisition related adjustments which decreased gross profit by $3.8 million. Excluding these purchase accounting and acquisition related adjustments, gross margin for 1999 was 37.1%. This increase in gross margin resulted from a decrease in the percentage of overall gross profit derived from the Intel Special Product (which had a lower gross margin than our other products) and an increase in the percentage of overall gross margin derived from Fluent, which has significantly higher overall gross margin percentages than Aavid Thermalloy.
Our selling, general and administrative expenses were $52.0 million, or 24.3% of net sales, for 1999 as compared to $43.8 million, or 20.9% of net sales, for 1998. The increase in selling, general and administrative expenses resulted from $4.3 million from Thermalloy's operations for the period October 21, 1999 through December 31, 1999 which are included in Aavid Thermalloy's 1999 results, an increase of $6.4 million at Fluent which was partially offset by a decline at Aavid Thermalloy of $2.5 million resulting from cost reductions in response to lower sales from the loss of the Intel Special Product.
Our research and development expenses consist primarily of funding for internal product development activities as well as product development activities conducted by third parties on our behalf. Research and development expenses also include the costs of obtaining patents on the technology developed in research and development activities. Research and development expenses were $7.5 million, or 3.5% of net sales, in 1999 as compared to $6.8 million, or 3.2% of net sales, in 1998. The increase in research and development expenses was primarily due to increased expenditures at Fluent.
In 1997, we opened a facility in Manchester, New Hampshire specifically for the production of a special heat dissipating plate for Intel Corporation (the "Intel Special Product"). In the second half of July 1998, Intel notified us of significant reductions in expected purchases of the Intel Special Product. As a result, during the third quarter of 1998, we decided to close our Manchester facility and we recorded a non-recurring pre-tax charge of $4.9 million, reflecting the costs associated with such closure. The non-recurring revenues related to the Intel Special Product were approximately $2.6 million, or 1% of net sales in 1999, $47.0 million, or 22% of net sales in 1998, and approximately $24.7 million, or 15% of sales in 1997. The Intel Special Product had a lower gross margin than our other thermal management products. Intel remains one of our major customers, although sales to Intel in 1999 were less than 5% of total sales. No customer generated more than 10% of sales in 1999.
Our income from operations in 1999 was $16.8 million, a decline of $3.3 million, or 16.4%, from $20.1 million in 1998 (excluding non-recurring charges (credits)). Our income from operations as a percentage of net sales was 7.8% in 1999 as compared with 9.6% in 1998 (excluding non-recurring charges). The decrease in income from operations as a percentage of net sales is primarily the result of the $3.8 million in purchase accounting and related adjustments discussed above, recorded as a reduction in gross profit in the fourth quarter of 1999, as well as $0.4 million of goodwill amortization recorded in selling, general and administrative expenses related to the Thermalloy acquisition. The impact of these additional expenses was mitigated somewhat because the percentage of overall operating profit derived from Fluent increased in 1999. Income from operations as a percentage of net sales at Aavid Thermalloy for the year ended December 31, 1999 was 6.0%, compared with 8.0% in 1998. This decrease in margin was the direct result of the purchase accounting effects and increased amortization discussed above. Fluent's income from operations as a percentage of net sales decreased to 15.3% in 1999, compared with 16.0% in 1998. Fluent's operating margins decreased primarily because selling, general and administrative expenditures grew at a faster rate than sales.
Our interest charges were $1.6 million in 1999, a $0.3 million increase over interest charges of $1.3 million in 1998. Interest charges in the fourth quarter of 1999 were $1.4 million, a $1.2 million increase over the fourth quarter of 1998. This increase in interest charges resulted from the $88.2 million of indebtedness incurred in connection with the Thermalloy acquisition. Future interest charges are expected to be significantly higher as a result of the $150 million senior subordinated notes issued subsequent to year end.
The effective tax rate for the year ended December 31, 1999 was 57.5% compared with 35.1% for 1998. The primary reason for the increase in effective tax rates occurred because we had to record a tax provision on certain foreign earnings which are expected to be repatriated into the U.S. to service debt incurred subsequent to year end. Because the Company is in a net operating loss carryforward position for U.S. tax purposes, the Company will not receive any tax benefit from foreign tax credits. These repatriated earnings will therefore incur both foreign income taxes and U.S. income taxes, effectively doubling up the tax rate. The significant net operating loss carryforwards in the U.S. will help offset the actual cash paid for taxes in the U.S. when the foreign earnings are repatriated. In addition, a small portion of the increase in the effective tax rate resulted from the increase in non-deductible goodwill amortization expense resulting from the Thermalloy acquisition.
LIQUIDITY AND CAPITAL RESOURCES
Historically, we have used internally generated funds and proceeds from financing activities to meet our working capital and capital expenditure requirements. As a result of the Thermalloy acquisition and the merger, we have significantly increased our cash requirements for debt service relating to the notes and our amended and restated credit facility. We intend to use amounts available under our amended and restated credit facility, future debt and equity financings and internally generated funds to finance our working capital requirements, capital expenditures and potential acquisitions.
Net cash provided by operating activities for the year ended December 31, 2000 was $24.2 million compared to $15.8 million for the year ended December 31, 1999. We had $26.8 million in working capital as of December 31, 2000 compared with $47.1 million for the prior year period. At December 31, 2000, accounts receivable days sales outstanding ("DSO") were 66 days, which compares with 71 days at December 31, 1999. At December 31, 2000, inventory turns were 6.4 times, which compares with 6.0 times at December 31, 1999.
During the year ended December 31, 2000, we made capital expenditures of $11.7 million compared with $13.1 million in 1999. Of these amounts, $0.2 million and $0.7 million related to assets acquired under capital leases in 2000 and 1999, respectively.
In connection with the Merger, pursuant to which we became a wholly-owned subsidiary of Heat Holdings Corp., we amended and restated our credit facility to, among other things, add Heat Holdings as a guarantor, permit the issuance of the senior notes and amend certain of the financial ratios and restrictive covenants to reflect such issuance. The amended and restated credit facility, which replaced our $100 million revolving credit and term loan facility, currently consists of a $53 million term loan facility (the "Term Facility") and a $17 million revolving credit facility, including a $2 million letter of credit subfacility (the "Revolving Facility"). The Term Facility, all of which was borrowed on February 2, 2000 to repay amounts outstanding under our existing credit facility, matures on March 31, 2005, and is being amortized in 18 consecutive quarterly installments, commencing December 31, 2000, as follows: five quarterly payments of $2 million each; four quarterly payments of $2.5 million each; four quarterly payments of $2.75 million each; two quarterly payments of $3.2 million each; two quarterly payments of $3.9 million; and a final payment of $7.8 million. The Revolving Facility matures on March 31, 2005. The Credit Facility bears interest at a rate equal to, at our 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 us and (y) a margin of between one and one-half percent and two and one-quarter percent (depending on our consolidated leverage ratio (as defined in the credit agreement)) or (2) the sum of (A) 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 (y) a margin of between one quarter percent and one percent (depending on our consolidated leverage ratio). The 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 and excess cash flow.
The Credit Facility limits our ability to incur debt, to sell or dispose of assets, to create or incur liens, to make additional acquisitions, to pay dividends, to purchase or redeem our stock and to merge or consolidate with any other person. In addition, the Credit Facility requires that we meet certain financial ratios, and provides the banks with the right to require the payment of all amounts outstanding under the facility, and to terminate all commitments thereunder, if we undergo a change in control. The Credit Facility is guaranteed by Heat Holdings Corp., Heat Holdings II Corp. and all of our subsidiaries and secured by our assets (including the assets and stock of our domestic subsidiaries and a portion of the stock of our foreign subsidiaries), and a pledge of our stock by Heat Holdings.
On February 2, 2000, as part of the transactions relating to the Merger, we issued 150,000 units (the "Units"), consisting of $150 million aggregate principal amount of our 12 3/4 % Senior Subordinated Notes due 2007 (the "Senior Notes") and warrants (the "Warrants") to purchase an aggregate of 60 shares of our Class A Common Stock, par value $0.01 per share, and 60 shares of our Class H Common Stock, par value $0.01 per share. The Notes are fully and unconditionally guaranteed on a joint and several basis by each of our domestic subsidiaries. The senior notes were issued pursuant to an Indenture (the "Indenture") among us, the subsidiary guarantors and Bankers Trust Company, as trustee. Approximately $4.6 million of the proceeds from the sale of the Units was allocated to the fair value of the Warrants and approximately $143.7 million was allocated to the Senior Notes, net of original issue discount of approximately $1.7 million.
The Indenture limits our ability to incur additional debt, to pay dividends or make other distributions, to purchase or redeem our stock or make other investments, to sell or dispose of assets, to create or incur liens, and to merge or consolidate with any other person. The Indenture also contains 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. The Indenture provides that upon a change in control of Aavid, we must offer to repurchase the Notes at 101% of the face value thereof, together with accrued and unpaid interest. The Notes are subordinated in right of payment to amounts outstanding under the Credit Facility and certain other permitted indebtedness.
At December 31, 2000, the Company was not in compliance with the leverage ratio covenant required by the amended and restated credit facility and the indenture under which our senior notes were issued. As a result, the Company's stockholders are required to make an equity contribution of up to $25.0 million 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. Subsequent to December 31, 2000, certain of the Company's stockholders and their affiliates agreed, subject to definitive documentation, to make an equity contribution of $8.0 million in cash and up to $25.0 million in principal amount of senior notes in full satisfaction of this obligation. This contribution is required to be made by May 15, 2001. In addition, the Company and the lenders under the amended and restated credit facility have agreed, subject to definitive documentation, to amend the facility such that the last three required quarterly principal payments in 2001 under the facility will be prepaid with $6 million of the proceeds of the equity contribution, and the four required principal payments in 2002 will be reduced by $0.5 million each, reflecting application of the remaining cash equity contribution. Further, certain covenant ratios and ratio definitions will be amended to levels which the Company expects to meet through December 31, 2001 and the available line of credit will be reduced to $17.0 million from $22.0 million. Based on the equity contribution, the Company's event of non-compliance with the leverage ratio covenant at December 31, 2000 will be cured.
During the first half of 2001 the Company plans to close its Dallas, Texas facility. In connection with the closure, the Company expects to record a one-time restructuring charge within the statement of operations for the first quarter of 2001. This one-time charge will include estimated amounts related to employee severance, write-off of fixed assets and write-off of most of a prepaid lease intangible asset that was originally recorded as part of the Thermalloy acquisition. The total restructuring charge is estimated to be in the range of $10.0 million to $13.5 million, of which approximately $4.0 million to $5.0 million relates to the write-off of the prepaid lease intangible. The estimated cash component of the restructuring charge is primarily related to employee severance and is expected to be in the range of $2.5 million to $3.5 million. The balance of the charge, $3.5 million to $5.0 million, is related to estimated fixed asset write-offs.
The Company has an obligation to purchase from one of its key suppliers a minimum quantity of aluminum coil stock. The Company believes that purchasing aluminum coil stock from this supplier is necessary to achieve consistently low tolerances, design, delivery flexibility, and price stability. Under the terms of this agreement the Company has agreed to purchase certain minimum quantities which approximates $1.605 million at December 31, 2000.
We believe that existing sources of liquidity and funds expected to be generated from operations will be sufficient to meet our debt service, capital expenditure and working capital requirements for the foreseeable future. Further expansion of our business or the completion of any material strategic acquisitions may require additional funds which, to the extent not provided by internally generated sources, could require us to seek access to debt and equity markets.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Upward or downward changes in market interest rates and their impact on the reported interest expense of the Company's variable rate borrowings will affect the our future earnings; however, a ten percent change in 2000 effective interest rates would have an approximate $0.5 million impact on our earnings for 2001, based on debt composition and rates in effect at December 31, 2000.
The Company did not enter into foreign currency forward exchange contracts or any other derivatives during 1999 or 1998. However, in 2000 the Company entered into forward exchange contracts to hedge certain intercompany sales transactions between a German operating company and a United States operating company. The Company had contracts outstanding for the sale of $1,200 U.S. Dollars for 2,466 German Marks. As these derivatives are intended to hedge anticipated transactions, they do not qualify for hedge accounting as of December 31, 2000 under Statement of Financial Accounting Standards No. 52 and thus the related gain (loss) on these contracts are recognized currently. On this basis of valuation, the gain (loss) for the future effects of the contracts will be approximately $(22). The fair value of open forward exchange contracts at December 31, 2000 was a liability of approximately $22, as determined by the counterparty financial institution and represents the present value of the gain/(loss) as if the settlement were to have taken place on December 31, 2000.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial Statements and supplementary data required pursuant to this Item begin on page 41 of this Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The following table sets forth the names of each of the our directors as of March 31, 2001, their ages, the year in which each became a director and their principal occupations during the past five years:
MEETINGS OF THE BOARD OF DIRECTORS
Our business affairs are managed under the direction of the Board of Directors. Members of the Board are kept informed through various reports and documents sent to them, through operating and financial reports routinely presented at Board and committee meetings by the Chairman and other officers, and through other means. In addition, our directors discharge their duties throughout the year not only by attending Board meetings, but also through personal meetings and other communications, including considerable telephone contact, with the Chairman of the Board and others regarding matters of interest and concern to Aavid.
During the fiscal year ended December 31, 2000, our Board of Directors held 5 formal meetings. Each director attended at least 75% of the meetings of the Board of Directors held during 2000.
BOARD COMMITTEES
Our Board of Directors did not have committees during the year ending December 31, 2000.
EXECUTIVE OFFICERS
Our executive officers are as follows:
RONALD F. BORELLI served as Chairman of the Board from October 15, 1996 through the present. He was our Chief Executive Officer and Chief Executive Officer of Aavid Thermalloy from October 15, 1996 until December 31, 1999. He has served as one of our directors since October 1993 and served as our President and President of Aavid Thermalloy from October 15, 1996 to October 15, 1997. From March 1989 until he joined Aavid, Mr. Borelli was the Chief Executive Officer and a Director of Spectra, Inc., a hot melt ink jet company focusing on color printers. From 1982 to March 1989 Mr. Borelli was a Senior Vice President of SCI Systems. Prior to that he spent 20 years at Honeywell in a variety of engineering and management positions.
BHARATAN R. PATEL, PH.D. became our and Aavid Thermalloy's Chief Executive Officer on January 1, 2000. He served as one of our directors since April 1996, our President since October 15, 1997 and Chief Executive Officer of Fluent since he helped form it in 1988 as a subsidiary of Creare, Inc. He served as our Chief Operating Officer from October 15, 1997 until December 31, 1999. Dr. Patel worked at Creare, Inc., an engineering consulting firm, from 1976 to 1988, serving in various capacities including Principal Engineer and Vice President. From 1971 to 1976, Dr. Patel was employed as a Senior Engineer in the Power Systems Group of Westinghouse Electric Corporation.
BRIAN BYRNE joined Aavid Thermal Technologies, Inc. in April, 2000 as its Chief Financial Officer. Mr. Byrne comes to Aavid from Jabil Circuits, Inc., where he served as Operations Manager. Prior to his position at Jabil, Mr. Byrne served as the Vice President Business Development for Altron Incorporated's (subsequently Sanmina Corporation) and its Massachusetts' printed circuit assembly division for 3 years. Prior to that, he spent 20 years at Compangnie Des Machines Bull in increasingly senior financial and executive positions, most recently as Division General Manager of Bull Electronics.
JOHN W. MITCHELL joined us in December 1995 as Vice President and General Counsel. From 1979 until he joined us, Mr. Mitchell was a corporate and business attorney at Sulloway & Hollis, a Concord, New Hampshire law firm, where he served as our principal outside legal counsel since May 1985.
H. FERIT BOYSAN, PH.D. became Chief Operating Officer of Fluent in July 1997 and President of Fluent in December 1998. Since 1991, he had been Managing Director of Fluent's European operations, headquartered in Sheffield, England. From 1986 to 1991, Dr. Boysan was the Managing Director of Flow Simulations, Ltd., the European distributor of Fluent products until the formation of Fluent Europe in 1991. Dr. Boysan was one of the original developers of Fluent's CFD software.
PETER CHRISTIE joined Fluent in 1998 as its Vice President and Chief Financial Officer. From 1984 to 1998, Mr. Christie held several senior management positions, including President and Chief Financial Officer, at Verax Corporation, a bioprocessing company. Prior to joining Verax, Mr. Christie was employed at Creare Inc., an engineering consulting firm, where he held the position of Chief Financial Officer from 1973 to 1978 and was President and founder of Creare Products Inc., a medical instruments manufacturer, from 1978 to 1984.
In March, 2001 Gerald Walle joined Aavid Thermalloy as its President and Chief Operating Officer. Mr. Walle comes to Aavid from Empirix Inc. where he was the Chief Financial Officer. From 1987 to 1999 he was the General Manager of the Microelectronics Division of Millipore Corporation. Prior to his tenure at Millipore, Gerald was the International Marketing Manager for Instrumentation Laboratory, a global manufacturer and distributor of clinical chemistry and blood gas analyzers owned by Allied-Signal and Fisher Scientific Group. Mr. Walle has also been the International Business Development Manager at Bendix and served as a management consultant with Mars & Co., Paris, France and the Boston Consulting Group, Paris, France.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION OF EXECUTIVE OFFICERS
The following table summarizes all compensation earned by or paid to our Chief Executive Officer and the four other most highly paid executive officers whose annual salary and bonus exceeded $100,000 (collectively, the "Named Executive Officers") for services rendered in all capacities to Aavid during the fiscal years indicated.
SUMMARY COMPENSATION TABLE
(1) Mr. Patel became President and Chief Operating Officer of Aavid in October 1997, and became Chief Executive Officer of Aavid on January 1, 2000.
(2) Mr. Byrne became joined the Company as Chief Financial Officer in April, 2000.
(3) Mr. Boysan became President of Fluent in December 1998.
EMPLOYMENT AGREEMENTS
Aavid has entered into an employment agreements with Messrs. Patel, Byrne and Mitchell, which currently expire on July 1, 2005 and Fluent has entered into an employment agreement with Mr. Boysan, which currently expires on July 1, 2005.
The employment agreements require each employee to devote his full business time and best efforts, business judgment, skill and knowledge exclusively to the advancement of the business and interests of Aavid. The employment agreements currently provide for the payment of a base salary to Messrs. Patel, Boysan, Mitchell and Byrne equal to $350,000, $200,000, $210,000, and $165,000, respectively, subject to increase at the discretion of the board of directors of their respective employers. Each employment agreement provides that the employee will continue to receive his base salary, benefits and other compensation for a specified period in the event their respective employers terminate their employment other than for "cause" or under certain other circumstances.
Each of Messrs. Byrne, Mitchell, and Patel is entitled to an annual bonus of 30%, 33.33% and 50%, respectively, based on Aavid's performance. Mr. Boysan is entitled to an annual bonus based on our actual performance against budgeted performance. We may renegotiate our obligation to make the payments under those employment agreements in connection with certain public offering or acquisition transactions.
The employment agreements contain non-competition covenants.
COMPENSATION OF DIRECTORS
Prior to the Merger, each of our non-employee directors received an annual fee of $10,000 and $500 for each Board of Directors and committee meeting attended. All directors were reimbursed for all reasonable expenses incurred by them in acting as a director or as a member of any committee of the Board of Directors. In addition, directors who were not employees of the Company were compensated through stock options under the 1995 Non-Employee Director Stock Option Plan (the "Directors' Plan"), which we adopted to promote our interests by attracting and retaining highly skilled, experienced and knowledgeable non-employee directors. An aggregate of 200,000 shares of Common Stock were reserved for issuance under the Directors' Plan. Options granted under the Directors' Plan did not qualify as incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"). The Directors' Plan provided for an automatic grant of an option to purchase 10,000 shares of Common Stock effective upon initial election or appointment to the Board of Directors of a non-employee director, and an automatic grant of an option to purchase an additional 2,500 shares of Common Stock on each anniversary of the date of his or her election or appointment to the Board of Directors.
In addition, the Directors' Plan provided for the automatic grant to each of Messrs. Borelli and Macey, as well as Messrs. Edward Glassmeyer, Douglas Newhouse, and William L. Selden, at the time non-employee directors of Aavid, of: (i) an option to purchase 10,000 shares of Common Stock in February 1996 (the "Initial Options") following the consummation of our initial public offering at an exercise price of $9.50 per share, the initial public offering price of the Common Stock; and (ii) on April 21st of each year, commencing April 21, 1996, an automatic grant of an option to purchase an additional 2,500 shares of Common Stock, provided such individual received Initial Options and was serving as a non-employee director at the close of business on April 21st of such year. The options had an exercise price of 100% of the fair market value of the Common Stock on the date of grant and had a ten-year term. Initial Options became exercisable in their entirety six months after the date of the grant. All other options granted under the Directors' Plan became fully exercisable on the first anniversary of the grant date.
Each outstanding option was subject to acceleration in the event of a change of control of Aavid (as defined in the Directors' Plan). The options could be exercised by payment in cash, check or shares of Common Stock. On April 10, 1997, Mr. Dickinson was granted an option to purchase 10,000 shares of Common Stock at an exercise price of $11.375 upon his election as a director. On April 15, 1997 Mr. Steadman was granted an option to purchase 10,000 shares of Common Stock at an exercise price of $11.25 upon his becoming a non-employee director. On April 21, 1997, each of Messrs. Glassmeyer, Macey, Newhouse and Selden was granted an option to purchase an additional 2,500 shares of Common Stock at an exercise price of $11.25; on April 21, 1998, each of Messrs. Glassmeyer, Macey and Newhouse was granted an option to purchase an additional 2,500 shares at an exercise price of $32.375; and on April 21, 1999, Mr. Macey was granted an option to purchase an additional 2,500 shares at an exercise price of $16.50. On each of April 10, 1998 and 1999, Mr. Dickinson was granted an option to purchase an additional 2,500 shares of Common Stock at an exercise price of $30.125 and $16.50, respectively. On each of April 15, 1998 and 1999, Mr. Steadman was granted an option to purchase an additional 2,500 shares of Common Stock at an exercise price of $32.25 and $16.50, respectively. On June 14, 1999 Mr. Pipp was granted an option to purchase an additional 2,500 shares of common stock at an exercise price of $20.89. On June 19, 1998, Mr. Pipp was granted an option to purchase 10,000 shares of Common Stock at an exercise price of $30.13 upon his election as a Director. These options were cashed out in the merger to the extent they remained outstanding at the time.
Messrs. Macey and Steadman, who together with Mr. Borelli constituted the committee appointed by the Board to negotiate with the interested buyers of Aavid, each received $75,000 for their service on the committee, regardless of whether a transaction was consummated. In addition, Mr. Steadman received a fee of $50,000 for his work on the Thermalloy transaction, which fee was not contingent on the consummation of the transaction.
After the Merger, each of Messrs. Steadman and Dickinson received an annual fee of $15,000 and $1,000 for each Board of Directors meeting attended. In addition, each of Mr. Steadman and Mr. Dickinson purchased 0.05% of the non-voting common equity of Aavid Thermalloy LLC.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
BENEFICIAL OWNERSHIP OF COMMON STOCK
Heat Holdings Corp. currently owns all of the issued and outstanding stock of Aavid (excluding detachable warrants, sold to noteholders in connection with the sale of the senior notes, to acquire, in the aggregate, 60 shares of Class A common stock and 60 shares of Class H common stock, representing 3% of the common stock of Aavid (on a fully diluted basis)).
The following table sets forth certain information regarding the beneficial ownership of the issued and outstanding common stock of Holdings as of March 1, 2001. None of our executive officers or directors own any Holdings securities, except as set forth below.
BENEFICIAL OWNERSHIP(1)
(1) "Beneficial ownership" generally means any person who, directly or indirectly, has or shares voting or investment power with respect to a security or has the right to acquire such power within 60 days. Unless otherwise indicated, we believe that each holder has sole voting and investment power with regard to the equity interests listed as beneficially owned.
(2) For each beneficial owner listed in the table above, the percentage of outstanding Holdings' Class A common stock, Class B common stock and total common stock owned by such holder is the same.
(3) Consists of 4,641,572.5 shares of each of Class A common stock and Class B common stock directly beneficially held by Willis Stein & Partners II, L.P. and 296,927.5 shares of each of Class A common stock and Class B common stock directly beneficially held by Willis Stein & Partners Dutch, L.P. Willis Stein & Partners Management II, L.L.C. is the general partner of both partnerships and may be deemed to beneficially own such shares. Avy H. Stein and Daniel H. Blumenthal, as managing directors of Willis Stein & Partners Management II, L.L.C., may be deemed to beneficially own the shares of common stock beneficially owned by the partnerships and their general partner. Messrs. Stein and Blumenthal disclaim beneficial ownership of any of such shares. Willis Stein's address is 227 West Monroe Street, Suite 4300, Chicago, Illinois 60606.
(4) The Chase Manhattan Bank acts as the trustee for the First Plaza Group Trust, a trust under and for the benefit of certain employee benefit plans of General Motors Corporation ("GM"), its subsidiaries and unrelated employers. These shares may be deemed to be owned beneficially by General Motors Investment Management Corporation ("GMIMCo"), a wholly-owned subsidiary of GM. GMIMCo's principal business is providing investment advice and investment management services with respect to the assets of certain employee benefit plans of GM, its subsidiaries and unrelated employers, and with respect to the assets of certain direct and indirect subsidiaries of GM and associated entities. GMIMCo is serving as the trust's investment manager with respect to these shares and in that capacity it has the sole power to direct the trustee as to the voting and disposition of these shares. Because of the trustee's limited role, beneficial ownership of the shares by the trustee is disclaimed. First Plaza Group Trust's address is c/o GMIMCo, 767 Fifth Ave., 16th Floor, New York, NY 10153.
(5) Consists of 480,455.0 shares of each of Class A common stock and Class B common stock directly beneficially held by Nassau Capital Partners III, L.P. and 3,712.0 shares of each of Class A common stock and Class B common stock directly beneficially held by NAS Partners I L.L.C. Such funds' address is 22 Chambers Street, Princeton, New Jersey 08542.
(6) Consists of 378,255.5 shares of each of Class A common stock and Class B common stock directly beneficially held by Abbott Capital 1330 Investors II, L.P., 75,651.0 shares of each of Class A common stock and Class B common stock directly beneficially held by Abbott Capital Private Equity Fund III, L.P. and 30,260.5 shares of each of Class A common stock and Class B common stock directly beneficially held by BNY Partners Fund, L.L.C. The address of such funds is c/o Abbott Capital Management, LLC, 1330 Avenue of the Americas, Suite 2800, New York, New York 10019.
(7) BancBoston's address is 175 Federal Street, 10th Floor, Boston, Massachusetts 02110.
Each of the stockholders listed in the table above currently holds an equivalent percentage interest in the Class A common stock and Class B common stock of Heat Holdings Corp. II, which holds 95% of the outstanding common membership interests in Aavid Thermalloy, LLC. At the time the Merger was completed, all options to purchase shares of Aavid common stock held by members of management were converted into the right to receive cash equal to the product of the number of shares subject to each option times the excess, if any, of $25.50 per share over the exercise price per share for such option.
Our executive officers and certain of our employees own approximately 8% of the non-voting common equity of Aavid Thermalloy LLC and approximately 9.5% of the non-voting common equity of Fluent Holdings, Inc.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
NONE
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K
(a) Financial Statements and Financial Schedules
(1) and (2) See "Index to Consolidated Financial Statements" beginning on page 42. Schedule II - Valuation and Qualifying Accounts and the Financial Data Schedule are filed herewith. All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and, therefore, have been omitted.
(3) The following exhibits are filed or incorporated by reference as part of this Annual Report are management contracts, compensatory plans or arrangements: Exhibits 10.9, 10.10, 10.11, 10.18, 10.21 and 10.22
NO. DESCRIPTION - --- -----------
2.1 Stock Purchase Agreement by and among Bowthorpe plc, Bowthorpe B.V., Bowthorpe International Inc., Bowthorpe GmbH (collectively, "Bowthorpe") and Aavid Thermal Technologies, Inc., dated as of August 23, 1999(1)
2.2 Agreement of Plan and Merger, dated as of August 23, 1999, by and among Heat Holdings Corp., Heat Merger Corp. and Aavid Thermal Technologies, Inc.(1)
3.1 Certificate of Incorporation (2)
3.2 By-laws(2)
4.1 Indenture dated as of February 2, 2000, among Aavid Thermal Technologies, Inc., the subsidiary guarantors and Bankers Trust Company, as trustee.(3)
4.2 Warrant Agreement, dated as of February 2, 2000, by and between Aavid Thermal Technologies, Inc. and Bankers Trust Company, as Warrant Agent.(3)
10.1 Employment Agreement, dated as of May 1, 1999, between Bharatan R. Patel and Fluent(5)
10.2 Employment Agreement, dated as of August 24, 1995, between Dr. Ferit Hassan Boysan and Fluent Europe Limited(4)
10.3 Agreement dated as of October, 1993, between Aavid Engineering and Materials Innovation, Inc.(4)
10.4 Warrant Purchase Agreement, dated as of October 14, 1993, between the Company and Rice Mezzanine Lenders, LP(4)
10.5 Form of indemnification agreement for the Company's officers and directors(4)
10.6 Employment Agreement, dated as of December 1, 1995, among John Mitchell, Aavid Engineering and the Company.(4)
10.7 Amendment No. 1 to Employment Agreement, dated as of March 24, 1999, between the Company and John Mitchell(5)
10.8 Credit Agreement, dated as of October 21, 1999, among Aavid Thermal Technologies, Inc., as Borrower, the several lenders from time to time party hereto, CIBC World Markets Corp., as Lead Arranger and Bookrunner, and Canadian Imperial Bank of Commerce, as Issuer and Administrative Agent.(6)
10.9 Amended and Restated Credit Agreement, dated as of February 2, 2000, among Aavid Thermal Technologies, Inc., Heat Holdings Corp., Heat Holdings II Corp., the several lenders from time to time parties hereto, CIBC World Markets Corp., as lead arranger and bookrunner, BankBoston, N.A., as documentation agent, and Canadian Imperial Bank of Commerce, as issuer and administrative agent. (3)
10.10 Registration Rights Agreement dated as of February 2, 2000, among Aavid Thermal Technologies, Inc., the subsidiary guarantors, CIBC World Markets Corp. and Fleet Boston Robertson Stephens Inc., as initial purchasers.(3)
10.26 Common Stock Registration Rights Agreement dated as of February 2, 2000, among Aavid Thermal Technologies, Inc., Heat Holdings Corp. and CIBC World Markets Corp. and Fleet Boston Robertson Stephens Inc., as initial purchasers.(3)
21.0 Subsidiaries of Registrant(2)
(1) Incorporated by reference to Exhibits to the Company's Current Report on Form 8-K dated August 23, 1999. (2) Incorporated by reference to Exhibits to the Company's Registration Statement on Form S-4 (No. 333-33126). (3) Incorporated by reference to Exhibits to the Company's Current Report on Form 8-K dated February 2, 2000. (4) Incorporated by reference to Exhibits to the Company's Registration Statement on Form S-1 (No. 33-99232). (5) Incorporated by reference to Exhibits to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1999. (6) Incorporated by reference to Exhibits to the Company's Current Report on Form 8-K dated October 21, 1999.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
AAVID THERMAL TECHNOLOGIES, INC.
By: /s/ Bharatan R. Patel ------------------------------------------ Bharatan R. Patel President and Chief Executive Officer April 13, 2001
Dated April 17, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AAVID THERMAL TECHNOLOGIES, INC.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO AAVID THERMAL TECHNOLOGIES, INC.:
We have audited the accompanying consolidated balance sheet of Aavid Thermal Technologies, Inc. and subsidiaries (a Delaware Corporation) as of December 31, 2000, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the period from February 2, 2000 through December 31, 2000. We have also audited the accompanying consolidated balance sheet of the Predecessor as of December 31, 1999 and the related consolidated statements of operations, changes in stockholders' equity and cash flows for the period from January 1, 2000 through February 1, 2000 and the years ended December 31, 1999 and 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Aavid Thermal Technologies, Inc. and subsidiaries as of December 31, 2000 and the results of their operations and their cash flows for the period from February 2, 2000 through December 31, 2000 and the financial position of the Predecessor as of December 31, 1999 and the results of their operations and their cash flows for the period from January 1, 2000 through February 1, 2000 and the years ended December 31, 1999 and 1998 in conformity with accounting principles generally accepted in the United States.
Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index of financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subject to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
/s/ ARTHUR ANDERSEN LLP BOSTON, MASSACHUSETTS April 16, 2001
AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying financial statements of the Predecessor and the Company are not comparable in all material respects since those financial statements report financial position, results of operations, and cash flows for these two separate entities.
The accompanying notes are an integral part of these consolidated financial statements.
AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands)
The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying financial statements of the Predecessor and the Company are not comparable in all material respects since those financial statements report financial position, results of operations, and cash flows for these two separate entities.
The accompanying notes are an integral part of these consolidated financial statements.
AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (in thousands, except share data)
The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying financial statements of the Predecessor and the Company are not comparable in all material respects since those financial statements report financial position, results of operations, and cash flows for these two separate entities.
The accompanying notes are an integral part of these consolidated financial statements.
AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED) (in thousands, except share data)
The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying financial statements of the Predecessor and the Company are not comparable in all material respects since those financial statements report financial position, results of operations, and cash flows for these two separate entities.
The accompanying notes are an integral part of these consolidated financial statements.
AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying financial statements of the Predecessor and the Company are not comparable in all material respects since those financial statements report financial position, results of operations, and cash flows for these two separate entities.
The accompanying notes are an integral part of these consolidated financial statements
AAVID THERMAL TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
A. OPERATIONS 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 dynamic ("CFD") software. Each of these businesses has an established reputation for high product quality, service excellence and engineering innovation in its market. Aavid designs, manufactures and distributes on a worldwide basis thermal management products that dissipate unwanted heat, which can degrade system performance and reliability, from microprocessors and industrial electronics products. Aavid's products, which include heat sinks, interface materials and attachment accessories, fans, heat spreaders and liquid cooling and phase change devices that it configures to meet customer-specific needs, serve the critical function of conducting, convecting and radiating away unwanted heat. CFD software is used in complex computer-generated modeling of fluid flows, heat and mass transfer and chemical reactions. Aavid's CFD software is used in a variety of industries, including the automotive, aerospace, chemical processing, power generation, material processing, electronics and HVAC industries.
Overall, the Company services a highly diversified base of more than 3,500 national and international customers including OEMs, distributors, and contract manufacturers through a highly integrated network of software, development, manufacturing, sales and distribution locations throughout North America, Europe, and the Far East.
On February 2, 2000, the Company was acquired by Heat Holdings Corp., a corporation newly formed by Willis Stein & Partners II, L.P. Pursuant to the merger, Aavid stockholders received $25.50 in cash for each outstanding share of common stock. In addition, all outstanding stock options and warrants were cashed out. The Merger was accounted for using the purchase method.
The Merger and related transaction costs were funded by a cash contribution from Heat Holdings and an affiliate of $152,000, proceeds of $148,312, net of original issue discount, from the sale by the Company of 12 3/4% senior subordinated notes and warrants due 2007, $54,700 pursuant to a 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 will be amortized over 20 years. The remainder, $69,971, is attributable to Fluent, the CFD software business, and will be amortized over 4 years. Management does not believe that the final purchase price allocation will produce materially different results than those reflected herein. The fair value of assets acquired and liabilities assumed at February 2, 2000 was as follows:
Of the $152,000 cash contribution, $4,811 was invested by Heat Holdings II Corp., an affiliate of Heat Holdings, to acquire 95% of the common equity of Aavid Thermalloy, LLC, the thermal management hardware business. The Company controls Aavid Thermalloy, LLC through a preferred equity interest and holds a 5% common equity interest and thus consolidates Aavid Thermalloy LLC in its results within the accompanying financial statements. The investment by Heat Holdings II Corp. has been recorded as minority interest within the accompanying financial statements. Based on the allocation methodology as defined within the Aavid Thermalloy LLC Agreement, $1,519 of losses at Aavid Thermalloy, LLC were allocated to the minority interest held by Heat Holdings II Corp. for the year ended December 31, 2000.
B. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
These financial statements reflect the consolidated financial position of the Company as of December 31, 1999 and the consolidated results of operations and cash flows of the Company for the period from January 1, 2000 to February 1, 2000 and the years ended December 31, 1999 and 1998 (collectively "Predecessor financial statements"). The Predecessor financial statements have been prepared using the historical cost of the Company's assets and have not been adjusted to reflect the merger with Heat Holdings Corp. The accompanying financial statements as of December 31, 2000 and for the period from February 2, 2000 to December 31, 2000 reflect the consolidated financial position, results of operations, and cash flows of the Company subsequent to the date of the merger and include adjustments required under the purchase method of accounting. The purchase method of accounting was used to record assets acquired and liabilities assumed by the Company. Such accounting generally results in increased amortization and depreciation reported in future periods. Accordingly, the accompanying financial statements of the Predecessor and the Company are not comparable in all material respects since those financial statements report financial position, results of operations, and cash flows for these two separate entities. The 2000 amounts included in the following notes include the combined results of the Predecessor for the period from January 1, 2000 through February 1, 2000 and the Company from February 2, 2000 through December 31, 2000.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All material intercompany transactions have been eliminated.
CONCENTRATION OF CREDIT RISK
Financial instruments that potentially subject the Company to significant concentration of credit risk consist principally of trade accounts receivable. The risk is limited due to the relatively large number of customers comprising the Company's customer base and their dispersion across many industries within the United States, Europe, and Asia. The Company performs ongoing credit evaluations of its customers' financial condition and generally requires no collateral from its customers. The Company maintains an allowance for uncollectible accounts receivable based upon expected collectibility of all accounts receivable. The Company's write-offs of accounts receivable have not been significant during the periods presented. At December 31, 2000 and 1999, there were no individual customer accounts receivable balances greater than 10% of total accounts receivable. The Company's sales have been primarily denominated in U.S. dollars, and the effects of foreign exchange fluctuations are not considered to be material.
INCOME TAXES
The Company accounts for income taxes under Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." Under this method, the amount of deferred tax liabilities or assets is calculated by applying the provisions of enacted tax laws to determine the amount of taxes payable or refundable currently or in future years. SFAS No. 109 requires a valuation allowance against deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realizable.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations as incurred. SFAS No. 86, "Accounting for the Costs of Computer Software To Be Sold, Leased, or Otherwise Marketed," requires capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on the Company's product development process, technological feasibility is established upon completion of a working model. Costs incurred by the Company between completion of the working model and the point at which the product is ready for general release have not been material. Accordingly, all research and software development costs have been expensed.
IN-PROCESS RESEARCH AND DEVELOPMENT
In connection with the merger, the Company allocated $15,000 of the purchase price to in-process research and development projects. This allocation represented the estimated fair value based on risk-adjusted cash flows related to the incomplete software research and development projects of Fluent, Inc. At the date of the merger, the development of these projects had not yet reached technological feasibility and the research and development in progress had no alternative future uses. Accordingly, these costs were expensed as of the merger date.
The Company allocated values to the in-process research and development based on an in-depth assessment of the R&D projects. The value assigned to these assets was limited to significant research projects for which technological feasibility had not been established, including development, engineering and testing activities associated with the introduction of the acquired in-process technologies.
The value assigned to purchased in-process technology was determined by estimating the costs to develop the acquired technology into commercially viable products, estimating the resulting net cash flows from the projects, and discounting the net cash flows to their present value. The revenue projection used to value the in-process research and development was based on historical results, estimates of relevant market sizes and growth factors, expected trends in technology, and the nature and expected timing of new product introductions by the Company and its competitors. The resulting net cash flows from such projects are based on management's estimates of cost of sales, operating expenses, and income taxes from such projects.
The nature of the efforts to develop the acquired in-process technologies into commercially viable products and services principally related to the completion of certain planning, designing, coding, prototyping, and testing activities that were necessary to establish that the developmental software technologies met their design specifications including functional, technical, and economic performance requirements. At the merger date, the technologies under development were between 40% and 80% complete, based upon project man-month and cost data. Anticipated completion dates ranged from 6 to 18 months, at which times the Company expects to begin selling the developed products. Development costs to complete the R&D were estimated at approximately $4,000.
Fluent's primary in-process R&D projects involved developing: (i) Fluent version 6.0; (ii) Gambit version 2.0; (iii) materials processing functionality; and, (iv) advanced infrastructure technology. Fluent 6.0 represents the Company's next-generation computational fluid dynamics (CFD) software engine. Gambit 2.0 includes new pre-processor CFD technologies. The development of materials processing technologies is designed to address CFD needs in new markets. The advanced infrastructure technology establishes a new platform upon which future products will be more efficiently and rapidly developed.
Aggregate revenues for the developmental Fluent products were estimated to peak within three years of acquisition and then decline steadily as other new products and technologies are expected to enter the market. Operating expenses were estimated based on historical results and management's analysis of Fluent's cost structure. Projected operating expenses as a percentage of revenues were expected to be stable for the foreseeable future.
The rates utilized to discount the net cash flows to their present value were based on estimated cost of capital calculations. A discount rate of 18 percent was considered appropriate for the in-process R&D, and a discount rate of 15 percent was appropriate for the existing products and technologies. These discount rates were commensurate with the Fluent's long history and market leadership position. The discount rate utilized for the in-process technology was higher than Aavid's cost of capital due to the inherent uncertainties surrounding the successful development of the purchased in-process technology, the useful life of such technology, the profitability levels of such technology and the uncertainty of technological advances that are unknown at this time.
With respect to the acquired in-process technology, the calculations of value were adjusted to reflect the development efforts of Fluent prior to the close of the merger. In doing so, consideration was given to each major project's stage of completion, the complexity of the work completed to date, the difficulty of completing the remaining development, costs already incurred, and the projected cost to complete the projects.
The Company believes that the foregoing assumptions used in the forecasts were reasonable at the time of the merger. No assurance can be given, however, that the underlying assumptions used to estimate sales, development costs or profitability, or the events associated with such projects, will transpire as estimated. For these reasons, actual results may vary from projected results. The most significant and uncertain assumptions relating to the in-process projects relate to the projected timing of completion of, and revenues attributable to, each project.
If these projects are not successfully developed, the sales and profitability of the Fluent division may be adversely affected in future periods. Additionally, the value of other acquired intangible assets may become impaired.
CASH AND CASH EQUIVALENTS AND FINANCIAL INSTRUMENTS
For purposes of the consolidated statements of cash flows, cash and cash equivalents consist of highly liquid investments with original maturities of three months or less.
The estimated fair value of the Company's financial instruments including accounts receivable, accounts payable and cash equivalents equals carrying value. The fair value of the Company's long-term debt instruments under the Company's amended and restated credit facility
is also estimated at carrying value due to their variable interest rates and relatively short maturities. The fair value of the Company's 12 3/4% senior subordinated notes was $128,250 at December 31, 2000.
INVENTORIES
For the year ending December 31, 2000 and 1999, inventories were valued at the lower of cost or market (first-in, first-out), and consist of materials, labor and overhead.
PROPERTY, PLANT AND EQUIPMENT
Property, plant, and equipment are stated at cost. The Company depreciates property, plant and equipment over their estimated remaining useful lives (buildings -- 30 to 40 years; machinery and equipment, -- 1 to 10 years; and vehicles -- 4 to 5 years) using both the straight-line and accelerated methods of depreciation.
Repairs and maintenance are charged against income when incurred; renewals and betterments are capitalized. When property, plant, and equipment are retired or sold, their cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized.
INTANGIBLE ASSETS
Costs incurred in connection with the issuance of the Company's debt obligations have been deferred and are being amortized over the term of the respective debt obligations. Other intangible assets consist principally of goodwill, developed technology, assembled workforce and prepaid rent. Intangibles are being amortized on a straight-line basis over the following estimated useful lives:
IMPAIRMENT OF LONG-LIVED ASSETS
In March 1995, the Financial Accounting Standards Board issued SFAS No. 121, "Accounting For the Impairment of Long-Lived Assets and For Long-Lived Assets To Be Disposed Of." This statement addresses the accounting for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to assets to be held and used, and for long-lived assets and certain identifiable intangibles to be disposed of.
This statement requires that long-lived assets, including intangibles, be reviewed for impairment whenever events or changes in circumstances, such as a change in market value, indicate that the asset carrying amounts may not be recoverable. In performing the review for recoverability, if future undiscounted cash flows (without interest charges) from the use and ultimate dispositions of the assets are less than their carrying values, an impairment loss is recognized. Impairment losses are to be measured based on the fair value of the asset. To date, the Company has not experienced any such impairments.
Subsequent to December 31, 2000, the Company formalized plans to close its Dallas, Texas facility. Certain assets carried in the financial statements related to the Dallas facility are currently being analyzed by management and will be written off during the first quarter of 2001 as part of a one-time restructuring charge. These assets include certain fixed assets as well as a prepaid rent intangible asset established as part of the purchase accounting related to the acquisition of Thermalloy. This intangible prepaid rent asset had a net book value of $5,103 at December 31, 2000 and it is likely that the majority of this asset will be written off during the first quarter of 2001.
REVENUE RECOGNITION
THERMAL PRODUCTS
Revenue is recognized when products are shipped. The Company records an estimate at that time for returns and warranty costs to be incurred.
SOFTWARE
The Company recognizes 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, installation or training. Under SOP 97-2, the determination of fair value is based on objective evidence that is specific to the vendor. If such evidence of fair value for the undelivered element of the arrangement does not exist, all revenue from the arrangement is deferred until such time that evidence of fair value does exist or until all elements of the arrangement are delivered. Revenue allocated to software products, specified upgrades and enhancements is generally recognized upon delivery of the related products, upgrades and enhancements. Revenue allocated to post-contract customer support is generally recognized ratably over the term of the support, and revenue allocated to service elements is generally recognized as the services are performed. SOP 97-2 was adopted by the Company effective January 1, 1998 and has not had a material effect on revenue recognition.
The Company licenses its software products under both annual and perpetual license arrangements. Software license revenue is recognized upon the execution of the license arrangements and shipment of the product, provided that no significant vendor post-contract support obligations remain outstanding, and collection of the resulting receivable is deemed probable. The Company recognizes revenue from post-contract support, which consists of telephone support and the right to software upgrades, ratably over the period of the post-contract arrangement.
COMPREHENSIVE INCOME
As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive Income", which establishes new rules for the reporting and display of comprehensive income and its components. SFAS 130 requires companies to report all changes in stockholders' equity during a period, except those resulting from investment by owners and distribution to owners, in comprehensive income in the period in which they are recognized. Accordingly, the foreign currency translation adjustments, which prior to adoption were reported seperately in stockholders'equity are included in other comprehensive income.
NET INCOME PER SHARE
At December 31, 2000 the Company's common stock was not publicly traded; therefore, earnings per share information is not presented.
USE OF ACCOUNTING ESTIMATES
The preparation of the consolidated financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and the reported amounts of revenues and expenses during the reporting period, and to disclose contingent assets and liabilities at the date of the financial statements. Actual results could differ from those estimates.
TRANSLATION OF FOREIGN CURRENCY
The financial statements of the Company's foreign subsidiaries are translated in accordance with SFAS 52, "Foreign Currency Translation". The financial statements of the Company's subsidiaries are translated from their functional currency into U.S. dollars utilizing the current rate method.
Accordingly, assets and liabilities are translated at exchange rates in effect at the end of the year, and revenues and expenses are translated at the weighted average exchange rate during the year. All cumulative translation gains and losses from the translation into U.S. dollars are included as a separate component of stockholder's equity in the consolidated balance sheets. Transaction gains and losses are included in the consolidated income statements and have not been material.
RECENT ACCOUNTING PRONOUNCEMENTS
In June, 1998 the Financial Accounting Standards Board issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities". This statement requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the value of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. SFAS 133, as amended by SFAS 137 and 138, is required to be adopted by the Company in the first quarter of 2001. This statement will not have a significant impact on the Company.
The Company did not enter into foreign currency forward exchange contracts or any other derivatives during 1999 or 1998. However, in 2000 the Company entered into forward exchange contracts to hedge certain intercompany sales transactions between a German operating company and a United States operating company. The Company had contracts outstanding for the sale of 1,200 U.S. Dollars for 2,466 German Marks. As these derivatives are intended to hedge anticipated transactions, they do not qualify for hedge accounting as of December 31, 2000 under Statement of Financial Accounting Standards No. 52 and thus the related gain (loss) on these contracts are recognized currently. On this basis of valuation, the gain (loss) for the future effects of the contracts will be approximately $(22). The fair value of open forward exchange contracts at December 31, 2000 was a liability of approximately $22, as determined by the counterparty financial institution and represents the present value of the gain/(loss) as if the settlement were to have taken place on December 31, 2000.
In December, 1999 the Securities and Exchange Commission released Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements. SAB 101 provides interpretative guidance on the recognition, presentation and disclosure of revenue. The Company adopted SAB 101 on January 1, 2000. The application of SAB 101 did not have a material effect on the Company's financial position or results of operations.
On February 14, 2001 the Financial Accounting Standards Board revised its Proposed Statement of Financial Accounting Standards, Business Combinations and Intangible Assets - Accounting for Goodwill. As currently proposed, goodwill already existing as of the effective date of this statement will no longer be amortized but rather will be accounted for using an impairment approach. The provisions of this statement would begin the first quarter following issuance of the final statement, which is currently expected in the second quarter of 2001. If enacted in its currently proposed form, the statement will significantly and favorably impact the Company's results of operations after adoption because of the significant goodwill that resulted from the acquisition of the Company in February, 2000.
C. ACQUISITION OF BUSINESSES
On October 21, 1999, the Company purchased all of the stock of the Thermalloy Division of Bowthorpe plc (Thermalloy) and 85.4% of the stock of Curamik Electronics Gmbh (Curamik) (the Thermalloy Acquisition) for a cash purchase price of $84,593, including transaction costs of $2,804. Thermalloy designs, manufactures and sells a wide variety of standard and proprietary heat sinks and associated products, similar to those produced by our thermal management business, within the computer and networking and industrial electronics (including telecommunications) industries. Curamik is a German corporation that manufactures direct bonded copper ceramic substrates that are used in the power semiconductor and other industrial electronics industries. Aavid used $12,619 of its cash on hand and $84,593 of borrowings under a new credit facility to complete the Thermalloy Acquisition, repay $12,619 of outstanding debt, and pay transaction costs.
The Thermalloy acquisition has been accounted for under the purchase method of accounting. The results of operations for Thermalloy and Curamik since October 21, 1999 have been presented in the accompanying consolidated statement of operations for the year ended December 31, 1999. Goodwill acquired was amortized on a straight-line basis using a 20 year life from October 21, 1999 through February 2, 2000. The fair value of assets acquired and liabilities assumed at October 21, 1999 was as follows:
Approximately $2,130 was recorded as restructuring charges in connection with the acquisition. The restructuring plans included initiatives to integrate the operations of the Company and Thermalloy and reduce overhead. The primary components of these plans related to (a.) the closure of duplicative operations in Hong Kong and the United Kingdom, (b.) the elimination of duplicative selling, general and administration functions on a global basis and (c.) the termination of certain contractual obligations. These activities to resulted in a workforce reduction of approximately 136 individuals. The Company finalized these plans during 2000 and the majority of the restructuring activities were completed by the end of 2000. See Note N.
The following table presents selected unaudited pro forma financial information for Aavid, Thermalloy and Curamik, assuming the companies had combined on January 1, 1998:
UNAUDITED PROFORMA CONDENSED STATEMENTS OF INCOME
The pro forma results are not necessarily indicative of either actual results of operations that would have occurred had the acquisition been made on January 1, 1998 or future results.
D. ACCOUNTS RECEIVABLE
The components of accounts receivable at December 31, 2000 and 1999 are as follows:
E. INVENTORIES
The components of inventories at December 31, 2000 and 1999 are as follows:
F. PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment, recorded at cost, by major classification as of December 31, 2000 and 1999 consist of the following:
Substantially all property, plant, and equipment serve as collateral under the Company's borrowing arrangements.
G. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Included in accrued expenses at December 31, 2000 and 1999 are the following:
H. DEBT OBLIGATIONS
Debt obligations as of December 31, 2000 and 1999 consist of the following:
On February 2, 2000, as part of the transactions relating to the Merger, the Company issued 150,000 units (the "Units"), consisting of $150,000 aggregate principal amount of its 12 3/4% Senior Subordinated Notes due 2007 (the "Notes") and warrants (the "Warrants") to purchase an aggregate of 60 shares of the Company's Class A Common Stock, par value $0.0001 per share, and 60 shares of the Company's Class H Common Stock, par value $0.0001 per share. The Notes are fully and unconditionally guaranteed on a joint and several basis by each of the Company's domestic subsidiaries (the "Subsidiary Guarantors") (see note (P) 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 period February 2, 2000 to December 31, 2000.
In connection with the Merger, the Company repaid all of the outstanding term loan and revolving line of credit under its 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 provides 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 are available for working capital purposes, capital expenditures and future acquisitions. The Revolving Facility will terminate, and all amounts outstanding thereunder will be payable, on March 31, 2005. Principal on the Term Facility is 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. In addition, commencing with the fiscal year ending December 31, 2001, the Company is required to apply 50% of excess cash flow, as
defined, 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 December 31, 2000, the interest rates on the Term Facility and the Revolving Facility were 8.89%.
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).
As of December 31, 2000, $7,700 was outstanding under the revolving credit facility and $51,000 was outstanding under the term facility, of which $10,000 was classified as current within the accompanying balance sheet.
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 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 from February 2, 2000 to December 31, 2000.
The Company was also contingently liable at December 31, 1999 for $45 related to outstanding letters of credit. The Company had no letters of credit outstanding at December 31, 2000.
Debt maturities payable for the five years and thereafter subsequent to December 31, 2000 are as follows:
At December 31, 2000, the Company was not in compliance with the leverage ratio covenant required by the amended and restated credit facility and the indenture under which our senior notes were issued. As a result, the Company's stockholders are required to make an equity contribution of up to $25,000 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. Subsequent to December 31, 2000, certain of the Company's stockholders and their affiliates agreed, subject to definitive documentation, to make an equity contribution of $8,000 in cash and up to $25,000 million in principal amount of senior notes in full satisfaction of this obligation. This contribution is required to be made by May 15, 2001. In addition, the Company and the lenders under the amended and restated credit facility have agreed, subject to definitive documentation, to amend the facility such that the last three required quarterly principal payments in 2001 under the facility will be prepaid with $6,000 of the proceeds of the equity contribution, and the four required principal payments in 2002 will be reduced by $500 each, reflecting application of the remaining cash equity contribution. Further, certain covenant ratios and ratio definitions will be amended to levels which the Company expects to meet through December 31, 2001 and the available line of credit will be reduced to $17,000 from $22,000. Based on the equity contribution, the Company's event of non-compliance with the leverage ratio covenant at December 31, 2000 will be cured.
I. EQUITY
COMMON STOCK
The Company's amended and restated certificate of incorporation authorizes the Company to issue 1000 shares of Class A Common Stock, par value $0.0001 per share; 1,000 shares of Class B Common Stock, par value $0.0001 per share; and 1,000 shares of Class H Common Stock, par value $0.0001 per share. As of December 31, 2000 the Company had issued and outstanding 940 shares of Class A Common Stock, 1,000 shares of Class B Common Stock and 40 shares of Class H Common Stock.
In the election of directors, the holders of Class B Common Stock will be entitled to elect two directors or a greater number established in our Bylaws (the "Class B Directors") and the Class A Common Stock and the Class H Common Stock, voting together as a single class, will be entitled to elect the number of directors established in our Bylaws (the "Class A Directors").
Except as otherwise provided by law, the vote of any class of Common Stock, voting as a separate class, will be necessary to approve a merger of Aavid into another corporation if the merger would adversely affect the rights of the class. In addition, except as otherwise provided by law, the vote of the holders of at least 66 2/3% of the holders of Class H Common Stock, voting as a separate class, is necessary for certain transactions, including dividends made with proceeds from the disposition of Aavid Thermalloy, LLC in any of our businesses other than a business operated by Aavid Thermalloy, LLC or its successors.
The Company is permitted to pay dividends on the Class H Common Stock only out of the lesser of (a) our funds legally available therefor and (b) the Available Hardware Dividend Amount, as defined in the amended and restated certificate of incorporation. Dividends payable in a class or series of our capital stock may be paid only in the same class or series.
If the Company disposes of all of its assets and liabilities to a wholly-owned subsidiary (a "Corporate Subsidiary"), the Company's board of directors may declare that all of the outstanding shares of Class A Common Stock and/or Class B Common Stock will be exchanged on a pro rata basis for all of the outstanding shares of the common stock of the Corporate Subsidiary having substantially similar rights, qualifications, limitations and restrictions to the Class A Common Stock and Class B Common Stock, respectively. Any share of Class A Common Stock or Class B Common Stock that is issued on conversion or exercise of any convertible securities will immediately upon issuance pursuant to such conversion or exercise be redeemed for $0.0001 in cash.
If the Company consummates a disposition of Aavid Thermalloy, LLC to any person, the Company will, on or prior to the first business day following the 60th day following the consummation of the disposition (a) declare and pay a dividend in cash and/or in securities or other property received as proceeds of the disposition to the holders of Class H Common Stock in any amount equal to the net proceeds of the disposition; (b) the number of whole shares of outstanding Class H Common Stock that have an aggregate average market value of the net proceeds of such disposition, for the property received as proceeds of such disposition in an amount equal to such net proceeds; or (c) exchange each outstanding share of Class H Common Stock for a number of shares of Class A Common Stock or, if there are no shares of Class A Common Stock outstanding, Class B Common Stock, equal to the average daily ratio of the market value of the Class H Common Stock to the market value of the Class A Common Stock or Class B Common Stock, as the case may be.
The Company's board of directors may, at any time after a dividend or redemption, declare that each of the remaining outstanding shares of Class H Common Stock will be exchanged for a number of shares of Class A Common Stock or, if there are no shares of Class A Common Stock outstanding and shares of Class B Common Stock are then outstanding, of Class B Common Stock, equal to the market value ratio of one share of Class H Common Stock to one share of Class A Common Stock or one share of Class B Common Stock, as the case may be. If all of the Company's indirect or directly owned common membership interest in Aavid Thermalloy, LLC (and no other assets or liabilities) is held, directly or indirectly, by a wholly-owned subsidiary of Aavid (the "Aavid Thermalloy Subsidiary"), the Company's board of directors may declare that all of the outstanding shares of Class H Common Stock will be exchanged for all of the outstanding shares of common stock of the Aavid Thermalloy Subsidiary, on a pro rata basis.
After any exchange date or redemption date on which all outstanding Class H Common Stock was exchanged or redeemed, any share of Class H Common Stock that is issued on conversion or exercise of any convertible securities will be (a) exchanged for the kind and amount of shares of capital stock and other securities and property that the holder would have received had the convertible security been converted immediately prior thereto; or (b) redeemed for $0.001 in cash.
In the event the Company dissolves, liquidates or winds up, the holders of the outstanding shares of each class of Common Stock will be entitled to receive a fraction of the funds remaining based on the Market Value of each class of stock.
WARRANTS
In connection with the issuance of the 12 3/4% Senior Subordinated Notes, the Company issued warrants to purchase 60 shares of Class A common stock and 60 shares of Class H common stock. The warrants are exercisable on or after an exercise event, as defined, and will expire on February 1, 2007. Each warrant entitles its holder to purchase 0.0004 shares of Class A common stock and 0.0004 shares of Class H common stock, subject to adjustment, as defined, at an exercise price of $0.01 per share.
MANAGEMENT INCENTIVE PURCHASE PROGRAM
During 2000, the Board of Directors approved the Management Incentive Purchase Program (the Program). The Program provides for the grant and purchase of non-voting restricted stock of Fluent and Aavid Thermalloy to and by certain employees and directors of the Company. Shares acquired pursuant to the Program are subject to a right of repurchase by the Company, which lapses as the stock vests. In the event of termination of services, the Company has the right to repurchase unvested shares at the original issuance price. The vesting is generally five years. The Board of Directors set aside approximately 10% of the common equity ownership in both Aavid Thermalloy and Fluent for the Program. The 10% of common equity in each company is equal to approximately 56,296 shares in Aavid Thermalloy, LLC and 28,149 shares in Fluent, Inc.
As of December 31, 2000 the Company held notes receivable for stock in the amount of $664 from employees in consideration for the purchase of common stock The notes bear interest at 7%. Notes issued in connection with Aavid Thermalloy shares are due October 1, 2007 or upon termination of employment and are collateralized by the underlying common stock. Notes issued in connection with Fluent shares are due November 1, 2007 or upon termination of employment and are collateralized by the underlying common stock. In addition, the interest due and the 60% of the note balance are full recourse to the employee. These notes are recorded in other long term assets in the accompanying balance sheet.
STOCK OPTIONS
During 1993, an officer of the Company was granted non-qualified stock options to acquire 249,205 shares of Common Stock at an exercise price of $0.19 per share, and 1,268,795 shares of Common Stock at an exercise price of $2.20 per share. These options vested and became exercisable as to 25% of the applicable shares immediately, with the remainder ratably in October 1994, 1995, and 1996, respectively. During 1999 and 1998, respectively, 268,000 and 1,025,000 options were exercised. In addition, between 1993 and 1999, the Company issued 556,875 non-qualified stock options to Directors of the Company and certain executives outside of the plans discussed below, at exercise prices ranging from $0.19 to $16.50. The exercise price of all these options equaled or exceeded the fair market value on the date of grant, as determined by the Board of Directors for issuance prior to its initial public offering or market prices thereafter.
During 1994, the Company's Board of Directors adopted and approved a stock option plan for officers and key employees (1994 Stock Option Plan). The 1994 Stock Option Plan provided for the grant to officers and key employees of the Company of stock options intended to qualify as incentive stock options under the applicable provisions of the Internal Revenue Code, as well as non-qualified options. The Company had reserved 894,326 shares of its Common Stock for issuance under this plan.
The 1994 Stock Option Plan provided that the exercise price of all options shall be at least equal to the fair market value of the Company's shares, as of the date on which the grant is made. The term of options issued under the plan could not exceed ten years. Options were generally exercisable in installments beginning on the date of grant. With respect to incentive stock options granted to a participant owning more than 10% of the Company's shares, the exercise price thereof is at least 110% of the fair market value of the Company's stock.
During 1995, the Company's Board of Directors adopted and approved a stock option plan for non-employee directors (Directors' Plan). The Company had reserved 200,000 shares of its Common Stock for issuance under this plan. The Directors' Plan provided for the automatic grant to non-employee directors of options to purchase shares of Common Stock reserved for issuance under the Directors' Plan. Options granted under the Directors' Plan did not qualify as incentive stock options under the applicable provisions of the Internal Revenue Code. The options had an exercise price of 100% of the fair market value of the Common Stock on the date of grant and have a ten-year term. Initial options became fully exercisable six (6) months after the date of grant. All other options granted under the Directors' Plan became fully exercisable from and after the first anniversary of the grant date.
During 1995, the Company's Board of Directors adopted and approved an employee stock purchase plan (Purchase Plan). Under the Purchase Plan, the Company would grant rights to purchase shares of Common Stock to eligible employees on a date or series of dates designated by the Board of Directors. The Company had reserved 250,000 shares of its Common Stock for issuance under this plan. The price per share with respect to each grant of rights under the Purchase Plan was the lesser of:
(i) 85% of the fair market value on the offering date on which such rights were granted, or
(ii) 85% of the fair market value on the date such right is exercised.
The Purchase Plan was intended to qualify as an employee stock purchase plan under the applicable provisions of the Internal Revenue Code. During 1999 and 1998, the Company sold 45,561 and 34,282, shares under this plan, respectively.
As was discussed in Note A, on February 2, 2000 all outstanding stock options were cashed out based on a value of $25.50 per share in connection with the Willis Stein merger. The 1994 Stock Option Plan, the Director's Plan and the Purchase Plan were all terminated in connection with the Merger. At December 31, 2000 there were no stock options outstanding. Due to the insignificant level of stock option activity during the period January 1, 2000 through February 1, 2000, such activity is not presented in this footnote.
A summary of historical stock option activity follows:
At December 31, 1999 and 1998 options for 916,086 and 932,602 shares were exercisable, respectively, with weighted average exercise prices of $13.20 and $8.53, respectively.
During 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation", which defines a fair value based method of accounting for employee stock options, or similar equity instruments, and encourages all entities to adopt that method of accounting for all of their employee stock compensation plans; however, it also allows an entity to continue to measure compensation costs for those plans using the intrinsic method of accounting prescribed by APB Opinion 25. Entities electing to remain with the accounting in APB Opinion 25 must make pro forma disclosures of net income and earnings per share as if the fair value based method of accounting defined in SFAS No. 123 has been applied.
The Company has elected to account for its stock-based compensation plan under APB Opinion 25; however, the Company has computed, for pro forma disclosure purposes, the value of all options granted during 1999 and 1998 using the Black-Scholes option-pricing model as prescribed by SFAS No. 123, using the following weighted-average assumptions for grants in 1999 and 1998:
The weighted average fair value of options granted in 1999 and 1998 were $8.43 and $14.29, respectively.
The total value of options granted during 1995 through 1999 would be amortized on a pro forma basis over the vesting period of the options. Options generally vest equally over two to four years. If the Company had accounted for these plans, including the Employee Stock Purchase Plan, in accordance with SFAS No. 123, the Company's net income and net income per share would have decreased or increased, as reflected in the following pro forma amounts:
J. INCOME TAXES
Income before income taxes and minority interest for domestic and foreign operations are as follows:
The income tax provision included in the consolidated statements of operations, consists of the following:
The Company has approximately $37,800 of U.S. federal net operating loss carryforwards available to reduce future taxable income, if any. These net operating loss carryforwards expire through 2020, and are subject to the review and possible adjustment by the Internal Revenue Service. Section 382 of the Internal Revenue Code also contains provisions that could place annual limitations on the utilization of these net operating loss carryforwards in the event of a change in ownership, as defined. These loss carryforwards have an annual limitation of approximately $13,000 per year as a result of the Merger described in Note A. A reconciliation of the income tax expense at the statutory federal income tax rate to the Company's actual income tax expense (benefit) is as follows:
Deferred tax assets and liabilities are measured as the difference between the financial statement and the tax bases of assets and liabilities at the applicable enacted tax rates. In 2000 and 1999, the Company provided for U.S. income taxes on $11,732 and $8,400, respectively, of
undistributed earnings from its foreign subsidiaries as it is the Company's intention to repatriate those earnings from its foreign operations in future years.
The components of the net deferred asset consist of the following:
The Company has provided a valuation allowance of $924 for certain tax credits whose future realization is uncertain. Any future reduction in the valuation allowance will be recorded as a reduction to goodwill.
K. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases various equipment and facilities under the terms of non-cancelable operating leases. Future lease commitments are as follows:
Lease expense was approximately $6,955, $5,634 and $3,141 for the years ended December 31, 2000, 1999 and 1998, respectively.
LITIGATION
Following the public announcement of the merger with Heat Merger Corp., lawsuits were filed against the Company, Willis Stein, the Company's directors, and one former director in the Court of Chancery of the State of Delaware by certain of our stockholders. The complaints alleged, among other things, that the Company's directors breached their fiduciary duties and sought to enjoin, preliminarily and permanently, the Merger and also sought compensatory damages. The stockholder plaintiffs, on behalf of the Company's public stockholders, also sought class action certification for their lawsuits. On March 11, 2001 the stockholders plaintiffs filed to dismiss the class action without prejudice. The Company is awaiting a final court order approving the dismissal.
The Company is involved in various other legal proceedings that are incidental to the conduct of its business, none of which it believes could reasonably be expected to have a materially adverse effect on the Company's financial condition.
PURCHASE COMMITMENT
The Company has an obligation to purchase from one of its key suppliers a minimum quantity of aluminum coil stock. The Company believes that purchasing aluminum coil stock from this supplier is necessary to achieve consistently low tolerances, design, delivery
flexibility, and price stability. Under the terms of this agreement the Company has agreed to purchase certain minimum quantities which approximates $1,605 at December 31, 2000.
L. 401(k) PROFIT SHARING PLAN
The Company has profit sharing plans, which permit participants to make contributions by salary reduction pursuant to Section 401(k) of the Internal Revenue Code. Employee eligibility is based on a minimum age and employment requirement. Annual employer contributions are determined by the Board of Directors, but cannot exceed the amount allowable for federal income tax purposes. The Company's contribution was approximately $823, $535 and $280 for the years ended December 31, 2000, 1999 and 1998, respectively.
M. SEGMENT REPORTING
Aavid provides thermal management solutions for microprocessors and integrated circuits ("ICs") for digital and power applications. In connection with the merger, we consolidated our business into two operating segments: thermal management products and computational fluid dynamics ("CFD") software. Aavid's thermal management products consist of products and services that solve problems associated with the dissipation of unwanted heat in electronic and electrical components and systems. The Company develops and offers CFD software for computer modeling and fluid flow analysis of products and processes that reduce time and expense associated with physical models and the facilities to test them. The Company also provides thermal design services to customers who choose to outsource their thermal design needs.
The accounting policies of the segments are the same as those described in the summary of significant accounting policies.
The Company accounts for inter-segment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices.
Aavid's reportable segments are strategic business units that offer different products and services. They are managed separately because each segment requires different marketing and sales strategies. Most of the businesses were acquired as a unit and the management at the time of acquisition has generally been retained.
The following summarizes the operations of each reportable segment for the years ending December 31, 2000, 1999 and 1998. 2000 results include the combined operations of the Company (February 2, 2000 through December 31, 2000) and the Predecessor (January 1, 2000 through February 1, 2000):
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.
Revenues from one customer of Aavid's thermal products division represented $47,000 of the Company's consolidated revenues for the years ending December 31, 1998. Due to a change in product mix at this customer, revenues from this customer were less than 10% of total revenues in 2000 and 1999. There were no other individual customers who made up more than 10% of consolidated revenues for the years ended December 31, 2000, 1999 or 1998.
N. NON-RECURRING CHARGES AND RESTRUCTURING RESERVES
During the first quarter of 1998, the Company recorded a non-recurring pre-tax charge of $1,858, which related to financial obligations arising from the Company's restructuring in 1993 and comprised two elements. First, the Company terminated an arrangement with certain venture investors, under which it was obligated to pay fixed management fees until at least the year 2000. Second, the Company provided for an obligation to pay a former director a bonus based on profits in excess of certain thresholds.
During the third quarter of 1998, the Company recorded a non-recurring pre-tax charge of $4,882 reflecting the costs associated with the closure of the Company's Manchester, New Hampshire, facility. This facility was dedicated to manufacturing a specific large volume product for a single customer. Following a change in product design by the customer, demand significantly decreased during the fourth quarter of 1998 to $8,600, from a level of $15,000 in the second quarter of 1998. The Manchester restructuring was concluded at the end of 1999.
The costs associated with the closure of the Manchester facility include the write-down and disposal of surplus equipment, totaling $2,823, settlement of certain purchase commitments of $1,127, provisions for leased property expenses of $382, and employee separation costs of $550. While the number of employees has been significantly reduced through natural attrition, the plan included the termination of 120 employees comprised of 90 direct and 30 indirect employees. The charge is offset by a $1,000 reduction in the previous estimate of obligations to pay a former director a bonus, paid on profits in excess of certain thresholds.
The following amounts have been provided to and charged against the Manchester restructuring reserves as of December 31, 2000 and 1999:
In the fourth quarter of 1999, the Company completed its restructuring of the Manchester facility. As a result, excess reserves totaling $630 were reversed into income in 1999.
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 included initiatives to integrate the operations of the Company and Thermalloy and reduce overhead. The primary components of these plans related to (a) the closure of duplicative Thermalloy operations in Hong Kong and the United Kingdom, (b) the elimination of duplicative selling, general and administration functions of Thermalloy on a global basis and (c) the termination of certain contractual obligations. During the year ended December 31, 2000, 136 individuals were terminated under the restructuring plan. The following amounts have been charged against the Thermalloy restructuring reserves during the year ended December 31, 2000:
Approximately $716 of restructuring charges were recorded in connection with the Merger. The restructuring plans included initiatives to integrate the operations of the Company and reduce overhead. The primary components of these plans related to (a) the closure of operations in California and the United Kingdom and (b) the termination of certain contractual obligations. During the year ended December 31, 2000, 89 individuals were terminated under the restructuring plan. The following amounts have been charged against the merger restructuring reserves during the year ended December 31, 2000:
During the first half of 2001 the Company plans to close its Dallas, Texas facility. In connection with the closure, the Company expects to record a one-time restructuring charge within the statement of operations for the first quarter of 2001. This one-time charge will include
estimated amounts related to employee severance, write-off of fixed assets and write-off of most of a prepaid lease intangible asset that was originally recorded as part of the Thermalloy acquisition. The total restructuring charge is estimated to be in the range of $10.0 million to $13.5 million, of which approximately $4.0 million to $5.0 million relates to the write-off of the prepaid lease intangible. The estimated cash component of the restructuring charge is primarily related to employee severance and is expected to be in the range of $2.5 million to $3.5 million. The balance of the charge, $3.5 million to $5.0 million, is related to estimated fixed asset write-offs.
O. QUARTERLY DATA (UNAUDITED)
Following is a summary of the quarterly results of operations for the years ended December 31, 2000 and 1999. First quarter of 2000 results include the combined operations of the Company (February 2, 2000 through March 31, 2000) and the Predecessor (January 1, 2000 through February 1, 2000). Second, third and fourth quarter are the results of the Company:
P. SELECTED CONSOLIDATING FINANCIAL STATEMENTS OF PARENT, GUARANTORS AND NON-GUARANTORS
The Company's wholly-owned domestic subsidiaries have jointly and severally guaranteed, on a senior subordinated basis, the $150,000 principal amount of the Company's 12 3/4% Senior Subordinated Notes, due 2007. The guarantors include the combined domestic operations of Aavid Thermalloy, LLC, which directly or indirectly owns all of the Company's thermal management operations and Fluent, Inc.,which directly or indirectly owns all of the Company's CFD operations, and the Company's subsidiary Applied Thermal Technologies, Inc. The non-guarantors include the combined foreign operations of Aavid Thermalloy, LLC and Fluent, Inc. The consolidating condensed financial statements of the Company depict Aavid Thermal Technologies, Inc., the Parent, carrying its investment in subsidiaries under the equity method and the guarantor and non-guarantor subsidiaries are presented on a combined basis. Management believes that there are no significant restrictions on the Parent's and guarantors' ability to obtain funds from their subsidiaries by dividend or loan. The principal elimination entries eliminate investment in subsidiaries and intercompany balances and transactions.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
ALLOWANCE FOR DOUBTFUL ACCOUNTS:
MANCHESTER RESTRUCTURING RESERVES:
THERMALLOY RESTRUCTURING RESERVES:
WILLIS STEIN RESTRUCTURING RESERVES: