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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission file number 0-27309
AAVID THERMAL TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 02-0466826
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
ONE EAGLE SQUARE, SUITE 509, CONCORD, NEW HAMPSHIRE 03301
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (603) 224-1117
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such report, and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ ] No [X](1)
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Aggregate market value of the Registrant's common stock held by
non-affiliates: N/A. The number of outstanding shares of the registrant's Common
Stock as of March 15, 2005 was 1,018.87 shares of class A, 1,078.87 shares of
Class B and 40 shares of Class H, all of which are owned by Heat Holdings Corp.
On February 2, 2000, a wholly-owned subsidiary of Heat Holdings Corp. was merged
with and into the Registrant with the Registrant becoming a wholly-owned
subsidiary of Heat Holdings Corp. and each share of Registrant's then
outstanding common stock was converted into $25.50 in cash. The Registrant's
Common Stock is no longer publicly traded; however, the Registrant's Senior
Subordinated Notes are publicly traded.
Documents incorporated by reference: none
- ----------
(1) Although the Company has not been subject to such filing requirements for
the past 90 days, it has filed all reports required to be filed by Section
15(d) of the Securities Exchange Act (the "Act") of 1934 during the
preceding twelve months. Pursuant to Section 15(d) of the Act, the
Company's duty to file reports is automatically suspended as a result of
having fewer than 300 holders of record of each class of its debt
securities outstanding, as of January 1, 2003, but the Company agreed under
the terms of certain long-term debt covenants to continue these filings.
PART I
ITEM 1. BUSINESS
COMPANY INTRODUCTION
We are a leading global provider of thermal management solutions for
electronic products and the leading developer and marketer of computational
fluid dynamics ("CFD") software. We design, manufacture and distribute on a
worldwide basis thermal management products that dissipate unwanted heat, which
can degrade system performance and reliability, from microprocessors and
industrial electronics products. Our products, which include heat sinks, heat
pipes, interface materials and attachment accessories, fans, heat spreaders and
liquid cooling and phase change devices that we configure to meet
customer-specific needs, serve the critical function of conducting, convecting
and radiating away unwanted heat. CFD software is used for complex computer
modeling of fluid flows, heat and mass transfer and chemical reactions. Our CFD
software is used in a variety of industries, including the automotive,
aerospace, chemical processing, power generation, material processing,
electronics and HVAC industries.
Our thermal management products are used in a wide variety of computer and
networking and industrial electronics applications, including computer systems
(desktops, laptops, disk drives, printers and peripheral cards), network devices
(servers, routers, set top boxes and local area networks), telecommunications
equipment (wireless base stations, satellite stations and PBXs), instrumentation
(semiconductor test equipment, medical equipment and power supplies),
transportation and motor drives (braking and traction systems) and consumer
electronics (stereo systems and video games). Our CFD software is used for a
wide variety of computer-based analyses, including the design of electronic
components and systems, automotive design, combustion systems modeling and
process plant troubleshooting. We have longstanding relationships with a highly
diversified base of more than 3,000 national and international customers,
including original equipment manufacturers (commonly referred to as OEMs),
electronics distributors and contract manufacturers.
On February 2, 2000 we were acquired in a merger ("Merger") with Heat
Holdings Corp., a corporation newly formed by Willis Stein & Partners II, L.P.
(together with affiliated funds, "Willis Stein") and other investors
(collectively the "Purchaser"). 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 includes Applied Thermal
Technologies, Inc.'s thermal design, validation and consulting services; and
Fluent.
INDUSTRY OVERVIEW
THERMAL MANAGEMENT
In today's electronic environment, microprocessors and their associated
power supplies, hard drives, advanced video chips and other peripheral devices
draw large amounts of power and, consequently, must dissipate a significant
amount of heat. The same heat generation occurs in semiconductors and integrated
circuits, in motor controls, telecommunications switches and other electronics.
Because these electronic components can only operate efficiently in narrow
temperature bands, heat is an absolute constraint in electronic system design.
The excessive heat generated within a component not only degrades semiconductor
and system performance and reliability, but can also cause semiconductor and
system failure.
Increasingly, neither externally generated off-the-shelf thermal management
products nor internally designed and produced parts have been able to
effectively address the expanding complexity of thermal management problems
resulting from the increasing amount of heat required to be dissipated by
electronic products. The complexity of thermal management problems has been
intensified by reductions in system size, shorter time-to-market, shorter
product life cycles and more demanding operating environments. These factors
have led to the development and growth of the thermal management industry.
2
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. However, CFD software is not a substitute for physical modeling and
testing prior to production or manufacture of the final product. Specific uses
of CFD-based flow analysis include the design of electronic components and
systems, automotive design, combustion systems modeling and process plant
troubleshooting.
The CFD software market, which has been growing rapidly over the past
decade, continued to grow in 2004. We believe that, through Fluent, we have
approximately 35-40% 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.
3
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 31 years of
experience in the area of fluid flows and thermal management and H. Ferit
Boysan, president of our CFD software business, has 24 years of experience in
the area of fluid flows and CFD software.
4
BUSINESS STRATEGY
Our business strategy is to continue to be a market leader in both the
thermal management and CFD software markets. We intend to continue this business
strategy and strengthen our competitive position through the following
initiatives:
CAPITALIZE ON THERMAL MANAGEMENT INDUSTRY GROWTH
We believe that our existing thermal management markets will continue to
experience growth in the long term. Growth will be driven by the need to
dissipate the increasing amount of heat being generated by electronic products,
as well as unit growth in these products. We believe our competitive strengths
position us to capitalize on these growth trends.
TAKE ADVANTAGE OF OUTSOURCING TREND
The increasing complexity of heat dissipation problems is driving a trend
among manufacturers to outsource the development of thermal management solutions
to companies with high levels of expertise in solving these problems. We intend
to capitalize on this trend by leveraging our technical expertise in designing
thermal management products and through continuing to partner with our customers
in creating customized solutions.
EXPAND OUR ADDRESSED THERMAL MANAGEMENT MARKET
We believe we have significant opportunities to expand the portion of the
outsourced thermal management market that we address. Our strategy is to expand
into the part of the outsourced thermal management market that we do not
currently serve by entering into new geographic markets and introducing new
products that complement our existing product offerings.
ACCELERATE GROWTH IN COMPUTATIONAL FLUID DYNAMICS SOFTWARE MARKET
Growth in the CFD software market will be driven by customers' needs to
reduce product development costs, minimize the time-to-market for their new
products and improve product performance, as well as by increasing applications
for CFD software. We intend to grow our CFD software business through internal
product development, licensing of externally developed technology, 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 150 Ph.D.s and 280 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.
5
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. Our customer base includes major customers which operate in the
computer, networking, contract manufacturing, communications and electronics
distribution market sectors.
One customer represented approximately 10.2% of our thermal management net
sales during 2003. No customer represented more than 10% of our thermal
management net sales in 2004 or 2002.
We currently have more than 2,000 licensees of our CFD software. Our
largest customers for CFD software applications operate in the aerospace,
automotive, chemical process, electronics, consumer products and power
generation market sectors.
THERMAL MANAGEMENT PRODUCTS AND SERVICES
We provide total integrated solutions to our thermal management customers.
We have the thermal design know-how to first analyze customers' thermal
management problems at the device-, board- and system-level, to then design,
simulate and prototype thermal management solutions and to finally manufacture,
distribute and support these solutions around the world.
We design, manufacture and sell both standard and customized thermal
management products. We seek to become a strategic supplier to our customers and
to differentiate ourselves from our competitors by offering a higher level of
service. We currently offer heat sinks, interface materials and attachment
accessories, fans, heat spreaders and liquid cooling and phase change devices
that we configure to meet customer-specific needs. The prices for our thermal
management products (including attachment devices and interface materials),
depend primarily on cost, the technology used to make the part and its value in
the customer's application. Because of the continued shrinking time-to-market
for most new products and the corresponding contraction of design cycles, we
also offer simulation and modeling software and hardware prototyping and testing
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:
PRODUCT OR SERVICE DESCRIPTION APPLICATION
------------------ ----------- -----------
Heat Sinks, Fan Heat Sinks and Heat These products are typically made from - Removes potentially damaging heat
Spreaders aluminum extrusions, stampings, castings from microprocessors and integrated
or multi-technology assemblies. These circuits in electronics
products have high surface area to applications
volume ratios and may rely on a fan
mounted directly on the heat sink to
increase the movement of air.
6
PRODUCT OR SERVICE DESCRIPTION APPLICATION
------------------ ----------- -----------
Interface Materials and Attachment Attachment devices are the spring clips, - Increases the effectiveness of heat
Accessories tapes, adhesives, tabs and similar sinks
devices which are used to attach the
heat sink to the semiconductor or - Promotes a highly efficient thermal
integrated circuit device and/or to the transfer between the microprocessor
customer's printed circuit board or or integrated circuit and heat sink
system chassis. Interface materials
include greases, silicon pads and other - Reduces the cost of the customer's
materials which have desirable thermal installation and repair
and electrical properties. We purchase
most of these materials on a private - Transfers heat from the component
label basis from a number of suppliers. being cooled to the heat sink
Liquid Cooling and Phase Change Devices These devices include cold plates, heat - Moves highly concentrated heat from
pipes and other liquid cooling designs microprocessors and integrated
that dissipate heat by conducting or circuits to a location where a
convecting the heat into a liquid, which traditional heat sink can dissipate
then transfers the heat away from the heat
source to the ultimate heat sink.
Applied Thermal Technologies' Design Applied Thermal Technologies' facilities - Analyzes customers' thermal
Centers are staffed by technicians with thermal problems at the device-, board-and
engineering and flow analysis expertise system-level
and utilize a variety of sophisticated
design, test and validation hardware and - Designs, simulates, prototypes, and
software. tests thermal management solutions
efficiently
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.
7
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 major CFD software
products:
PRODUCT OR SERVICE DESCRIPTION FEATURES
- ------------------ ----------- --------
Fluent Fluent is general purpose CFD software - Provides a choice of solver options
used across a wide range of industries for optimum convergence and
and is ideally suited for incompressible accuracy for a wide range of flow
and mildly compressible (transonic) and regimes
highly compressible (supersonic and
hypersonic) flows. Fluent contains - Structured and solution adaptive
physical models for a wide range of unstructured mesh capability
applications including turbulent flows,
heat transfer, reacting flows, chemical - Enables easier problem setup
mixing, combustion and multi-phase
flows.
Fidap Fidap is general purpose CFD software - Offers complete mesh flexibility
for the simulation of incompressible or
compressible flows, including prediction - Provides a wide range of physical
of liquid-free surfaces, non-Newtonion models, with particular strength
rheology and advanced radiation for application in the materials
modeling. processing, biomedical,
semiconductor, food paper and
chemical industries
Icepak Icepak is a fully-interactive, - Used for component board- and
object-based CFD software tool cabinet- level design
specifically designed to analyze air
flow and thermal management in - Reduces design costs
electronics design.
- Reduces the time-to-market of
high-performance electronic systems
Airpak Airpak, like Icepak, is a fully - Used to determine the layout of
interactive, object-based CFD software ventilation systems in rooms and
tool. Airpak is specifically designed to buildings in order to provide
analyze air flow, contamination and maximum comfort and air quality.
thermal comfort in room and building
designs. - Assesses the risk of airborne
contamination
- Improves the energy performance of
heating and cooling designs.
GAMBIT GAMBIT supports a single user interface - Reduces the time to create a CFD
for geometry creation and meshing. model
Different CFD problems require different
mesh types, and GAMBIT brings together - Allows users to import geometries
all of Fluent's options in one created under other CAD/CAE
environment. packages into the Fluent suite of
software products.
- Enables users to automatically
create unstructured meshes for
extremely complex geometries
- Provides a concise and powerful
set of solid modeling-based
geometry tools with both
geometry and "clean-up"
functions
8
PRODUCT OR SERVICE DESCRIPTION FEATURES
- ------------------ ----------- --------
MixSim MixSim is a fully interactive, - Reduces the time to create a CFD
object-based CFD software tool model: The geometry is
specifically designed to analyze the interactively assembled from
fluid flow and blending in stirred tank application-specific objects
reactors. Based on, and fully compatible (impeller library); the mesh and
with FLUENT and GAMBIT, it fully FLUENT solver case setup is created
automates and thus simplifies their fully automatic by the software
application to stirred tank reactors for
both CFD beginners and expert users. - Flexible interface for the addition
of new objects (e.g. arbitrary new
agitators) by the user, including
import of CAD files
Application-specific results
examination and evaluation
FloWizard FloWizard is a highly automated flow - Basic, steady state fluid flow and
simulation tool that is specifically heat transfer analysis.
built for design and process engineers.
It allows engineers to rapidly turn - Accepts files from all major CAD
their CAD (computer aided design) models software.
into fluid flow models without requiring
extensive data input. - A Wizard driven interface that
requires minimal user training.
SALES AND SUPPORT
We sell our thermal management products and CFD software primarily through
a global network of direct sales personnel, manufacturers' representatives,
agents and a network of independent distributors. We provide support services to
our customers, particularly in the CFD software area where we believe that
high-quality support service is critical to the success of the CFD software
business. Aavid Thermalloy (including Applied Thermal Technologies) and Fluent
both have their own sales, support and marketing personnel, all of whom
cross-sell each other's products and services where appropriate. We currently
employ approximately 325 sales, support and marketing personnel.
TECHNOLOGY
We believe that technology leadership is essential to our growth strategy
and have focused our approximately 150 Ph.D.s and 280 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.
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COMPUTATIONAL FLUID DYNAMIC SOFTWARE TECHNOLOGY
We believe that we are the technology leader in CFD software. Fluent's CFD
software includes:
- automatic unstructured mesh generation, which allows the automatic
creation of meshes,
- numerical algorithms for the accurate solution of fluid flow equations
on structured and unstructured meshes,
- solution adaptive mesh which allows for interactive mesh refinement to
provide improved solution accuracy,
- state-of-the-art physical models for important fluid flow phenomena
such as turbulence, turbulence-chemistry interactions, free surface
flows and multiphase flows,
- algorithms for efficient execution on multi-processor computers and
distributed computer networks,
- interactive client/server architecture with a flexible and
customizable user interface, and
- post-processing and data analysis tools.
PRODUCT DEVELOPMENT
Our thermal management product development activities are focused on
lowering production costs, improving thermal characteristics and ease of
attachment of conventional heat sinks, and developing new thermal management
products and technologies to address the emerging and anticipated thermal
management problems of our customers. We are developing new products, both
internally as well as through collaborative efforts with third parties. These
development efforts are directed toward: heat sink characterization and
optimization; fan designs; air flow management; boundary layer optimization and
focused flow; re-circulating passive and active cooling systems including heat
pipes; thermoelectric coolers, which use electricity to create a temperature
difference across an interface between the electronic device and a heat sink;
liquid and sub-ambient cooling systems; tab and surface mount heat sink
attachment methods; and adhesive and interface systems that have a high degree
of thermal conductivity.
Our CFD product development activities are focused on enhancing the
capabilities of its solvers, implementing new physical models to increase the
range of applications and developing front-end user interfaces that are easy to
use for engineers in specific industries. We are also focusing on various
application and industry-specific CFD software projects which we believe will
enable us to penetrate the design engineering market.
SUPPLIERS
We purchase raw aluminum, aluminum extrusion, aluminum coil and various
components from a limited number of outside sources. We purchase substantially
all of our aluminum coil stock from a single supplier. We believe that
purchasing aluminum extrusion and coil stock from a limited number of suppliers
is necessary to obtain lower prices and to consistently achieve the tolerances
and design and delivery flexibility that we require.
For raw aluminum extrusion and coil stock, we typically make a purchasing
commitment to a key supplier of up to 24 months. In return, this supplier
commits to maintaining local inventory and to reserving run-time on critical
machines. The cost of aluminum extrusion is generally negotiated annually, with
the price adjusted monthly, based upon the changes in the price of aluminum
ingot, which has historically been highly cyclical.
10
COMPETITION
Our thermal management products business competes with a number of major
providers of thermal management products throughout the world. In addition,
there are a large number of smaller heat sink companies, as well as hundreds of
machine shops, that fabricate heat sinks, usually under subcontract with an OEM
customer. Further, some aluminum die casters offer cast heat sinks, and a number
of aluminum extruders sell heat sink products and fabrication capability,
including aluminum extruders serving the automotive industry and the power
conversion market.
Fluent currently competes with a number of companies, primarily on the
basis of product performance. To the extent that Fluent expands into additional
applications and industry-specific markets, it will encounter additional
competition from software companies already serving such specific markets. In
addition, certain CFD software is available in the public domain.
BACKLOG AND LICENSE RENEWAL
Our hardware products typically are produced and shipped within 30 days of
the receipt of orders and, accordingly, we operate with little backlog. As a
result, net sales in any quarter generally are dependent on orders booked and
shipped in that quarter. All orders are subject to cancellation or rescheduling
by customers. Because of our quick turn of orders to shipments, the timing of
orders, delivery intervals, customer and product mix and the possibility of
customer changes in delivery schedules, we do not believe our backlog at a
particular date is a reliable indicator of actual sales for any succeeding
period.
Our software products are typically sold under annual license agreements or
with annual maintenance agreements. In recent years, greater than 80% of our
annual software license revenue was renewed in the following year.
EMPLOYEES
As of December 31, 2004, we had a total of 2,157 employees including
approximately 500 contract employees in China. Except for the employees in our
manufacturing facility in Mexico, none of our employees are represented by labor
unions or collective bargaining units. We believe that our relationship with our
employees is good.
RISK FACTORS
This Annual Report on Form 10-K contains certain forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. All statements regarding our expected
future financial position, results of operations, cash flows, financing plans,
business strategy, competitive position, plans and objectives and words such as
"anticipate," "believe," "estimate," "expect," "intend," "plan" and other
similar expressions are forward-looking statements. Such forward looking
statements are inherently uncertain, and holders of our securities must
recognize that actual results could differ materially from those projected or
contemplated in the forward-looking statements as a result of a variety of
factors, including the factors set forth below. Holders of our securities should
not place undue reliance on these forward-looking statements.
The forward-looking statements speak only as of the date on which they are
made, and we undertake no obligation to update any forward-looking statement to
reflect events or circumstances after the date on which the statement is made or
to reflect the occurrence of unanticipated events. In addition, we cannot assess
the effect of each factor on our business or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
contained in any forward-looking statements.
11
RISKS RELATING TO OUR BUSINESS
WE MAY NOT BE ABLE TO EFFECTIVELY MANAGE OUR INTERNAL GROWTH.
We intend to increase our thermal products and software businesses
overseas, expand the products and services we offer, and possibly make selective
acquisitions as the economy improves. This growth and expansion may place a
significant strain on our production, technical, financial and other management
resources. To manage any growth effectively, we must maintain a high level of
manufacturing quality, efficiency, delivery and performance and must continue to
enhance our operational, financial and management systems, and attract, train,
motivate and manage our employees. We may not be able to effectively manage this
expansion, and any failure to do so could have a material adverse effect on our
business and financial condition.
OUR OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.
Our quarterly and annual operating results are affected by a wide variety
of factors, many of which are outside our control, that have in the past and
could in the future materially and adversely affect our net sales, gross margins
and profitability. These factors include:
- the volume and timing of orders received;
- competitive pricing pressures;
- the availability and cost of raw materials;
- changes in the mix of products and services sold;
- potential cancellation or rescheduling of orders;
- general economic conditions;
- changes in the level of customer inventories of our products;
- the timing of new product and manufacturing process technology
introductions by us or our competitors;
- the availability of manufacturing capacity; and
- market acceptance of new or enhanced products introduced by us.
Additionally, our growth and results of operations have in the past been,
are currently being and would in the future be, adversely affected by downturns
in the semiconductor or electronics industries. Our ability to reduce costs
quickly in response to revenue shortfalls is limited, and this limitation will
be exacerbated to the extent we continue to add additional manufacturing
capacity. The need for continued investment in research and development could
also limit our ability to reduce expenses accordingly. As a result of these
factors, we expect our operating results to continue to fluctuate. Results of
operations in any one quarter should not be considered indicative of results to
be expected for any future period, and fluctuations in operating results may
also cause fluctuations in the market price of the senior subordinated notes. We
cannot provide assurance that the overall thermal management market, or the
segments of the market served by us, will continue to grow in the future. See
"Item 7. Management Discussion and Analysis of Financial Condition and Results
of Operations."
12
OUR BUSINESS IS DEPENDENT ON THE SEMICONDUCTOR MARKET.
A significant portion of our net sales has been, and is expected to
continue to be, dependent upon sales of thermal management products for
industrial electronics applications, consisting primarily of integrated
circuits, and for computer and networking applications, consisting primarily of
microprocessors and related chip sets. The thermal management market for
computer and networking applications is characterized by rapid technological
change, short product life cycles, greater pricing pressure and increasing
foreign and domestic competition as compared to the thermal management market
for industrial electronics applications.
Future growth will, to a significant extent, depend upon increased demand
for semiconductor devices and products that require thermal solutions. The
semiconductor industry (both computer and networking and industrial) has
historically been cyclical and subject to significant economic downturns
characterized by diminished product demand and eroding average selling prices. A
decrease in demand for semiconductor products would reduce demand for our
products and have an adverse impact on our results of operations. Further, in
developing and designing new products, semiconductor manufacturers and their
customers 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.
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, 2004, 2003 and 2002, 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 decides 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."
13
WE SUPPLY PRODUCTS AND SERVICES TO INDUSTRIES THAT EXPERIENCE RAPID
TECHNOLOGICAL CHANGE, WHICH MAY MAKE OUR PRODUCTS OBSOLETE.
The markets for our products are characterized by rapidly changing
technology, frequent new product introductions and enhancements and rapid
product obsolescence. Our future success will be highly dependent upon our
ability to continually enhance or develop new thermal and software products,
materials, manufacturing processes and services in order to keep pace with the
technological advancements of our customers and their corresponding increasingly
complex thermal management and computational fluid dynamics software needs. We
may not be able to identify new product trends or opportunities, develop and
bring to market new products or respond effectively to new technological changes
or product announcements by others, develop or obtain access to advanced
materials, or achieve commercial acceptance of our products. In addition, other
companies, including our customers, may develop products or technologies which
render our products or technologies noncompetitive or obsolete.
WE FACE INTENSE COMPETITION, WHICH COULD ADVERSELY AFFECT OUR ABILITY TO
MAINTAIN OR INCREASE SALES OF OUR PRODUCTS.
The markets for thermal management products and computational fluid
dynamics software are highly competitive. Certain of our competitors, which
include divisions or subsidiaries of large companies, may have greater
technical, financial, research and development and marketing resources than we
do. Further, we expect that as the trend toward outsourcing continues, a number
of new competitors may emerge, some of which may have greater technical,
financial, research and development and marketing resources than we do. Our
ability to compete successfully depends upon a number of factors, including
price, customer acceptance of our products, cost effective high-volume
manufacturing, proximity to customers, lead times, ease of installation of our
products, new product and manufacturing process technology introductions by us
and our competitors, access to new technologies and general market and economic
conditions. We cannot provide assurance that we will be able to compete
successfully in the future against existing or potential competitors, or that
our operating results will not be adversely affected by increased price
competition. In addition, our customers for thermal management and software
products may manufacture or develop such products internally or actively support
new entrants into our market rather than purchase thermal products from us.
Further, many of our customers like to maintain dual sources for thermal
management products.
OUR BUSINESS EXPERIENCES SEASONAL VARIATIONS.
Our CFD software business has experienced and is expected to continue to
experience significant seasonality due to, among other things, the second and
third quarter slowdown in software billings primarily due to the purchasing and
budgeting patterns of Fluent's software customers. In addition, our thermal
management business has experienced slight seasonal variations due to the
slowdown during the third quarter's summer months which historically has
occurred in the electronics industry. Typically, our billings are lowest during
the second and third quarters of the fiscal year, which ends in December.
WE DEPEND ON KEY PERSONNEL AND SKILLED EMPLOYEES WHO MAY NOT REMAIN WITH US
IN THE FUTURE.
Our success depends to a large extent upon the continued services of our
senior management and technical personnel. Our business also depends upon our
ability to retain skilled and semi-skilled employees. There is intense
competition for qualified management and skilled and semi-skilled employees and
our failure to recruit, train and retain such employees could adversely affect
our business.
14
OUR INTERNATIONAL OPERATIONS EXPOSE US TO ADDITIONAL RISKS.
We currently have multiple international manufacturing locations to better
service our customers, many of whom have moved their manufacturing operations
and expanded their business overseas. International operations are subject to a
number of risks, including:
- greater difficulties in controlling and administering business;
- less familiarity with business customs and practices;
- increased reliance on key local personnel;
- the imposition of tariffs and import and export controls;
- changes in governmental policies (including U.S. policy toward these
countries);
- difficulties caused by language barriers;
- increased difficulty in collecting receivables;
- availability of, and time required for, the transportation of products
to and from foreign countries;
- political instability;
- foreign currency fluctuations; and
- expropriation and nationalization.
The occurrence of any of these or other factors may have a material adverse
effect on our results of operations and could have an adverse effect on our
relationships with our customers. Furthermore, the occurrence of certain of
these factors in countries in which we operate could result in the impairment or
loss of our investment in such countries. The trend by our customers to move
manufacturing operations and expand their business overseas may have an adverse
impact on our sales of domestically manufactured products.
A part of our net sales is currently derived from products manufactured at
our manufacturing facility in Guang Dong Province in The People's Republic of
China. We commenced manufacturing at this facility in early 1998 and currently
maintain approximately 140,000 square feet of manufacturing space. Because of
language and cultural differences, managing operations in China can be
difficult, and although we have focused significant management resources on this
operation, we cannot provide assurance that this business will be successful. An
inability to successfully manage this business or an interruption in the
operations at this facility could have a material adverse effect on our overall
financial performance until we are able to obtain substitute production
capability with similar low operating costs. We have additional manufacturing
facilities in North America and Europe.
As of the date of this filing, there has been significant speculation that
the People's Republic of China may elect to adjust the exchange rate of the
Chinese Yuan against the U.S. Dollar. While there have been no official
decisions made, or timetables established, current press reports indicate that
some form of revaluation may occur in 2005. Currently, the Chinese Yuan has a
fixed exchange rate against the U.S. dollar. Should China adjust the exchange
rate of the Yuan, or allow the value of the Yuan to float, it is possible that
this change could negatively impact our operation in China by making it more
expensive for us to do business there. A revaluation of the Yuan could also
result in foreign currency exchange gains or losses within our statement of
operations in 2005 or future periods. It is impossible, based on current facts
or circumstances, to estimate the impact on our business in 2005 or future
periods of a revaluation of the Chinese Yuan.
15
WE MAY BE UNABLE TO PROTECT OUR PROPRIETARY TECHNOLOGY.
Our success depends in part on our proprietary technology. We attempt to
protect our proprietary technology through patents, copyrights, trademarks,
trade secrets and license agreements. We believe, however, that our success will
depend to a greater extent upon innovation, technological expertise and
distribution strength. We cannot provide assurance that we will be able to
protect our technology, or that our competitors will not be able to develop
similar technology independently. We cannot provide assurance that the claims
allowed on any patents held by us will be sufficiently broad to protect our
technology. In addition, no assurance can be given that any patents issued to us
will not be challenged, invalidated or circumvented, or that the rights granted
thereunder will provide competitive advantages to us. In addition, effective
patent, copyright and trade secret protection may be unavailable or limited in
certain foreign countries in which we conduct business. Although we believe that
our products and technology do not infringe upon proprietary rights of others,
there can be no assurance that third parties will not assert infringement claims
in the future. Moreover, litigation may be necessary in the future to enforce
our patents, copyrights and other intellectual property rights, to protect our
trade secrets, to determine the validity and scope of the proprietary rights of
others, or to defend against claims of infringement or invalidity. Such
litigation could result in substantial costs and diversion of resources and
could have a material adverse effect on our financial condition and results of
operations.
WE ARE SUBJECT TO EXTENSIVE ENVIRONMENTAL AND OTHER REGULATIONS.
We are subject to a variety of United States and foreign environmental laws
and regulations, including those relating to the use, storage, treatment,
discharge and disposal of hazardous materials, substances and wastes used to
manufacture our products and remediation of soil and groundwater contamination.
Public attention has increasingly been focused on the environmental impact of
operations that use hazardous materials. Some of the environmental laws impose
strict, and in certain cases joint and several, liability for response costs at
contaminated properties on their owners or operators, or on persons who arranged
for the disposal of regulated materials at these properties. Our operations are
also governed by laws and regulations relating to workplace safety and worker
health, principally the Occupational Safety and Health Act and regulations
thereunder which, among other requirements, establish noise and dust standards.
We believe we are in material compliance with applicable environmental, health
and safety requirements. Our failure to comply with present or future laws or
regulations could result in substantial liability to us. We cannot predict the
nature, scope or effect of legislation or regulatory requirements that could be
imposed or how existing or future laws or regulations will be administered or
interpreted with respect to products or activities to which they have not
previously applied. Enactment of more stringent laws or regulations, as well as
more vigorous enforcement policies of regulatory agencies or discovery of
previously unknown conditions requiring remediation, could require substantial
expenditures by us and could adversely affect our results of operations.
RISKS RELATED TO OUR INDEBTEDNESS
OUR SUBSTANTIAL DEBT COULD ADVERSELY AFFECT OUR FINANCIAL CONDITION AND
PREVENT US FROM FULFILLING OUR OBLIGATIONS UNDER THE SENIOR SUBORDINATED
NOTES.
We have a substantial amount of debt. The following chart shows certain
important credit statistics:
AS OF DECEMBER 31, 2004
(DOLLARS IN THOUSANDS)
-----------------------
Total debt (including current portion)................ $138,467
Stockholders' deficit................................. (67,639)
Debt to stockholders' equity.......................... N/A
16
Our substantial indebtedness could have important consequences to holders
of our senior subordinated notes. For example, it could:
- make it difficult for us to satisfy our obligations with respect to
the senior subordinated notes and our obligations under our current
senior credit facility (the "Loan and Security Agreement");
- require us to dedicate a substantial portion of our cash flow from
operations to payments on our debt, which will reduce amounts
available for working capital, capital expenditures, research and
development and other general corporate purposes;
- limit our flexibility in planning for, or reacting to, changes in our
business and the industry in which we operate;
- increase our vulnerability to general adverse economic and industry
conditions;
- place us at a competitive disadvantage compared to our competitors
with less debt; and
- limit our ability to borrow additional funds.
The terms of the indenture governing our senior subordinated notes do not
fully prohibit us or our subsidiaries from incurring substantial additional debt
in the future. Our Loan and Security Agreement also permits additional
borrowing. All of the borrowings under our Loan and Security Agreement are
senior to the senior subordinated notes. If new debt is added to our current
debt levels, the related risks that we now face could intensify.
In addition, a portion of our debt, including debt incurred under our Loan
and Security Agreement, bears interest at variable rates. An increase in the
interest rates on our debt will reduce the funds available to repay the senior
subordinated notes and our other debt and for operations and future business
opportunities and will intensify the consequences of our leveraged capital
structure. See "Item 7. Management Discussion and Analysis of Financial
Condition and Results of Operations" for a description of our Loan and Security
Agreement and the senior subordinated notes.
TO SERVICE OUR DEBT, WE WILL REQUIRE A SIGNIFICANT AMOUNT OF CASH, WHICH
DEPENDS ON MANY FACTORS BEYOND OUR CONTROL.
Our ability to make payments on and to refinance our debt, including the
senior subordinated notes and the Loan and Security Agreement, will depend on
our ability to generate cash in the future. This, to an extent, is subject to
general economic, financial, competitive, legislative, regulatory and other
factors that are beyond our control.
We cannot provide assurance that our business will generate sufficient cash
flow or that future borrowings will be available to us in an amount sufficient
to enable us to pay our debt, including the senior subordinated notes, or to
fund our other liquidity needs. If our future cash flow from operations and
other capital resources are insufficient to pay our obligations as they mature
or to fund our liquidity needs, we may be forced to reduce or delay our business
activities and capital expenditures, sell assets, obtain additional equity
capital or restructure or refinance all or a portion of our debt, including the
senior subordinated notes, on or before maturity. We cannot assure noteholders
that we will be able to refinance any of our debt, including the senior
subordinated notes, on a timely basis or on satisfactory terms if at all. In
addition, the terms of our existing debt, including the senior subordinated
notes and the Loan and Security Agreement, and other future debt may limit our
ability to pursue any of these alternatives.
17
OUR LOAN AND SECURITY AGREEMENT AND THE INDENTURE IMPOSE OPERATIONAL AND
FINANCIAL RESTRICTIONS ON US.
Our Loan and Security Agreement and the indenture under which our senior
subordinated notes were issued include restrictive covenants that, among other
things, restrict our ability to:
- incur more debt;
- pay dividends and make distributions;
- issue stock of subsidiaries;
- make certain investments;
- repurchase stock;
- create liens;
- enter into transactions with affiliates;
- enter into sale-leaseback transactions;
- merge or consolidate; and
- transfer and sell assets.
Our Loan and Security Agreement also requires us to maintain financial
ratios. All of these restrictive covenants may restrict our ability to expand or
to pursue our business strategies. Our ability to comply with these and other
provisions of our indenture and Loan and Security Agreement may be affected by
changes in our business condition or results of operations, adverse regulatory
developments or other events beyond our control.
RISKS RELATED TO THE SENIOR SUBORDINATED NOTES
OUR CONTROLLING STOCKHOLDER, WILLIS STEIN, MAY HAVE INTERESTS THAT CONFLICT
WITH HOLDERS OF THE SENIOR SUBORDINATED NOTES.
We are a wholly owned subsidiary of Heat Holdings Corp., whose equity
securities are held by Willis Stein and some co-investors. Through its
controlling interest in Aavid and pursuant to the terms of the security holders'
agreement among the equity investors, Willis Stein has the ability to control
the operations and policies of Aavid. Circumstances may occur in which the
interests of Willis Stein, as the controlling equity holder, could be in
conflict with the interests of the holders of the senior subordinated notes. In
addition, the equity investors may have an interest in pursuing acquisitions,
divestitures or other transactions that, in their judgment, could enhance their
equity investment, even though such transactions might involve risks to the
holders of the senior subordinated notes.
THE SENIOR SUBORDINATED NOTES ARE CONTRACTUALLY SUBORDINATED IN RIGHT OF
PAYMENT TO OUR SENIOR DEBT.
The senior subordinated notes are senior subordinated obligations of Aavid
ranking junior to all of our existing and future senior debt, equal in right of
payment with all of our existing and future senior subordinated debt and senior
in right of payment to any of our subordinated debt. The senior subordinated
notes are contractually subordinated in right of payment to borrowings under our
Loan and Security Agreement.
18
As of December 31, 2004, we had $14.7 million of senior debt outstanding
under the Loan and Security Agreement, all of which was secured debt. The
indenture limits, and in some (but not all) instances prohibits, the incurrence
of additional debt.
In addition, all payments on the senior subordinated notes will be blocked
in the event of a payment default under the Loan and Security Agreement and may
be blocked for up to 179 consecutive days in any given year in the event of
non-payment defaults on senior debt. In the event of a default on the senior
subordinated notes and any resulting acceleration of the senior subordinated
notes, the holders of senior debt then outstanding will be entitled to payment
in full in cash of all obligations in respect of such senior debt before any
payment or distribution may be made with respect to the senior subordinated
notes.
In a bankruptcy, liquidation or reorganization or similar proceeding
relating to us, holders of the senior subordinated notes will participate with
trade creditors and all other holders of subordinated debt in the assets
remaining after we have paid all of the senior debt. However, because the
indenture requires that amounts otherwise payable to holders of the senior
subordinated notes in a bankruptcy or similar proceeding be paid to holders of
senior debt instead, holders of the senior subordinated notes may receive
proportionately less than holders of trade payables in any such proceeding. In
any of these cases, we cannot provide assurance that sufficient assets will
remain to make any payments on the senior subordinated notes.
WE ARE A HOLDING COMPANY AND OUR ONLY SOURCE OF CASH TO PAY INTEREST ON AND
THE PRINCIPAL OF THE SENIOR SUBORDINATED NOTES IS DISTRIBUTIONS FROM OUR
SUBSIDIARIES.
We are a holding company with no business operations of our own. Our only
significant asset is and will be our equity interests in our subsidiaries. We
conduct all of our business operations through our subsidiaries. Accordingly,
our only source of cash to make payments of interest on and principal of the
senior subordinated notes is distributions with respect to our ownership
interest in our subsidiaries from the net earnings and cash flows generated by
such subsidiaries.
WE MAY NOT HAVE THE ABILITY TO RAISE THE FUNDS NECESSARY TO FINANCE THE
CHANGE OF CONTROL OFFER REQUIRED BY THE INDENTURE.
If we undergo a "change of control," as defined in the indenture under
which the senior subordinated notes were issued, we must offer to buy back the
senior subordinated notes for a price equal to 101% of the principal amount,
plus interest that has accrued but has not been paid as of the repurchase date.
We cannot assure note holders that we will have sufficient funds available to
make the required repurchases of the senior subordinated notes in that event, or
that we will have sufficient funds to pay our other debts. In addition, our Loan
and Security Agreement prohibits us from repurchasing the senior subordinated
notes after a change of control until we have repaid in full our debt under such
credit facility. If we fail to repurchase the senior subordinated notes upon a
change of control, we will be in default under both the senior subordinated
notes and our Loan and Security Agreement. Any future debt that we incur may
also contain restrictions on repurchases in the event of a change of control or
similar event.
19
THE SENIOR SUBORDINATED NOTES AND THE GUARANTEES COULD BE VOIDED OR
SUBORDINATED TO OUR OTHER DEBT IF THE ISSUANCE OF THE SENIOR SUBORDINATED
NOTES OR THE GUARANTEES CONSTITUTED A FRAUDULENT CONVEYANCE.
If a bankruptcy case or lawsuit is initiated by our unpaid creditors, the
debt represented by the senior subordinated notes and the guarantees of the
senior subordinated notes by certain of our subsidiaries may be reviewed under
the federal bankruptcy laws and comparable provisions of state fraudulent
transfer laws. Under these laws, the debt could be voided, or claims in respect
of the senior subordinated notes and the guarantees could be subordinated to all
other debts of Aavid or its subsidiaries if, among other things, the court found
that, at the time we incurred the debt represented by the senior subordinated
notes and the subsidiaries incurred the debt represented by the guarantee, we or
any subsidiary:
- received less than reasonably equivalent value or fair consideration
for the incurrence of such debt; and
- were insolvent or rendered insolvent by reason of such incurrence; or
- were engaged in a business or transaction for which the remaining
assets constituted unreasonably small capital; or
- intended to incur, or believed that we or a subsidiary executing a
guarantee thereof would incur, debts beyond the ability to pay such
debts as they matured; or
- intended to hinder, delay or defraud creditors.
The measure of insolvency for purposes of fraudulent transfer laws varies
depending on the law applied. Generally, however, a debtor would be considered
insolvent if:
- the sum of its debts, including contingent liabilities, were greater
than the fair saleable value of all of its assets; or
- the present fair saleable value of its assets was less than the amount
that would be required to pay its probable liability on its existing
debts, including contingent liabilities, as they become absolute and
mature; or
- it could not pay its debts as they become due.
EFFECT OF ORIGINAL ISSUE DISCOUNT ON HOLDERS OF THE SENIOR SUBORDINATED
NOTES.
The senior subordinated notes are considered to have been issued with
original issue discount. Holders of the senior subordinated notes are required
to include the accretion of the original issue discount in gross income for U.S.
federal income tax purposes in advance of receipt of the cash payments to which
such income is attributable. If a bankruptcy case is commenced by or against us
under the United States Bankruptcy Code, the claim of a holder of senior
subordinated notes with respect to the principal amount thereof may be limited
to an amount equal to the sum of (i) the purchase price and (ii) that portion of
the original issue discount which has been amortized as of the date of any such
bankruptcy filing.
20
ITEM 2. PROPERTIES
Aavid Thermalloy has a total of approximately 480,000 square feet of
manufacturing space with locations in Laconia, New Hampshire; Monterrey, Mexico;
the United Kingdom; Italy; China; and Toronto, Canada. We employ a broad range
of aluminum and copper fabrication and processing capabilities. Manufacturing
operations consist of cutting, stamping, machining, joining, brazing, soldering,
assembling and finishing, including anodizing capabilities. We have a
substantial in-house tool and die capability that enables us to create our own
extrusion and progressive stamping dies and other production tooling. A key
element of our business strategy has been to expand internationally. Many of our
customers have short product cycles that demand facilities to support
quick-ramp, high-volume, high-quality manufacturing at their geographically
dispersed manufacturing locations. We plan to continue to build or acquire
additional manufacturing facilities overseas and/or expand supplier
relationships to better service our customers, many of whom have moved
manufacturing operations and expanded their business overseas. Fluent's total
sales, marketing, development, and support facilities consist of approximately
237,000 square feet.
There can be no assurance that our expansion of our foreign operations will
be successful. Foreign operations are subject to a number of risks including:
work stoppages; transportation delays and interruptions; expropriation;
nationalization; misappropriation of intellectual property; imposition of
tariffs, foreign currency fluctuations and import and export controls; changes
in governmental policies (including U.S. policy toward these countries); and
other factors which could have an adverse effect on our business. In addition,
we may be subject to risks associated with the availability of, and time
required for, the transportation of products to and from foreign countries. The
occurrence of any of these factors may delay or prevent the delivery of goods
ordered by customers, and such delay or inability to meet customers'
requirements would have a materially adverse effect our results of operations
and could have an adverse effect on the our relationships with our customers.
Furthermore, the occurrence of certain of these factors in countries where we
own or operate manufacturing facilities could result in the impairment or loss
of our investment in such countries.
We currently operate in the following locations:
U.S. LOCATIONS PRINCIPAL ACTIVITY
- -------------- ------------------
Concord, NH............................. Corporate Offices, Aavid Thermalloy Corporate Offices
Chicago, IL............................. Fluent-Software Development, Sales and Marketing
Dallas, TX.............................. Aavid Thermalloy -Sales and Marketing
Laconia, NH............................. Aavid Thermalloy-Manufacturing
Lebanon, NH............................. Fluent-Software Development, Sales and Marketing
Santa Clara, CA......................... Fluent-- Software Sales and Marketing; Applied Thermal
Technologies-Research and Development and Consulting
Morgantown, WV.......................... Fluent-Research and Development and Consulting
Ann Arbor, MI........................... Fluent-Software Sales and Marketing
INTERNATIONAL LOCATIONS PRINCIPAL ACTIVITY
- ----------------------- ------------------
Toronto, Canada......................... Aavid Thermalloy-Manufacturing
Monterrey, Mexico....................... Aavid Thermalloy-Manufacturing
Darmstadt, Germany...................... Fluent-Software Sales and Marketing
Swindon, U.K............................ Aavid Thermalloy-Manufacturing
Sheffield, U.K.......................... Fluent-Software Development, Sales and Marketing
Bologna, Italy.......................... Aavid Thermalloy-Manufacturing
Le Bretonneaux, France.................. Fluent-Software Sales and Marketing
Guang Dong Prov., PRC................... Aavid Thermalloy-Manufacturing
Singapore............................... Aavid Thermalloy-Sales and Marketing
Taipei, Taiwan.......................... Aavid Thermalloy-Sales and Marketing
Pune, India............................. Fluent-Software Development, Sales and Marketing;
Applied Thermal Technologies-Research and Development and Consulting
Tokyo, Japan............................ Fluent-Software Development, Sales and Marketing
Milan, Italy............................ Fluent-Software Sales and Marketing
Goteborg, Sweden........................ Fluent-Software Sales and Marketing
Brussels, Belgium....................... Fluent-Software Development, Sales and Marketing
Shanghai, China......................... Fluent-Software Development, Sales and Marketing
21
ITEM 3. LEGAL PROCEEDINGS
We are involved in various 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. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS.
MARKET PRICES OF AAVID COMMON STOCK
Our Common Stock traded on the Nasdaq National Market under the symbol
"AATT" until February 2, 2000, the date we were acquired by Heat Holdings. As a
result of the merger, our Common Stock is no longer publicly traded.
We have never paid a cash dividend on our Common Stock, and we currently
intend to retain all earnings for use in our business and do not anticipate
paying cash dividends in the foreseeable future. Our current Loan and Security
Agreement and senior subordinated notes indenture contain restrictive covenants
which, among other things, impose limitations on the payment of dividends.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA(1)
The following tables set forth selected statement of operations and balance
sheet data derived from the consolidated financial statements of the Company and
the Predecessor for the periods indicated. The following tables should be read
in conjunction with "Management Discussion and Analysis of Financial Condition
and Results of Operations," the Consolidated Financial Statements, and related
Notes thereto 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.
22
THE PERIOD
JANUARY 1, THE PERIOD
2000 FEBRUARY 2,
THROUGH THROUGH YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED
FEBRUARY 1, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
2000(1) 2000(1) 2001(1) 2002(1) 2003(1) 2004(1)
------------- ------------- ------------- ------------- ------------- -------------
(PREDECESSOR) (THE COMPANY) (THE COMPANY) (THE COMPANY) (THE COMPANY) (THE COMPANY)
STATEMENT OF OPERATIONS DATA:
(AMOUNTS IN THOUSANDS)
Net sales $22,437 $253,414 $ 170,892 $161,942 $188,167 $227,131
Cost of goods sold 14,879 166,801 124,000 88,532 97,061 112,232
------- -------- --------- -------- -------- --------
Gross profit 7,558 86,613 46,892 73,410 91,106 114,899
Selling, general and administrative
expenses 4,952 92,849 92,742 58,835 62,565 68,924
Research and development 631 8,495 10,775 12,492 15,004 16,658
Intangible asset impairment charge(2) -- -- 115,210 -- -- --
Restructuring charge (credit)(3) -- -- 16,885 858 (90) (6)
Loss on sale of division(4) -- -- 4,322 -- -- --
Acquired in-process research and
development(5) -- 15,000 -- -- -- --
------- -------- --------- -------- -------- --------
Income (loss) from continuing
operations 1,975 (29,731) (193,042) 1,225 13,627 29,323
Interest expense, net (816) (23,136) (22,217) (20,141) (18,137) (17,940)
Other income (expense), net 68 (1,012) 1,098 453 2,483 1,077
------- -------- --------- -------- -------- --------
Income (loss) from continuing
operations before income
taxes and minority interest 1,227 (53,879) (214,161) (18,463) (2,027) 12,460
Benefit (provision) for income taxes (533) (5) 10,959 (817) (1,627) (4,807)
------- -------- --------- -------- -------- --------
Income (loss) from continuing
operations before minority interest 694 (53,884) (203,202) (19,280) (3,654) 7,653
Minority interest -- 1,519 3,294 -- -- --
------- -------- --------- -------- -------- --------
Income (loss) from continuing
operations 694 (52,365) (199,908) (19,280) (3,654) 7,653
Income (loss) from discontinued
operations, net (including gain
on disposal of $7,082 in 2002)(6) (69) 1,040 1,445 6,725 -- --
------- -------- --------- -------- -------- --------
Net income (loss)(7) $ 625 $(51,325) $(198,463) $(12,555) $ (3,654) $ 7,653
======= ======== ========= ======== ======== ========
BALANCE SHEET DATA AT YEAR END:
Working capital $ 37,359 $(152,980) $ (19,359) $(18,276) $(12,751)
Total assets 386,288 175,294 139,052 145,693 171,690
Total long term debt, including
current portion 204,002 175,832 139,450 138,810 138,467
Stockholders' (deficit) equity 100,160 (70,888) (70,416) (75,331) (67,639)
23
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, 2004, 2003, 2002, 2001 and 2000, and the
consolidated results of operations of the Company for the years ended
December 31, 2004, 2003, 2002, 2001, and the period February 2, 2000
through December 31, 2000 and of the Predecessor for the period from
January 1, 2000 to February 1, 2000. The Predecessor financial statements
have been prepared using the historical cost of the Company's assets and
have not been adjusted to reflect the merger with Heat Holdings Corp. on
February 2, 2000. The accompanying financial data as of and for the years
ended December 31, 2004, 2003, 2002, 2001 and as of December 31, 2000 and
for the period from February 2, 2000 to December 31, 2000 reflect the
consolidated financial position and results of operations of the Company
subsequent to the date of the merger and include adjustments required under
the purchase method of accounting.
(2) In the fourth quarter of 2001 and in accordance with SFAS 121, we recorded
an impairment charge related to goodwill and intangible assets acquired in
connection with the Merger.
(3) Represents the credit in 1999 of $630 related to the reversal of excess
restructuring reserves which were no longer required upon the completion of
the Manchester restructuring in the fourth quarter of 1999. Restructuring
charges of $16,885 in 2001 were recorded in connection with the cessation
of manufacturing activities at the Dallas, Texas, Terrell, Texas and
Loudwater, United Kingdom facilities, reduction of the New Hampshire
workforce and reduction of China workforce including closure of the fan
factory and write-off of associated fixed assets. Restructuring charges of
$858 in 2002 were recorded in the fourth quarter of 2002 in connection with
the reduction in workforce and cessation of manufacturing activities in
Singapore and Malaysia. Restructuring credit of $90 in 2003 and $6 in 2004
consists of excess accruals originally recorded in Singapore that were
reversed once actual restructuring activities were concluded in 2003 and
2004.
(4) Represents loss realized on sale of Franklin, New Hampshire extrusion plant
that occurred in the fourth quarter of 2001.
(5) 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) On July 17, 2002, the Company sold all of the outstanding shares of Aavid
Thermalloy Holdings, GmbH, which in turn owned approximately 89.5% of the
outstanding shares of curamik electronics GmbH, pursuant to a Share Sale
and Purchase Agreement between the Company and Electrovac Fabrikation
Electrotechnischer Spezialartikel GesmbH dated July 10, 2002 (the "Sale
Agreement"). The sale of Curamik and its related operating results have
been excluded from income (losses) from continuing operations and is
classified as a discontinued operation for all periods presented, in
accordance with the requirements of Statement of Financial Accounting
Standards (SFAS) No. 144 "Accounting for Impairment or Disposal of
Long-Lived Assets".
(7) Because the Company's common stock is not publicly traded, earnings per
share information is not presented.
24
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 AND EXECUTIVE SUMMARY
We are a leading global provider of thermal management solutions for
electronic products and the leading developer and marketer of CFD software.
Prior to February 2, 2000 we were a publicly traded company, listed on the
NASDAQ National Market under the trading symbol "AATT". Since February 2, 2000,
we have been a privately held company, owned by Heat Holdings Corp., a
corporation formed by Willis Stein and other investors. Our acquisition by
Willis Stein was accounted for under the purchase method of accounting and was
financed through a combination of 12 3/4% senior subordinated notes and senior
bank debt.
We are organized as two operating units 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. These two business units, while complementary,
are quite different from each other and as a result, Aavid Thermalloy and Fluent
will be discussed separately when analyzing performance and industry trends.
Aavid Thermalloy is a global manufacturing business. Revenues are generated
through the sale of fabricated and purchased thermal management products and
components. Our thermal management products are used in a wide variety of
computer, 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 primary raw
materials include extruded aluminum and copper and our business can be greatly
affected by changes in the prices of aluminum and copper. We have manufacturing
operations in the U.S., Canada, Mexico, U.K., Italy and China. Additionally, we
have several other sales offices throughout the world. The electronics industry
in which Aavid Thermalloy operates is very cost competitive. We compete in this
market by manufacturing many of our products in low cost regions, such as China
and Mexico. We also compete by offering state of the art engineering and design
services to our customers to assist them in solving difficult and complex
thermal management problems. These design services are carried out or assisted
through our specialized engineering and design consulting offices in New
Hampshire, California and India. We partner very closely with many of our
customers in the design phase of product development in order to assist in
prototype development and to develop relationships that allow us to maintain a
strong position as a primary supplier for new products. The operating
environment for Aavid Thermalloy over the past several years has been very
difficult due to the global economic slowdown experienced by the electronics
industry. We have adjusted to the slowdown through significant cost cutting and
consolidation of manufacturing operations that have occurred over the period of
2000 through 2002. By the end of 2002, we had completed our restructuring
efforts and achieved an appropriate cost structure to support the current market
environment. In 2004, Aavid Thermalloy achieved revenue growth of over 20% when
compared with 2003 while keeping our operating expenses as a percentage of
revenue below 2003 levels, allowing us to significantly improve cash flows.
25
Fluent's 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. Fluent's
software is used in a variety of industries including, among others, the
automotive, aerospace, chemical processing, power generation, material
processing, electronics and HVAC industries. Fluent develops and markets their
CFD software products worldwide and currently maintains sales, support and
design centers in North America, Europe and Asia. Fluent markets their product
using two different licensing options. Annual licenses, which make up the
majority of the overall licenses sold, allow the user to use the software and
obtain support and other services for a period of one year. Each year the entire
license must be renewed or the software can no longer be used. Perpetual
licenses allow the customer to use the software for life, however, in order to
continue to receive support, upgrades etc, the customer must purchase an annual
maintenance contract. Revenue from annual licenses (and the bundled maintenance)
is recognized ratably over the term of the license. However, in most cases, the
entire fee for the license and maintenance is billed and collected at the
beginning of the contract period. Software license revenue for perpetual
licenses is recognized immediately upon the signing of the contract and delivery
of the software, while the related maintenance revenue is recognized ratably
over the term of the maintenance agreement. Similar to the annual licenses, the
entire perpetual license and related maintenance contracts are billed and
collected at the beginning of the contract term. Historically, Fluent has
achieved an annual contract renewal rate of greater than 80% and overall annual
revenue growth of better than 19% each of the last two years. The nature of
Fluent's products allow for a very consistent recurring revenue base and
associated cash flows. Fluent is one of the larger companies within the CFD
market space. Fluent has achieved consistent growth by penetrating new
industries and also by achieving greater penetration within companies in
existing industries. In the past, CFD software was a generalized software that
required complex customization to be adapted for use within a particular
industry. As a result, the primary user base was limited to upper level PhD
caliber engineers. In the past few years, Fluent has worked to develop industry
specific tools that come with many pre-loaded templates that simplify the
overall use of the CFD software. This has opened up the use of CFD software to a
much broader range of customer employee skill sets and therefore has allowed
Fluent to sell more seat licenses per customer. This strategy is ultimately
leading to a much greater penetration of customer R&D departments. In 2004,
Fluent achieved revenue growth of over 20% when compared with 2003, while
keeping operating expenses as a percentage of revenues below 2003 levels,
allowing us to improve cash flows.
Both Fluent and Aavid Thermalloy have significant operations outside the
United States. As a result, financial performance can be affected by changes in
foreign currency exchange rates.
As of the date of this filing, there has been significant speculation that
the People's Republic of China may elect to adjust the exchange rate of the
Chinese Yuan against the U.S. Dollar. While there have been no official
decisions made, or timetables established, current press reports indicate that
some form of revaluation is likely in 2005. Currently, the Chinese Yuan has a
fixed exchange rate against the U.S. dollar. Should China adjust the exchange
rate of the Yuan, or allow the value of the Yuan to float, it is possible that
this change could negatively impact our operation in China by making it more
expensive for us to do business there. A revaluation of the Yuan could also
result in foreign currency exchange gains or losses within our statement of
operations in 2005 or future periods. It is impossible, based on current facts
or circumstances, to estimate the impact on our business in 2005 or future
periods of a revaluation of the Chinese Yuan.
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.
26
YEAR ENDED DECEMBER 31,
-----------------------
2002 2003 2004
----- ----- -----
Net sales............................................ 100.0% 100.0% 100.0%
Cost of goods sold................................... 54.7 51.6 49.4
----- ----- -----
Gross profit...................................... 45.3 48.4 50.6
Selling, general and administrative expenses......... 36.3 33.2 30.4
Research and development............................. 7.7 8.0 7.3
Restructuring charge................................. 0.5 -- --
----- ----- -----
Income from continuing operations................. 0.8 7.2 12.9
Interest expense, net................................ (12.4) (9.6) (7.9)
Other income, net.................................... 0.2 1.3 0.5
----- ----- -----
Income (loss) from continuing operations
before income taxes............................ (11.4) (1.1) 5.5
Provision for income taxes........................... (0.5) (0.8) (2.1)
----- ----- -----
Income (loss) from continuing operations
before income taxes............................ (11.9) (1.9) 3.4
Income from discontinued operations, net............. 4.1 -- --
----- ----- -----
Net income (loss)................................. (7.8)% (1.9)% 3.4%
===== ===== =====
2004 COMPARED WITH 2003
YEAR ENDED
DECEMBER 31,
---------------
NET SALES (DOLLARS IN MILLIONS) 2003 2004 CHANGE
------------------------------- ------ ------ ------
Computer, Networking and Industrial Electronics...... $100.5 $121.6 21.0%
Consulting and Design (Applied)...................... 1.1 1.1 --
------ ------ ----
Total Aavid Thermalloy............................ 101.6 122.7 20.8%
Total Fluent...................................... 86.5 104.3 20.6%
Total Enductive Solutions......................... 0.1 0.1 --
------ ------ ----
Total Aavid Thermal Technologies.................. $188.2 $227.1 20.7%
====== ====== ====
Net sales for 2004 were $227.1 million, an increase of $39.0 million, or
20.7%, compared with $188.2 million for 2003. The overall increase in sales was
a combination of increasing revenues at both Aavid Thermalloy and Fluent as well
as the benefit received due to the significant weakening of the U.S. Dollar
versus foreign currencies, including the Euro, British Pound, and Canadian
Dollar, that occurred over the course of 2004. Had 2004 revenues in local
currencies been translated at the average exchange rates in effect during 2003,
revenues would have been $8.7 million dollars lower.
Aavid Thermalloy's net sales were $122.7 million for 2004, an increase of
$21.1 million, or 20.8%, compared with $101.6 million for 2003. Excluding
foreign exchange rate fluctuations from year to year, the increase was primarily
the result of a moderate improvement in the semiconductor and electronics
industries in 2004, as well as an improvement in the Company's market share
position.
Fluent's net sales were $104.3 million for 2004, an increase of $17.8
million, or 20.6%, over 2003 sales of $86.5 million. Excluding foreign exchange
rate fluctuations from year to year, the increase was primarily due to an
overall increase in sales across all of Fluent's offerings.
International net sales (which include North American exports) increased to
56.4% of net sales for the year ended December 31, 2004 as compared with 53.1%
for the year ended December 31, 2003.
27
Our gross profit in 2004 was $114.9 million, an increase of $23.8 million,
or 26.1% higher than 2003 gross profit of $91.1 million. Our gross margin in
2004 was 50.6%, which compares with 48.4% in 2003. Aavid Thermalloy saw
continued improvement in gross profit and gross margin in 2004. This is
attributable to improved cost efficiencies in manufacturing and supply chain
operations. Additionally, Fluent's revenue and gross profit remained a large
percentage of the Company's overall revenue and gross profit in 2004. As
Fluent's gross margin tends to be much greater than the gross margin of Aavid
Thermalloy, the high percentage of Fluent revenue to overall Company revenues
also serves to increase the overall gross margin of the Company.
Our selling, general and administrative expenses, excluding amortization of
intangibles, were $68.1 million, or 30.0% of sales for 2004, as compared with
$59.1 million, or 31.4% of net sales, for 2003. Aavid Thermalloy's 2004 S,G&A
expenses were up $1.4 million from 2003 levels, although such costs decreased as
a percentage of net sales. Fluent's 2004 S,G&A increased $7.5 million from 2003
levels as Fluent continued to enhance its sales and support infrastructure to
support its revenue growth. Lastly, the Company's corporate offices experienced
a $0.2 million increase in administrative costs.
Intangible asset amortization of $0.9 million was recorded in 2004 compared
with $3.5 million recorded in 2003, a decrease of $2.6 million. This
amortization is primarily related to intangible assets established as part of
the acquisition of Aavid by Heat Holdings Corp. The decrease in amortization is
due primarily to Fluent's developed technology intangible asset becoming fully
amortized in January 2004, while 2003 had a full year of amortization expense
related to this intangible asset.
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
$16.7 million, or 7.3% of net sales, which compares with $15.0 million, or 8.0%
of net sales, in 2003. The increase in research and development expense was
primarily due to increased expenditures at Fluent in connection with the
development of next generation software.
Our income from continuing operations in 2004 was $29.3 million, an
increase of $15.7 million over 2003 income from continuing operations of $13.6
million. Aavid Thermalloy, excluding intangible asset amortization and
restructuring costs, had operating income of $5.4 million in 2004 compared with
an operating loss of $0.2 million in 2003. This improvement stemmed primarily
from the Aavid Thermalloy's ability to increase its sales and gross profit in
2004, while holding S,G&A costs in line with 2003 levels. Fluent's operating
income, excluding intangible asset amortization, increased to $25.3 million in
2004, compared with an operating income of $17.7 million in 2003. Fluent
experienced an increase in operating profit primarily due to its ability to hold
S,G&A growth to a lower rate than the growth rate seen in revenue and gross
profit.
Our foreign exchange gains were $0.9 million in 2004 compared with $2.5
million in 2003. Foreign exchange gains occurred in 2004 due to the continued
weakening of the U.S. Dollar versus the Euro, British Pound, and Canadian Dollar
experienced over the last two years. Aavid Thermalloy and Fluent have
significant long-term inter-company notes due to certain U.S. locations from
certain foreign locations. These inter-company notes are the primary contributor
to the foreign exchange gains recorded in 2004 and 2003. Should the U.S. dollar
strengthen in 2005, it is likely that the Company will realize foreign currency
losses associated with these inter-company notes.
Our net interest charges were $17.9 million in 2004, compared with $18.1
million in 2003 as interest rates in 2004 remained at levels comparable to 2003,
while overall debt levels remained relatively flat from year to year.
28
The Company recorded a tax provision of $4.8 million in 2004 compared to a
tax provision of $1.6 million in 2003. The Company incurred a tax provision in
2003 despite having significant operating losses because of state tax provisions
on applicable state components of U.S. income and foreign tax provisions on
foreign earnings. We recorded a tax provision on foreign earnings which are
expected to be repatriated into the U.S. to service debt. Because the Company is
in a net operating loss carryforward position for U.S. tax purposes, the Company
will not receive any tax benefit from foreign tax credits. These repatriated
earnings will, therefore, incur both foreign income taxes and U.S. income taxes,
effectively doubling up the tax rate on the foreign earnings. The significant
net operating loss carryforwards in the U.S. will help offset the actual cash
paid for taxes in the U.S. when the foreign earnings are repatriated.
The Company's EBITDA, as defined in the Loan and Security Agreement with
the Company's senior lenders, was $44.4 million in 2004 compared with $35.7
million in 2003. EBITDA is a non-GAAP financial measure that the Company
believes is relevant to potential readers of our financial statements as it is
the primary measure of performance and compliance with financial covenants
utilized by our lenders. A reconciliation of net income to EBITDA is as follows:
FOR THE YEAR ENDED
---------------------------
DECEMBER 31, DECEMBER 31,
(DOLLARS IN MILLIONS) 2004 2003
--------------------- ------------ ------------
Net income (loss)................................. $ 7.7 $(3.7)
Cash interest expense............................. 16.5 16.7
Bond discount amortization........................ 0.8 0.7
Deferred financing fee amortization............... 1.0 1.0
Provision for income taxes........................ 4.8 1.6
Depreciation...................................... 7.3 8.0
Intangible asset amortization..................... 0.8 3.5
Deferred revenue change during period (1) ........ 5.5 7.8
Loss on disposal of fixed assets.................. 0.0 0.2
Restructuring charges(credits) ................... -- (0.1)
----- -----
EBITDA............................................ $44.4 $35.7
===== =====
(1) Change in deferred revenue as defined in the Loan and Security Agreement
represents the net change in deferred revenue found on the Company's
balance sheet from the beginning of the applicable reporting period to the
end of the applicable reporting period. An increase in deferred revenue
during the period will increase EBITDA. A decrease in deferred revenue
during the period will decrease EBITDA, as defined.
2003 COMPARED WITH 2002
YEAR ENDED
DECEMBER 31,
---------------
NET SALES (DOLLARS IN MILLIONS) 2002 2003 CHANGE
------------------------------- ------ ------ ------
Computer, Networking and Industrial Electronics... $ 88.3 $100.5 13.8%
Consulting and Design (Applied)................... 1.3 1.1 (15.4)%
------ ------ -----
Total Aavid Thermalloy......................... 89.6 101.6 13.4%
Total Fluent................................... 72.2 86.5 19.7%
Total Enductive Solutions...................... 0.1 0.1 --
------ ------ -----
Total Aavid Thermal Technologies............... $161.9 $188.2 16.2%
====== ====== =====
Net sales for 2003 were $188.2 million, an increase of $26.3 million, or
16.2%, compared with $161.9 million for 2002. The overall increase in sales was
a combination of increasing revenues at both Aavid Thermalloy and Fluent as well
as the benefit received due to the significant weakening of the U.S. Dollar
versus foreign currencies, including the Euro, British Pound, and Canadian
Dollar, that occurred over the course of 2003. Had 2003 revenues in local
currencies been translated at the exchange rates in effect during 2002, revenues
would have been $9.4 million dollars lower.
Aavid Thermalloy's net sales were $101.6 million for 2003, an increase of
$12.0 million, or 13.4%, compared with $89.6 million for 2002. Excluding foreign
exchange rate fluctuations from year to year, the
29
increase was primarily the result of a moderate improvement in the semiconductor
and electronics industries in 2003, as well as an improvement in the Company's
market share position.
Fluent's net sales were $86.5 million for 2003, an increase of $14.3
million, or 19.8%, over 2002 sales of $72.2 million. Excluding foreign exchange
rate fluctuations from year to year, the increase was primarily due to an
overall increase in sales across all of Fluent's offerings.
International net sales (which include North American exports) increased to
53.1% of net sales for the year ended December 31, 2003 as compared with 50.3%
for the year ended December 31, 2002.
Our gross profit in 2003 was $91.1 million, an increase of $17.7 million,
or 24.1% higher than 2002 gross profit of $73.4 million. Our gross margin in
2003 was 48.4%, which compares with 45.3% in 2002. Aavid Thermalloy saw a
significant improvement in gross profit and gross margin in 2003 primarily due
to the restructuring activities that occurred over the prior two years.
Additionally, Fluent's revenue and gross profit continued to become a larger
percentage of the overall Company's revenue and gross profit in 2003. As
Fluent's gross margin tends to be much greater than the gross margin of Aavid
Thermalloy, the increase of Fluent as a percentage of overall Company revenues
also serves to increase the overall gross margin of the Company.
Our selling, general and administrative expenses, excluding amortization of
intangibles, were $59.1 million, or 31.4% of sales for 2003, as compared with
$55.4 million, or 34.2% of net sales, for 2002. Aavid Thermalloy's 2003 S,G&A
expenses were down $0.6 million from 2002 levels primarily due to a Company wide
effort to maintain costs consistent with 2002 levels. Fluent's 2003 S,G&A
increased $5.9 million from 2002 levels as Fluent continued to enhance its sales
and support infrastructure to support its revenue growth. Lastly, the Company's
corporate offices experienced a $1.6 million decrease in administrative costs
primarily related to lower legal and accounting costs incurred in 2003. In 2002,
the Company incurred higher than normal legal and accounting costs associated
with debt refinancings, re-audits of prior years due to the dissolution of the
Company's previous audit firm, Arthur Andersen, and foreign corporate
reorganizations.
Intangible asset amortization of $3.5 million was recorded in 2003 compared
with $3.4 million recorded in 2002. This amortization is primarily 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
$15.0 million, or 8.0% of net sales, which compares with $12.5 million, or 7.7%
of net sales, in 2002. The increase in research and development expense was
primarily due to increased expenditures at Fluent in connection with the
development of next generation software.
Our income from continuing operations in 2003 was $13.6 million, an
increase of $12.4 million over 2002 income from continuing operations of $1.2
million. Aavid Thermalloy, excluding intangible asset amortization and
restructuring costs, had an operating loss of $0.2 million in 2003 compared with
an operating loss of $6.2 million in 2002. This improvement stemmed primarily
from the Aavid Thermalloy's ability to increase its sales and gross profit in
2003, while holding S,G&A costs in line with 2002 levels. Fluent's operating
income, excluding intangible asset amortization, increased to $17.7 million in
2003, compared with an operating income of $14.1 million in 2002. Fluent
experienced an increase in operating profit primarily due to its ability to hold
S,G&A growth to a lower rate than the growth rate seen in revenue and gross
profit.
Our foreign exchange gains were $2.5 million in 2003 compared with $0.5
million in 2002. Foreign exchange gains increased primarily due to the
significant weakening of the U.S. Dollar versus the Euro, British Pound, and
Canadian Dollar that occurred over the course of 2003. Aavid Thermalloy and
Fluent have significant long-term inter-company notes due to certain U.S.
locations from certain foreig