10-Q 1 b44470aae10vq.txt AAVID THERMAL TECHNOLOGIES, INC. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 28, 2002 COMMISSION FILE NO. 000-27308. AAVID THERMAL TECHNOLOGIES, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) DELAWARE 02-0466826 ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) ONE EAGLE SQUARE, SUITE 509, CONCORD, NH 03301 --------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (603) 224-1117 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [ ] Aggregate market value of the Registrant's common stock held by non-affiliates: N/A. The number of outstanding shares of the registrant's Common Stock as of November 12, 2002 was 1,019 shares of Class A, 1,079 shares of Class B and 40 shares of Class H, all of which are owned by Heat Holdings Corp. The Registrant's Common Stock is no longer publicly traded; however, the Registrant's Senior Subordinated Notes are publicly traded. AAVID THERMAL TECHNOLOGIES, INC. INDEX TO FORM 10-Q PAGE Part I. Financial Information Item 1. Financial Statements a.) Consolidated Balance Sheets as of September 28, 2002 and December 31, 2001......................................... 3 b.) Consolidated Statements of Operations for the quarter and nine months ended September 28, 2002 and the quarter and nine months ended September 29, 2001.................. 4 c.) Consolidated Statements of Cash Flows for the nine months ended September 28, 2002 and September 29, 2001.... 5 d.) Notes to Consolidated Financial Statements................ 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................... 21 Part II. Other Information Item 1. Legal Proceedings................................................. 32 Item 5. Other Information................................................. 32 Item 6. Exhibits and Reports on Form 8-K.................................. 32 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED)

The accompanying notes are an integral part of these consolidated financial statements. 3 AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS) (UNAUDITED)

The accompanying notes are an integral part of these consolidated financial statements. 4 AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)

The accompanying notes are an integral part of these consolidated financial statements. 5 AAVID THERMAL TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA) (1) ORGANIZATION AND MERGER Aavid Thermal Technologies, Inc. (the "Company" or "Aavid") is a leading global provider of thermal management solutions for electronic products and the leading developer and marketer of Computational Fluid Dynamics (CFD) software. On February 2, 2000, the Company was acquired by Heat Holdings Corp., a corporation newly formed by Willis Stein & Partners II, L.P. (the "Merger"). Pursuant to the Merger, Aavid stockholders received $25.50 in cash for each outstanding share of common stock. In addition, all outstanding stock options and warrants were cashed out. The Merger was accounted for using the purchase method. The Merger and related transaction costs were funded by a cash contribution from Heat Holdings and an affiliate of $152,000, proceeds of $148,312, net of original issue discount, from the sale by the Company of 12 3/4% senior subordinated notes and warrants due 2007, $54,700 pursuant to a new credit facility entered into by the Company, and approximately $4,653 of cash on hand. Additionally, the Company used $7,085 of cash on hand to pay financing fees associated with the senior credit facility and 12 3/4% senior subordinated notes. Net assets on the date of acquisition were $156,560. Based upon fair value of assets acquired and liabilities assumed, goodwill of $183,676 was established. Approximately $113,705 of this goodwill is attributable to Aavid Thermalloy, the hardware business, and was being amortized over 20 years through December 31, 2001. The remainder, $69,971, is attributable to Fluent, the CFD software business, and was being amortized over 4 years through December 31, 2001. During the fourth quarter of 2001, the Company wrote off the goodwill attributable to Aavid Thermalloy after performing a review for impairment under Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." The impairment charge recorded in the fourth quarter of 2001 related to the goodwill attributable to Aavid Thermalloy was $94,233. The Company adopted SFAS 142, "Goodwill and Other Intangible Assets," on January 1, 2002. Under the provisions of SFAS 142, the remaining goodwill attributable to Fluent is no longer amortized, but instead will be tested for impairment at least annually. Of the $152,000 cash contribution, $4,811 was invested by Heat Holdings II Corp., an affiliate of Heat Holdings, to acquire 95% of the common equity of Aavid Thermalloy, LLC, the thermal management hardware business. The Company controls Aavid Thermalloy, LLC through a preferred equity interest and holds a 5% common equity interest and thus consolidates Aavid Thermalloy LLC in its results within the accompanying financial statements. The investment by Heat Holdings II Corp. has been recorded as minority interests within the accompanying financial statements. On February 2, 2000, as part of the transactions relating to the Merger, the Company issued 150,000 units (the "Units"), consisting of $150,000 aggregate principal amount of its 12 3/4% Senior Subordinated Notes due 2007 (the "Notes") and warrants (the "Warrants") to purchase an aggregate of 60 shares of the Company's Class A Common Stock, par value $0.0001 per share, and 60 shares of the Company's Class H Common Stock, par value $0.0001 per share. The Notes are fully and unconditionally guaranteed on a joint and several basis by each of the Company's domestic subsidiaries (the "Subsidiary Guarantors") (see note 12 for selected consolidating financial statements of parent, guarantors and non-guarantors). The Notes were issued pursuant to an Indenture (the "Indenture") among the Company, the Subsidiary Guarantors and Bankers Trust Company, as trustee. $4,560 of the proceeds from the sale of the Units was allocated to the fair value of the Warrants and $143,752 was allocated to the Notes, net of original issue discount of $1,688. The total discount of $6,248 is being accreted over the term of the notes, using the effective interest rate method. This accretion is recorded as interest expense within the accompanying statement of operations for the quarters and nine months ended September 28, 2002 and September 29, 2001. In connection with the Merger, the Company repaid all of the outstanding term loan and revolving line of credit under its then existing credit facility, which aggregated approximately $88,200 at December 31, 1999, and entered into an amended and restated credit facility (the "Amended and Restated Credit Facility"). The Amended and Restated Credit Facility provided for a $22,000 revolving credit facility (the "Revolving Facility") (of which $1,700 was drawn at the closing of the Merger) and a $53,000 term loan facility (the "Term Facility") (which was fully drawn at the closing of the Merger). Subject to compliance with the terms of the Amended and Restated Credit Facility, borrowings under the Revolving Facility were available for working capital purposes, capital expenditures and future acquisitions. The Revolving Facility was to terminate, and all amounts outstanding thereunder were to be payable, on March 31, 2005. Principal on the Term Facility was required to be repaid in quarterly installments commencing December 6 31, 2000 and ending March 31, 2005 as follows: five installments of $2,000; four installments of $2,500; four installments of $2,750; two installments of $3,200; two installments of $3,900; and a final installment of $7,800. In addition, commencing with our fiscal year ending December 31, 2001, the Company was required to apply 50% of excess cash flow, as defined, to permanently reduce the Term Facility. The Amended and Restated Credit Facility bore interest at a rate equal to, at the Company's option, either (1) in the case of Eurodollar loans, the sum of (x) the interest rate in the London interbank market for loans in an amount substantially equal to the amount of borrowing and for the period of borrowing selected by Aavid and (y) a margin of between 1.50% and 2.25% (depending on the Company's consolidated leverage ratio (as defined in the Amended and Restated Credit Facility)) or (2) the sum of the higher of (x) Canadian Imperial Bank of Commerce's prime or base rate or (y) one-half percent plus the latest overnight federal funds rate plus (z) a margin of between .25% and 1.00% (depending on the Company's consolidated leverage ratio). On May 4, 2001, in response to the Company not being in compliance with a leverage ratio covenant at December 31, 2000, certain of the Company's stockholders and their affiliates made an equity contribution of $8,000 in cash and $26,191 in principal amount of 12-3/4% senior subordinated notes. In addition, the Company and the lenders amended the facility to provide that the last three required quarterly principal payments in 2001 under the facility were prepaid with $6,000 of the proceeds of the equity contribution, and the four required principal payments in 2002 were reduced by $500 each, reflecting application of the remaining cash equity contribution. Further, certain covenant ratios and ratio definitions were amended and the available line of credit was reduced to $17,000 from $22,000. The Amended and Restated Credit Facility may be prepaid at any time in whole or in part without penalty, and must be prepaid to the extent of certain equity or asset sales. The Amended and Restated Credit Facility limits the Company's ability to incur additional debt, to sell or dispose of assets, to create or incur liens, to make additional acquisitions, to pay dividends, to purchase or redeem its stock and to merge or consolidate with any other party. In addition, the Amended and Restated Credit Facility requires that the Company meet certain financial ratios, and provides the lenders with the right to require the payment of all amounts outstanding under the facility, and to terminate all commitments thereunder, if there is a change in control of Aavid. The Amended and Restated Credit Facility is guaranteed by each of Heat Holdings Corp. and Heat Holdings II Corp., and all of the Company's domestic subsidiaries and secured by the Company's assets (including the assets and stock of its domestic subsidiaries and a portion of the stock of its foreign subsidiaries). The Company incurred approximately $7,085 in underwriting, legal and other professional fees in connection with the issuance of the Notes and the establishment of the Amended and Restated Credit Facility. These costs, in addition to the $1,624 of unamortized costs associated with the original Credit Facility, have been capitalized as deferred financing fees and are being amortized over the respective terms of the related debt. This amortization is recorded in interest expense in the accompanying statement of operations for the quarters and nine months ended September 28, 2002 and September 29, 2001. As of December 31, 2001 and continuing through June 29, 2002, the Company was not in compliance with certain financial covenants under the Amended and Restated Credit Facility. The Company notified its lenders concerning the noncompliance. The resulting event of default was not waived by the Company's lenders at December 31, 2001; accordingly, the lenders could have demanded full payment of all amounts outstanding under the Amended and Restated Credit Facility. As a result of the event of default, the Company classified $17,000 outstanding under the revolving credit facility, $38,192 outstanding under the term facility and $119,653 of 12-3/4 % Senior Subordinated Notes as current within the December 31, 2001 balance sheet. On January 29, 2002 the Company and its Senior lenders entered into a forbearance agreement with an expiration date of May 31, 2002. The forbearance agreement, among other things, required the Company's owners to contribute $12,000 of additional equity and allowed the Company to pay its semi-annual interest payment due February 1, 2002 on its 12-3/4% Senior Subordinated Notes. The forbearance agreement also required the Company to accelerate a principal payment of $1,985 on the term loan that was originally due on March 31, 2002. This payment of $1,985 was made at the time of the signing of the forbearance agreement. On August 1, 2002, the Company refinanced its Amended and Restated Credit Facility with two of the four banks that were party to the Amended and Restated Credit Facility. The new credit facility (the "Loan and Security Agreement") is a $27,500 asset based facility. The facility consists of a term loan component secured by certain United States real estate and machinery and equipment and requires quarterly principal payments of $359 commencing November 1, 2002. The Loan and Security Agreement also consists of a revolving line of credit component secured by inventory in the United States and receivables in the United States and the United Kingdom. Availability under the line of credit component is determined by a borrowing base of 85% of eligible accounts receivable and 50% of eligible inventory, as defined in the Loan and Security Agreement. At August 1, 2002, the available borrowing base was $23,880, of which $22,620 was drawn at closing. Debt outstanding under the Loan and Security Agreement bears interest at a rate 7 equal to, at the Company's option, either (1) in the case of LIBOR rate loans, the sum of the offered rate for deposits in United states dollars for a period equal to such interest period as it appears on Telerate page 3750 as of 11:00am London time and a margin of between 2.5% and 2.85% or (2) the sum of LaSalle Business Credit's prime rate plus a margin of between .25% and .50%. At September 28, 2002, the interest rates on the Loan and Security Agreement ranged from 4.32% to 5.25%. Debt classified as long term in the accompanying balance sheet as of September 28, 2002 consists of the long term portion of the term loan component of the new Loan and Security Agreement and all of the 12 3/4% senior subordinated notes. These amounts have been classified as long term due to the refinancing of the Amended and Restated Credit Agreement which occurred on July 31, 2002. On January 30, 2002, as part of the equity contribution required under the forbearance agreement discussed above, Heat Holdings contributed to Aavid Thermal Technologies, Inc. an aggregate of $12,000 in cash in exchange for: (a) a warrant to purchase 174,389 Series B Preferred Units of Aavid Thermalloy, LLC held beneficially and of record by Aavid Thermal Technologies, Inc. and (b) 67.71 shares of Aavid Thermal Technologies, Inc. Series A Preferred Stock, par value $.0001 per share and 67.71 shares of Aavid Thermal Technologies, Inc. Series B Preferred Stock, par value $.0001 per share. The portion of the equity contribution related to the warrant has been recorded in additional paid in capital in the accompanying balance sheet as of September 28, 2002. Dividends on the Company's Series A and Series B Preferred Stock (Preferred Stock) shall be paid at the rate of 12% per annum, compounded annually, of the Liquidation Value of such shares (plus any accrued and unpaid dividends as of the end of the previous anniversary of the date of issuance of such shares) from and including the date of issuance of such shares of Preferred Stock to and including the first to occur of: (i) the date on which the Liquidation Value (plus all accrued and unpaid dividends thereon) of such shares of Preferred Stock is paid to the holder thereof in connection with the liquidation of the Corporation or the redemption of such shares of Preferred Stock by the Company or; (ii) the date on which such shares are otherwise acquired by the Company. Such dividends shall accrue whether or not they have been declared and whether or not there are profits, surplus or other funds of the Company legally available for the payment of dividends, and such dividends shall be cumulative such that all accrued and unpaid dividends shall be fully paid or declared with funds irrevocably set apart for payment thereof and shall be paid before any dividends, distributions, redemptions or other payments may be made with respect to any Junior Securities, other than Participating Dividends. On all matters submitted to a vote of the stockholders, each holder of outstanding shares of Preferred Stock shall have the number of votes such holder would have had if such holder had converted such holder's Preferred Stock into Common Stock on the record date of such vote (or, if no record date is established, immediately prior to such vote). Upon any liquidation, dissolution or winding up of the Company, each holder of Preferred Stock shall be entitled to be paid, before any distribution or payment is made upon any Junior Securities, an amount in cash equal to the greater of (i) the aggregate Liquidation Value of all Shares of Preferred Stock held by such holder (plus any accrued and unpaid dividends) or (ii) the amount such holder of Preferred Stock would receive if the holder converted all of such holder's shares of Preferred Stock into shares of Common Stock immediately prior to such liquidation, dissolution or winding up of the Company. At any time after April 13, 2022, the Company may redeem the Preferred Stock by delivering a written notice of such redemption at least thirty days prior to the redemption date. For each share of Preferred Stock which is to be redeemed, the Company shall be obligated on the redemption date to pay the holder of such share an amount equal to the Liquidation Value of such share (plus any accrued and unpaid dividends). At any time and from time to time, any holder of Preferred Stock may convert all or any portion of the Preferred Stock (including a fraction of a share) held by such holder into a number of shares of Common Stock computed by multiplying the number of shares to be converted by $10.00 and dividing the result by the applicable Conversion Price then in effect ($3.55 is the Initial Conversion Price). The Initial Conversion Price may be adjusted from time to time for certain dilutive events. The Liquidation Value of any share of Preferred Stock as of any particular date shall be $75,738.83 per share, as such amount is adjusted for stock splits, stock dividends and similar transactions. The total liquidation value of the Preferred Stock is $11,076 at September 28, 2002. (2) RESTATEMENT OF FINANCIAL RESULTS The Company's software subsidiary, Fluent, has historically recognized software revenue in accordance with Statement of Position (SOP) 97-2, "Software Revenue Recognition" and SOP 98-9, "Modification of SOP 97-2 Software Revenue Recognition, With Respect to Certain Transactions." These statements provide specific industry guidance and stipulate that revenue recognized from 8 software arrangements is to be allocated to each element of the arrangement based on the relative fair values of the elements, such as software products, upgrades, enhancements, post-contract customer support ("PCS"), installation or training. Under the terms of Fluent's arrangements, the software is delivered upon signing and the bundled PCS is available to the customer over the term of the contract. SOP 97-2 requires a seller of software with bundled PCS to establish vendor specific objective evidence ("VSOE") of the value of the undelivered element of the contract (in Fluent's case the PCS) in order to account separately for the PCS revenue. In order to establish VSOE, there needs to be specific instances in which a customer purchases the PCS separately from the software such that a true market value could be determined. Prior to 2001, Fluent's product offerings consisted of both perpetual licenses and annual licenses that included bundled PCS. Purchasers of perpetual licenses would renew their PCS each year for a specific price therefore establishing VSOE for the PCS. Fluent used this VSOE of the value of PCS for both perpetual and annual licenses. SOP 98-9 modified SOP 97-2 to require the use of the "residual method" in situations where VSOE of value exists for all undelivered elements, but does not exist for one or more of the delivered elements. Under the residual method, the undiscounted VSOE of fair value of the undelivered elements (PCS) is deferred and the difference (residual) between the total fee and the amount deferred for the undelivered elements is recognized immediately as revenue. In sum, revenue related to the software element is recognized upon signing of the contract and delivery of the product. Revenue related to PCS is recognized ratably over the life of the contract. Using the residual method methodology, Fluent, with the concurrence of Arthur Andersen LLP, its auditors at the time, determined that 36% of the annual license fee was attributable to PCS, using the price charged for PCS on a perpetual license as VSOE of value of PCS for an annual license. Therefore, upon delivery of software under an annual software license, 64% of the license fee was recognized immediately and the remaining 36% was deferred and amortized to revenue over the 12 month life of the license. On December 29, 2000, the American Institute of Certified Public Accountants (AICPA) issued Technical Practice Aid (TPA) 5100.68. TPA 5100.68 dealt with the issue of whether a perpetual license with separately priced PCS established VSOE of value for shorter term software licenses with bundled PCS. The AICPA specifically stated in TPA 5100.68 that PCS services for a perpetual license and PCS services for a shorter term license are two different elements. Therefore, the renewal rate charged for PCS on a perpetual license does not provide VSOE of value for PCS on the shorter term license. Due to the issuance of this TPA, the Company and its auditors, Arthur Andersen LLP, concluded that under Fluent's bundled contract business practice the Company could no longer establish VSOE of the value of PCS related to their annual licenses based on the PCS used for perpetual licenses. In order to maintain a consistent revenue recognition methodology and to more definitely confirm VSOE of value on the individual elements of the contract, the Company elected to change its annual license agreements and proposals in 2001 to offer PCS as a separately priced item from the software (the "unbundled method"), that could be purchased at the customer's election. In other words, customers could license Fluent's software, which no longer included PCS, and either separately contract for PCS or elect not to take PCS. The Company, along with Arthur Andersen LLP, determined at that time that the unbundled method would establish VSOE of value on the PCS such that the Company could continue to recognize the software revenue upon contract signing and shipment of the software, and defer only the PCS portion of the revenue ratably over the term of the contract. This change had minimal impact on revenue recognition when compared to prior periods, but did clearly identify separate prices for the software and service elements of the contract. On July 10, 2002, the Company announced it had changed auditors from Arthur Andersen LLP to Ernst & Young LLP. Arthur Andersen LLP's fate has been widely publicized and the firm is no longer available to the Company. Based on discussions with Ernst & Young LLP, the Company has determined that the VSOE of value that it was relying upon to support the portion of the license fee attributed to the PCS during 2001, even in the unbundled state, may not have been sufficient to support such treatment. As a result, Ernst & Young LLP advised the Company that it should recognize revenue for the entire software license, and not just the PCS portion of the agreement, ratably over the 12 month term of the license. Ernst & Young LLP further advised the Company to restate its financial results for the year ended December 31, 2001 to reflect this change. Accordingly, the Company has restated its financial statements as of December 31, 2001, and for the year then ended, and for the three and nine month periods ended September 29, 2001, included herein, to reflect this change in revenue recognition. The Company has also restated its financial statements for the first quarter of 2002 and has conformed its third quarter 2002 financial statements to this revenue recognition methodology. While this change has a significant impact on recorded revenues within the statements of operations, and consequently net loss and EBITDA, this change does not affect the Company's statements of cash flows for the three and nine month periods ended September 29, 2001, and the three month period ended March 30, 2002, other than re-allocating certain changes in balance sheet accounts within the cash flow from operations section of the statement. For the three and nine months ended 9 September 29, 2001, the amount of revenue originally recognized but now deferred is $41 and $12,926 respectively. For the three month period ended March 30, 2002, the amount of revenue originally recognized but now deferred was $4,627. Regardless Fluent continues to be paid by its customers upon commencement of the execution of the non-cancellable license agreement. An additional restatement matter arises from the Company's sale of its German subsidiary, Aavid Thermalloy Holdings, GmbH ("Curamik") (see Note 3) on July 17, 2002. Due to the sale, the Company must treat Curamik as a discontinued operation, which requires all prior periods presented to be restated to remove the results of Curamik from earnings from continuing operations and instead, reflect Curamik's results as earnings from discontinued operations. All amounts in this Form 10-Q have been restated to reflect the change in revenue recognition and discontinued operation as discussed above. As a result of the unavailability of Arthur Andersen LLP to reissue their report on the restated fiscal year 2001 results, the Company's financial statements for fiscal year 2001 will have to be reaudited. Accordingly, all periods presented in this Form 10-Q have been marked as "unaudited". It is also possible that periods prior to 2001 may also need to be reaudited due to the discontinued operation restatement related to Curamik. Although the Company is not presently aware of any other matters that could give rise to changes in prior period financial statements, it is possible that the reaudit of the Company's financial statements may result in additional changes to the consolidated financial statements as of December 31, 2001, and for the year then ended, and for the three and nine months ended September 29, 2001 and September 28, 2002, included herein. Ernst & Young LLP, the Company's independent accountants, have not performed a review of the consolidated financial statements included in this Quarterly Report on Form 10-Q in accordance with Statement on Auditing Standards No. 71, "Interim Financial Information," and as required by Rule 10-01(d) of Regulation S-X, because the Company's consolidated financial statements for the fiscal year ended December 31, 2001 will have to be reaudited as discussed above. Upon completion of the fiscal year 2001 reaudit by Ernst & Young LLP and completion of the SAS 71 review, amended Form 10-Q's and an amended Form 10-K will be filed for all applicable periods. (3) DISCONTINUED OPERATION On July 17, 2002, the Company sold all of the outstanding shares of Aavid Thermalloy Holdings, GmbH, which in turn owns approximately 89.5% of the outstanding shares of curamik electronics GmbH, pursuant to a Share Sale and Purchase Agreement between the Company and Electrovac Fabrikation Electrotechnischer Spezialartikel GesmbH dated July 10, 2002 (the "Sale Agreement"). Under the Sale Agreement, the Company received consideration of 31,290 euros, subject to possible adjustment based upon consolidated net assets of Curamik and certain indemnification obligations of the Company. The Company recorded a pre-tax gain on the sale of $6,101 in the accompanying statement of operations for the third quarter of 2002. $27,683 of the sale proceeds was used to pay down senior debt. The sale of Curamik and its related operating results have been excluded from losses from continuing operations and is classifed as a discontinued operation for all periods presented, in accordance with the requirements of Statement of Financial Accounting Standards (SFAS) No. 144 "Accounting for Impairment or Disposal of Long-Lived Assets". See Note 2 above. The following is a summary of the results of discontinued operations for the quarter and nine months ended September 28, 2002 and September 29, 2001:

10 The table that follows presents a breakdown of the major components of assets and liabilities of discontinued operations at December 31, 2001: DECEMBER 31, 2001 ------------ ASSETS Cash $ 1,521 Accounts receivable -- trade, net 2,469 Inventories 2,030 Prepaid and other current assets 614 Property, plant and equipment, net 5,122 Goodwill, net 8,610 Developed technology, net 5,955 -------- Total assets of discontinued operations $ 26,321 ======== LIABILITIES Accounts payable -- trade $ 654 Accrued expenses and other current liabilities 1,271 Accrued taxes payable 970 Long-term deferred income taxes (222) -------- Total liabilities of discontinued operations $ 2,673 ======== (4) BASIS OF PRESENTATION In the opinion of management, the accompanying unaudited consolidated financial statements reflect all adjustments, consisting only of normal adjustments, necessary to present fairly the financial position of Aavid Thermal Technologies, Inc. and its consolidated subsidiaries at September 28, 2002 and December 31, 2001, and the results of operations and cash flows for the quarters and nine months ended September 28, 2002 and September 29, 2001. Interim results are not necessarily indicative of results for a full year. As previously discussed in Note 2 above, the financial statements as of December 31, 2001 and for the three and nine month periods ended September 29, 2001, included herein, have been restated to reflect a change in revenue recognition at the Company's software subsidiary, Fluent. While this change has a significant impact on recorded revenues within the statements of operations, and consequently net loss and EBITDA, this change does not affect the Company's statements of cash flows for the three and nine month periods ended September 29, 2001 and the three month period ended March 30, 2002 other than re-allocating certain changes in balance sheet accounts within the cash flow from operations section of the statement. Ernst & Young LLP, the Company's independent accountants, have not performed a review of the consolidated financial statements included in this Quarterly Report on Form 10-Q in accordance with Statement on Auditing Standards No. 71, "Interim Financial Information," and as required by Rule 10-01(d) of Regulation S-X, because the Company's consolidated financial statements for the fiscal year ended December 31, 2001 will have to be reaudited as discussed above. Upon completion of the fiscal year 2001 reaudit by Ernst & Young LLP and completion of the SAS 71 review, as discussed in Note 2 above, amended Form 10-Q's and an amended Form 10-K will be filed for all applicable periods. (5) RECLASSIFICATIONS Certain reclassifications have been made to the 2001 financial statements to conform to the 2002 presentation. (6) ACCOUNTS RECEIVABLE The components of accounts receivable at September 28, 2002 and December 31, 2001 are as follows: SEPTEMBER 28, DECEMBER 31, 2002 2001 ------------- ------------ (UNAUDITED) (UNAUDITED) Accounts receivable $ 31,984 $ 33,659 Allowance for doubtful accounts (3,514) (3,199) --------- --------- Net accounts receivable $ 28,470 $ 30,460 ========= ========= (7) INVENTORIES Inventories are valued at the lower of cost or market (first-in, first-out), and consist of materials, labor and overhead. The components of inventories at September 29, 2002 and December 31, 2001 are as follows: 11 SEPTEMBER 28, DECEMBER 31, 2002 2001 ------------- ------------ (UNAUDITED) (UNAUDITED) Raw materials $ 3,404 $ 4,277 Work-in-process 1,590 1,407 Finished goods 3,568 4,846 ------- --------- $ 8,562 $ 10,530 ======= ========= (8) COMPREHENSIVE INCOME In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income," which specifies the presentation and disclosure requirements for comprehensive income. The following details comprehensive income for the periods reported herein:

(9) NON-RECURRING CHARGES AND RESTRUCTURING RESERVES Approximately $2,130 of restructuring charges have been recorded in connection with the Company's October 1999 acquisition of Thermalloy, the thermal management business of Bowthorpe plc. The restructuring plan includes initiatives to integrate the operations of the Company and Thermalloy and reduce overhead. The primary components of these plans relate to (a) the closure of duplicative Thermalloy operations in Hong Kong and the United Kingdom, (b) the elimination of duplicative selling, general and administration functions of Thermalloy on a global basis and (c) the termination of certain contractual obligations. During the year ended December 31, 2000, 136 individuals were terminated. The following amounts have been charged against the Thermalloy restructuring reserves during the quarter ended September 28, 2002:

12 During the first half of 2001, the Company ceased manufacturing activities at its Dallas, Texas facility and reduced its New Hampshire workforce. In connection with these actions, the Company recorded a restructuring charge within the statement of operations for the first quarter of 2001. This restructuring charge totaled $12,073 and included estimated amounts related to employee severance, write-off of fixed assets and write-off of a prepaid lease intangible asset that was originally recorded as part of the Thermalloy acquisition. 81 individuals were terminated under the restructuring plan. The following amounts have been charged against these restructuring reserves during the third quarter of 2002:

During the third quarter of 2001 the Company made the decision to cease manufacturing operations at its Terrell, Texas facility and further reduce its New Hampshire workforce. In connection with this action, the Company recorded a restructuring charge within the statement of operations for the third quarter of 2001. This restructuring charge totals $1,222 and includes estimated amounts related to employee severance and the write-off of fixed assets. During the quarter ended September 29, 2001, 105 individuals were terminated under the restructuring plan. The following amounts have been charged against these restructuring reserves during the third quarter of 2002:

During the fourth quarter of 2001 the Company made the decision to cease manufacturing operations at its fan facility in China and reduce its workforce in North America, Europe and Asia. In connection with this action, the Company recorded a restructuring charge within the statement of operations for the fourth quarter of 2001. This restructuring charge totals $3,314 and includes estimated amounts related to employee severance, the write-off of fixed assets and charges related to certain contractual obligations. During the quarter ended December 31, 2001, 253 individuals were terminated under this restructuring plan. The following amounts have been charged against these restructuring reserves during the third quarter of 2002:

(10) RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) 141, "Business Combinations" and SFAS 142, "Goodwill and Other Intangible Assets." SFAS 141 requires business combinations initiated after June 30, 2001 to be accounted for using the purchase method of accounting. It also specifies the types of acquired intangible assets that are required to be recognized and reported separately from goodwill. SFAS 142 requires that goodwill and certain intangibles, including assembled workforce, no longer be amortized, but instead tested for impairment at least annually. The Company adopted SFAS 142 on January 1, 2002. The Company completed its initial review during the first quarter of 2002 and determined its intangible assets were not impaired. Because goodwill and some intangible assets are no longer being amortized, the reported amounts of goodwill and intangible assets (as well as total assets) will not decrease at the same time and in the same manner as under previous standards. There may be more volatility in future earnings of the Company than under previous standards because impairment losses are likely to occur irregularly and in varying amounts. Additionally, the Company was required to reclassify the net balance of its assembled workforce intangible asset of $3,714 to goodwill upon adoption of the statement. In the third quarter of 2001, the Company 13 recorded $6,420 of amortization related to goodwill that was not recorded in the third quarter 2002 under the provisions of SFAS No. 142. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of" and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" for the disposal of a segment of a business (as previously defined in that Opinion). The Company adopted SFAS No. 144 on January 1, 2002. The adoption of SFAS No. 144 did not have a material effect on the Company's financial position or results of operations. (11) SEGMENT REPORTING The Company consists of two distinct reportable segments: (1) thermal management products and (2) computational fluid dynamics ("CFD") software. Aavid's thermal management products consist of products and services that solve problems associated with the dissipation of unwanted heat in electronic and electrical components and systems. The Company develops and offers CFD software for computer modeling and fluid flow analysis of products and processes that reduce time and expense associated with physical models and the facilities to test them. The accounting policies of the segments are the same as those described in the summary of significant accounting policies as disclosed in the Company's Form 10-K for the year ended December 31, 2001, with the exception of software revenue recognition which is further discussed in footnote (2) to these financial statements. The Company accounts for inter-segment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices. Aavid's reportable segments are strategic business units that offer different products and services. They are managed separately because each segment requires different marketing and sales strategies. The following summarizes the operations of each reportable segment for the quarters and nine months ending September 28, 2002 and September 29, 2001:

14 The following table provides geographic information about the Company's operations. Revenues are attributable to an operation based on the location the product was shipped from. Long-lived assets are attributable to a location based on physical location.

15 (12) SELECTED CONSOLIDATING FINANCIAL STATEMENTS OF PARENT, GUARANTORS AND NON-GUARANTORS (UNAUDITED) The Company's wholly-owned domestic subsidiaries have jointly and severally guaranteed, on a senior subordinated basis, the principal amount of the Company's 12 3/4% Senior Subordinated Notes, due 2007. The guarantors include the combined domestic operations of Aavid Thermalloy, LLC and Fluent, Inc. and the Company's subsidiary Applied Thermal Technologies, Inc. The non-guarantors include the combined foreign operations of Aavid Thermalloy, LLC and Fluent, Inc. The consolidating condensed financial statements of the Company depict Aavid Thermal Technologies, Inc., (the "Parent"), carrying its investment in subsidiaries under the equity method and the guarantor and non-guarantor subsidiaries are presented on a combined basis. Management believes that there are no significant restrictions on the Parent's and guarantors' ability to obtain funds from their subsidiaries by dividend or loan. The principal elimination entries eliminate investment in subsidiaries and intercompany balances and transactions.

20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Statements in this Quarterly Report on Form 10-Q concerning the Company's business outlook or future economic performance; anticipated profitability, revenues, expenses or other financial items; introductions and advancements in development of products, and plans and objectives related thereto; and statements concerning assumptions made or expectations as to any future events, conditions, performance or other matters, are "forward-looking statements" as that term is defined under the Federal Securities Laws. Forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those stated in such statements. Such risks, uncertainties and factors include, but are not limited to, changes in the Company's markets, particularly the potentially volatile semiconductor market, changes in and delays in product development plans and schedules, customer acceptance of new products, changes in pricing or other actions by competitors, patents owned by the Company and its competitors, risk of foreign operations and markets, the Company's substantial indebtedness and general economic conditions, as well as other risks detailed in the Company's filings with the Securities and Exchange Commission, including the Company's Annual Report on Form 10-K for the year ended December 31, 2001. The Company undertakes no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future. OVERVIEW Aavid Thermal Technologies, Inc. (the "Company" or "Aavid") is a leading global provider of thermal management solutions for electronics products and the leading developer and marketer of computational fluid dynamics ("CFD") software. Each of these businesses has a leading reputation for high product quality, service excellence and engineering innovation in its market. Aavid designs, manufactures and distributes on a worldwide basis thermal management products that dissipate heat from microprocessors and industrial electronics products. Aavid's products include heat sinks, interface and attachment accessories, fans, heat spreaders and liquid cooling and phase change devices that can be configured to meet customer-specific needs. CFD software is used in complex computer-generated modeling of fluid flows, heat and mass transfer and chemical reactions. Aavid's CFD software is used in a variety of industries, including the automotive, aerospace, chemical processing, power generation, electronics and bio-medical industries. On February 2, 2000, the Company was acquired by Heat Holdings Corp., a corporation newly formed by Willis Stein & Partners II, L.P. Pursuant to the merger, Aavid stockholders received $25.50 in cash for each outstanding share of common stock. In addition, all outstanding stock options and warrants were cashed out. The Merger was accounted for using the purchase method. The Merger and related transaction costs were funded by a cash contribution from the Purchaser of $152.0 million, proceeds of $148.3 million, net of original issue discount, from the sale by the Company of 12 3/4% senior subordinated notes and warrants due 2007, $54.7 million pursuant to a new credit facility entered into by the Company, and approximately $4.7 million of cash on hand. Net stockholders' equity on the date of acquisition was $156.6 million. Based upon fair value of assets acquired and liabilities assumed, goodwill of $183.7 million was established. Approximately $113.7 million of this goodwill is attributable to Aavid Thermalloy, the hardware business, and was being amortized over 20 years through December 31, 2001. The remainder, $70.0 million, is attributable to Fluent, the CFD software business, and was being amortized over 4 years through December 31, 2001. During the fourth quarter of 2001, the Company wrote off the goodwill attributable to Aavid Thermalloy after performing a review for impairment under Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." The impairment charge recorded in the fourth quarter of 2001 related to the goodwill attributable to Aavid Thermalloy was $94.2 million. The Company adopted SFAS 142, "Goodwill and Other Intangible Assets," on January 1, 2002. Under the provisions of SFAS 142, the remaining goodwill attributable to Fluent is no longer amortized, but instead will be tested for impairment at least annually. The Company completed its initial review for impairment during the first quarter of 2002 and determined its intangible assets were not impaired. Because goodwill and some intangible assets are no longer being amortized, the reported amounts of goodwill and intangible assets (as well as total assets) will not decrease at the same time and in the same manner as under previous standards. There may be more volatility in future earnings of the Company than under previous standards because impairment losses are likely to occur irregularly and in varying amounts. Additionally, the Company was required to reclassify the net balance of its assembled workforce intangible asset of $3.7 million to goodwill upon adoption of the statement. In the third quarter of 2001, the Company recorded $6.4 million and $19.3 million, respectively, of amortization related to goodwill that was not recorded in the third quarter and first nine months of 2002 under the provisions of SFAS No. 142. Of the $152.0 million cash contribution, $4.8 million was invested by Heat Holdings II Corp., an affiliate of Heat Holdings, to acquire 95% of the common equity of Aavid Thermalloy, LLC, the thermal management hardware business. The Company controls 21 Aavid Thermalloy, LLC through a preferred equity interest and holds a 5% common equity interest and thus consolidates Aavid Thermalloy LLC in its results within the accompanying financial statements. The investment by Heat Holdings II Corp. has been recorded as minority interest within the accompanying financial statements. On February 2, 2000, as part of the transactions relating to the Merger, the Company issued 150,000 units (the "Units"), consisting of $150,000,000 aggregate principal amount of its 12 3/4% Senior Subordinated Notes due 2007 (the "Notes") and warrants (the "Warrants") to purchase an aggregate of 60 shares of the Company's Class A Common Stock, par value $0.0001 per share, and 60 shares of the Company's Class H Common Stock, par value $0.0001 per share. The Notes are fully and unconditionally guaranteed on a joint and several basis by each of the Company's domestic subsidiaries (the "Subsidiary Guarantors"). The Notes were issued pursuant to an Indenture (the "Indenture") among the Company, the Subsidiary Guarantors and Bankers Trust Company, as trustee. Approximately $4.6 million of the proceeds from the sale of the Units was allocated to the fair value of the Warrants and approximately $143.8 million was allocated to the Notes, net of original issue discount of approximately $1.7 million. The total discount of $6.2 million is being accreted over the term of the notes, using the effective interest rate method. This accretion is recorded as interest expense within the accompanying statement of operations for the quarter and nine months ended September 28, 2002 and September 29, 2001. The Indenture limits the Company's ability to incur additional debt, to pay dividends or make other distributions, to purchase or redeem our stock or make other investments, to sell or dispose of assets, to create or incur liens, and to merge or consolidate with any other person. The Indenture also contained provisions requiring additional equity investments by Willis Stein & Partners in the event the Company does not achieve certain leverage to EBITDA ratios, as defined, in years 2000 and 2001. As described below, Willis Stein made the maximum required equity investment in 2001 in respect of year 2000 and is not required to make an additional equity investment even if the Company does not achieve the required ratios in 2002. The Indenture provides that upon a change in control of Aavid, the Company must offer to repurchase the Notes at 101% of the face value thereof, together with accrued and unpaid interest. The Notes are subordinated in right of payment to amounts outstanding under the Amended and Restated Credit Facility and certain other permitted indebtedness. In connection with the Merger, the Company repaid all of the outstanding term loan and revolving line of credit under its then existing credit facility and entered into an amended and restated credit facility (the "Amended and Restated Credit Facility"). The Amended and Restated Credit Facility provided for a $22.0 million revolving credit facility (the "Revolving Facility") (of which $1.7 million was drawn at the closing of the Merger) and a $53.0 million term loan facility (the "Term Facility") (which was fully drawn at the closing of the Merger). Subject to compliance with the terms of the Amended and Restated Credit Facility, borrowings under the Revolving Facility were available for working capital purposes, capital expenditures and future acquisitions. The Revolving Facility was to terminate, and all amounts outstanding thereunder were to be payable, on March 31, 2005. Principal on the Term Facility was required to be repaid in quarterly installments commencing December 31, 2000 and ending March 31, 2005 as follows: five installments of $2.0 million; four installments of $2.5 million; four installments of $2.75 million; two installments of $3.2 million; two installments of $3.9 million; and a final installment of $7.8 million. In addition, commencing with our fiscal year ending December 31, 2001, the Company is required to apply 50% of our excess cash flow, as defined in the credit agreement, to permanently reduce the Term Facility. The Amended and Restated Credit Facility bears interest at a rate equal to, at the Company's option, either (1) in the case of Eurodollar loans, the sum of (x) the interest rate in the London interbank market for loans in an amount substantially equal to the amount of borrowing and for the period of borrowing selected by Aavid and (y) a margin of between 1.50% and 2.25% (depending on the Company's consolidated leverage ratio (as defined in the Amended and Restated Credit Facility)) or (2) the sum of the higher of (x) Canadian Imperial Bank of Commerce's prime or base rate or (y) one-half percent plus the latest overnight federal funds rate plus (z) a margin of between .25% and 1.00% (depending on the Company's consolidated leverage ratio). The Amended and Restated Credit Facility may be prepaid at any time in whole or in part without penalty, and must be prepaid to the extent of certain equity or asset sales. The Amended and Restated Credit Facility limits the Company's ability to incur additional debt, to sell or dispose of assets, to create or incur liens, to make additional acquisitions, to pay dividends, to purchase or redeem its stock and to merge or consolidate with any other person. In addition, the Amended and Restated Credit Facility requires that the Company meet certain financial ratios, and provides the lenders with the right to require the payment of all amounts outstanding under the facility, and to terminate all commitments thereunder, if there is a change in control of Aavid. The Amended and Restated Credit Facility is guaranteed by each of Holdings Corp. and Heat Holdings II Corp., and all of the Company's domestic subsidiaries and secured by the Company's assets (including the assets and stock of its domestic subsidiaries and a portion of the stock of its foreign subsidiaries). 22 The Company incurred approximately $7.1 million in underwriting, legal and other professional fees in connection with the issuance of the Notes and the obtainment of the Amended and Restated Credit Facility. These costs, in addition to the $1.6 million of unamortized costs associated with the original Credit Facility, have been capitalized as deferred financing fees and are being amortized over the respective terms of the related debt. This amortization is recorded in interest expense in the statement of operations. At December 31, 2000 the Company was not in compliance with the leverage ratio covenant required by the Amended and Restated Credit Facility. As a result, the Company's stockholders were required to make an equity contribution sufficient to allow the Company to pay down enough debt to achieve a 4.5 to 1 leverage ratio based on total leverage at December 31, 2000. On May 4, 2001 certain of the Company's stockholders and their affiliates made an equity contribution of $8.0 million in cash and $26.2 million in principal amount of Senior Subordinated Notes in full satisfaction of this obligation. In addition, the Company and the lenders amended the Amended and Restated Credit Facility (Amendment No. 1) to provide that the last three required quarterly principal payments in 2001 under the facility be prepaid with $6.0 million of the proceeds of the equity contribution, and the four required principal payments in 2002 be reduced by $0.5 million each, reflecting application of the remaining cash equity contribution. Further, certain covenant ratios and ratio definitions were amended and the available line of credit was reduced to $17.0 million from $22.0 million. Based on the equity contribution, the Company's events of non-compliance with its debt covenants at December 31, 2000 and March 31, 2001 were cured. As of December 31, 2001 and continuing through June 29, 2002, the Company was not in compliance with certain financial covenants under the Amended and Restated Credit Facility. The Company notified its lenders concerning the noncompliance. The resulting event of default was not waived by the Company's lenders at December 31, 2001; accordingly, the lenders could have demanded full payment of all amounts outstanding under the Amended and Restated Credit Facility. On January 29, 2002 the Company and its Senior lenders entered into a forbearance agreement with an expiration date of May 31, 2002. The forbearance agreement, among other things, required the Company's owners to contribute $12.0 million of additional equity and allowed the Company to pay its semi-annual interest payment due February 1, 2002 on its 12-3/4% Senior Subordinated Notes. The forbearance agreement also required the Company to accelerate a principal payment of $2.0 million on the term loan that was originally due on March 31, 2002. This payment of $2.0 million was made at the time of the signing of the forbearance agreement. On January 30, 2002, as part of the equity contribution required under the forbearance agreement discussed above, Heat Holdings contributed to Aavid Thermal Technologies, Inc. an aggregate of $12.0 million in cash in exchange for: (a) a warrant to purchase 174,389 Series B Preferred Units of Aavid Thermalloy, LLC held beneficially and of record by Aavid Thermal Technologies, Inc. and (b) 67.71 shares of Aavid Thermal Technologies, Inc. Series A Preferred Stock, par value $.0001 per share and 67.71 shares of Aavid Thermal Technologies, Inc. Series B Preferred Stock, par value $.0001 per share. The portion of the equity contribution related to the warrant has been recorded in additional paid in capital in the accompanying balance sheet as of September 28, 2002. On August 1, 2002, the Company refinanced its Amended and Restated Credit Facility with two of the four banks that were party to the Amended and Restated Credit Facility. The new credit facility (the "Loan and Security Agreement") is a $27.5 million asset based facility. The facility consists of a term loan component secured by certain United States real estate and machinery and equipment and requires quarterly principal payments of $0.4 million commencing November 1, 2002. The Loan and Security Agreement also consists of a revolving line of credit component secured by inventory in the United States and accounts receivable in the United States and the United Kingdom. Availability under the line of credit component is determined by a borrowing base of 85% of eligible accounts receivable and 50% of eligible inventory, as defined in the Loan and Security Agreement. At August 1, 2002 the available borrowing base was $23.9 million, of which $22.6 million was drawn at closing. Debt outstanding under the Loan and Security Agreement bears interest at a rate equal to, at the Company's option, either (1) in the case of LIBOR rate loans, the sum of the offered rate for deposits in United states dollars for a period equal to such interest period as it appears on Telerate page 3750 as of 11:00am London time and a margin of between 2.5% and 2.85% or (2) the sum of LaSalle Business Credit's prime rate plus a margin of between .25% and .50%. At September 28, 2002, the interest rates on the Loan and Security Agreement ranged from 4.32% to 5.25%. RESTATEMENT OF FINANCIAL RESULTS The Company's software subsidiary, Fluent, has historically recognized software revenue in accordance with Statement of Position (SOP) 97-2, "Software Revenue Recognition" and SOP 98-9, "Modification of SOP 97-2 Software Revenue Recognition, With Respect to Certain Transactions." These statements provide specific industry guidance and stipulate that revenue recognized from software arrangements is to be allocated to each element of the arrangement based on the relative fair values of the elements, such as software products, upgrades, enhancements, post-contract customer support ("PCS"), installation or training. Under the terms of Fluent's arrangements, the software is delivered upon signing and the bundled PCS is available to the customer over the term of the 23 contract. SOP 97-2 requires a seller of software with bundled PCS to establish vendor specific objective evidence ("VSOE") of the value of the undelivered element of the contract (in Fluent's case the PCS) in order to account separately for the PCS revenue. In order to establish VSOE, there needs to be specific instances in which a customer purchases the PCS separately from the software such that a true market value could be determined. Prior to 2001, Fluent's product offerings consisted of both perpetual licenses and annual licenses that included bundled PCS. Purchasers of perpetual licenses would renew their PCS each year for a specific price therefore establishing VSOE for the PCS. Fluent used this VSOE of the value of PCS for both perpetual and annual licenses. SOP 98-9 modified SOP 97-2 to require the use of the "residual method" in situations where VSOE of value exists for all undelivered elements, but does not exist for one or more of the delivered elements. Under the residual method, the undiscounted VSOE of fair value of the undelivered elements (PCS) is deferred and the difference (residual) between the total fee and the amount deferred for the undelivered elements is recognized immediately as revenue. In sum, revenue related to the software element is recognized upon signing of the contract and delivery of the product. Revenue related to PCS is recognized ratably over the life of the contract. Using the residual method methodology, Fluent, with the concurrence of Arthur Andersen LLP, its auditors at the time, determined that 36% of the annual license fee was attributable to PCS, using the price charged for PCS on a perpetual license as VSOE of value of PCS for an annual license. Therefore, upon delivery of software under an annual software license, 64% of the license fee was recognized immediately and the remaining 36% was deferred and amortized to revenue over the 12 month life of the license. On December 29, 2000, the American Institute of Certified Public Accountants (AICPA) issued Technical Practice Aid (TPA) 5100.68. TPA 5100.68 dealt with the issue of whether a perpetual license with separately priced PCS established VSOE of value for shorter term software licenses with bundled PCS. The AICPA specifically stated in TPA 5100.68 that PCS services for a perpetual license and PCS services for a shorter term license are two different elements. Therefore, the renewal rate charged for PCS on a perpetual license does not provide VSOE of value for PCS on the shorter term license. Due to the issuance of this TPA, the Company and its auditors, Arthur Andersen LLP, concluded that under Fluent's bundled contract business practice the Company could no longer establish VSOE of the value of PCS related to their annual licenses based on the PCS used for perpetual licenses. In order to maintain a consistent revenue recognition methodology and to more definitely confirm VSOE of value on the individual elements of the contract, the Company elected to change its annual license agreements and proposals in 2001 to offer PCS as a separately priced item from the software (the "unbundled method"), that could be purchased at the customer's election. In other words, customers could license Fluent's software, which no longer included PCS, and either separately contract for PCS or elect not to take PCS. The Company, along with Arthur Andersen LLP, determined at that time that the unbundled method would establish VSOE of value on the PCS such that the Company could continue to recognize the software revenue upon contract signing and shipment of the software, and defer only the PCS portion of the revenue ratably over the term of the contract. This change had minimal impact on revenue recognition when compared to prior periods, but did clearly identify separate prices for the software and service elements of the contract. On July 10, 2002, the Company announced it had changed auditors from Arthur Andersen LLP to Ernst & Young LLP. Arthur Andersen LLP's fate has been widely publicized and the firm is no longer available to the Company. Based on discussions with Ernst & Young LLP, the Company has determined that the VSOE of value that it was relying upon to support the portion of the license fee attributed to the PCS during 2001, even in the unbundled state, may not have been sufficient to support such treatment. As a result, Ernst & Young LLP advised the Company that it should recognize revenue for the entire software license, and not just the PCS portion of the agreement, ratably over the 12 month term of the license. Ernst & Young LLP further advised the Company to restate its financial results for the year ended December 31, 2001 to reflect this change. Accordingly, the Company has restated its financial statements as of December 31, 2001,and for the year then ended, and for the three and nine month periods ended September 29, 2001, included herein, to reflect this change in revenue recognition. The Company has also restated its financial statements for the first quarter of 2002 and has conformed its third quarter 2002 financial statements to this revenue recognition methodology. While this change has a significant impact on recorded revenues within the statements of operations, and consequently net loss and EBITDA, this change does not affect the Company's statements of cash flows for the three and nine month periods ended September 29, 2001, and the three month period ended March 30, 2002, other than re-allocating certain changes in balance sheet accounts within the cash flow from operations section of the statement. For the three and nine months ended September 29, 2001, the amount of revenue originally recognized but now deferred is $41,000 and $12.9 million, respectively. For the three month period ended March 30, 2002, the amount of revenue originally recognized but now deferred was $4.6 million. 24 Regardless, Fluent continues to be paid by its customers upon commencement of the execution of the non-cancellable license agreement. An additional restatement matter arises from the Company's sale of its German subsidiary, Aavid Thermalloy Holdings, GmbH ("Curamik") (see "Discontinued Operation" below) on July 17, 2002. Due to the sale, the Company must treat Curamik as a discontinued operation, which requires all prior periods presented to be restated to remove the results of Curamik from earnings from continuing operations and instead, reflect Curamik's results as earnings from discontinued operations. All amounts in this Form 10-Q have been restated to reflect the change in revenue recognition and discontinued operation as discussed below. As a result of the unavailability of Arthur Andersen LLP to reissue their report on the restated fiscal year 2001 results, the Company's financial statements for fiscal year 2001 will have to be reaudited. Accordingly, all periods presented in this Form 10-Q have been marked as "unaudited". It is also possible, that periods prior to 2001 may also need to be reaudited due to the discontinued operation restatement related to Curamik. Although the Company is not presently aware of any other matters that could give rise to changes in prior period financial statements, it is possible that the reaudit of the Company's financial statements may result in additional changes to the consolidated financial statements as of December 31, 2001, and for the year then ended, and for the three and nine months ended September 29, 2001 and September 28, 2002, included herein. Ernst & Young LLP, the Company's independent accountants, have not performed a review of the consolidated financial statements included in this Quarterly Report on Form 10-Q in accordance with Statement on Auditing Standards No. 71, "Interim Financial Information," and as required by Rule 10-01(d) of Regulation S-X, because the Company's consolidated financial statements for the fiscal year ended December 31, 2001 will have to be reaudited as discussed above. Upon completion of the fiscal year 2001 reaudit by Ernst & Young LLP and completion of the SAS 71 review, amended Form 10-Q's and an amended Form 10-K will be filed for all applicable periods. DISCONTINUED OPERATION On July 17, 2002, the Company sold all of the outstanding shares of Aavid Thermalloy Holdings, GmbH, which in turn owns approximately 89.5% of the outstanding shares of curamik electronics GmbH, pursuant to a Share Sale and Purchase Agreement between the Company and Electrovac Fabrikation Electrotechnischer Spezialartikel GesmbH dated July 10, 2002 (the "Sale Agreement"). Under the Sale Agreement, the Company received consideration of 31,290,000 euros, subject to possible adjustment based upon consolidated net assets of Curamik and certain indemnification obligations of the Company. The Company recorded a pre-tax gain on the sale of $6.1 million in the accompanying statement of operations for the third quarter of 2002. $27.7 million of the sale proceeds was used to pay down senior debt. The sale of Curamik and its related operating results have been excluded from losses from continuing operations and is classifed as a discontinued operation for all periods presented, in accordance with the requirements of Statement of Financial Accounting Standards (SFAS) No. 144 "Accounting for Impairment or Disposal of Long-Lived Assets". RESULTS OF OPERATIONS For The Quarter and Nine Months Ended September 28, 2002 Compared With The Quarter and Nine Months Ended September 29, 2001

Sales in the third quarter of 2002 were $39.1 million, a decrease of $1.2 million, or 3.0% from the comparable period of 2001. Sales for the nine months ended September 29, 2002 were $117.9 million, a decrease of $13.2 million or 10.1% from the comparable period of 2001. The overall decrease in sales stems from Aavid Thermalloy and is primarily the result of the significant decline experienced by the semi-conductor and electronics industries during 2001 and which has extended through the first nine months of 2002. The decline experienced by Aavid Thermalloy was in part offset by an increase in sales experienced at Fluent. Part of this increase results from a revenue recognition change made by Fluent in 2001 as discussed below. 25 Fluent software sales of $17.7 million in the third quarter of 2002 were $3.3 million, or 22.9%, higher, than the third quarter of 2001. The majority of the increase was due to the change in the way Fluent recognizes revenue, which occurred in the first quarter of 2001. Fluent changed to a ratable recognition methodology for software license revenue, as discussed above in the section titled "Restatement of Financial Results". Beginning in 2001, all revenue related to a software contract is deferred and recognized ratably over 12 months. Prior to 2001, Fluent had only deferred a portion of the contract (approximately 36%) and recognized the remaining 64% immediately upon delivery of the software. This change caused a significant drop in revenue during 2001 due to an increase in the amount of revenue deferred upon signing and delivery of a software contract. Because 2001 is the transition year, revenue is significantly less in 2001 than what can be expected in future years due to the fact that at January 1, 2001 there was not a signficant "backlog" of deferred revenue already in place to generate revenues in 2001 from contract signings that occurred in 2000. In 2000, 64% of the contract was immediately recognized upon contract signing and delivery and so was not available for recognition in 2001. Had Fluent continued to recognize revenue in 2001 and 2002 consistent with how it was recognized in prior years, Fluent's revenue for the quarter and nine months ended Sept 28, 2002 and September 29, 2001 would have been as follows:

As can be seen above, under the revenue recognition methodology used by Fluent through the year 2000, Fluent experienced solid year over year growth, however, the magnitude of the growth appears greater when looking at the restated revenue due to the changes discussed above. Aavid Thermalloy's sales were $21.4 million in the third quarter of 2002, a decrease of $4.5 million, or 17.4%, over the third quarter of 2001. Aavid Thermalloy's sales for the first nine months of 2002 were $65.8 million, a decrease of $29.7 million or 31.1% over the comparable period for 2001. As discussed above, this was the result of a significant decline in the overall industry in which Aavid Thermalloy's customers operate in. Based on the current booking activity, management expects to see an environment of flat revenues on a sequential basis in the fourth quarter when compared with the third quarter of 2002. Additionally, at the end of the second quarter of 2002, Jason Huang, Aavid Thermalloy's President of Asian Operations resigned his position. The position has been taken over directly by Bart Patel, CEO with assistance by George Davision, Vice President of Sales and Marketing. In the fourth quarter of 2002, Bart Patel hired a new Vice President of Asia Pacific Sales and a new General Manager China Operations. International sales (which include U.S. exports) increased to 55.3% of sales for the third quarter of 2002 compared with 54.7% in the third quarter of 2001. For the nine months ended September 28, 2002 international sales were 56.9% of sales compared with 51.5% for the nine months ended September 29, 2001. No customer generated greater than 10% of the Company's revenues in the third quarter and first nine months of 2002 or 2001. The Company's gross profit for the third quarter of 2002 was $18.1 million compared with $11.3 million in the comparable period from 2001. Gross margin as a percentage of sales increased from 28.1% in the third quarter of 2001 to 46.2% for the comparable period of 2002. Gross profit for the nine months ended September, 2002 increased to $52.3 million from $35.2 million in the comparable period of 2001. Gross margin improved to 44.3% for the nine months of 2002 from 26.9% for the comparable period of 2001. Gross margin at Aavid Thermalloy has improved through significant improvements in manufacturing efficiency and utilization as a result of the consolidation of manufacturing facilities (including the shut-down of the Loudwater, U.K. facility and the Dallas and Terrell, Texas facilities) that occurred during 2001. Aavid Thermalloy's gross margin increased approximately 17.5 percentage points from the third quarter of 2001 to the third quarter of 2002. Additionally, due to the restatement of Fluent's revenue as discussed above, Fluent's gross margin was much less in 2001 than what would normally be expected due to the decreased revenue level. As Fluent's cost of sales was not impacted by the restatement in 2001, gross profit decreased dollar for dollar by the amount of the sales decrease. In the third quarter of 2002 the Company's operating income of $1.0 million compares with an operating loss of $15.8 million in the third quarter of 2001. For the first nine months of 2002, the Company's operating loss was $0.3 million compared with and operating loss of $57.7 million for the comparable period of 2001. For the quarter, operating loss saw a large improvement over the third quarter of 2001 due to several factors. First, amortization of intangible assets in the third quarter of 2002 was $0.7 million, a decrease of $7.9 million, over the $8.6 million of amortization recorded in the comparable quarter of 2001. This decrease in amortization expense is a result of the cessation of goodwill amortization beginning in the first quarter of 2002 due to the adoption of 26 SFAS 142. Second, Fluent's operating income, excluding the effect of decreased amortization, improved $1.6 million from the third quarter of 2001 to the third quarter of 2002 due to the revenue restatement effect of the change in revenue recognition discussed above. Aavid Thermalloy saw a $7.0 million improvement in operating loss from the third quarter of 2001 to the third quarter of 2002 due to the improvement in manufacturing utilization and cost savings achievements discussed above. Corporate headquarters experienced an improvement in operating loss of $0.3 million from the third quarter of 2001 to the third quarter of 2002 due to decreased legal and administrative costs. The magnitude of the operating loss in the first nine months of 2001 was primarily impacted by restructuring charges of $14.5 million that were recorded in connection with the cessation of manufacturing activities at the Dallas facility and the reduction of the New Hampshire workforce. Also contributing to the operating loss for the first nine months of 2001 is goodwill amortization which is not recorded in 2002, as discussed below, along with the impact of the restatement of Fluent's revenues in 2001 as discussed above. Aavid Thermalloy's selling, general and administrative expenses, excluding amortization of intangibles, declined $5.8 million, from $21.5 million in the first nine months of 2001 to $15.7 million in the first nine months of 2002 due to cost savings resulting from facility consolidations and workforce reductions in 2001. Fluent's S,G&A expenses, exclusive of intangible asset amortization, increased by $1.9 million in the first nine months of 2002 compared to the first nine months of 2001. Amortization of intangible assets in the first nine months of 2002 was $2.0 million, a decrease of $23.7 million over the $25.7 million of amortization recorded in the comparable period of 2001. This decrease in amortization expense is a result of the cessaton of goodwill amortization beginning in the first quarter of 2002 due to the adoption of SFAS 142, combined with lower amortization of developed technology due to the write-down of this intangible asset in the fourth quarter of 2001. Net interest charges, including cash interest expense and income, deferred financing fee amortization and bond discount amortization, for the Company were $5.5 million in the third quarter and $15.9 million in the first nine months of 2002 which compares with $5.2 million for the third quarter and $18.3 million for the first nine months of 2001. The decrease in interest expense for the first nine months of 2002 is due to the lower debt levels in the first half of 2002 compared to the first half of 2001 resulting from the retirement of $26.2 million of Senior Subordinated Notes that occurred in the second quarter of 2001, combined with lower interest rates on the senior credit facility in 2002 compared to 2001. The Company incurred a tax provision for the first nine months of 2002 despite having significant operating losses in the United States because of significant foreign tax provisions on foreign earnings. The Company's tax provision in 2002 represents the foreign tax provision on foreign earnings. The Company incurred significant losses in the United States and the Company only benefits the U.S. losses to the extent of foreign earnings which are expected to be repatriated in the United States. Because the Company is in a net operating loss position for U.S. tax purposes, the Company will not receive any tax benefit from foreign tax credits. Accordingly, there is no net benefit recorded for the United States losses, resulting in an overall tax provision for foreign taxes. The Company's net income was $1.9 million for the third quarter of 2002 and net loss was $12.1 million for the first nine months of 2002, versus a net loss for the comparable periods of 2001 of $21.4 million and $68.1 million, respectively. The primary reasons for the improvement in net loss from 2001 to 2002 have been discussed above but include the following: First, Fluent revenue restatement caused an unusually high net loss in 2001 versus 2002. Fluent's net loss decreased $3.4 million from the third quarter 2001 to the third quarter 2002 and $13.6 million from the first nine months of 2001 compared with the first nine months of 2002 (excluding impact of amortization). Second, restructuring charges of $14.5 million were recorded in the first nine months of 2001 at Aavid Thermalloy. Third, amortization expense decreased significantly both on a quarterly and year to date basis from 2001 to 2002 as discussed above. Fourth, Aavid Thermalloy experienced significant improvements in manufacturing efficiency through plant shut-downs and other cost savings initiatives. Lastly, the Company recognized a gain on the sale of Curamik of $6.1 million in the third quarter of 2002. 27 The Company's EBITDA, as defined in the Loan and Security Agreement with the Company's senior lenders, was $0.8 million for the third quarter of 2002 and $13.8 million for the nine months ended September 28, 2002, compared with $(1.9) million and $8.0 million, respectively, for the equivalent periods in the prior year. A reconciliation of net income to EBITDA is as follows:

FINANCIAL CONDITION Historically, the Company had used internally generated funds and proceeds from financing activities to meet its working capital and capital expenditure requirements. As a result of the Thermalloy acquisition and the Merger, the Company had significantly increased its cash requirements for debt service relating to the Notes and its Bank debt described in footnote (1) in the accompanying financial statements. The Company currently uses amounts available under its new Loan and Security Agreement, debt and equity financings and internally generated funds to finance its working capital requirements, capital expenditures and potential acquisitions. See "Overview" for a discussion of the Notes and Loan and Security Agreement. During the first nine months of 2002, the Company used $6.7 million of cash for operations, versus using $9.4 million of cash for operations in the first nine months of 2001. Of the $6.7 million of cash used for operations for the first nine months of 2002, $17.6 million related to interest payments made during the period. During the period, the Company was provided with $28.5 million of cash in connection with investing activities versus using $5.5 million in the comparable period of 2001. Of the $28.5 million of cash provided from investing activities, $31.3 million was received in connection with the sale of Curamik in July 2002. The Company used $4.3 million for capital expenditures in the first nine months of 2002 versus $4.7 million in the comparable period of 2001. The Company used $24.9 million of cash in connection with financing activities for the first nine months of 2002, compared to being provided with $6.6 million of cash from financing activities for the comparable period in 2001. The primary use of cash in connection with financing activities for the first nine months of 2002 resulted from the paydown of debt with the net proceeds from the sale of Curamik. As of December 31, 2001 and continuing through July 31, 2002, the Company was not in compliance with certain financial covenants under the Amended and Restated Credit Facility. The Company notified its lenders concerning the noncompliance. The resulting event of default was not waived by the Company's lenders at December 31, 2001; accordingly, the lenders could have demanded full payment of all amounts outstanding under the Amended and Restated Credit Facility. On January 29, 2002 the Company and its Senior lenders entered into a forbearance agreement with an expiration date of May 31, 2002. The forbearance agreement, among other things, required the Company's owners to contribute $12.0 million of additional equity and allowed the Company to pay its semi-annual interest payment due February 1, 2002 on its 12-3/4% Senior Subordinated Notes. The forbearance -------- (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 create an addition to EBITDA. A decrease in deferred revenue during the period creates a subtraction from EBITDA, as defined. 28 agreement also required the Company to accelerate a principal payment of $2.0 million on the term loan that was originally due on March 31, 2002. This payment of $2.0 million was made at the time of the signing of the forbearance agreement. On August 1, 2002, the Company refinanced its Amended and Restated Credit Facility with two of the four banks that were party to the Amended and Restated Credit Facility. The new credit facility (the "Loan and Security Agreement") is a $27.5 million asset based facility. The facility consists of a term loan component secured by certain United States real estate and machinery and equipment and requires quarterly principal payments of $0.4 million commencing November 1, 2002. The Loan and Security Agreement also consists of a revolving line of credit component secured by inventory in the United States and accounts receivable in the United States and the United Kingdom. Availability under the line of credit component is determined by a borrowing base of 85% of eligible accounts receivable and 50% of eligible inventory, as defined in the Loan and Security Agreement. At August 1, 2002, the available borrowing base was $23.9 million, of which $22.6 million was drawn at closing. Debt outstanding under the Loan and Security Agreement bears interest at a rate equal to, at the Company's option, either (1) in the case of LIBOR rate loans, the sum of the offered rate for deposits in United states dollars for a period equal to such interest period as it appears on Telerate page 3750 as of 11:00am London time and a margin of between 2.5% and 2.85% or (2) the sum of LaSalle Business Credit's prime rate plus a margin of between .25% and .50%. At September 28, 2002, the interest rates on the Loan and Security Agreement ranged from 4.32% to 5.25%. Debt classified as long term in the accompanying balance sheet as of September 28, 2002 consists of the long term portion of the term loan component of the new Loan and Security Agreement and all of the 12 3/4% senior subordinated notes. These amounts have been classified as long term due to the refinancing of the Amended and Restated Credit Agreement which occurred on August 1, 2002. As of September 28, 2002, the Company had an eligible borrowing base of $9.8 million related to the line of credit, of which $6.3 million was drawn. The Company has an obligation to purchase from one of its key suppliers a minimum quantity of aluminum coil stock. The Company believes that purchasing aluminum coil stock from this supplier is necessary to achieve consistently low tolerances, design, delivery flexibility, and price stability. Under the terms of this agreement the Company has agreed to purchase certain minimum quantities which approximates $0.4 million at September 28, 2002. At September 28, 2002 and December 31, 2001, inventory turns were 7.4. At September 28, 2002, accounts receivable days sales outstanding ("DSO") were 71, which compare with 65 days at December 31, 2001. This increase primarily relates to increases in DSO experienced by foreign locations of Fluent, primarily in Europe. CRITICAL ACCOUNTING POLICIES We prepare the consolidated financial statements of Aavid Thermal Technologies, Inc. in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based on the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies which we believe are the most critical to aid in fully understanding and evaluating our financial reporting results include the following: REVENUE RECOGNITION AND SALES RETURNS AND ALLOWANCES THERMAL PRODUCTS Revenue is recognized when products are shipped. We offer certain distributors limited rights of return and stock rotation rights. Due to these return rights, we continuously monitor and track product returns and we record a provision for the estimated future amount of such future returns, based on historical experience and any notification we receive of pending returns. While such returns have historically been within our expectations and provisions established, we cannot guarantee that we will continue to experience the same return rates that we have in the past. Any significant decrease in product demand experienced by our distributor customers and the resulting credit returns could have a material adverse impact on our operating results for the period or periods in which such returns materialize. 29 SOFTWARE The Company's software subsidiary, Fluent, has historically recognized software revenue in accordance with Statement of Position (SOP) 97-2, "Software Revenue Recognition" and SOP 98-9, "Modification of SOP 97-2 Software Revenue Recognition, With Respect to Certain Transactions." These statements provide specific industry guidance and stipulate that revenue recognized from software arrangements is to be allocated to each element of the arrangement based on the relative fair values of the elements, such as software products, upgrades, enhancements, post-contract customer support ("PCS"), installation or training. Under the terms of Fluent's arrangements, the software is delivered upon signing and the bundled PCS is available to the customer over the term of the contract. SOP 97-2 requires a seller of software with bundled PCS to establish vendor specific objective evidence ("VSOE") of the value of the undelivered element of the contract (in Fluent's case the PCS) in order to account separately for the PCS revenue. In order to establish VSOE, there needs to be specific instances in which a customer purchases the PCS separately from the software such that a true market value could be determined. Prior to 2001, Fluent's product offerings consisted of both perpetual licenses and annual licenses that included bundled PCS. Purchasers of perpetual licenses would renew their PCS each year for a specific price therefore establishing VSOE for the PCS. Fluent used this VSOE of the value of PCS for both perpetual and annual licenses. SOP 98-9 modified SOP 97-2 to require the use of the "residual method" in situations where VSOE of value exists for all undelivered elements, but does not exist for one or more of the delivered elements. Under the residual method, the undiscounted VSOE of fair value of the undelivered elements (PCS) is deferred and the difference (residual) between the total fee and the amount deferred for the undelivered elements is recognized immediately as revenue. In sum, revenue related to the software element is recognized upon signing of the contract and delivery of the product. Revenue related to PCS is recognized ratably over the life of the contract. Using the residual method methodology, Fluent, with the concurrence of Arthur Andersen LLP, its auditors at the time, determined that 36% of the annual license fee was attributable to PCS, using the price charged for PCS on a perpetual license as VSOE of value of PCS for an annual license. Therefore, upon delivery of software under an annual software license, 64% of the license fee was recognized immediately and the remaining 36% was deferred and amortized to revenue over the 12 month life of the license. On December 29, 2000, the American Institute of Certified Public Accountants (AICPA) issued Technical Practice Aid (TPA) 5100.68. TPA 5100.68 dealt with the issue of whether a perpetual license with separately priced PCS established VSOE of value for shorter term software licenses with bundled PCS. The AICPA specifically stated in TPA 5100.68 that PCS services for a perpetual license and PCS services for a shorter term license are two different elements. Therefore, the renewal rate charged for PCS on a perpetual license does not provide VSOE of value for PCS on the shorter term license. Due to the issuance of this TPA, the Company and its auditors, Arthur Andersen LLP, concluded that under Fluent's bundled contract business practice the Company could no longer establish VSOE of the value of PCS related to their annual licenses based on the PCS used for perpetual licenses. In order to maintain a consistent revenue recognition methodology and to more definitely confirm VSOE of value on the individual elements of the contract, the Company elected to change its annual license agreements and proposals in 2001 to offer PCS as a separately priced item from the software (the "unbundled method"), that could be purchased at the customer's election. In other words, customers could license Fluent's software, which no longer included PCS, and either separately contract for PCS or elect not to take PCS. The Company, along with Arthur Andersen LLP, determined at that time that the unbundled method would establish VSOE of value on the PCS such that the Company could continue to recognize the software revenue upon contract signing and shipment of the software, and defer only the PCS portion of the revenue ratably over the term of the contract. This change had minimal impact on revenue recognition when compared to prior periods, but did clearly identify separate prices for the software and service elements of the contract. On July 10, 2002, the Company announced it had changed auditors from Arthur Andersen LLP to Ernst & Young LLP. Arthur Andersen LLP's fate has been widely publicized and the firm is no longer available to the Company. Based on discussions with Ernst & Young LLP, the Company has determined that the VSOE of value that it was relying upon to support the portion of the license fee attributed to the PCS during 2001, even in the unbundled state, may not have been sufficient to support such treatment. As a result, Ernst & Young LLP advised the Company that it should recognize revenue for the entire software license, and not just the PCS portion of the agreement, ratably over the 12 month term of the license. Ernst & Young LLP further advised the Company to restate its financial results for the year ended December 31, 2001 to reflect this change. 30 Accordingly, the Company has restated its financial statements as of December 31, 2001,and for the year then ended, and for the three and nine month periods ended September 29, 2001, included herein, to reflect this change in revenue recognition. The Company has also restated its financial statements for the first quarter of 2002 and has conformed its third quarter 2002 financial statements to this revenue recognition methodology. While this change has a significant impact on recorded revenues within the statements of operations, and consequently net loss and EBITDA, this change does not affect the Company's statements of cash flows for the three and nine month periods ended September 29, 2001, and the three month period ended March 30, 2002, other than re-allocating certain changes in balance sheet accounts within the cash flow from operations section of the statement. For the three and nine months ended September 29, 2001, the amount of revenue originally recognized but now deferred is $41,000 and $12.9 million respectively. Regardless, Fluent continues to be paid by its customers upon commencement of the execution of the non-cancellable license agreement. Ernst & Young LLP, the Company's independent accountants, have not performed a review of the consolidated financial statements included in this Quarterly Report on Form 10-Q in accordance with Statement on Auditing Standards No. 71, "Interim Financial Information," and as required by Rule 10-01(d) of Regulation S-X, because the Company's consolidated financial statements for the fiscal year ended December 31, 2001 will have to be reaudited as discussed above. Upon completion of the fiscal year 2001 reaudit by Ernst & Young LLP and completion of the SAS 71 review, amended Form 10-Q's and an amended Form 10-K will be filed for all applicable periods. ACCOUNTS RECEIVABLE We perform ongoing credit evaluations of our customers and adjust credit limits based on payment history and the customer's current credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based on our historical experience and any specific customer collection issues we have identified. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates we have in the past. In the event that economic or other conditions cause a change in liquidity or financial condition in multiple customers, there could be a material adverse effect on our collection of receivables and future results of operations. INVENTORIES We value our inventory, which consists of materials, labor and overhead, at the lower of the actual cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production demand for the next twelve months. As demonstrated in 2001, demand for our products can fluctuate significantly. A significant increase in demand for our products could result in a short-term increase in the cost of inventory purchases and production costs while a significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand. In addition, our industry is characterized by rapid technological change, frequent new product development and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Additionally, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess or obsolete inventory. In the future, if our inventory is determined to be overvalued, we would be required to recognize such costs in our cost of goods sold at the time of determination. Likewise, if our inventory is determined to be undervalued, we may have over-reported our cost of sales in previous periods and would be required to recognize such additional operating income at the time of sale. Therefore, although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and reported operating results. VALUATION OF LONG-LIVED ASSETS AND INTANGIBLE ASSETS AND GOODWILL In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of" and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" for the disposal of a segment of a business (as previously defined in that Opinion). The Company adopted SFAS No. 144 on January 1, 2002. The application of SFAS No. 144 did not have a material effect on the Company's financial position or results of operations. 31 During 2001 and prior periods, we assessed the impairment of identifiable intangibles, long-lived assets and related goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable as required under SFAS 121. Factors we considered important which could trigger an impairment review included the following: - significant underperformance relative to expected historical or projected future operating results; - significant changes in the manner of our use of the acquired assets or the strategy for our overall business; - significant negative industry or economic trends. Under SFAS 121, when we determine that the carrying value of intangibles, long-lived assets and related goodwill may not be recoverable based on the existence of one or more of the above indicators of impairment, we measure any impairment based on a projected discounted cashflow method using a discount rate determined by our management to be commensurate with the risk inherent in our business model. During 2001, global macroeconomic conditions weakened and the demand for industrial and consumer electronics contracted significantly and as a result we determined that our ability to achieve our long term financial forecast had been negatively impacted. We determined that a triggering event, as defined by SFAS 121, had occurred related to the intangible assets initially acquired in connection with the Merger. Based on cash flow projections related to the acquired assets, we concluded that all of the acquired intangible assets related to Aavid Thermalloy and certain intangible assets related to Fluent had been impaired. During the fourth quarter of 2001, upon completion of our analysis of the impairment, we wrote down the assets, along with any allocated goodwill, to fair value based on the related discounted cash flow. In order to measure the impairment loss related to goodwill, the difference between the carrying value and the fair value of goodwill was calculated using a business enterprise methodology. This method of goodwill measurement entails calculating the total enterprise value of each of Aavid's business units. Goodwill and intangible assets were then estimated by subtracting the allocated tangible assets (normal levels of working capital and fixed assets) from the total enterprise value. REGULATORY REPORTING The Company is considering electing the option of not being a reporting Company to the Securities and Exchange Commission, effective as of January 1, 2003. The Company would continue to meet its reporting requirements as set forth in its Senior Subordinated Notes Indenture. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Company is involved in various other legal proceedings that are incidental to the conduct of the Company's business, none of which the Company believes could reasonably be expected to have a materially adverse effect on the Company's financial condition. ITEM 4. CONTROLS AND PROCEDURES As of September 28, 2002, an evaluation was performed under the supervision and with the participation of the Company's management, including the CEO and CFO, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective as of September 28, 2002. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to September 28, 2002. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits None. (b) Reports on Form 8-K July 10, 2002 Announcement of the replacement of Arthur Andersen, LLP with Ernst & Young, LLP as the Company's independent public accountants for the fiscal year ending December 31, 2002. August 1, 2002 Announcement of sale of Aavid Thermalloy Holdings, GmbH, which owned approximately 89.5% of the outstanding shares of curamik electronics, GmbH. 32 Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SIGNATURES DATE: November 12, 2002 AAVID THERMAL TECHNOLOGIES, INC. By: /s/ Brian A. Byrne -------------------------------- Vice President and Chief Financial Officer (Principal Financial Officer) 33

AAVID THERMAL TECHNOLOGIES INC 10-Q