10-Q 1 b48015ate10vq.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 27, 2003 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 [ ] No [X](1) Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 126-2 of the Exchange Act). Yes [ ] No [X] The number of outstanding shares of the registrant's Common Stock as of November 7, 2003 was 1,018.87 shares of class A, 1,078.87 shares of Class B and 40 shares of Class H, all of which are owned by Heat Holdings Corp. On February 2, 2000, a wholly-owned subsidiary of Heat Holdings Corp. was merged with and into the Registrant with the Registrant becoming a wholly-owned subsidiary of Heat Holdings Corp. and each share of Registrant's then outstanding common stock was converted into $25.50 in cash. The Registrant's Common Stock is no longer publicly traded. ------------ (1) Although the Company has not been subject to such filing requirements for the past 90 days, it has filed all reports required to be filed by Section 15(d) of the Securities Exchange Act of 1934 (the "Act") during the preceding twelve months. Pursuant to Section 15(d) of the Act, the Company's duty to file reports is automatically suspended as a result of having fewer than 300 holders of record of its debt securities outstanding, as of January 1, 2003, but the Company agreed under the terms of certain long-term debt covenants to continue these filings. AAVID THERMAL TECHNOLOGIES, INC. INDEX TO FORM 10-Q

2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS AAVID THERMAL TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

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

* Restated. See Note 2. 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)

* Restated. See Note 2. The accompanying notes are an integral part of these consolidated financial statements. 5 AAVID THERMAL TECHNOLOGIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT PER SHARE AND SHARE DATA) (1) ORGANIZATION AND MERGER Aavid Thermal Technologies, Inc. (the "Company" or "Aavid") is 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 $95,651. 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 10 for selected consolidating financial statements of parent, guarantors and non-guarantors). The Notes were issued pursuant to an Indenture (the "Indenture") among the Company, the Subsidiary Guarantors and Bankers Trust Company, as trustee. $4,560 of the proceeds from the sale of the Units was allocated to the fair value of the Warrants and $143,752 was allocated to the Notes, net of original issue discount of $1,688. The total discount of $6,248 is being accreted over the term of the notes, using the effective interest rate method. This accretion is recorded as interest expense within the accompanying statement of operations for the quarter and nine months ended September 27, 2003 and the quarter and nine months ended September 28, 2002. In connection with the Merger, the Company entered into an amended and restated credit facility (the "Amended and Restated Credit Facility"). The Amended and Restated Credit Facility provided for a $22,000 revolving credit facility (the "Revolving Facility") (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). 6 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. On August 1, 2002, the Company refinanced its Amended and Restated Credit Facility with two of the four banks that were party to the Amended and Restated Credit Facility. The new credit facility (the "Loan and Security Agreement") is a $27,500 asset based facility. The facility consists of a term loan component which requires quarterly principal payments of $359 commencing November 1, 2002. The Loan and Security Agreement also consists of a revolving line of credit component. All borrowings under the new credit facility are secured by substantially all assets of the Company. Availability under the line of credit component is determined by a borrowing base of 85% of eligible accounts receivable and 50% of eligible inventory, as defined in the Loan and Security Agreement. At August 1, 2002, the total available credit under the Loan and Security Agreement was $23,880, of which $22,620 was drawn at closing. Debt outstanding under the Loan and Security Agreement bears interest at a rate equal to, at the Company's option, either (1) in the case of LIBOR rate loans, the sum of the offered rate for deposits in United States dollars for a period equal to such interest period as it appears on Telerate page 3750 as of 11:00 am 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 27, 2003, the interest rates on the Loan and Security Agreement ranged from 3.62% to 4.50%. Availability under the revolving line of credit was $11,948 at September 27, 2003, of which $5,729 had been drawn. The Company incurred costs related to underwriting, legal and other professional fees in connection with the issuance of the Notes and the establishment of its senior credit facilities. These costs have been capitalized as deferred financing fees and are being amortized over the respective terms of the related debt. This amortization is recorded in interest expense in the accompanying statement of operations for the quarter and nine months ended September 27, 2003 and the quarter and nine months ended September 28, 2002. Debt classified as long term in the accompanying balance sheet as of September 27, 2003 consists of the long term portion of the term loan component of the new Loan and Security Agreement, long term portion of capital leases, long term portion of foreign debt obligations and all of the 12 3/4% senior subordinated notes. On January 29, 2002, as part of an equity contribution required under a forbearance agreement with the Company's previous senior credit holders, 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 sheets as of September 27, 2003 and December 31, 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. 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 $12,406 at September 27, 2003. Total cumulative unpaid dividends at September 27, 2003 were $2,150. 7 (2) RESTATEMENT OF FINANCIAL RESULTS Due to the Company restating the intangible asset impairment charge that was recorded in 2001 (see Note C to the consolidated financial statements included in the Company's Form 10-K for the year ended December 31, 2002), the Company restated amortization recorded in 2002 related to the impacted intangible assets. At the time of the Company's sale of Curamik, the Company anticipated a potential tax liability associated with the profit earned on the sale and so recorded an estimated amount of tax expense. However, during the year end final calculation of the Company's tax provision, it was determined that there was no tax expense associated with the sale of Curamik. Due to this, the tax expense recorded originally at the time of the sale was reversed. The statement of operations for the quarter and nine months ended September 28, 2002 and the statement of cash flows for the nine months ended September 28, 2002 included in this Form 10-Q have been restated to reflect the intangible asset amortization as discussed above. Accumulated deficit at September 28, 2002 (unaudited) has been restated in connection with changes made to the consolidated statements of operations for the quarter and nine months ended September 28, 2002 as follows:

(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 89.4% of the outstanding shares of curamik electronics GmbH, pursuant to a Share Sale and Purchase Agreement between the Company and Electrovac Fabrikation Electrotechnischer Spezialartikel GesmbH dated July 10, 2002 (the "Sale Agreement"). Under the Sale Agreement, the Company received consideration of $31,524, subject to possible adjustment based upon consolidated net assets of Curamik and certain indemnification obligations of the Company. The sale of Curamik and its related operating results have been excluded from losses from continuing operations and is classified as a discontinued operation for the quarter and nine months ended September 28, 2002, 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:

8 (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 27, 2003 and December 31, 2002, and the results of operations and cash flows for the quarter and nine months ended September 27, 2003 and September 28, 2002. Interim results are not necessarily indicative of results for a full year. (5) ACCOUNTS RECEIVABLE The components of accounts receivable at September 27, 2003 and December 31, 2002 are as follows:

(6) 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 27, 2003 and December 31, 2002 are as follows:

(7) COMPREHENSIVE INCOME (LOSS) 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 loss for the periods reported herein:

9 (8) RESTRUCTURING CHARGES AND RESERVES Approximately $2,130 of restructuring charges were recorded in connection with the Company's October 1999 acquisition of Thermalloy, the thermal management business of Bowthorpe plc. The restructuring plan included initiatives to integrate the operations of the Company and Thermalloy and reduce overhead. The primary components of these plans related to (a) the closure of duplicative Thermalloy operations in Hong Kong and the United Kingdom, (b) the elimination of duplicative selling, general and administration functions of Thermalloy on a global basis and (c) the termination of certain contractual obligations. During the year ended December 31, 2000, 136 individuals were terminated under the restructuring plan. The following amounts have been charged against the Thermalloy restructuring reserves during the quarter ended September 27, 2003:

During 2001, the Company ceased manufacturing operations in Dallas and Terrell, Texas, Loudwater, United Kingdom and its fan factory in China. Additionally, the Company reduced its workforce in New Hampshire, Europe and Asia, including both selling general and administrative and manufacturing personnel. In connection with these actions, the Company recorded a restructuring charge within the statement of operations during 2001. This restructuring charge totaled $16,885 and included amounts related to employee severance, lease terminations, write-off of fixed assets and write-off of a prepaid lease intangible asset that was originally recorded as part of the Thermalloy acquisition. Approximately 524 individuals were terminated under the restructuring plan. The following amounts have been charged against these reserves during the quarter ended September 27, 2003:

10 During 2002, the Company ceased manufacturing operations in Malaysia and reduced its workforce in Singapore. In connection with these actions, the Company recorded a restructuring charge within the statement of operations during 2002. This restructuring charge totaled $858 and included amounts related to employee severance, facility costs/lease terminations and write-off of fixed assets. Approximately 57 individuals were terminated under the restructuring plan. The following amounts have been charged against these reserves during the quarter ended September 27, 2003:

(9) 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, 2002. 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. 11 The following summarizes the operations of each reportable segment for the quarters and nine months ending September 27, 2003 and September 28, 2002:

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.

* Restated. See Note 2. 12 (10) 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.

* Restated. See Note 2. 15

* Restated. See Note 2. 16

* Restated. See Note 2 17 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, 2002. 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 a leading developer and marketer of computational fluid dynamics ("CFD") software. Each of these businesses has a 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. RESULTS OF OPERATIONS For The Quarter and Nine Months Ended September 27, 2003 Compared With The Quarter and Nine Months Ended September 28, 2002:

Aavid's sales in the third quarter of 2003 were $44.2 million, an increase of $5.1 million, or 13.0%, from the comparable period of 2002. Aavid's sales for the first nine months of 2003 were $135.6 million, an increase of $17.7 million, or 15.0%, from the first nine months of 2002. The overall increase in sales is a combination of an improvement in Aavid Thermalloy, driven by an increase in market share and a slight improvement experienced by the semi-conductor and electronics industries as excess inventories throughout the industry have been reduced, combined with an increase in revenues experienced by Fluent. Fluent software sales of $21.6 million in the third quarter of 2003 were $3.9 million, or 22.0%, higher than the third quarter of 2002. Fluent sales for the first nine months of 2003 were $62.1 million, an increase of $10.0 million, or 19.2%, from the comparable period of 2002. The increase was spread among all product offerings due to overall growth in the market for computational fluid dynamics design software, as well as the continued success of application specific products, such as "Icepak" and "Airpak". 18 Aavid Thermalloy's sales were $22.6 million in the third quarter of 2003, an increase of $1.2 million, or 5.6%, over the third quarter of 2002. Aavid Thermalloy sales for the first nine months of 2003 were $73.5 million, an increase of $7.7 million, or 11.7%, from the comparable period of 2002. As discussed above, this was the result of both an increase in market share and a slight improvement in the overall industry in which Aavid Thermalloy's customers operate in, primarily due to the industry's ability to significantly reduce levels of excess inventories existing in 2002. Based on the current booking activity, management expects to see moderate growth of revenues in the fourth quarter of 2003 when compared with the third quarter of 2003. The Company's international sales (which include U.S. exports) increased to 53.1% of sales for the third quarter of 2003 compared with 47.8% in the third quarter of 2002. No customer generated greater than 10% of the Company's revenues in the third quarter of 2003 or 2002. The Company's gross profit for the third quarter of 2003 was $21.8 million compared with $18.1 million in the comparable period from 2002. Gross profit for the first nine months of 2003 was $65.3 million, an increase of $13.1 million, or 25.0%, from the first nine months of 2002. Gross margin as a percentage of sales was 49.4% and 48.2%, respectively, for the third quarter and first nine months of 2003, compared with 46.2% and 44.3% for the comparable periods of 2002. 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, the Malacca, Malaysia facility and the Dallas and Terrell, Texas facilities) that occurred during 2001 and 2002. Aavid Thermalloy's gross margin increased approximately 1.4% percentage points from the third quarter of 2002 to the third quarter of 2003. Gross margin at Fluent remained steady at 80.6% in the third quarter of 2002 compared to 80.7% in the third quarter of 2003. In the third quarter of 2003, the Company's operating income of $2.9 million compares with operating income of $0.8 million in the third quarter of 2002. Operating income for the first nine months of 2003 was $7.1 million, compared with an operating loss of $0.8 million from the comparable period in the prior year. Aavid Thermalloy saw improvements of $0.9 million and $5.3 million, respectively, in operating income from the third quarter and first nine months of 2002 to the third quarter and first nine months of 2003. This is primarily due to the improvement in manufacturing utilization and cost savings achievements discussed above. Fluent's operating income improved $1.0 million and $1.6 million, respectively, in the third quarter and first nine months of 2003 as compared to the comparable periods in the prior year, with higher gross profit partially offset by higher operating expenses. Corporate headquarters experienced an improvement in operating loss of $0.2 million and $1.1 million, respectively, from the third quarter and first nine months of 2002 to the comparable periods of 2003 due to decreased legal and administrative costs. Net interest charges, including cash interest expense and income, deferred financing fee amortization and bond discount amortization, for the Company were $4.5 million and $13.7 million, respectively, in the third quarter and first nine months of 2003 which compares with $5.5 million and $15.9 million for the comparable periods of 2002. The decrease in interest expense for the third quarter and first nine months of 2003 is due to lower debt levels in the first nine months of 2003 compared to the first nine months of 2002, combined with lower interest rates on bank debt in 2003 compared to 2002. The Company incurred a tax provision for the third quarter and first nine months of 2003 despite having operating losses in the United States because of state tax provisions on applicable state components of U.S. income and foreign tax provisions 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. 19 The Company's net loss was $1.6 million and $6.5 million, respectively, for the quarter and nine months ended September 27, 2003 compared with net income of $1.9 million in the third quarter of 2002 and net loss of $12.4 million for the first nine months of 2002. Net income (loss) for the quarter and nine months ended September 28, 2002 includes a gain on the sale of curamik electronics GmbH of $6.4 million (see note 3 to the financial statements). Excluding the gain on the sale of curamik electronics GmbH in 2002 results, the primary reasons for the improvement in net loss from 2002 to 2003 have been discussed above, but include Aavid Thermalloy's revenue growth and significant improvements in manufacturing efficiency through plant shut-downs and other cost savings initiatives. The Company's EBITDA, as defined in the Loan and Security Agreement with the Company's senior lenders, was $2.8 million and $21.6 million, respectively, for the third quarter and first nine months of 2003, compared with $0.8 million and $13.8 million for the comparable periods in 2002. A reconciliation of net income to EBITDA is as follows:

Aavid Thermalloy operates a manufacturing plant in Guangdong Province, China and sales offices in Taipei, Taiwan and Singapore. Each of these locations had been identified by the World Health Organization as an affected area for Severe Acute Respiratory Syndrome (SARS) in early 2003. While the SARS epidemic appears to have been contained and travel and other restrictions have been lifted as of the date of this filing, the performance of our Asian operations could be materially adversely affected should the disease manifest itself again in future periods. LIQUIDITY AND CAPITAL RESOURCES 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. -------- (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. 20 During the first nine months of 2003, the Company generated $9.3 million of cash from operations, versus using $6.7 million of cash for operations in the first nine months of 2002. During the first nine months of 2003, the Company used $2.8 million of cash in connection with investing activities versus being provided with $28.5 million in the comparable period of 2002. Cash provided from investing activities during the first nine months of 2002 includes $31.3 million of proceeds from the sale of Curamik. The Company used $3.0 million for capital expenditures in the first nine months of 2003 versus $4.3 million in the comparable period of 2002. The Company used $2.9 million of cash in connection with financing activities for the first nine months of 2003, compared to $24.9 million of cash used in financing activities for the comparable period in 2002. 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. 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 11:00 am 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 27, 2003, the interest rates on the Loan and Security Agreement ranged from 3.62% to 4.50%. Availability under the revolving line of credit was $11.9 million at September 27, 2003, of which $5.7 million had been drawn. Debt classified as long term in the accompanying balance sheet as of September 27, 2003 consists of the long term portion of the term loan component of the new Loan and Security Agreement, long term portion of capital leases, long term portion of foreign debt obligations and all of the 12 3/4% senior subordinated notes. The Company has obligations to purchase minimum quantities of raw materials from three of its key suppliers. The Company believes that purchasing these raw materials from a few key suppliers is necessary to achieve consistently low tolerances, design, delivery flexibility, and price stability. Under the terms of these agreements the Company has agreed to purchase certain minimum quantities which approximates $1.2 million at September 27, 2003. The Company has entered into various long-term debt, capital lease and operating lease arrangements. The future payments required by these arrangements at September 27, 2003 are as follows:

At September 27, 2003 and December 31, 2002, inventory turns were 9.7. At September 27, 2003, accounts receivable days sales outstanding ("DSO") were 64 days, which compare with 66 days at December 31, 2002. 21 CRITICAL ACCOUNTING POLICIES We prepare the consolidated financial statements of Aavid Thermal Technologies, Inc. in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based on the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies which we believe are the most critical to aid in fully understanding and evaluating our financial reporting results include the following: REVENUE RECOGNITION AND SALES RETURNS AND ALLOWANCES THERMAL PRODUCTS Revenue is recognized when products are shipped. We offer certain distributors limited rights of return and stock rotation rights. Due to these return rights, we continuously monitor and track product returns and we record a provision for the estimated future amount of such future returns, based on historical experience and any notification we receive of pending returns. While such returns have historically been within our expectations and provisions established, we cannot guarantee that we will continue to experience the same return rates that we have in the past. Any significant decrease in product demand experienced by our distributor customers and the resulting credit returns could have a material adverse impact on our operating results for the period or periods in which such returns materialize. SOFTWARE The Company's software subsidiary, Fluent, recognizes software revenue in accordance with Statement of Position (SOP) 97-2, "Software Revenue Recognition" and SOP 98-9, "Modification of SOP 97-2 Software Revenue Recognition, With Respect to Certain Transactions." These statements provide specific industry guidance and stipulate that revenue recognized from software arrangements is to be allocated to each element of the arrangement based on the relative fair values of the elements, such as software products, upgrades, enhancements, post-contract customer support ("PCS"), installation or training. Under the terms of Fluent's arrangements, the software is delivered upon signing and the bundled PCS is available to the customer over the term of the contract. SOP 97-2 requires a seller of software with bundled PCS to establish vendor specific objective evidence ("VSOE") of the value of the undelivered element of the contract (in Fluent's case the PCS) in order to account separately for the PCS revenue. In order to establish VSOE, there needs to be specific instances in which a customer purchases the PCS separately from the software such that a true market value can be determined. Fluent's product offerings consist of both perpetual licenses and annual licenses that include bundled PCS. Purchasers of perpetual licenses renew their PCS each year for a specific price. Due to this practice, there is VSOE for the value of the PCS, which allows Fluent to separate the software element from the PCS element and recognize the software element immediately upon signing of the contract and delivery of the product. PCS revenue is then recognized ratably over the term of the agreement. For annual license arrangements, the Company believes it does not have sufficient VSOE to support the separation of the contract into separate elements (which would allow the Company to recognize revenue associated with the software element immediately upon signing of the contract). Therefore, the Company recognizes revenue associated with the entire annual license arrangement ratably, over the term of the agreement. 22 ACCOUNTS RECEIVABLE We perform ongoing credit evaluations of our customers and adjust credit limits based on payment history and the customer's current credit worthiness, as determined by our review of their current credit information. We continuously monitor collections and payments from our customers and maintain a provision for estimated credit losses based on our historical experience and any specific customer collection issues we have identified. While such credit losses have historically been within our expectations and the provisions established, we cannot guarantee that we will continue to experience the same credit loss rates we have in the past. In the event that economic or other conditions cause a change in liquidity or financial condition in multiple customers, there could be a material adverse effect on our collection of receivables and future results of operations. INVENTORIES We value our inventory, which consists of materials, labor and overhead, at the lower of the actual cost to purchase and/or manufacture the inventory or the current estimated market value of the inventory. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production demand for the next twelve months. As demonstrated in 2002 and 2001, demand for our products can fluctuate significantly. A significant increase in demand for our products could result in a short-term increase in the cost of inventory purchases and production costs while a significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand. In addition, our industry is characterized by rapid technological change, frequent new product development and rapid product obsolescence that could result in an increase in the amount of obsolete inventory quantities on hand. Additionally, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess or obsolete inventory. In the future, if our inventory is determined to be overvalued, we would be required to recognize such costs in our cost of goods sold at the time of determination. Likewise, if our inventory is determined to be undervalued, we may have over-reported our cost of sales in previous periods and would be required to recognize such additional operating income at the time of sale. Therefore, although we make every effort to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and reported operating results. VALUATION OF LONG-LIVED ASSETS AND INTANGIBLE ASSETS AND GOODWILL In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of" and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" for the disposal of a segment of a business (as previously defined in that Opinion). The Company adopted SFAS No. 144 on January 1, 2002. The application of SFAS No. 144 did not have a material effect on the Company's financial position or results of operations. During 2001 and prior periods, we assessed the impairment of identifiable intangibles, long-lived assets and related goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable as required under SFAS 121. Factors we considered important which could trigger an impairment review included the following: - significant underperformance relative to expected historical or projected future operating results; - significant changes in the manner of our use of the acquired assets or the strategy for our overall business; - significant negative industry or economic trends. 23 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 Although the Company has not been subject to the filing requirements of a reporting company to the Securities and Exchange Commission for the past 90 days, it has filed all reports required to be filed by Section 15(d) of the Securities Exchange Act (the "Act") of 1934 during the preceding twelve months. Pursuant to Section 15(d) of the Act, the Company's duty to file reports is automatically suspended as a result of having fewer than 300 holders of record of each class of its debt securities outstanding, as of January 1, 2003, but the Company agreed under the terms of certain long-term debt covenants to continue these filings. BOARD OF DIRECTORS On October 21, 2003 the Board of Directors amended the bylaws of the corporation to provide for one additional Class B director, and then elected Christopher Boehm, Principal, Willis Stein & Partners to fill the vacancy created. He will continue to serve in accordance with the terms of the Certificate of Incorporation and the bylaws. ITEM 4. CONTROLS AND PROCEDURES As of September 27, 2003, 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 27, 2003 in ensuring that material information relating to the Company is made known to the CEO and CFO by others within the Company during the period in which the report was being prepared. 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 27, 2003. 24 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 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 31.1 Certification of CEO 31.2 Certification of CFO (b) Reports on Form 8-K None. SIGNATURES DATE: November 7, 2003 AAVID THERMAL TECHNOLOGIES, INC. By: /s/ Brian A. Byrne ------------------------------------------ Vice President and Chief Financial Officer (Principal Financial Officer) 25

AAVID THERMAL TECHNOLOGIES INC 10-Q