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Friday, August 14, 1998
Aavid Thermal Technologies, Inc.
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Phone: 603-224-1117
Website: http://www.aatt.com
Price (8/13/98): $11
HOW DID IT FIND TROUBLE?
Aavid Thermal cooled down faster than a Pentium II heats up. The irony is that Aavid is a leading provider of the kinds of thermal management solutions that keep such digital and power electronics equipment from suffering in the heat. Intel <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %> had been the firm's biggest customer, but that's about to change. Thus, an Arctic blast has chilled the stock price.
On July 22, Aavid shares plunged into icy waters, down 51% to $14 1/4, after the firm announced the bad news along with second quarter results in line with analyst estimates. Just a week earlier, management learned that Intel, which accounted for 27% of Aavid's second quarter sales, would cut back on orders. From now on, the PC manufacturers will be installing most of the thermal protection devices themselves.
While Aavid has relationships with the top eight PC makers, this transition will lead to lower third quarter unit shipments. Management expects third quarter EPS to be flat with the year-ago period, or $0.25 per share compared to previous estimates of $0.36. CEO Ronald Borelli said, "[W]e expect to see an interruption to our long-term growth trend in the third and to a lesser extent, the fourth quarter."
The chill has worsened as investors discount the uncertainty factor.
BUSINESS DESCRIPTION
Based in Concord, New Hampshire, Aavid provides thermal management solutions such as aluminum sinks for dissipating the heat that can damage electronic equipment. This business accounted for 82.5% of sales in the second quarter, with two-thirds derived from the computer and networking industries and the rest from other industries such as telecommunications. In addition to Intel, customers include Compaq, Chrysler, General Electric, and IBM.
Its Fluent software unit, which provides computational fluid dynamics software for computer modeling and flow analysis, accounts for most of Aavid's other sales. Its more than 1,800 customers include Boeing, Ford, and Motorola. A smaller thermal design unit works with the likes of Cisco and Bay Networks.
The company recently increased the size of its manufacturing facilities in China from 40,000 to over 100,000 square feet.
Competitors include Alpha Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ATGI)") else Response.Write("(Nasdaq: ATGI)") end if %>, Bowthorpe Pic's Thermalloy unit, Foxconn of Taiwan, and Johnson Matthey Electronics. Insiders own 15% of the stock, while another 13.5% is owned by former CEO Alan Beane (who is suing the company in a royalty dispute.)
FINANCIAL FACTS
Income Statement*
12-month sales: $206.1 million
12-month income: $11.1 million
12-month EPS: $1.21
Profit Margin: 5.4%
Market Cap: $104.4 million
(*Excludes one-time compensation charges.)
Balance Sheet
Cash: $3.2 million
Current Assets: $65.1 million
Current Liabilities: $36.8 million
Long-term Debt: $13.3 million
Ratios
Price-to-earnings: 9.1
Price-to-sales: 0.5
HOW COULD YOU HAVE SEEN IT COMING?
With higher performance computer chips often running hotter and thus boosting the threat of systems failures, secular demand for Aavid's thermal solutions seemed strong. With sales increasing sequentially seven quarters in a row and the firm's net margins and inventory turns improving, Aavid appeared well-positioned for the long term, even as fears of slowing PC sales periodically spooked investors.
One might have worried about the dependence on Intel, which accounted for 15% of FY97 sales and 22% of fourth quarter revenue. Moreover, the transition to Intel's Celeron chip for the under $1,000 PC might have sparked some questions. Still, while Aavid's management expected Intel to shift the responsibility for thermal solutions back to the PC makers, the transition happened much faster than expected. The market was even less prepared for the news.
WHERE TO FROM HERE?
Aavid gets major kudos for archiving its conference calls on its website. Investor relations folks the world over should take note.
On the other hand, management's disclosure was a little vague on the second quarter conference call because the recent events have created significant uncertainty about near-term results. Analysts repeatedly asked whether the third quarter shortfall will represent a one-time blip as Intel's inventories work through the PC manufacturers, or whether Aavid may indeed lose market share in this transition. As many times as management addressed this question, the real answer seems to be that they don't know yet.
It sounds like most thermal products will eventually be the responsibility of the PC manufacturers and that low-cost PCs will cut into the average selling price, but some of that ground will be made up on the high-end server side. In the meantime, Aavid's new manufacturing facility capacity should reduce production expenses even as Aavid looks to trim operating expenses. Also, the company will be looking at more opportunities outside the PC market.
For now, though, the outlook is cautious, with analysts slicing their estimates to a low of $1.05 per share for FY98 from an earlier consensus of $1.39. Similarly, the low FY99 estimate is now $1.18, versus a consensus of $1.77 prior to the warning. Given its decent balance sheet, Aavid may represent a real bargain at today's prices if events pan out as well as management hopes.
Yet, with price pressures roiling all PC component suppliers, interested investors will need to do some serious due diligence at this point or simply wait until third quarter results are in and Aavid's management has a better purchase on the future.
-- Louis Corrigan
([email protected])
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