SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form
10-K
(Mark
One)
[X] ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the fiscal year-ended December 31, 2006
OR
[
] TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES
EXCHANGE ACT OF 1934
For
the
transition period from __________ to __________
Commission
file number: 333-119902
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Nortek,
Inc.
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|
(exact
name of registrant as specified in its charter)
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| |
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Delaware
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05-0314991
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|
(State
or other jurisdiction of incorporation or organization)
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(IRS
Employer Identification Number)
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| |
|
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50
Kennedy Plaza
Providence,
Rhode Island
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02903-2360
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(Address
of principal executive offices)
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(zip
code)
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| |
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Registrant’s
Telephone Number, Including Area Code:
(401)
751-1600
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| |
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Securities
registered pursuant to Section 12(b) of the Act: None
|
Indicate
by check mark if the registrant is a well-known seasoned issuer (as defined
in
Rule 405 of the Securities Act). Yes
[_] No
[X]
Indicate
by check mark if the registrant is not required to file reports pursuant
to
Section 13 or 15(d) of the Exchange Act. Yes
[X] No
[_]
Indicate
by check mark whether 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 and (2) has been subject to such filing requirements
for the
past 90 days. Yes
[_] No
[X]
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment
to this
Form 10-K. [X]
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of
the
Act).
|
Large
accelerated filer [_]
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Accelerated
Filer [_]
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Non-accelerated
filer [X]
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes
[_] No
[X]
The
aggregate market value of voting stock held by non-affiliates is
zero.
The
number of shares of Common Stock outstanding as of March 30, 2007 was
3,000.
NORTEK,
INC. AND SUBSIDIARIES
December
31, 2006
PART
I
Item
1. Business.
General
Nortek,
Inc.
(“Nortek” or the “Company”) is a leading diversified manufacturer of innovative,
branded residential and commercial products, operating within three reporting
segments:
| · |
the
Residential Ventilation Products, or RVP,
segment,
|
| · |
the
Home
Technology Products, or HTP, segment, and
|
| · |
the
Air
Conditioning and Heating Products, or HVAC,
segment.
|
Through
these
segments, the Company manufactures and sells, primarily in the United States,
Canada and Europe, a wide variety of products for the professional remodeling
and replacement markets, the residential and commercial construction markets,
the manufactured housing market and the do-it-yourself, or DIY,
market.
The
levels of
residential replacement and remodeling, new residential construction and
non-residential construction significantly impact the Company’s performance.
Interest rates, seasonality, inflation, consumer spending habits and
unemployment are factors that affect these levels.
As
used in this
report, the terms “Company” and “Nortek” refer to Nortek, Inc., together with
its subsidiaries, unless the context indicates otherwise. Such terms as
“Company” and “Nortek” are used for convenience only and are not intended as a
precise description of any of the separate corporations, each of which
manages
its own affairs.
Additional
information concerning the Company’s business is set forth in Management’s
Discussion and Analysis of Financial Condition and Results of Operations,
Item 7
of Part II of this report, incorporated herein by reference. Additional
information on foreign and domestic operations is set forth in Note 11
of the
Notes to the Consolidated Financial Statements, Item 8 of Part II of this
report, incorporated herein by reference.
Our
Business Segments
Residential
Ventilation Products Segment
The
Company’s
Residential Ventilation Products segment primarily manufactures and distributes
room and whole house ventilation products and other products primarily
for the
professional remodeling and replacement markets, residential new construction
market and DIY market. The principal products of the segment, which are
sold
under the Broan®, NuTone®, Venmar®, Best® and Zephyr® brand names, among others,
are:
| · |
exhaust
fans
(such as bath fans and fan, heater and light combination units),
and
|
| · |
indoor
air
quality products.
|
The
Company is one
of the world’s largest suppliers of residential range hoods and exhaust fans,
and is the largest supplier of these products in North America. The Company
is
also one of the leading suppliers in Europe of luxury “Eurostyle” range hoods.
The Company’s kitchen range hoods expel grease, smoke, moisture and odors from
the cooking area and are offered under an array of price points and styles
from
economy to upscale models. The exhaust fans the Company offers are primarily
used in bathrooms to remove odors and humidity and include combination
units,
which may have lights, heaters or both. The Company’s range hood and exhaust fan
products are differentiated on the basis of air movement as measured in
cubic
feet per minute and sound output as measured in sones. The Home Ventilating
Institute in the United States certifies the Company’s range hood and exhaust
fan products, as well as its indoor air quality products.
The
Company’s sales
of kitchen range hoods and exhaust fans accounted for approximately 15.9%
and
13.0%, respectively, of the Company’s consolidated net sales in 2006, 15.9% and
14.7%, respectively, of the Company’s consolidated net sales in 2005 and 18.6%
and 17.0%, respectively, of the Company’s consolidated net sales in
2004.
The
Company is one
of the largest suppliers in North America of indoor air quality products,
which
include air exchangers, as well as heat or energy recovery ventilators
(HRVs and
ERVs) that provide whole house ventilation. These systems bring in fresh
air
from the outdoors while exhausting stale air from the home. Both HRVs and
ERVs
moderate the temperature of the fresh air by transferring heat from one
air
stream to the other. In addition, ERVs also modify the humidity content
of the
fresh air. The Company also sells powered attic ventilators, which alleviate
heat build up in attic areas and reduce deterioration of roof
structures.
Since
the late
1970s, homes have been built more airtight and insulated in order to increase
energy efficiency. According to published studies, this trend correlates
with an
increased incidence of respiratory problems such as asthma and allergies
in
individuals. In addition, excess moisture, which may be trapped in a home,
has
the potential to cause significant deterioration to the structure and interiors
of the home. Proper intermittent ventilation in high concentration areas
such as
kitchens and baths as well as whole house ventilation will mitigate these
problems.
The
Company sells
other products in this segment, including among others, door chimes, medicine
cabinets, trash compactors, ceiling fans and central vacuum systems, by
leveraging its strong brand names and distribution network.
The
Company sells
the products in its RVP segment to distributors and dealers of electrical
and
lighting products, kitchen and bath dealers, retail home centers and original
equipment manufacturers under the Broan®, NuTone®, Venmar®, Best® and Zephyr®
brand names, among others. Private label customers accounted for approximately
24.3% of the net sales of this segment in 2006.
A
key component of
the Company’s operating strategy for this segment is the introduction of new
products and innovations, which capitalize on the strong brand names and
the
extensive distribution system of the segment’s businesses. These include the new
QT series of ultra-quiet exhaust fans with new grille styles, decorative
and
recessed fan/light combination units, as well as high performance range
hoods
used in today’s “gourmet” kitchen environments. The Company believes that its
variety of product offerings and new product introductions help it to maintain
and improve its market position for its principal products. At the same
time,
the Company believes that its status as a low-cost producer provides the
segment
with a competitive advantage.
The
Company’s
primary residential ventilation products compete with many domestic and
international suppliers in various markets. The Company competes with suppliers
of competitive products primarily on the basis of quality, distribution,
delivery and price. Although the Company believes it competes favorably
with
other suppliers of residential ventilation products, some of the Company’s
competitors have greater financial and marketing resources than this segment
of
the Company’s business.
Product
manufacturing in the RVP segment generally consists of fabrication from
coil and
sheet steel and formed metal utilizing stamping, pressing and welding methods,
assembly with components and subassemblies purchased from outside sources
(principally motors, fan blades, heating elements, wiring harnesses, controlling
devices, glass, mirrors, lighting fixtures and polyethylene components
and
electronic components) and painting, finishing and packaging.
The
Company’s RVP
segment had 13 manufacturing plants and employed approximately 3,100 full-time
people as of December 31, 2006, of which approximately 300 are covered
by
collective bargaining agreements which expire in 2007 and approximately
100 are
covered by collective bargaining agreements which expire in 2008. See
“Employees” for more information regarding the Company’s collective bargaining
agreement which expired in 2005.
Home
Technology Products Segment
The
Company’s Home
Technology Products segment manufactures and distributes a broad array
of
products designed to provide convenience and security for residential and
light
commercial applications. The principal products the Company sells in this
segment are:
| · |
audio/video
distribution and control equipment,
|
| · |
speakers
and
subwoofers,
|
| · |
security
and
access control products,
|
| · |
power
conditioners and surge protectors,
|
| · |
audio/video
wall mounts and fixtures,
|
The
segment’s
audio/video distribution and control equipment products include
multi-room/multi-source amplifiers, home theatre receivers, intercom systems,
hard disk media servers and control devices such as keypads, remote controls
and
volume controls. The segment’s speakers are primarily built-in (in-wall or
in-ceiling) and are primarily used in multi-room or home theatre applications.
These products are sold under the Niles®, Elan®, SpeakerCraft®, JobSite®,
Proficient Audio Systems®, Sunfire®, Imerge®, Xantech®, M&S Systems® and
Channel Plus® brand names.
The
segment’s
security and access control products include residential and light commercial
intrusion protection systems, garage and gate operators and devices to
gain
entry to buildings and gated properties such as radio transmitters and
contacts,
keypads and telephone entry systems. These products are sold under the
Linear®,
GTO/PRO®, Mighty Mule®, OSCO® and other private label brand names, as well as
Westinghouse®, which is licensed.
Other
products in
this segment include power conditioners and surge protectors sold under
the
Panamax® and Furman® brand names, audio/video wall mounts and fixtures sold
under the OmniMount® brand name, structured wiring products sold under the
OpenHouse® and Channel Plus® brand names, audio/video products distributing,
extending and converting signals to multiple display screens under the
Magenta™
and Gefen® brand names, radio frequency control products and accessories sold
under the iJet® brand name for use with Apple’s iPod® brand products and
lighting control products sold under the Litetouch® brand name (which was
acquired in 2007).
The
Company sells
the products in its HTP segment to distributors, professional installers,
electronics retailers and original equipment manufacturers. The majority
of the
sales in this segment are driven by demand factors other than new construction
such as replacement applications, new installations in existing properties
and
the purchases of high-priced audio/video equipment such as flat panel
televisions and displays. Therefore, this segment is not heavily dependent
on
the level of new construction in the United States. The penetration of
audio/video distribution and control systems in the United States housing
stock
is relatively low and is believed to be growing. In addition, the demand
for
security and access control products in the United States is also believed
to be
growing due to homeowners’ security concerns.
A
key component to
the Company’s growth of this segment has been strategic acquisitions of
companies with similar or complementary products and distribution channel
strengths. There have been 13 acquisitions within the segment since December
31,
2003. Post-acquisition savings and synergies have been realized in the
areas of
manufacturing, sourcing and distribution as well as in the administrative,
engineering and sales and marketing areas.
The
segment offers
a broad array of products under widely-recognized brand names with various
features and price points, which the Company believes allows it to expand
its
distribution in the professional installation and retail markets. Another
key
component of the Company’s operating strategy is the introduction of new
products and innovations, which capitalize on the Company’s well-known brand
names and strong customer relationships.
The
segment’s
primary products compete with many domestic and international suppliers
in
various markets. In the access control market, the segment’s primary competitor
is Chamberlain Corporation (a subsidiary of Duchossois Industries, Inc.).
The
segment competes with suppliers of competitive products primarily on the
basis
of quality, distribution, delivery and price. Although the Company believes
it
competes favorably with other suppliers of home technology products, some
of the
Company’s competitors have greater financial and marketing resources than this
segment of the Company’s business.
The
Company has
several administrative and distribution facilities in the United States
in this
segment and a significant amount of its products are manufactured in
its facility located in China. In addition, certain products are sourced
from
low cost Asian suppliers based on our specifications. The Company believes
that
its Asian operations provide the Company with a competitive cost
advantage.
The
Company’s HTP
segment had 6 manufacturing plants and employed approximately 2,400 full-time
people as of December 31, 2006. The Company believes that its relationships
with
its employees in this segment are satisfactory.
Air
Conditioning and Heating Products Segment
The
Company’s Air
Conditioning and Heating Products segment manufactures and sells heating,
ventilating and air conditioning, or HVAC, systems and products for site-built
residential and manufactured housing structures, custom-designed commercial
applications and standard light commercial applications.
Residential
HVAC Products
The
segment
principally manufactures and sells split-system air conditioners, heat
pumps,
air handlers, furnaces and related equipment, accessories and parts for
the
residential and light commercial markets. For site-built homes and light
commercial structures, the segment markets its products under the licensed
names
Frigidaire®, Tappan®, Philco®, Kelvinator®, Gibson®, Westinghouse® and Maytag®
as well as several private label names. Within the residential market,
the
Company is one of the largest suppliers of HVAC products for manufactured
homes
in the United States and Canada. In the manufactured housing market, the
segment
markets its products under the Intertherm®
and Miller® brand
names.
Demand
for
replacing and modernizing existing equipment, the level of housing starts
and
manufactured housing shipments are the principal factors that affect the
market
for the segment’s residential HVAC products. The Company anticipates that the
replacement market will continue to expand as a large number of previously
installed heating and cooling products become outdated or reach the end
of their
useful lives. The market for residential cooling products, including those
the
segment sells into, which excludes window air conditioners, is affected
by
spring and summer temperatures. The window air conditioner market is highly
seasonal and significantly impacted by spring and summer temperatures.
The
Company believes that its ability to offer both heating and cooling products
helps offset the effects of seasonality on this segment’s sales.
The
segment sells
its manufactured housing products to builders of manufactured housing and,
through distributors, to manufactured housing retailers and owners. The
majority
of sales to builders of manufactured housing consist of furnaces designed
and
engineered to meet or exceed certain standards mandated by the U.S. Department
of Housing and Urban Development, or HUD, and other federal agencies. These
standards differ in several important respects from the standards for furnaces
used in site-built residential homes. The aftermarket channel of distribution
includes sales of both new and replacement air conditioning units and heat
pumps
and replacement furnaces. The Company believes that it has one major competitor
in the manufactured housing furnace market, York International Corporation
(a
subsidiary of Johnson Controls, Inc.) which markets its products primarily
under
the “Coleman” name. The segment competes with most major industry manufacturers
in the manufactured housing air conditioning market.
The
segment sells
residential HVAC products for use in site-built homes through independently
owned distributors who sell to HVAC contractors. The site-built residential
HVAC
market is very competitive. In this market, the segment competes with,
among
others, Carrier Corporation (a subsidiary of United Technologies Corporation),
Rheem Manufacturing Company, Lennox Industries, Inc., The Trane Company
(a
subsidiary of American Standard Companies Inc.), York International Corporation
(a subsidiary of Johnson Controls, Inc.) and Goodman Global, Inc. The Company
estimates that between approximately 55% and 60% of this segment’s sales of
residential HVAC products in 2006 were attributable to the replacement
market,
which tends to be less cyclical than the new construction market.
The
segment
competes in both the site-built and manufactured housing markets on the
basis of
breadth and quality of its product line, distribution, product availability
and
price. Although the Company believes that it competes favorably with respect
to
certain of these factors, most of the segment’s competitors have greater
financial and marketing resources and the products of certain competitors
may
enjoy greater brand awareness than the Company’s residential HVAC
products.
Commercial
HVAC
Products
The
segment also
manufactures and sells HVAC systems that are custom-designed to meet customer
specifications for commercial offices, manufacturing and educational facilities,
hospitals, retail stores, clean rooms and governmental buildings. These
systems
are designed primarily to operate on building rooftops (including large
self-contained walk-in-units), or on individual floors within a building,
and to
have cooling capacities ranging from 40 tons to 600 tons. The segment markets
its commercial HVAC products under the Governair®, Mammoth®, Temtrol®, Venmar
CES™, Ventrol®, Webco™, Huntair® and Cleanpak™ brand names. The Company’s
subsidiary, Eaton-Williams Group Limited, manufactures and markets custom
and
standard air conditioning and humidification equipment throughout Western
Europe
under the Vapac®, Cubit®, Qualitair®, Edenaire®, Colman™ and Moducel™ brand
names.
The
market for
commercial HVAC equipment is divided into standard and custom-designed
equipment. Standard equipment can be manufactured at a lower cost and therefore
offered at substantially lower initial prices than custom-designed equipment.
As
a result, standard equipment suppliers generally have a larger share of
the
overall commercial HVAC market than custom-designed equipment suppliers,
such as
the Company. However, because of certain building designs, shapes or other
characteristics, the Company believes there are many applications for which
custom-designed equipment is required or is more cost effective over the
life of
the building. Unlike standard equipment, the segment’s commercial HVAC equipment
can be designed to match a customer’s exact space, capacity and performance
requirements. The segment’s packaged rooftop and self-contained walk-in
equipment rooms maximize a building’s rentable floor space because this
equipment is located outside the building. In addition, the manner of
construction and timing of installation of commercial HVAC equipment can
often
favor custom-designed over standard systems. As compared with site-built
and
factory built HVAC systems, the segment’s systems are factory assembled
according to customer specifications and then installed by the customer
or third
parties, rather than assembled on site, permitting extensive testing prior
to
shipment. As a result, the segment’s commercial systems can be installed later
in the construction process than site-built systems, thereby saving the
owner or
developer construction and labor costs. The segment sells its commercial
HVAC
products primarily to contractors, owners and developers of commercial
office
buildings, manufacturing and educational facilities, hospitals, retail
stores,
clean rooms and governmental buildings. The segment seeks to maintain
strong relationships nationwide with design engineers, owners and developers,
and the persons who are most likely to value the benefits and long-term
cost
efficiencies of its custom-designed equipment.
The
Company
estimates that between approximately 30% and 35% of its air conditioning
and
heating product commercial sales in 2006 came from replacement and retrofit
activity, which typically is less cyclical than new construction activity
and
generally commands higher margins. The segment continues to develop product
and
marketing programs to increase penetration in the growing replacement and
retrofit market.
The
segment’s
commercial HVAC products are marketed through independently owned manufacturers’
representatives and approximately 327 sales, marketing and engineering
professionals as of December 31, 2006. The independent representatives
are
typically HVAC engineers, a factor which is significant in marketing the
segment’s commercial products because of the design intensive nature of the
market segment in which it competes.
The
Company
believes that it is among the largest suppliers of custom-designed commercial
HVAC products in the United States. The segment’s four largest competitors in
the commercial HVAC market are Carrier Corporation, York International,
McQuay
International (a subsidiary of OYL Corporation) and The Trane Company.
The
segment competes primarily on the basis of engineering support, quality,
design
and construction flexibility and total installed system cost. Although
the
Company believes that it competes favorably with respect to some of these
factors, most of its competitors have greater financial and marketing resources
than this segment of the Company’s business and enjoy greater brand awareness.
However, the Company believes that its ability to produce equipment that
meets
the performance characteristics required by the particular product application
provides it with advantages that some of its competitors do not
enjoy.
The
Company’s HVAC
segment had 18 manufacturing plants and employed approximately 4,300 full-time
people as of December 31, 2006, of which approximately 100 are covered
by
collective bargaining agreements which expire in 2007 and approximately
100 are
covered by collective bargaining agreements which expire in 2008. The Company
believes that its relationships with its employees in this segment are
satisfactory.
Backlog
Backlog
expected to
be filled within the next twelve months as of December 31, 2006 was
approximately $275.8 million and was approximately $228.1 million as of
December
31, 2005. The increase in backlog from December 31, 2005 to December 31,
2006
primarily reflects an increase of backlog related to commercial HVAC customers
of approximately $106.1 million (including approximately $57.9 million
from
acquisitions), partially offset by a reduction in the backlog for residential
HVAC cooling products.
Backlog
is not
regarded as a significant factor for operations where orders are generally
for
prompt delivery. While backlog stated for all periods is believed to be
firm, as
all orders are supported by either a purchase order or a letter of intent,
the
possibility of cancellations makes it difficult to assess the firmness
of
backlog with certainty, and therefore there can be no assurance that the
Company’s backlog will result in actual revenues.
Raw
Materials
The
Company
purchases raw materials and most components used in its various manufacturing
processes. The principal raw materials the Company purchases are rolled
sheet
steel, formed and galvanized steel, copper, aluminum, plate mirror glass,
various chemicals, paints and plastics.
The
materials,
molds and dies, subassemblies and components purchased from other manufacturers,
and other materials and supplies used in manufacturing processes have generally
been available from a variety of sources. From time to time increases in
raw
material costs can affect future supply availability due in part to raw
material
demands by other industries. Whenever practical, the Company establishes
multiple sources for the purchase of raw materials and components to achieve
competitive pricing, ensure flexibility and protect against supply disruption.
The Company employs a company-wide procurement strategy designed to reduce
the
purchase price of raw materials and purchased components. The Company believes
that the use of these strategic sourcing procurement practices will continue
to
enhance its competitive position by reducing costs from its vendors and
limiting
cost increases for goods and services in sectors experiencing rising
prices.
The
Company is
subject to significant market risk with respect to the pricing of its principal
raw materials. If prices of these raw materials were to increase dramatically,
the Company may not be able to pass such increases on to its customers
and, as a
result, gross margins could decline significantly.
The
Company has
certain sole-source suppliers in Italy and Poland that are currently
experiencing financial difficulty. See “Risk Factors” included elsewhere
herein.
Research
and Development
The
Company’s
research and development activities are principally new product development
and
represent approximately 2.0%, 1.9% and 1.7% of the Company’s consolidated net
sales in 2006, 2005 and 2004, respectively.
Trademarks
and Patents
The
Company owns or
licenses numerous trademarks that it uses in the marketing of its products.
Certain of the trademarks the Company owns, including Broan® and NuTone®, are
particularly important in the marketing of its products. The Company also
holds
numerous design and process patents, but no single patent is material to
the
overall conduct of the Company’s business. It is the Company’s policy to obtain
and protect patents whenever such action would be beneficial to it.
Environmental
and Regulatory Matters
The
Company is
subject to numerous federal, state, local and foreign laws and regulations,
relating to protection of the environment, including those that impose
limitations on the discharge of pollutants into the air and water, establish
standards for the use, treatment, storage and disposal of solid and hazardous
materials and wastes and govern the cleanup of contaminated sites. The
Company
believes that it is in substantial compliance with the material laws and
regulations applicable to it. The Company is involved in current, and may
become
involved in future, remedial actions under federal and state environmental
laws
and regulations which impose liability on companies to clean up, or contribute
to the cost of cleaning up, sites currently or formerly owned or operated
by
such companies or sites at which their hazardous wastes or materials were
disposed of or released. Such claims may relate to properties or business
lines
acquired by the Company after a release has occurred. In other instances,
the
Company may be partially liable under law or contract to other parties
that have
acquired businesses or assets from the Company for past practices relating
to
hazardous materials or wastes. Expenditures in 2006, 2005 and 2004 to evaluate
and remediate such sites were not material. While the Company is able to
reasonably estimate its losses, the Company is unable to estimate with
certainty
its ultimate financial exposure in connection with identified or yet to
be
identified remedial actions due, among other reasons, to: (i) uncertainties
surrounding the nature and application of current or future environmental
regulations, (ii) the Company’s lack of information about additional sites to
which it may be listed as a potentially responsible party, or PRP, (iii)
the
level of clean-up that may be required at specific sites and choices concerning
the technologies to be applied in corrective actions and (iv) the time
periods
over which remediation may occur. Furthermore, since liability for site
remediation may be joint and several, each PRP is potentially wholly liable
for
other PRPs that become insolvent or bankrupt. Thus, the solvency of other
PRPs
could directly affect the Company’s ultimate aggregate clean-up costs. In
certain circumstances, the Company’s liability for clean-up costs may be covered
in whole or in part by insurance or indemnification obligations of third
parties.
The
Company’s HVAC
products must be designed and manufactured to meet various regulatory standards.
The United States and other countries have implemented a protocol on
ozone-depleting substances that limits its ability to use HCFCs, a refrigerant
used in air conditioning and heat pump products. In addition, the Company’s
residential HVAC products are subject to federal minimum efficiency standards,
which increased to 13 SEER in 2006. The Company’s residential HVAC products for
manufactured housing include furnaces which must be designed and engineered
to
meet certain standards required by the U.S. Department of Housing and Urban
Development and other federal agencies. The Company must continue to improve
its
products to meet these and other applicable standards as they develop and
become
more stringent over time.
Employees
The
Company
employed approximately 9,800 full time persons as of December 31,
2006.
A
work stoppage at
one of the Company’s facilities that lasts for a significant period of time
could cause the Company to lose sales, incur increased costs and adversely
affect its ability to meet customers’ needs. A plant shutdown or a substantial
modification to a collective bargaining agreement could result in material
gains
or losses or the recognition of an asset impairment. As agreements expire
and
until negotiations are completed, the Company does not know whether it
will be
able to negotiate collective bargaining agreements on the same or more
favorable
terms as the current agreements or at all and without production interruptions,
including labor stoppages.
On
June 8, 2005,
the Company's collective bargaining agreement with the United Automobile
Aerospace & Agricultural Implement Workers of America and its Local No. 2029
expired. That bargaining unit covered approximately 4.4% of the Company's
employees (414 employees), which were located at the Cincinnati, OH location
of
the Company's subsidiary NuTone. On or about June 8, 2005, the Company
presented
its final proposal to the union bargaining committee but such proposal
was not
accepted by the union members. On July 16, 2005, the Company locked out
the
union employees at the NuTone Cincinnati, OH facility. On September 6,
2005, the
Company notified the union bargaining committee that negotiations had reached
an
impasse and that it was unilaterally implementing the terms of its final
offer.
Among other things, this implemented final offer does not provide the NuTone
union members with post retirement medical and life insurance benefits.
In late
June 2006, the Company informed the union that the Company would close
the
manufacturing operations at the Cincinnati, OH facility on or about August
30,
2006. NuTone’s operating results are included in the RVP segment.
On
July 27, 2006
the union members ratified a Closedown Agreement providing for the closedown
and
permanent layoff of all bargaining unit employees employed at the NuTone
plant
effective August 30, 2006, and the release by the union of any claims it
may
have against the Company. In 2007, the Company expects to record additional
restructuring expenses of approximately $2.1 million as it completes the
closedown of this facility.
Working
Capital
The
carrying of
inventories to support customers and to permit prompt delivery of finished
goods
requires substantial working capital. Substantial working capital is also
required to carry receivables. The demand for the Company’s products is
seasonal, particularly in the Northeast and Midwest regions of the United
States
and in Canada where inclement weather during the winter months usually
reduces
the level of building and remodeling activity in both the home improvement
and
new construction markets. Certain of the residential product businesses
in the
Air Conditioning and Heating Products Segment have in the past been more
seasonal in nature than the Company’s other businesses’ product categories. As a
result, the demand for working capital of the Company’s subsidiaries is greater
from late in the first quarter until early in the fourth quarter. See “Liquidity
and Capital Resources” in Management’s Discussion and Analysis of Financial
Condition and Results of Operations, Item 7 of Part II of this report,
incorporated herein by reference.
Website
The
Company’s
periodic and current reports are available on its website, www.nortek-inc.com,
free of charge, as soon as reasonably practicable after such materials
are filed
with, or furnished to the Securities and Exchange Commission
(“SEC”).
Item
1A.
Risk Factors.
The
Company’s business is dependent upon the levels of remodeling and replacement
activity and new construction activity and could be hurt by economic
downturns.
Critical
factors in
the level of the Company’s sales, profitability and cash flows are the levels of
residential remodeling and replacement activity and new residential and
non-residential construction activity. The level of new residential and
non-residential construction activity and, to a lesser extent, the level
of
residential remodeling and replacement activity are affected by seasonality
and
cyclical factors such as interest rates, inflation, consumer spending habits,
employment levels and other macroeconomic factors, over which the Company
has no
control. Any decline in economic activity as a result of these or other
factors
typically results in a decline in new construction and, to a lesser extent,
residential remodeling and replacement purchases, which would result in
a
decrease in the Company’s sales, profitability and cash flows. For example,
reduced levels of home sales and housing starts and other softening in
the
housing markets in 2006 negatively affected the Company’s results of operations
over the second half of 2006 and these factors are expected to continue
to
negatively affect the Company’s results of operations in 2007.
Fluctuations
in the cost or availability of raw materials and components and increases
in
freight and other costs could have an adverse effect on the Company’s
business.
The
Company is
dependent upon raw materials and purchased components, including, among
others,
steel, motors, compressors, copper, packaging material, aluminum, plastics,
glass and various chemicals and paints that it purchases from third parties.
As
a result, the Company’s results of operations, cash flows and financial
condition may be adversely affected by increases in costs of raw materials
or
components, or in limited availability of raw materials or components.
The
Company does not typically enter into long-term supply contracts for raw
materials and components. In addition, the Company generally does not hedge
against its supply requirements. Accordingly, the Company may not be able
to
obtain raw materials and components from its current or alternative suppliers
at
reasonable prices in the future, or may not be able to obtain raw materials
and
components on the scale and within the time frames the Company requires.
Further, if the Company’s suppliers are unable to meet the Company’s supply
requirements, the Company could experience supply interruptions and/or
costs
increases which (to the extent the Company was unable to find alternate
suppliers or pass along these additional costs to its customers) could
adversely
affect the Company’s results of operations, cash flows and financial
condition.
For
example, during
2004, 2005 and 2006, the Company experienced significant increases in the
prices
it paid for steel, copper, aluminum and steel fabricated parts. In addition,
the
Company has experienced and may continue to experience an increase in freight
and other costs due to rising oil and other energy prices. While the Company
was
able to offset a portion of these cost increases in these periods by raising
prices to its customers for some products, as well as through strategic
sourcing
initiatives and improvements in manufacturing efficiency, there can be
no
assurance that the Company will be able to offset all material cost increases
in
2007 or in any future periods.
The
availability of certain raw materials and component parts from sole or
limited
sources of supply may have an adverse effect on the Company’s
business.
Sources
of raw
materials or component parts for certain of the Company’s operations may be
dependent upon limited or sole sources of supply which may impact the Company’s
ability to manufacture finished product. While the Company continually
reviews
alternative sources of supply, there can be no assurance that the Company
will
not face disruptions in sources of supply which could adversely affect
the
Company’s results of operations, cash flows and financial position.
Certain
sole source
suppliers of various fabricated material components and sub-assemblies
(“material components”) to the Company’s kitchen range hood subsidiaries based
in Italy and Poland experienced financial difficulties in January 2007.
The
Company is working and will continue to work closely with these suppliers
to
help them in meeting the supply needs of these subsidiaries for the foreseeable
future. The Company has not experienced any significant difficulties in
its
production or shipments to its customers as a result of these suppliers’
difficulties in maintaining its production as of March 30, 2007. However,
there
can be no assurance that the Company will be able to continue to prevent
a
disruption in the supply of such material components or be able to find
alternative suppliers. Should these suppliers be unable to continue in
operation
and the Company is unable to find alternative suppliers for a lengthy period
of
time, the Company could experience a material adverse effect on its operations.
These subsidiaries based in Italy and Poland accounted for approximately
7% of
the Company’s consolidated net sales and 5%, before the loss described below, of
consolidated operating earnings for the year ended December 31, 2006 and
accounted for approximately 7% of the Company’s consolidated net sales and 4% of
consolidated operating earnings for the year ended December 31, 2005 and
approximately 6.5% and 6.3% of consolidated assets at December 31, 2006
and
2005, respectively. The Company recorded approximately $16.0 million of
estimated losses in the RVP segment in the fourth quarter of 2006 in selling,
general and administrative expense, net resulting from the unlikelihood
that
these suppliers will be able to repay advances from our subsidiaries based
in
Italy and Poland and amounts due under other arrangements. While the Company
has
recorded its best estimate of the losses related to these suppliers, the
actual
losses may be different than the amounts recorded at December 31,
2006.
Weather
fluctuations may negatively impact the Company’s
business.
Weather
fluctuations may adversely affect the Company’s operating results and its
ability to maintain sales volume. In the Company’s HVAC segment, operations may
be adversely affected by unseasonably warm weather in the months of November
to
February and unseasonably cool weather in the months of May to August,
which has
the effect of diminishing customer demand for heating and air conditioning
products. In all of the Company’s segments, adverse weather conditions at any
time of the year may negatively affect overall levels of new construction
and
remodeling and replacement activity, which in turn may lead to a decrease
in
sales. Many of the Company’s operating expenses are fixed and cannot be reduced
during periods of decreased demand for its products. Accordingly, the Company’s
results of operations and cash flows will be negatively impacted in quarters
with lower sales due to weather fluctuations.
If
the
Company fails to identify suitable acquisition candidates, or to integrate
the
businesses it has acquired or will acquire in the future, it could negatively
impact the Company’s business.
Historically,
the
Company has engaged in a significant number of acquisitions, and those
acquisitions have contributed significantly to the Company’s growth in sales and
profitability, particularly in the HTP segment. The Company believes that
acquisitions will continue to be a key component of its growth strategy.
However, the Company cannot assure that it will continue to locate and
secure
acquisition candidates on terms and conditions that are acceptable to the
Company. If the Company is unable to identify attractive acquisition candidates,
its growth, particularly in the HTP segment, could be impaired.
There
are several
risks in acquisitions, including:
| · |
the
difficulty and expense that the Company incurs in connection with
the
acquisition,
|
| · |
the
difficulty and expense that the Company incurs in the subsequent
assimilation of the operations of the acquired company into the
Company’s
operations,
|
| · |
adverse
accounting consequences of conforming the acquired company's accounting
policies to the Company’s,
|
| · |
the
difficulties and expense of developing, implementing and monitoring
systems of internal controls at acquired companies, including disclosure
controls and procedures and internal controls over financial
reporting,
|
| · |
the
difficulty in operating acquired
businesses,
|
| · |
the
diversion
of management's attention from the Company’s other business
concerns,
|
| · |
the
potential
loss of customers or key employees of acquired
companies,
|
| · |
the
impact on
the Company’s financial condition due to the timing of the acquisition or
the failure to meet operating expectations for the acquired business,
and
|
| · |
the
assumption of unknown liabilities of the acquired
company.
|
The
Company cannot
assure that any acquisition it has made or may make will be successfully
integrated into the Company’s on-going operations or that the Company will
achieve any expected cost savings from any acquisition. If the operations
of an
acquired business do not meet expectations, the Company’s profitability and cash
flows may be impaired and the Company may be required to restructure the
acquired business or write-off the value of some or all of the assets of
the
acquired business.
Because
the Company competes against competitors with substantially greater resources,
the Company faces external competitive risks that may negatively impact
its
business.
The
Company’s RVP
and HTP segments compete with many domestic and international suppliers
in
various markets. The Company competes with suppliers of competitive products
primarily on the basis of quality, distribution, delivery and price. Some
of the
Company’s competitors in these markets have greater financial and marketing
resources than the Company does.
In
the HVAC
segment, the Company’s residential HVAC products compete in both the site-built
and manufactured housing markets on the basis of breadth and quality of
product
line, distribution, product availability and price. Most of the Company’s
residential HVAC competitors have greater financial and marketing resources
and
the products of certain of the Company’s competitors may enjoy greater brand
awareness than the Company’s residential HVAC products. The Company’s commercial
HVAC products compete primarily on the basis of engineering support, quality,
design and construction flexibility and total installed system cost. Most
of the
Company’s competitors in the commercial HVAC market have greater financial and
marketing resources and enjoy greater brand awareness than the Company
does.
Competitive
factors
could require the Company to reduce prices or increase spending on product
development, marketing and sales, either of which could adversely affect
its
operating results.
Fluctuations
in currency exchange rates could adversely affect the Company’s revenues,
profitability and cash flows.
The
Company’s
foreign operations expose the Company to fluctuations in currency exchange
rates
and currency devaluations. The Company reports its financial results in
U.S.
dollars, but a portion of its sales and expenses are denominated in Euros
and
other currencies. As a result, changes in the relative values of U.S. dollars,
Euros and other currencies will affect the Company’s levels of revenues and
profitability. If the value of the U.S. dollar increases relative to the
value
of the Euro and other currencies, the Company’s levels of revenue and
profitability will decline since the translation of a certain number of
Euros or
units of such other currencies into U.S. dollars for financial reporting
purposes will represent fewer U.S. dollars. In addition, in the case of
sales to
customers in certain locations, the Company’s sales are denominated in U.S.
dollars or Euros but all or a substantial portion of the Company’s associated
costs are denominated in a different currency. As a result, changes in
the
relative values of U.S. dollars, Euros and any such different currency
will
affect the Company’s profitability and cash flows.
Because
the Company has substantial operations outside the United States, the Company
is
subject to the economic and political conditions of foreign
nations.
The
Company has
manufacturing facilities in several countries outside of the United States.
In
2006, the Company sold products in approximately 100 countries other than
the
United States. Foreign net sales, which are attributed based upon the location
of the Company’s subsidiary responsible for the sale, were approximately 18.5%
and 19.5% of consolidated net sales for the years ended December 31, 2005
and
2006, respectively. The Company’s foreign operations are subject to a number of
risks and uncertainties, including risks that:
| · |
foreign
governments may impose limitations on the Company’s ability to repatriate
funds,
|
| · |
foreign
governments may impose withholding or other taxes on remittances
and other
payments to the Company, or the amount of any such taxes may
increase,
|
| · |
an
outbreak
or escalation of any insurrection, armed conflict or act of terrorism,
or
another form of political instability, may
occur,
|
| · |
natural
disasters may occur, and local governments may have difficulties
in
responding to these events,
|
| · |
foreign
governments may nationalize foreign assets or engage in other forms
of
government protectionism,
|
| · |
foreign
governments may impose or increase investment barriers, customs
or tariffs
or other restrictions affecting the Company’s business,
and
|
| · |
development,
implementation and monitoring of systems of internal controls of
the
Company’s international operations, including disclosure controls and
procedures and internal controls over financial reporting, may
be
difficult and expensive.
|
The
occurrence of
any of these conditions could disrupt the Company’s business in particular
countries or regions of the world, or prevent the Company from conducting
business in particular countries or regions, which could reduce sales and
adversely affect profitability. In addition, the Company relies on dividends
and
other payments or distributions from its subsidiaries to meet its debt
obligations. If foreign governments impose limitations on the Company’s ability
to repatriate funds or impose or increase taxes on remittances or other
payments
to the Company, the amount of dividends and other distributions the Company
receives from its subsidiaries could be reduced, which could reduce the
amount
of cash available to the Company to meet its debt obligations.
Varying
international business practices.
The
Company
currently purchases raw materials, components and finished products from
various
foreign suppliers. To the
extent that any
such foreign supplier utilizes labor or other practices that vary from
those
commonly accepted in the United States, the Company’s business and reputation
could be adversely affected by any resulting litigation, negative publicity,
political pressure or otherwise.
A
decline in the Company’s relations with its key distributors and dealers or loss
of major customers may negatively impact the Company’s
business.
The
Company’s
operations depend upon its ability to maintain relations with its independent
distributors and dealers and the Company does not typically enter into
long-term
contracts with them. If the Company’s key distributors or dealers are unwilling
to continue to sell the Company’s products or if any of them merge with or are
purchased by a competitor, the Company could experience a decline in sales.
If
the Company is unable to replace such distributors or dealers or otherwise
replace the resulting loss of sales, the Company’s business, results of
operations and cash flows could be adversely affected. For the year ended
December 31, 2006, approximately 54% of the Company’s consolidated net sales
were made through its independent distributors and dealers, and the Company’s
largest distributor or dealer accounted for approximately 5.1% of consolidated
net sales for the year ended December 31, 2006.
In
addition, the
loss of one or more of the Company’s other major customers, or a substantial
decrease in such customers' purchases from the Company, could have a material
adverse effect on results of operations and cash flows. Because the Company
does
not generally have binding long-term purchasing agreements with its customers,
there can be no assurance that the Company’s existing customers will continue to
purchase products from the Company. The Company’s largest customer (other than a
distributor or dealer) accounted for approximately 4.6% of consolidated
net
sales for the year ended December 31, 2006.
Labor
disruptions or cost increases could adversely affect the Company’s
business.
A
work stoppage at
one of the Company’s facilities that lasts for a significant period of time
could cause the Company to lose sales, incur increased costs and adversely
affect its ability to meet customers' needs. A plant shutdown or a substantial
modification to employment terms (including the collective bargaining agreements
affecting the Company’s unionized employees) could result in material gains or
losses or the recognition of an asset impairment. As collective bargaining
agreements expire and until negotiations are completed, it is not known
whether
the Company will be able to negotiate collective bargaining agreements
on the
same or more favorable terms as the current agreements or at all without
production interruptions, including labor stoppages. Currently, approximately
6.7% of the Company’s employees are unionized, and from time to time the Company
experiences union organizing efforts directed at the Company’s non-union
employees. The Company may also experience labor cost increases or disruptions
in its non-union facilities in circumstances where the Company must compete
for
employees with necessary skills and experience or in tight labor
markets.
The
Company must continue to innovate and improve its products to maintain
its
competitive advantage.
The
Company’s
ability to maintain and grow its market shares depends on the ability to
continue to develop high quality, innovative products. An important part
of the
Company’s competitive strategy includes leveraging its distributor and dealer
relationships and its existing brands to introduce new products. In addition,
some of the Company’s HVAC products are subject to federal minimum efficiency
standards and/or protocols concerning the use of ozone-depleting substances
that
have and are expected to continue to become more stringent over time. The
Company cannot assure that its investments in product innovation and
technological development will be sufficient or that it will be able to
create
and market new products to enable the Company to successfully compete with
new
products or technologies developed by the Company’s competitors or meet
heightened regulatory requirements in the future.
The
Company could incur substantial costs, including cleanup costs, fines and
civil
or criminal sanctions, as a result of violations of or liabilities under
environmental laws.
The
Company’s
operations are subject to numerous federal, state, local and foreign laws
and
regulations relating to protection of the environment, including those
that
impose limitations on the discharge of pollutants into the air and water,
establish standards for the use, treatment, storage and disposal of solid
and
hazardous materials and wastes and govern the cleanup of contaminated sites.
The
Company has used and continues to use various substances in its products
and
manufacturing operations, and has generated and continues to generate wastes,
which have been or may be deemed to be hazardous or dangerous. As such,
the
Company’s business is subject to and may be materially and adversely affected by
compliance obligations and other liabilities under environmental, health
and
safety laws and regulations. These laws and regulations affect ongoing
operations and require capital costs and operating expenditures in order
to
achieve and maintain compliance. For example, the United States and other
countries have established programs for limiting the production, importation
and
use of certain ozone depleting chemicals, including hydrochlorofluorocarbons,
or
HCFCs, a refrigerant used in the Company’s air conditioning and heat pump
products. Some of these chemicals have been banned completely, and others
are
currently scheduled to be phased out in the United States by the year 2010.
Modifications to the design of the Company’s products may be necessary in order
to utilize alternative refrigerants.
In
addition, the
Company could incur substantial costs, including cleanup costs, fines and
civil
or criminal sanctions, and third party property damage or personal injury
claims, as a result of violations of or liabilities under environmental
laws or
non-compliance with environmental permits required at its facilities. Certain
environmental laws and regulations also impose liability, without regard
to
knowledge or fault, relating to the existence of contamination at or associated
with properties used in the Company’s current and former operations or those of
the Company’s predecessors, or at locations to which current or former
operations or those of the Company’s predecessors have shipped waste for
disposal. Contaminants have been detected at certain of the Company’s former
sites, and the Company has been named as a potentially responsible party
at
several third-party waste disposal sites. While the Company is not currently
aware of any such sites as to which material outstanding claims or obligations
exist, the discovery of additional contaminants or the imposition of additional
cleanup obligations at these or other sites could result in significant
liability. In addition, the Company cannot be certain that identification
of
presently unidentified environmental conditions, more vigorous enforcement
by
regulatory agencies, enactment of more stringent laws and regulations,
or other
unanticipated events will not arise in the future and give rise to material
environmental liabilities, which could have a material adverse effect on
the
Company’s business, financial condition, results of operations and cash
flows.
The
Company faces risks of litigation and liability claims on product liability,
workers compensation and other matters, the extent of which exposure can
be
difficult or impossible to estimate and which can negatively impact the
Company’s business, financial condition, results of operations and cash
flows.
The
Company is
subject to legal proceedings and claims arising out of its businesses that
cover
a wide range of matters, including contract and employment claims, product
liability claims, warranty claims and claims for modification, adjustment
or
replacement of component parts of units sold. Product liability and other
legal
proceedings include those related to businesses the Company has acquired
or
properties it has previously owned or operated.
The
development,
manufacture, sale and use of the Company’s products involve risks of product
liability and warranty claims, including personal injury and property damage
arising from fire, soot, mold and carbon monoxide. The Company currently
carries
insurance and maintains reserves for potential product liability claims.
However, the Company’s insurance coverage may be inadequate if such claims do
arise and any liability not covered by insurance could have a material
adverse
effect on the Company’s business. To date, the Company has been able to obtain
insurance in amounts it believes to be appropriate to cover such liability.
However, the Company’s insurance premiums may increase in the future as a
consequence of conditions in the insurance business generally or the Company’s
situation in particular. Any such increase could result in lower profits
or
cause the need to reduce the Company’s insurance coverage. In addition, a future
claim may be brought against the Company which would have a material adverse
effect on the Company. Any product liability claim may also include the
imposition of punitive damages, the award of which, pursuant to certain
state
laws, may not be covered by insurance. The Company’s product liability insurance
policies have limits that if exceeded, may result in material costs that
would
have an adverse effect on future profitability. In addition, warranty claims
are
generally not covered by the Company’s product liability insurance. Further, any
product liability or warranty issues may adversely affect the Company’s
reputation as a manufacturer of high-quality, safe products and could have
a
material adverse effect on its business.
Product
recalls or reworks may adversely affect the Company’s
business.
In
the event the
Company produces a product that is alleged to contain a design or manufacturing
defect, the Company could be required to incur costs involved to recall
or
rework that product. While the Company has undertaken several voluntary
product
recalls and reworks over the past several years, additional product recalls
and
reworks could result in material costs. Many of the Company’s products,
especially certain models of bath fans, range hoods and residential furnaces
and
air conditioners, have a large installed base, and any recalls and reworks
related to products with a large installed base could be particularly costly.
The costs of product recalls and reworks are not generally covered by insurance.
In addition, the Company’s reputation for safety and quality is essential to
maintaining its market share and protecting its brands. Any recalls or
reworks
may adversely affect the Company’s reputation as a manufacturer of high-quality,
safe products and could have a material adverse effect on its financial
condition, results of operations and cash flows.
The
Company’s business operations could be significantly disrupted if it lost
members of its management team.
The
Company’s
success depends to a significant degree upon the continued contributions
of its
executive officers and key employees and consultants, both individually
and as a
group. The Company’s future performance will be substantially dependent on its
ability to retain and motivate them. The loss of the services of any of
these
executive officers or key employees and consultants, particularly the Company’s
chairman and chief executive officer, Richard L. Bready, and the Company’s other
executive officers, could prevent the Company from executing its business
strategy.
The
Company’s business operations could be negatively impacted if it fails to
adequately protect its intellectual property rights, if it fails to comply
with
the terms of its licenses or if third parties claim that the Company is
in
violation of its intellectual property rights.
The
Company is
highly dependent on certain of the brand names under which it sells its
products, including Broan® and NuTone®. Failure to protect these brand names and
other intellectual property rights or to prevent their unauthorized use
by third
parties could adversely affect the Company’s business. The Company seeks to
protect its intellectual property rights through a combination of trademark,
copyright, patent and trade secret laws, as well as confidentiality agreements.
These protections may not be adequate to prevent competitors from using
the
Company’s brand names and trademarks without authorization or from copying the
Company’s products or developing products equivalent to or superior to the
Company’s. The Company licenses several brand names from third parties. In the
event the Company fails to comply with the terms of these licenses, the
Company
could lose the right to use these brand names. In addition, the Company
faces
the risk of claims that the Company is infringing third parties' intellectual
property rights. Any such claim, even if it is without merit, could be
expensive
and time-consuming; could cause the Company to cease making, using or selling
certain products that incorporate the disputed intellectual property; could
require the Company to redesign its products, if feasible; could divert
management time and attention; and could require the Company to enter into
costly royalty or licensing arrangements.
The
Company’s substantial debt could negatively impact its business, prevent the
Company from fulfilling its outstanding debt obligations and adversely
affect
its financial condition.
The
Company has a
substantial amount of debt. As of December 31, 2006, the Company had
approximately $1,405.6 million of total debt outstanding and a debt to
equity
ratio of approximately 2.5:1. The terms of the Company’s outstanding debt,
including the Company’s 8 1/2% senior subordinated notes and senior secured
credit facility limit, but do not prohibit, the Company from incurring
additional debt. As of March 30, 2007, Nortek had approximately $34.0 million
outstanding and approximately $133.2 million of additional borrowing capacity
under the U.S. revolving portion of its senior secured credit facility,
with
approximately $22.8 million in outstanding letters of credit, and had no
outstanding borrowings and approximately $10.0 million of additional borrowing
capacity under the Canadian revolving portion of its senior secured credit
facility. If additional debt is added to current debt levels, the related
risks
described below could intensify.
The
substantial
amount of the Company’s debt could have important consequences, including the
following:
| · |
the
Company’s
ability to obtain additional financing for working capital, capital
expenditures, acquisitions, refinancing indebtedness, or other
purposes
could be impaired,
|
| · |
a
substantial
portion of the Company’s cash flow from operations will be dedicated to
paying principal and interest on its debt, thereby reducing funds
available for expansion or other
purposes,
|
| · |
the
Company
may be more leveraged than some of its competitors, which may result
in a
competitive disadvantage,
|
| · |
the
Company
may be vulnerable to interest rate increases, as certain of its
borrowings, including those under the Nortek senior secured credit
facility, are at variable rates,
|
| · |
the
Company’s
failure to comply with the restrictions in its financing agreements
would
have a material adverse effect on the
Company,
|
| · |
the
Company’s
significant amount of debt could make it more vulnerable to changes
in
general economic conditions,
|
| · |
the
Company
may be restricted from making strategic acquisitions, investing
in new
products or capital assets or taking advantage of business opportunities,
and
|
| · |
the
Company
may be limited in its flexibility in planning for, or reacting
to, changes
in its business and the industries in which it
operates.
|
The
Company
believes that it will need to access the capital markets in the future
to raise
the funds to repay its debt that remains outstanding at December 31, 2006.
The
Company has no assurance that it will be able to complete a refinancing
or that
it will be able to raise any additional financing, particularly in view
of the
Company’s anticipated high levels of debt and the restrictions under its current
debt agreements. If the Company is unable to satisfy or refinance its current
debt as it comes due, the Company may default on its debt obligations.
If the
Company defaults on its debt obligations, virtually all of the Company’s other
debt would become immediately due and payable. Any default on the Company’s debt
obligations or the acceleration of its debt will likely have a substantial
adverse effect on the Company’s financial condition, results of operations and
cash flows.
The
terms of the Company’s debt covenants could limit how the Company conducts its
business and its ability to raise additional funds.
The
agreements
which govern the terms of the Company’s debt, including the indenture that
governs Nortek's 8 1/2% senior subordinated notes and the agreement that
governs
Nortek's senior secured credit facility, contain covenants that restrict
the
Company’s ability and the ability of the Company’s subsidiaries to:
| · |
incur
additional indebtedness,
|
| · |
pay
dividends
or make other distributions,
|
| · |
make
loans or
investments,
|
| · |
enter
into
transactions with affiliates, and
|
| · |
consolidate,
merge or sell assets.
|
In
addition,
Nortek's senior secured credit facility contains financial maintenance
covenants, which become more restrictive over time, and the Company cannot
assure that these covenants will always be met. A breach of the covenants
under
the indenture that governs Nortek's 8 1/2% senior subordinated notes or
under
the agreement that governs Nortek's senior secured credit facility could
result
in an event of default under the applicable indebtedness. Such default
may allow
the creditors to accelerate the related debt and may result in the acceleration
of any other debt to which a cross-acceleration or cross-default provision
applies. In addition, an event of default under Nortek's senior secured
credit
facility would permit the lenders to terminate all commitments to extend
further
credit under that facility. Furthermore, if Nortek was unable to repay
the
amounts due and payable under its senior secured credit facility, those
lenders
could proceed against the collateral granted to them to secure that
indebtedness. In the event the Company’s lenders or noteholders accelerate the
repayment of their borrowings, the Company cannot assure that the Company
and
its subsidiaries would have sufficient assets to repay such indebtedness.
The
Company’s future financing arrangements will likely contain similar or more
restrictive covenants. As a result of these restrictions, the Company may
be:
| · |
limited
in
how the Company conducts its business,
|
| · |
unable
to
raise additional debt or equity financing to operate during general
economic or business downturns, or
|
| · |
unable
to
compete effectively or to take advantage of new business
opportunities.
|
These
restrictions
may affect the Company’s ability to grow in accordance with its plans. Refer to
Note 6 of the Notes to the Consolidated Financial Statements, Item 8 of
Part II
of this report, incorporated herein by reference.
The
Company may be unable to generate sufficient cash to service all of its
indebtedness and may be forced to take other actions to satisfy its obligations
under such indebtedness, which may not be successful.
The
Company’s
ability to make scheduled payments on or to refinance its debt obligations
depends on the Company’s subsidiaries' financial condition and operating
performance, which is subject to prevailing economic and competitive conditions
and to financial, business and other factors beyond the Company’s control. The
Company cannot assure that its subsidiaries will maintain a level of cash
flows
from operating activities sufficient to permit the Company to pay or refinance
its indebtedness. If the Company’s subsidiaries' cash flows and capital
resources are insufficient to fund the Company’s debt service obligations, the
Company and its subsidiaries could face substantial liquidity problems
and may
be forced to reduce or delay capital expenditures, sell assets, seek additional
capital or restructure or refinance its indebtedness. These alternative
measures
may not be successful and may not permit the Company to meet its scheduled
debt
service obligations.
If
the
Company is unable to access funds generated by its subsidiaries the Company
may
not be able to meet its financial obligations.
Because
the Company
conducts all of its operations through its subsidiaries, the Company depends
on
those entities for dividends, distributions and other payments to generate
the
funds necessary to meet its financial obligations. Legal restrictions in
the
United States and foreign jurisdictions applicable to the Company’s subsidiaries
and contractual restrictions in certain agreements governing current and
future
indebtedness of the Company’s subsidiaries, as well as the financial condition
and operating requirements of the Company’s subsidiaries, may limit the
Company’s ability to obtain cash from its subsidiaries. All of the Company’s
subsidiaries are separate and independent legal entities and have no obligation
whatsoever to pay any dividends, distributions or other payments to the
Company.
Item
1B.
Unresolved Staff Comments.
None.
Item
2.
Properties.
Set
forth below is
a brief description of the location and general character of the principal
administrative and manufacturing facilities and other material real properties
of the Company’s continuing operations, all of which the Company considers to be
in satisfactory repair. All properties are owned, except for those indicated
by
an asterisk (*), which are leased under operating leases and those with
a double
asterisk (**), which are leased under capital leases.
| |
|
Approximate
|
|
|
Location
(1)
|
Description
|
Square
Feet
|
|
| |
|
|
|
|
Residential
Ventilation Products Segment:
|
|
|
|
|
Union,
IL
|
Manufacturing/Warehouse/Administrative
|
197,000
|
(2)
|
|
Hartford,
WI
|
Manufacturing/Warehouse/Administrative
|
538,000
|
(3)
|
|
Mississauga,
ONT, Canada
|
Manufacturing/Warehouse/Administrative
|
110,000
|
|
|
Fabriano,
Italy
|
Manufacturing/Warehouse/Administrative
|
166,000
|
|
|
Cerreto
D’Esi, Italy
|
Manufacturing/Warehouse/Administrative
|
180,000
|
|
|
Montefano,
Italy
|
Manufacturing/Warehouse/Administrative
|
93,000
|
(2)
|
|
Cleburne,
TX
|
Manufacturing/Warehouse/Administrative
|
215,000
|
(3)
|
|
Los
Angeles, CA
|
Manufacturing/Administrative
|
177,000
|
*
|
|
Drummondville,
QUE, Canada
|
Manufacturing/Warehouse/Administrative
|
126,000
|
|
|
Cincinnati,
OH
|
Manufacturing/Warehouse/Administrative
|
735,000
|
(4)
|
|
Chenjian,
Huizhou, PRC
|
Manufacturing/Warehouse/Administrative/Other
|
198,000
|
|
|
San
Francisco, CA
|
Warehouse/Administrative
|
50,000
|
*
|
|
Gliwice,
Poland
|
Manufacturing/Warehouse/Administrative
|
151,000
|
|
| |
|
|
|
|
Home
Technology Products Segment:
|
|
|
|
|
Sylmar,
CA
|
Administrative
|
18,000
|
*
|
|
Xiang,
Bao An County, Shenzhen, PRC
|
Manufacturing/Warehouse/Administrative/Other
|
251,000
|
*
|
|
Chaiwan,
Hong Kong
|
Administrative
|
15,000
|
*
|
|
Lexington,
KY
|
Warehouse/Administrative
|
48,000
|
*
|
|
Carlsbad,
CA
|
Warehouse/Administrative
|
64,000
|
*
|
|
Vista,
CA
|
Warehouse
|
55,000
|
*
|
|
Riverside,
CA
|
Administrative
|
82,000
|
*
|
|
Casnovia,
MI
|
Manufacturing/Warehouse/Administrative
|
23,000
|
*
|
|
Phoenix,
AZ
|
Manufacturing/Warehouse/Administrative
|
51,000
|
*
|
|
Petaluma,
CA
|
Warehouse/Administrative
|
26,000
|
*
|
|
Miami,
FL
|
Warehouse/Administrative
|
62,000
|
*
|
|
Cambridge,
U.K.
|
Warehouse/Administrative
|
11,000
|
|
|
Snohomish,
WA
|
Manufacturing/Warehouse/Administrative
|
25,000
|
*
|
|
Tallahassee,
FL
|
Manufacturing/Warehouse/Administrative
|
71,000
|
(3)
|
|
Summerville,
SC
|
Warehouse/Administrative
|
162,000
|
*
|
|
New
Milford, CT
|
Manufacturing/Warehouse/Administrative
|
17,000
|
**
|
|
Woodland
Hills, CA
|
Warehouse/Administrative
|
10,000
|
*
|
|
Salt
Lake City, UT
|
Manufacturing/Warehouse/Administrative
|
25,000
|
*
|
| |
|
|
|
|
Air
Conditioning and Heating Products Segment:
|
|
|
|
St.
Leonard d’Aston, QUE, Canada
|
Manufacturing/Administrative
|
95,000
|
*
|
|
Saskatoon,
Saskatchewan, Canada
|
Manufacturing/Administrative
|
49,000
|
*
|
|
O’Fallon,
MO
|
Warehouse/Administrative
|
70,000
|
*
|
|
St.
Louis, MO
|
Manufacturing/Warehouse
|
103,000
|
*
|
|
Boonville,
MO
|
Manufacturing
|
250,000
|
(3)
|
|
Boonville,
MO
|
Warehouse/Administrative
|
150,000
|
(2)
|
|
Tipton,
MO
|
Manufacturing
|
50,000
|
(3)
|
|
Poplar
Bluff, MO
|
Manufacturing/Warehouse
|
725,000
|
**
|
|
Dyersburg,
TN
|
Manufacturing/Warehouse
|
368,000
|
**
|
|
Holland,
MI
|
Manufacturing/Administrative
|
45,000
|
*
|
|
Chaska,
MN
|
Manufacturing/Administrative
|
230,000
|
*
|
|
Oklahoma
City, OK
|
Manufacturing/Administrative
|
127,000
|
(3)
|
|
Okarche,
OK
|
Manufacturing/Warehouse/Administrative
|
228,000
|
(3)
|
|
Springfield,
MO
|
Manufacturing/Warehouse/Administrative
|
113,000
|
*
|
|
Anjou,
QUE, Canada
|
Manufacturing/Administrative
|
122,000
|
*
|
|
Edenbridge,
Kent, U.K.
|
Manufacturing/Administrative
|
92,000
|
*
|
|
Fenton,
Stoke-on-Trent, U.K.
|
Manufacturing/Administrative
|
104,000
|
*
|
|
Miami,
FL
|
Manufacturing/Warehouse/Administrative
|
24,000
|
*
|
|
Anji
County, Zhejiang, PRC
|
Manufacturing/Warehouse/Administrative
|
202,000
|
(2)
|
|
Clackamas,
OR
|
Manufacturing/Warehouse/Administrative
|
172,000
|
*
|
|
Tualatin,
OR
|
Manufacturing/Warehouse/Administrative
|
191,000
|
*
|
| |
|
|
|
|
Other:
|
|
|
|
|
Providence,
RI
|
Administrative
|
23,000
|
*
|
(1) Certain
locations may represent more than one property and the square footage includes
all properties within that location.
| (2) |
These
facilities are pledged as security under various subsidiary debt
agreements.
|
| (3) |
These
facilities are pledged as security under Nortek’s senior secured credit
facility.
|
| (4) |
This
property and facility is currently under agreement to be
sold.
|
Item
3. Legal Proceedings.
The
Company and its
subsidiaries are subject to numerous federal, state and local laws and
regulations, including environmental laws and regulations that impose
limitations on the discharge of pollutants into the air and water and establish
standards for the treatment, storage and disposal of solid and hazardous
wastes.
The Company believes that it is in substantial compliance with the material
laws
and regulations applicable to it. The Company is involved in current, and
may
become involved in future, remedial actions under federal and state
environmental laws and regulations which impose liability on companies
to clean
up, or contribute to the cost of cleaning up, sites at which their hazardous
wastes or materials were disposed of or released. Such claims may relate
to
properties or business lines acquired by the Company after a release has
occurred. In other instances, the Company may be partially liable under
law or
contract to other parties that have acquired businesses or assets from
the
Company for past practices relating to hazardous substances management.
The
Company believes that all such claims asserted against it, or such obligations
incurred by it, will not have a material adverse effect upon the Company’s
financial condition or results of operations. Expenditures in 2006, 2005
and
2004 to evaluate and remediate such sites were not material. While the
Company
is able to reasonably estimate its losses, the Company is unable to estimate
with certainty its ultimate financial exposure in connection with identified
or
yet to be identified remedial actions due among other reasons to: (i)
uncertainties surrounding the nature and application of environmental
regulations, (ii) the Company’s lack of information about additional sites to
which it may be listed as a potentially responsible part (“PRP”), (iii) the
level of clean-up that may be required at specific sites and choices concerning
the technologies to be applied in corrective actions and (iv) the time
periods
over which remediation may occur. Furthermore, since liability for site
remediation is joint and several, each PRP is potentially wholly liable
for
other PRP’s that become insolvent or bankrupt. Thus, the solvency of other PRP’s
could directly affect the Company’s ultimate aggregate clean-up costs. In
certain circumstances, the Company’s liability for clean-up costs may be covered
in whole or in part by insurance or indemnification obligations of third
parties.
In
addition to
legal matters described above, the Company and its subsidiaries are named
as
defendants in a number of legal proceedings, including a number of product
liability lawsuits, incident to the conduct of their businesses.
The
Company does
not expect that any of the above described proceedings will have a material
adverse effect, either individually or in the aggregate, on the Company’s
financial position, results of operations, liquidity or competitive position.
(See Note 9 of the Notes to the Consolidated Financial Statements, Item
8 of
Part II of this report, incorporated herein by reference.)
Item
4.
Submission of Matters to a Vote of Security Holders.
None.
PART
II
Item
5.
Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer
Purchases of Equity Securities.
On
November 20,
2002, the Company reorganized into a holding company structure and each
outstanding share of capital stock of the Company was converted into an
identical share of capital stock of the former Nortek Holdings. The former
Nortek Holdings became the successor public company, and the Company became
a
wholly-owned subsidiary of the former Nortek Holdings. As of November 20,
2002,
there is no established public trading market for the Company’s capital stock.
As
of March 30,
2007, there were 3,000 shares of common stock of the Company authorized
and
3,000 shares of common stock of the Company outstanding, all of which are
owned
by Nortek Holdings, Inc. (“Nortek Holdings”).
NTK
Holdings, Inc.
(“NTK Holdings”) was formed to hold the capital stock of Nortek Holdings. Prior
to February 10, 2005, Nortek Holdings was a direct wholly-owned subsidiary
of
Investors LLC. On February 10, 2005, NTK Holdings issued 3,000 shares of
capital
stock to Investors LLC in exchange for Investor LLC’s 3,000 shares of capital
stock of Nortek Holdings.
On
May 5, 2006,
NTK
Holdings filed a registration statement on Form S-1 (most recently amended
on
September 15, 2006) with the SEC for an initial public offering of shares
of its
common stock (the “Offering”). Although NTK Holdings has not withdrawn its
registration statement on Form S-1, there can be no assurance that the
Company
will complete the Offering in the foreseeable future.
On
May 10, 2006,
NTK Holdings borrowed an aggregate principal amount of $205.0 million under
a
senior unsecured loan facility. A portion of these proceeds was used to
contribute capital of approximately $25.9 million to Nortek Holdings, which
was
used by Nortek Holdings, together with a dividend of approximately $28.1
million
from the Company to make a distribution of approximately $54.0 million
to
participants under the 2004 Nortek Holdings, Inc. Deferred Compensation
Plan
(including certain of the Company’s executive officers).
The
Company’s
senior secured credit facility and the Indenture for its 8 1/2% $625.0
million senior subordinated notes due 2014 contain restrictions on the
Company’s
ability to pay certain dividends. For more information see Note 6 of the
Notes
to the Consolidated Financial Statements, Item 8 of Part II of this report,
incorporated herein by reference.
See
Notes 1, 2, 6
and 7 of the Notes to the Consolidated Financial Statements, Item 8 of
Part II
of this report, incorporated herein by reference.
Item
6. Consolidated Selected Financial Data.
| |
|
For
the Periods
|
|
|
|
|
Post-Acquisition
|
|
Pre-Acquisition
|
|
Pre-Recapitalization
|
|
|
|
|
Jan.
1, 2006 -
|
|
Jan.
1, 2005 -
|
|
Aug.
28, 2004 -
|
|
Jan.
1, 2004 -
|
|
Jan.
10, 2003 -
|
|
Jan.
1, 2003 -
|
|
Jan.
1, 2002 -
|
|
|
|
|
Dec.
31, 2006
|
|
Dec.
31, 2005
|
|
Dec.
31, 2004
|
|
Aug.
27, 2004
|
|
Dec.
31, 2003
|
|
Jan.
9, 2003
|
|
Dec.
31, 2002
|
|
| |
|
(In
millions except ratios)
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated
Summary of Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
|
$
|
2,218.4
|
|
$
|
1,959.2
|
|
$
|
561.0
|
|
$
|
1,117.9
|
|
$
|
1,480.6
|
|
$
|
24.8
|
|
$
|
1,376.5
|
|
|
Operating
earnings (loss) (1)
|
|
|
267.0
|
|
|
237.2
|
|
|
42.1
|
|
|
32.6
|
|
|
159.4
|
|
|
(81.8
|
)
|
|
120.5
|
|
|
Earnings
(loss) from continuing operations
|
|
|
89.7
|
|
|
80.5
|
|
|
(2.2
|
)
|
|
(111.3
|
)
|
|
62.1
|
|
|
(60.9
|
)
|
|
44.2
|
|
|
Earnings
(loss) from discontinued operations
|
|
|
---
|
|
|
---
|
|
|
(0.5
|
)
|
|
67.4
|
|
|
12.1
|
|
|
(1.0
|
)
|
|
18.3
|
|
|
Net
earnings (loss)
|
|
|
89.7
|
|
|
80.5
|
|
|
(2.7
|
)
|
|
(43.9
|
)
|
|
74.2
|
|
|
(61.9
|
)
|
|
62.5
|
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Financial
Position:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrestricted
cash, investments and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
marketable
securities
|
|
$
|
57.4
|
|
$
|
77.2
|
|
$
|
95.0
|
|
$
|
202.0
|
|
$
|
194.1
|
|
$
|
283.6
|
|
$
|
294.8
|
|
|
Working
capital
|
|
|
211.1
|
|
|
273.8
|
|
|
284.1
|
|
|
(645.2
|
)
|
|
689.8
|
|
|
830.0
|
|
|
816.3
|
|
|
Total
assets
|
|
|
2,627.3
|
|
|
2,416.6
|
|
|
2,297.4
|
|
|
1,730.3
|
|
|
2,100.0
|
|
|
1,781.2
|
|
|
1,830.9
|
|
|
Total
debt--
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
|
|
|
43.3
|
|
|
19.7
|
|
|
19.8
|
|
|
13.4
|
|
|
15.3
|
|
|
4.4
|
|
|
5.5
|
|
|
Long-term
|
|
|
1,362.3
|
|
|
1,354.1
|
|
|
1,350.2
|
|
|
30.4
|
|
|
1,324.6
|
|
|
953.7
|
|
|
953.8
|
|
|
Current
ratio
|
|
|
1.4:1
|
|
|
1.7:1
|
|
|
1.9:1
|
|
|
0.5:1
|
|
|
2.7:1
|
|
|
2.9:1
|
|
|
3.1:1
|
|
|
Debt
to equity ratio
|
|
|
2.5:1
|
|
|
2.7:1
|
|
|
3.3:1
|
|
|
0.4:1
|
|
|
6.7:1
|
|
|
3.5:1
|
|
|
3.0:1
|
|
Depreciation
and amortization expense including non-cash interest
|
|
|
66.5
|
|
|
51.2
|
|
|
24.4
|
|
|
50.5
|
|
|
38.2
|
|
|
0.7
|
|
|
32.6
|
|
|
Capital
expenditures (2)
|
|
|
42.3
|
|
|
33.7
|
|
|
15.1
|
|
|
12.7
|
|
|
24.7
|
|
|
0.2
|
|
|
19.0
|
|
|
Stockholder’s
investment
|
|
|
563.1
|
|
|
500.3
|
|
|
417.0
|
|
|
114.6
|
|
|
200.1
|
|
|
272.1
|
|
|
317.5
|
|
See
the Notes to
the Consolidated Financial Statements and Management’s Discussion and Analysis
of Financial Condition and Results of Operations, included elsewhere herein
regarding the effect on operating results of acquisitions, discontinued
operations and other matters. See Part II, Item 5 of this report, incorporated
herein by reference, for a discussion on certain Stockholder
Matters.
(1)
See
Note 14
of the Notes to the Consolidated Financial Statements included elsewhere
herein.
(2) Includes
capital
expenditures financed under capital leases of approximately $4.8 million,
$1.6
million, $0.9 million and $7.6 million for the year ended December 31,
2005 and
the periods from August 28, 2004 to December 31, 2004, from January 1,
2004 to
August 27, 2004 and from January 10, 2003 to December 31, 2003, respectively.
There were no capital leases for the year ended December 31, 2006, the
period
from January 1, 2003 to January 9, 2003 and the year ended December 31,
2002.
NORTEK,
INC. AND SUBSIDIARIES
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
December
31, 2006
Item
7. Management’s Discussion and Analysis of Financial Condition and Results of
Operation.
Nortek,
Inc. and
its wholly-owned subsidiaries (individually and collectively the “Company” or
“Nortek”) are diversified manufacturers of innovative, branded residential and
commercial building products, operating within three reporting segments:
| · |
the
Residential Ventilation Products, or RVP, segment,
|
| · |
the
Home
Technology Products, or HTP, segment, and
|
| · |
the
Air
Conditioning and Heating Products, or HVAC, segment.
|
Through
these
segments, the Company manufactures and sells, primarily in the United States,
Canada and Europe, a wide variety of products for the professional remodeling
and replacement markets, the residential and commercial construction markets,
the manufactured housing market and the do-it-yourself (“DIY”) market.
The
Residential
Ventilation Products segment manufactures and sells room and whole house
ventilation products and other products primarily for the professional
remodeling and replacement markets, the residential new construction market
and
the DIY market. The principal products sold by the segment include:
| · |
exhaust
fans
(such as bath fans and fan, heater and light combination units),
and
|
| · |
indoor
air
quality products.
|
The
Home Technology
Products segment manufactures and sells a broad array of products designed
to
provide convenience and security for residential and light commercial
applications. The principal products sold by the segment are:
| · |
audio
/ video
distribution and control equipment,
|
| · |
speakers
and
subwoofers,
|
| · |
security
and
access control products,
|
| · |
power
conditioners and surge protectors,
|
| · |
audio
/ video
wall mounts and fixtures,
|
The
Air
Conditioning and Heating Products segment manufactures and sells heating,
ventilating and air conditioning (“HVAC”) systems for site-built residential and
manufactured housing structures, custom-designed commercial applications
and
standard light commercial applications. The principal products sold by
the
segment are:
| · |
split
system
air conditioners and heat pumps,
|
| · |
furnaces
and
related equipment,
|
| · |
large
custom
roof top cooling and heating products.
|
In
the results of
operations presented below, Unallocated includes corporate related items,
intersegment eliminations and certain income and expense not allocated
to its
segments.
Changes
in Structure and Ownership
Over
the past
several years, the Company has undergone changes in its structure and ownership
that are useful to an understanding of the Company’s financial results over this
time period.
| · |
Nortek
had
been a public company for over thirty-five years until November
2002 when
the former Nortek Holdings was formed to become its holding company
and
successor public company.
|
| · |
The
former
Nortek Holdings was then taken private in an acquisition by affiliates
and
designees of Kelso & Company L.P., together with members of the
Company’s management, in January 2003.
|
| · |
Affiliates
of
Thomas H. Lee Partners, L.P., together with members of the Company’s
management, purchased the former Nortek Holdings from affiliates
and
designees of Kelso & Company L.P. in August 2004. The former Nortek
Holdings was merged out of existence and a newly formed acquisition
subsidiary became the parent company of Nortek and was renamed
Nortek
Holdings.
|
| · |
NTK
Holdings,
then a newly formed company, became the parent company of Nortek
Holdings
in February 2005 in order to facilitate a financing and related
dividend.
|
These
events, as
well as further developments and recent acquisitions and discontinued
operations, are discussed in more detail below.
The
THL
Transaction
On
August 27, 2004,
THL Buildco, a newly formed corporation affiliated with Thomas H. Lee Partners,
L.P. and a subsidiary of THL Buildco Holdings, Inc., purchased all of the
outstanding capital stock of the former Nortek Holdings pursuant to a stock
purchase agreement for a purchase price of approximately $743.2 million.
The
Company refers to this transaction as the “Acquisition”.
Immediately
upon
the completion of the Acquisition, THL Buildco was merged with and into
the
former Nortek Holdings, with the former Nortek Holdings continuing as the
surviving corporation. The former Nortek Holdings was then merged with
and into
Nortek, Inc., with Nortek, Inc. continuing as the surviving corporation
and a
wholly-owned subsidiary of THL Buildco Holdings. THL Buildco Holdings was
then
renamed Nortek Holdings, Inc. Nortek Holdings is wholly owned by NTK Holdings,
which is wholly owned by THL-Nortek Investors, LLC, a Delaware limited
liability
company (“Investors LLC”). In connection with the Acquisition, members of Nortek
management reinvested a portion of their equity interest in the former
Nortek
Holdings for an equity interest in Investors LLC and interests in a deferred
compensation plan established by Nortek Holdings. The Acquisition and the
above
events are collectively referred to herein as the “THL
Transaction”.
Financial
Statement Presentation
The
consolidated
financial statements included herein for the period from January 1, 2004
to
August 28, 2004 (“Pre-Acquisition”) reflects the financial position, results of
operations and cash flows of the former Nortek Holdings, Inc. and all of
its
wholly-owned subsidiaries (the predecessor company) and periods subsequent
to
August 27, 2004 (“Post-Acquisition”), reflect the financial position, results of
operations and cash flows of Nortek, Inc. and all of its wholly-owned
subsidiaries (the successor company and survivor from the mergers noted
above in
connection with the THL Transaction).
Discontinued
Operations
On
July 31, 2004,
the Company sold the capital stock of its wholly-owned subsidiary, La Cornue
SAS
(“La Cornue”). La Cornue was included in the Company’s Residential Ventilation
Products Segment.
On
February 12,
2004, the Company’s wholly-owned subsidiary, WDS, LLC, sold all of the capital
stock of Ply Gem Industries, Inc. (“Ply Gem”). The results of operations of the
operating subsidiaries of Ply Gem comprised the Company’s entire Window, Doors
and Siding Products (“WDS”) reporting segment and the corporate expenses of Ply
Gem which were previously included in Unallocated in the Company’s segment
reporting.
The
results of La
Cornue and Ply Gem have been excluded from earnings from continuing operations
and are classified separately as discontinued operations for all periods
presented. Accordingly, for purposes of this presentation of Management’s
Discussion and Analysis of Financial Condition and Results of Operations,
all
discussion relates to the results from continuing operations (see Notes
10 and
11 of the Notes to the Consolidated Financial Statements included elsewhere
herein).
Acquisitions
The
Company has
made the following acquisitions since January 1, 2004:
|
Acquired
Company
|
Date
of
Acquisition
|
Primary
Business
of
Acquired Company
|
Reporting
Segment
|
| |
|
|
|
|
LiteTouch,
Inc.
|
March
2, 2007
|
Design,
manufacture and sale of automated lighting control for a variety
of
applications including residential, commercial, new construction
and
retro-fit.
|
HTP
|
| |
|
|
|
|
Gefen,
Inc.
|
December
12, 2006
|
Design
and sale of audio and video products which extend, switch, distribute
and
convert signals in a variety of formats, including high definition,
for
both the residential and commercial markets.
|
HTP
|
| |
|
|
|
|
Zephyr
Corporation
|
November
11, 2006
|
Design
and sale of upscale range hoods.
|
RVP
|
| |
|
|
|
|
Pacific
Zephyr Range Hood, Inc.
|
November
11, 2006
|
Design,
sale and installation of range hoods and other kitchen products
for Asian
cooking markets in the United States.
|
RVP
|
| |
|
|
|
|
Magenta
Research, Ltd.
|
July
18, 2006
|
Design
and sale of products
that distribute audio and video signals over Category 5 and fiber
optic
cable to multiple display screens.
|
HTP
|
| |
|
|
|
|
Secure
Wireless, Inc.
|
June
26, 2006
|
Design
and sale of wireless security products for the residential and
commercial
markets.
|
HTP
|
| |
|
|
|
|
Advanced
Bridging Technologies, Inc.
|
June
26, 2006
|
Design
and sale of innovative radio frequency control products and
accessories.
|
HTP
|
| |
|
|
|
|
Huntair,
Inc.
|
April
14, 2006
|
Design,
manufacture and sale of custom air handlers and related products
for
commercial and clean room applications.
|
HVAC
|
| |
|
|
|
|
Cleanpak
International, LLC
|
April
14, 2006
|
Design,
manufacture and sale of custom air handlers and related products
for
commercial and clean room applications.
|
HVAC
|
| |
|
|
|
|
Furman
Sound, Inc.
|
February
22, 2006
|
Design
and sale of audio and video signal processors and innovative
power
conditioning and surge protection products.
|
HTP
|
| |
|
|
|
|
Mammoth
(Zhejiang) EG Air Conditioning Ltd. (1)
|
January
25, 2006
|
Design,
manufacture and sale of commercial HVAC products, including water
source
heat pumps.
|
HVAC
|
| |
|
|
|
|
Shanghai
Mammoth Air Conditioning Co., Ltd. (1)
|
January
25, 2006
|
Design,
manufacture and sale of commercial HVAC products, including water
source
heat pumps.
|
HVAC
|
| |
|
|
|
|
GTO,
Inc.
|
December
9, 2005
|
Design,
manufacture and sale of automatic electric gate openers and access
control
devices to enhance the security and convenience of both residential
and
commercial property fences.
|
HTP
|
| |
|
|
|
|
Sunfire
Corporation
|
August
26, 2005
|
Design,
manufacture and sale of home audio and home cinema amplifiers,
receivers
and subwoofers.
|
HTP
|
| |
|
|
|
|
Imerge
Limited
|
August
8, 2005
|
Design
and sale of hard disk media players and multi-room audio
servers.
|
HTP
|
| |
|
|
|
|
Niles
Audio Corporation
|
July
15, 2005
|
Design,
manufacture and sale of whole-house audio/video distribution
equipment,
including speakers, receivers, amplifiers, automation devices,
controls
and accessories.
|
HTP
|
| |
|
|
|
|
International
Marketing Supply, Inc.
|
June
13, 2005
|
Sale
of heating, ventilation and air conditioning equipment to customers
in
Latin America and the Caribbean.
|
HVAC
|
| |
|
|
|
|
Panamax,
Inc.
|
April
26, 2005
|
Design
and sale of innovative power conditioning and surge protection
products
that prevent loss or damage of home and small business equipment
due to
power disturbances.
|
HTP
|
| |
|
|
|
|
M&S
Systems, LP
|
December
17, 2004
|
Design
and sale of distributed audio and communication equipment and
speakers
|
HTP
|
| |
|
|
|
|
OmniMount
Systems, Inc.
|
March
9, 2004
|
Design,
manufacture and sale of audio/video wall mounts and
fixtures.
|
HTP
|
(1) Increase
in ownership to 60%
These
acquisitions
have been accounted for under the purchase method of accounting and accordingly,
the results of these acquisitions are included in the Company’s consolidated
results since the date of their acquisition.
Critical
Accounting Policies
The
Company’s
discussion and analysis of its financial condition and results of operations
are
based upon the Company’s Consolidated Financial Statements, which have been
prepared in accordance with U.S. generally accepted accounting principles.
(See
the Notes to the Consolidated Financial Statements included elsewhere herein.)
Certain of the Company’s accounting policies require the application of judgment
in selecting the appropriate assumptions for calculating financial estimates.
By
their nature, these judgments are subject to an inherent degree of uncertainty.
The Company periodically evaluates the judgments and estimates used for its
critical accounting policies to ensure that such judgments and estimates
are
reasonable for its interim and year-end reporting requirements. These judgments
and estimates are based on the Company’s historical experience, current trends
and other information available, as appropriate. If different conditions
result
from those assumptions used in the Company’s judgments, the results could be
materially different from the Company’s estimates. The Company’s critical
accounting policies include:
Revenue
Recognition, Accounts Receivable and Related Expenses
The
Company
recognizes sales based upon shipment of products to its customers and has
procedures in place at each of its subsidiaries to ensure that an accurate
cut-off is obtained for each reporting period.
Allowances
for cash
discounts, volume rebates, and other customer incentive programs, as well
as
gross customer returns, among others, are recorded as a reduction of sales
at
the time of sales based upon the estimated future outcome. Cash discounts,
volume rebates and other customer incentive programs are based upon certain
percentages agreed to with the Company’s various customers, which are typically
earned by the customer over an annual period. The Company records periodic
estimates for these amounts based upon the historical results to date, estimated
future results through the end of the contract period and the contractual
provisions of the customer agreements. For calendar year customer agreements,
the Company is able to adjust its periodic estimates to actual amounts as
of
December 31 each year based upon the contractual provisions of the customer
agreements. For those customers who have agreements that are not on a calendar
year cycle, the Company records estimates at December 31 consistent with
the
above described methodology. As a result, at the end of any given reporting
period, the amounts recorded for these allowances are based upon estimates
of
the likely outcome of future sales with the applicable customers and may
require
adjustment in the future if the actual outcome differs. The Company believes
that its procedures for estimating such amounts are reasonable.
Customer
returns
are recorded on an actual basis throughout the year and also include an estimate
at the end of each reporting period for future customer returns related to
sales
recorded prior to the end of the period. The Company generally estimates
customer returns based upon the time lag that historically occurs between
the
date of the sale and the date of the return while also factoring in any new
business conditions that might impact the historical analysis such as new
product introduction. The Company believes that its procedures for estimating
such amounts are reasonable.
Provisions
for the
estimated costs for future product warranty claims are recorded in cost of
sales
at the time a sale is recorded. The amounts recorded are generally based
upon
historically derived percentages while also factoring in any new business
conditions that might impact the historical analysis such as new product
introduction. The Company also periodically evaluates the adequacy of its
reserves for warranty recorded in its consolidated balance sheet as a further
test to ensure the adequacy of the recorded provisions. Warranty claims can
extend far into the future. As a result, significant judgment is required
by the
Company in determining the appropriate amounts to record and such judgments
may
prove to be incorrect in the future. The Company believes that its procedures
for estimating such amounts are reasonable.
Provisions
for the
estimated allowance for doubtful accounts are recorded in selling, general
and
administrative expense, net at the time a sale is recorded. The amounts recorded
are generally based upon historically derived percentages while also factoring
in any new business conditions that might impact the historical analysis
such as
changes
in economic
conditions, past due and nonperforming accounts, bankruptcies
or
other events affecting particular customers.
The Company also
periodically evaluates the adequacy of its allowance for doubtful accounts
recorded in its consolidated balance sheet as a further test to ensure the
adequacy of the recorded provisions. The analysis for allowance for doubtful
accounts often involves subjective analysis of a particular customer’s ability
to pay. As a result, significant judgment is required by the Company in
determining the appropriate amounts to record and such judgments may prove
to be
incorrect in the future. The Company believes that its procedures for estimating
such amounts are reasonable.
Inventory
Valuation
The
Company values
inventories at the lower of the cost or market with approximately 39.6% of
the
Company’s inventory as of December 31, 2006 valued using the last-in, first-out
(“LIFO”) method and the remainder valued using the first-in, first-out (“FIFO”)
method. In connection with both LIFO and FIFO inventories, the Company will
record provisions, as appropriate, to write-down obsolete and excess inventory
to estimated net realizable value. The process for evaluating obsolete and
excess inventory often requires the Company to make subjective judgments
and
estimates concerning future sales levels, quantities and prices at which
such
inventory will be able to be sold in the normal course of business. Accelerating
the disposal process or incorrect estimates of future sales potential may
cause
the actual results to differ from the estimates at the time such inventory
is
disposed or sold. The Company believes that its procedures for estimating
such
amounts are reasonable.
Prepaid
Income
Tax Assets and Deferred Tax Liabilities
The
Company
accounts for income taxes using the liability method in accordance with SFAS
No.
109 “Accounting for Income Taxes” (“SFAS No. 109”), which requires that the
deferred tax consequences of temporary differences between the amounts recorded
in the Company’s Consolidated Financial Statements and the amounts included in
the Company’s federal, state and foreign income tax returns to be recognized in
the balance sheet. As the Company generally does not file their income tax
returns until well after the closing process for the December 31 financial
statements is complete, the amounts recorded at December 31 reflect estimates
of
what the final amounts will be when the actual tax returns are filed for
that
fiscal year. In addition, estimates are often required with respect to, among
other things, the appropriate state income tax rates to use in the various
states that the Company and its subsidiaries are required to file, the potential
utilization of operating and capital loss carry-forwards and valuation
allowances required, if any, for tax assets that may not be realizable in
the
future. The Company requires each of its subsidiaries to submit year-end
tax
information packages as part of the year-end financial statement closing
process
so that the information used to estimate the deferred tax accounts at December
31 is reasonably consistent with the amounts expected to be included in the
filed tax returns. SFAS No. 109 requires balance sheet classification of
current
and long-term deferred income tax assets and liabilities based upon the
classification of the underlying asset or liability that gives rise to a
temporary difference. As such, the Company has historically had prepaid income
tax assets due principally to the unfavorable tax consequences of recording
expenses for required book reserves for such things as, among others, bad
debts,
inventory valuation, insurance, product liability and warranty that cannot
be
deducted for income tax purposes until such expenses are actually paid. The
Company believes that the amounts recorded as prepaid income tax assets will
be
recoverable through future taxable income generated by the Company, although
there can be no assurance that all recognized prepaid income tax assets will
be
fully recovered. The Company believes the procedures and estimates used in
its
accounting for income taxes are reasonable and in accordance with established
tax law. The income tax estimates used have historically not resulted in
material adjustments to income tax expense in subsequent periods when the
estimates are adjusted to the actual filed tax return amounts, although there
may be reclassifications between the current and long-term portion of the
deferred tax accounts.
In
June 2006, the
Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement
No. 109)”, (“FIN 48”). FIN 48 clarifies the criteria that an individual tax
position must satisfy for some or all of the benefits of that position to
be
recognized in a company’s financial statements. FIN 48 prescribes a recognition
threshold of “more-likely-than-not” and a measurement attribute for all tax
positions taken or expected to be taken on a tax return in order for those
tax
positions to be recognized in the financial statements. FIN 48 is effective
for
fiscal years beginning after December 31, 2006. Accordingly, the Company
will
adopt FIN 48 on January 1, 2007. The cumulative effect of applying the
provisions of FIN 48 will be reported as an adjustment of the Company’s opening
balance of retained earnings (or other appropriate components of equity or
net
assets in the statement of financial position). The
Company has
assessed the impact of this interpretation on its domestic subsidiaries and
currently estimates that the application of this standard on such subsidiaries
will result in a reduction of retained earnings of between $3.0 million
(unaudited) and $4.0 million (unaudited), and an increase of goodwill
related to pre-acquisition tax uncertainties of between $6.0 (unaudited)
and
$7.0 million (unaudited). The Company is currently in the process of assessing
the impact of this interpretation on its foreign subsidiaries.
Goodwill
and
Other Long-Lived Assets
The
Company
accounts for acquired goodwill and intangible assets in accordance with SFAS
No.
141, “Business Combinations” (“SFAS No. 141”) which involves judgment with
respect to the determination of the purchase price and the valuation of the
acquired assets and liabilities in order to determine the final amount of
goodwill. The Company believes that the estimates that it has used to record
its
acquisitions are reasonable and in accordance with SFAS No. 141.
The
Company
accounts for acquired goodwill and goodwill impairment in accordance with
SFAS
No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”) (see Note 1 of
the Notes to the Consolidated Financial Statements included elsewhere herein)
which requires considerable judgment in the valuation of acquired goodwill
and
the ongoing evaluation of goodwill impairment. The Company primarily utilizes
a
discounted cash flow approach in order to value the Company’s reporting units
required to be tested for impairment by SFAS No. 142, which requires that
the
Company forecast future cash flows of the reporting units and discount the
cash
flow stream based upon a weighted average cost of capital that is derived
from
comparable companies within similar industries. The discounted cash flow
calculations also include a terminal value calculation that is based upon
an
expected long-term growth rate for the applicable reporting unit. The Company
believes that its procedures for applying the discounted cash flow methodology,
including the estimates of future cash flows, the weighted average cost of
capital and the long-term growth rate, are reasonable and consistent with
market
conditions at the time of the valuation. The Company has evaluated the carrying
value of reporting unit goodwill and determined that no impairment existed
at
either the date of the Acquisition, its annual evaluation date of October
1,
2006 or December 31, 2006 in accordance with SFAS No. 142. Accordingly, no
adjustments were required to be recorded in the Company’s Consolidated Financial
Statements.
The
Company
performs an annual evaluation, and more frequently if impairment indicators
are
identified, for the impairment of long-lived assets, other than goodwill,
based
on expectations of non-discounted future cash flows compared to the carrying
value of the subsidiary in accordance with SFAS No. 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”). The Company’s cash
flow estimates are based upon historical cash flows, as well as future projected
cash flows received from subsidiary management in connection with the annual
Company wide planning process, and include a terminal valuation for the
applicable subsidiary based upon a multiple of earnings before interest expense,
net, depreciation and amortization expense and income taxes (“EBITDA”). The
Company estimates the EBITDA multiple by reviewing comparable company
information and other industry data. The Company believes that its procedures
for estimating gross futures cash flows, including the terminal valuation,
are
reasonable and consistent with current market conditions. The Company
historically has not had any material impairment adjustments.
Pensions
and
Post Retirement Health Benefits
The
Company’s
accounting for pensions, including supplemental executive retirement plans,
and
post retirement health benefit liabilities requires the estimating of such
items
as the long-term average return on plan assets, the discount rate, the rate
of
compensation increase and the assumed medical cost inflation rate. These
estimates require a significant amount of judgment as items such as stock
market
fluctuations, changes in interest rates, plan amendments and curtailments
can
have a significant impact on the assumptions used and therefore on the ultimate
final actuarial determinations for a particular year. The Company believes
the
procedures and estimates used in its accounting for pensions and post retirement
health benefits are reasonable and consistent with acceptable actuarial
practices in accordance with U.S. generally accepted accounting
principles.
On
December 31,
2006, the Company adopted SFAS
No. 158,
“Employers’ Accounting for Defined Benefit Pension and Other Postretirement
Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS No.
158”). SFAS No. 158 requires the Company to: (a) recognize the over-funded or
under-funded status of its defined benefit post-retirement plans as an asset
or
liability in its statement of financial position; (b) recognize changes in
the
funded status in the year in which the changes occur through comprehensive
income and (c) measure plan assets and benefit obligations as of the date
of the
employer’s fiscal year-end. The Company is required to initially recognize the
funded status of its defined benefit plans and to provide the required
disclosures for the fiscal year ended December 31, 2006. The requirement
to
measure benefit obligations as of the date of the employer’s fiscal year-end
statement of financial position is effective for the Company for the fiscal
year
ended December 31, 2008. See Notes 1 and 8 of the Notes to the Consolidated
Financial Statements included elsewhere herein.
Insurance
Liabilities
The
Company records
insurance liabilities and related expenses for health, workers compensation,
product and general liability losses and other insurance reserves and expenses
in accordance with either the contractual terms of its policies or, if
self-insured, the total liabilities that are estimable and probable as of
the
reporting date. Insurance liabilities are recorded as current liabilities
to the
extent payments are expected to be made in the succeeding year by the Company
with the remaining requirements classified as long-term liabilities. The
accounting for self-insured plans requires that significant judgments and
estimates be made both with respect to the future liabilities to be paid
for
known claims and incurred but not reported claims as of the reporting date.
The
Company considers historical trends when determining the appropriate insurance
reserves to record in the consolidated balance sheet. In certain cases where
partial insurance coverage exists, the Company must estimate the portion
of the
liability that will be covered by existing insurance policies to arrive at
the
net expected liability to the Company. The Company believes that its procedures
for estimating such amounts are reasonable.
Contingencies
The
Company is
subject to contingencies, including legal proceedings and claims arising
out of
its business that cover a wide range of matters, including, among others,
environmental matters, contract and employment claims, worker compensations
claims, product liability, warranty and modification, adjustment or replacement
of component parts of units sold, which may include product recalls. Product
liability, environmental and other legal proceedings also include matters
with
respect to businesses previously owned.
The
Company
provides accruals for direct costs associated with the estimated resolution
of
contingencies at the earliest date at which it is deemed probable that a
liability has been incurred and the amount of such liability can be reasonably
estimated. Costs accrued have been estimated based upon an analysis of potential
results, assuming a combination of litigation and settlement strategies and
outcomes.
While
it is
impossible to ascertain the ultimate legal and financial liability with respect
to contingent liabilities, including lawsuits, the Company believes that
the
aggregate amount of such liabilities, if any, in excess of amounts provided
or
covered by insurance, will not have a material adverse effect on the
consolidated financial position or results of operations of the Company.
It is
possible, however, that future results of operations for any particular future
period could be materially affected by changes in our assumptions or strategies
related to these contingencies or changes out of the Company’s
control.
Overview
We
are a leading
diversified manufacturer of innovative, branded residential and commercial
products, operating within three reporting segments: the Residential Ventilation
Products, or RVP, segment, the Home Technology Products, or HTP, segment,
and
the Air Conditioning and Heating Products, or HVAC, segment. Through these
segments, we manufacture and sell, primarily in the United States, Canada
and
Europe, a wide variety of products for the professional remodeling and
replacement markets, the residential and commercial construction markets,
the
manufactured housing market and the do-it-yourself, or DIY, market. We
manufacture a broad array of residential and commercial products for a wide
range of end markets and many of our products have leading market positions.
We
have achieved organic growth in each of our segments and have augmented this
growth with a number of strategic acquisitions, primarily in our HTP segment.
We
are one of the world's largest suppliers of residential range hoods and exhaust
fans, and are the largest supplier of these products in North America. We
are
also one of the leading suppliers in Europe of luxury “Eurostyle” range hoods.
We are also one of the largest suppliers in North America of residential
indoor
air quality products. Within the residential market, we are one of the largest
suppliers of HVAC products for manufactured homes in the United States and
Canada and are among the largest suppliers of custom designed commercial
HVAC
products in the United States. For the year ended December 31, 2006, the
RVP
segment accounted for approximately 37% of consolidated net sales and 48%
of
operating earnings before unallocated expense, the HTP segment accounted
for
approximately 22% of consolidated net sales and 29% of operating earnings
before
unallocated expense and the HVAC segment accounted for approximately 41%
of
consolidated net sales and 23% of operating earnings before unallocated expense.
From
2001 through
2006, our net sales grew at a Compound Annual Growth Rate (“CAGR”) of
approximately 12%, and our operating earnings grew at a CAGR of approximately
19%. Our net sales and operating earnings increased by approximately 13%
each
for 2006 as compared to 2005. For 2006, operating earnings include an
approximate $35.9 million gain from curtailment of post-retirement medical
and
life insurance
benefits,
partially offset by approximately $19.4 million of net other expense items
included in cost of products sold and selling, general and administrative
expense, net. We have generated cash flow from operations as a result of
our
EBITDA growth and expanding EBITDA margins. Our EBITDA margins increased
in 2006
from 2001 while capital expenditures have averaged approximately 2% of net
sales
per year since 2001. The resulting cash flow has given us the ability to
reinvest in our business, through both acquisitions and new product
development.
We
achieved growth
in the past several years through a focus on our operating strategy and through
acquisitions. Our operations are managed by an experienced management team
at
both the corporate and divisional levels. Our management team has grown our
business organically, while reducing overhead, rationalizing costs and
integrating acquisitions through market cycles and under a leveraged capital
structure. Also, we have identified, acquired and integrated 18 companies
since
December 31, 2003, across all of our business segments. In addition to
integrating these acquisitions, we have reduced costs, in many cases by
relocating production or sourcing of materials and component parts to
manufacturing operations in China.
In
particular, we
have created a Home Technology Products segment which has generated net sales
and operating earnings CAGR’s of approximately 57% and 56%, respectively, from
2003 through 2006. Growth in this segment has been driven by both organic
growth
and acquisitions of companies with similar or complementary products and
distribution channels which allows us to leverage our dealer and distributor
relationships to generate additional organic growth. We continually evaluate
a
wide variety of acquisition opportunities, which can provide scale, enhance
product offerings, expand our geographic presence, obtain cost savings and
generate other synergies.
We
have a history
of developing and branding new products and marketing them to customers.
Across
our segments we have employed a strategy of using well-recognized brand names
(most of which are owned, such as Broan® and NuTone®, and several of which are
licensed, such as Frigidaire®, Westinghouse® and Maytag®) and have introduced
new products and made selected acquisitions to improve growth and profitability.
In both the manufactured housing and commercial HVAC products markets, we
have
maintained our market shares. We have been able to recognize market needs
and
create products that address these opportunities. For example, we recently
introduced our QT series of ultra-quiet exhaust fans, which generated net
sales
of $42.9 million during 2005, its first full year in the market, and $58.6
million in 2006.
Our
products are
marketed through our portfolio of brand names that facilitate the introduction
of new products and extend existing product lines. Additionally, we continue
to
capitalize on our dealers’ and distributors’ desire to carry many of our leading
branded products, and are able to drive additional product lines through
our
distribution channels and sell a wider portfolio of products to our
customers.
Our
manufacturing
strategy focuses on providing quality products at low costs. We source an
increasing amount of our raw materials and components from lower cost regions.
To further reduce costs we are positioning ourselves to be able to move certain
manufacturing and production to our existing locations in China and to other
lower cost regions such as Poland. Additionally, we began implementing Demand
Flow Technology practices in the early 1990s at a number of our manufacturing
facilities. This program allows us to manufacture products according to actual
demand, rather than manufacturing to forecast, providing us with improved
product quality, increased manufacturing efficiency and flexibility, improved
response time to our customers and lower working capital needs.
Sales
of our
products are affected by the level of residential improvement and repair
activity, the level of new residential construction and to a lesser extent
the
level of private non-residential construction spending and manufactured housing
shipments. A little more than half of the products we sell are believed to
be
used in the remodeling and replacement markets and the balance serves the
new
construction market. Through the end of 2005, the levels of remodeling and
replacement activity and new construction activity in the site-built residential
market had been strong for several years and this strength contributed
positively to our operating performance in these periods. Reduced levels
of home
sales and housing starts and other softening in the housing markets in 2006
negatively affected our business over the second half of 2006 and these factors
are expected to continue to negatively affect our business in 2007. The level
of
business activity in the manufactured housing industry has been weak in recent
years and in 2006 became weaker. Although the level of business activity
in the
private non-residential construction industry has improved over the past
several
years, our HVAC business has grown mostly through acquisitions. As we entered
2007, our backlog of commercial HVAC product was approximately $193.9 million,
of which approximately $57.9 million was contributed by acquisitions, as
compared to approximately $87.8 million at December 31, 2005.
Key
industry
activity affecting our businesses in the United States for the past three
years
was as follows: