NTK
Holdings, Inc.
(the “Company” or “NTK Holdings”) is a Delaware corporation that was formed to
hold the capital stock of Nortek Holdings, Inc. (“Nortek Holdings”). NTK
Holdings became the parent company of Nortek Holdings on February 10,
2005.
General
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 “NTK Holdings” refer to NTK Holdings, Inc.,
together with its subsidiaries, unless the context indicates otherwise. Such
terms as “Company” and “NTK Holdings” 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 6.2% 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