-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GjI8KcuLJag8nHR57m05sID58ferQagGWbbvrmCaMrE00C3KjjEgpNZi4t8nhPqW 0BI2kkeeab+ENIY+oua31g== 0000072423-99-000008.txt : 19990331 0000072423-99-000008.hdr.sgml : 19990331 ACCESSION NUMBER: 0000072423-99-000008 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NORTEK INC CENTRAL INDEX KEY: 0000072423 STANDARD INDUSTRIAL CLASSIFICATION: AIR COND & WARM AIR HEATING EQUIP & COMM & INDL REFRIG EQUIP [3585] IRS NUMBER: 050314991 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-06112 FILM NUMBER: 99578812 BUSINESS ADDRESS: STREET 1: 50 KENNEDY PLZ CITY: PROVIDENCE STATE: RI ZIP: 02903 BUSINESS PHONE: 4017511600 MAIL ADDRESS: STREET 1: 50 KENNEDY PLAZA CITY: PROVIDENCE STATE: RI ZIP: 02903 10-K405 1 NORTEK 1998 ANNUAL REPORT SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------- Form 10-K 405 (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, 1998 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: 1-6112 ------------------------ Nortek, Inc. (exact name of Registrant as specified in its charter) Delaware 05-0314991 (State or other jurisdiction (IRS Employer of incorporation or organization) Identification Number) 50 Kennedy Plaza Providence, Rhode Island 02903-2360 (Address of principal executive offices) (zip code) Registrant's telephone number, including area code: (401) 751-1600 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered Common Stock, $1.00 par value New York Stock Exchange Preference Stock Purchase Rights New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: Title of Class Special Common Stock, $1.00 par value 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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __. 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]. 1 The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 5, 1999 was $292,420,423. See Item 12. The number of shares of Common Stock outstanding as of March 5, 1999 was 11,302,630. The number of shares of Special Common Stock outstanding as of March 5, 1999 was 559,913. Documents Incorporated by Reference Portions of the registrant's Proxy Statement for use at its 1999 Annual Meeting of Shareholders are incorporated by reference into Part III. 2 NORTEK, INC. AND SUBSIDIARIES PART I ITEM 1. BUSINESS General The Company is a diversified manufacturer of residential and commercial building products, operating within three principal segments: the Residential Building Products Segment; the Air Conditioning and Heating ("HVAC") Products Segment; and the Windows, Doors and Siding Products Segment. Through these segments, the Company manufactures and sells, primarily in the United States, Canada and Europe, a wide variety of products for the residential and commercial construction, manufactured housing, and the do-it-yourself and professional remodeling and renovation markets. (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.) The Company's domestic performance is dependent to a significant extent upon the levels of residential replacement and remodeling, new residential construction and non-residential construction, which are affected by such factors as interest rates, inflation, consumer spending habits and unemployment. 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, Part II of this report, incorporated herein by reference. Information on foreign and domestic operations is set forth in Note 10, Notes to Consolidated Financial Statements, Item 8 of Part II of this report, incorporated herein by reference. Residential Building Products Segment The Residential Building Products Segment manufactures and distributes built-in products primarily for the residential new construction, do-it-yourself and professional remodeling and renovation markets. The principal products sold by the Segment are kitchen range hoods, bath fans, combination units (fan, heater and light combinations), indoor air quality products, bath cabinets, radio intercoms and central vacuum systems. The Segment is the largest supplier in North America of range hoods, bath fans and combination units, indoor air quality products (such as continuous-ventilation systems and energy-recovery ventilators) and one of the leading suppliers in Western Europe, 3 NORTEK, INC. AND SUBSIDIARIES South America and the Middle East of luxury "Eurostyle" range hoods. Products are sold under the Broan(R), NuTone(R), Nautilus(R), Venmar(R), Flair(R), vanEE(R), Rangaire(R) and Best(R) brand names, among others, to distributors and dealers of electrical and lighting products, kitchen and bath dealers, retail home centers and original equipment manufacturers (OEMs). Customers for the Segment's products include residential and electrical contractors, professional remodelers and do-it-yourself homeowners. Other products sold by this Segment include, among others, wireless security products, audio speakers, door chimes and ceiling fans. The Company's sales of kitchen range hoods accounted for approximately 10.4% of the Company's consolidated net sales in 1998. A key component of the Segment's operating strategy is the introduction of new products which capitalize on the strong Broan(R), NuTone(R), Nautilus(R), Venmar(R), Flair(R), vanEE(R), Rangaire(R) and Best(R) brand names and the extensive distribution system of the Segment's businesses. Products sold under these brand names include the Broan Rangemaster(R) and Finesse(R) rangehood, Sensaire(R), Solitaire(R) and Solitaire Ultra Silent(R) fans and fan lights, LoSone(R) fans, the Best by Broan(TM) "Eurostyle" luxury rangehoods, the Venmar(R), Flair(R) and vanEE(R) Super Compact line of indoor air quality systems and the Broan 12" wide trash compactor. With respect to certain product lines, several private label customers account for a substantial portion of net sales. In 1998, approximately 22.6% of the total sales of the Segment were made to private label customers. Production 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 (motors, fan blades, heating elements, wiring harnesses, controlling devices, glass, mirrors, lighting fixtures, lumber, wood and polyethylene components, speakers, grilles and similar electronic components, and compact disc and tape player mechanisms) and painting, finishing and packaging. The Segment offers a broad array of products with various features and styles across a range of price points. The Company believes that the Segment's variety of product offerings helps the Segment maintain and improve its market position for its principal products. At the same time, the Company believes that the Segment's status as a low-cost producer, in large part as a result of advanced manufacturing processes, provides the Segment with a competitive advantage. 4 NORTEK, INC. AND SUBSIDIARIES The Segment's primary products compete with many domestic and international suppliers in their various markets. The Segment competes with suppliers of competitive products primarily on the basis of quality, distribution, delivery and price. Although the Segment believes it competes favorably among suppliers of the Segment's products, certain of these suppliers have greater financial and marketing resources than the Segment. The Segment has 16 manufacturing plants and employed 3,424 full-time people as of December 31, 1998, 747 of whom are covered by collective bargaining agreements which expire in 1999, 2000 and 2001. The Company believes that the Segment's relationships with its employees are satisfactory. Air Conditioning and Heating Products Segment The Air Conditioning and Heating Products Segment manufactures and sells HVAC systems for custom-designed commercial applications and for manufactured and site-built residential housing. Commercial Products. The Segment's commercial products consist of HVAC systems which are custom-designed to meet customer specifications for commercial offices, manufacturing and educational facilities, hospitals, retail stores and governmental buildings. Such systems are primarily designed to operate on building rooftops (including large self-contained walk-in-units) or on individual floors within a building, and range from 40 to 600 tons of cooling capacity. The Segment markets its commercial products under the Governair(R), Mammoth(R), Temtrol(TM), Aston, Venmar(R), Ventrol(R) and Webco(TM) brand names. The market for commercial HVAC equipment is segmented between 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, suppliers of standard equipment generally have a larger share of the overall commercial HVAC market than suppliers of custom-designed equipment, including the Segment. 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 the exact space, capacity and performance requirements of the customer. The Segment's packaged rooftop and self-contained walk-in equipment rooms maximize a building's rentable floor space because they 5 NORTEK, INC. AND SUBSIDIARIES are located outside the building. In addition, factors relating to the manner of construction and timing of installation of commercial HVAC equipment can often favor custom-designed rather than standard systems. As compared with site-built and standard HVAC systems, the Segment's systems are factory assembled and then installed, 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 products primarily to contractors, owners and developers of commercial office buildings, manufacturing and educational facilities, hospitals, retail stores 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 the Segment's custom-designed equipment. The Company estimates that about half of the Segment's commercial sales in 1998 were attributable to 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 products are marketed through independently-owned manufacturers' representatives and an in-house sales, marketing and engineering group of approximately 145 persons as of December 31, 1998. 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 the Segment competes. The Company believes that the Segment is among the largest suppliers of custom-designed commercial HVAC products in the United States. The Segment's three largest competitors in the commercial HVAC market are York International Corporation (which sells under the "Pace" and "Miller-Picking" trade names), McQuay International (a subsidiary of OYL Corporation), and The Trane Company (a subsidiary of American Standard Inc.). The Segment competes primarily on the basis of engineering support, quality, flexibility in design and construction and total installed system cost. Although the Company believes that the Segment competes favorably with respect to certain of these factors, most of the Segment's competitors have greater financial and marketing resources than the Segment and enjoy greater brand 6 NORTEK, INC. AND SUBSIDIARIES awareness. However, the Company believes that the Segment's ability to produce equipment that meets the performance characteristics required by the particular product application provides it with advantages not enjoyed by certain of these competitors. Residential Products. The Segment manufactures air conditioners, heat pumps, and furnaces for the manufactured housing market, which are marketed under the Intertherm(R) and Miller(R) brand names. The Segment is one of the largest suppliers of these products to the manufactured housing market in the United States. In addition, the Segment manufactures HVAC and light commercial products for site-built homes and light commercial structures, which are marketed under the Frigidaire(R), Tappan(R), Philco(R), Kelvinator(R) and Gibson(R) names. The principal factors affecting the market for the Segment's residential HVAC products are the demand for replacements and modernization of existing equipment and the levels of manufactured housing shipments and housing starts. 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. This growth may be accelerated by a tendency among consumers to replace older heating and cooling products with higher efficiency models prior to the end of such equipment's useful life. The market for residential cooling products, including those sold by the Segment, is affected by spring and summer temperatures. The Segment does not sell window air conditioners, a segment of the market which is highly seasonal and especially affected by spring and summer temperatures. The Company believes that the Segment's ability to offer both heating and cooling products helps offset the effects of seasonality of the Segment's sales. The Segment sells its manufactured housing products to builders of manufactured housing and, through distributors, to manufactured housing retailers and owners of such housing. The majority of sales to builders of manufactured housing consist of furnaces designed and engineered to meet or exceed certain standards mandated by federal agencies, including HUD. These standards differ in several important respects from the standards for furnaces used in site-built residential homes. The after market channel of distribution includes sales of both new and replacement air conditioning units and heat pumps and replacement furnaces. The Company believes that the Segment has one major competitor in this segment of this market, Evcon Industries, a subsidiary of York International Corporation which markets its products under the "Evcon/Coleman" name. 7 NORTEK, INC. AND SUBSIDIARIES Residential HVAC products for use in site-built homes are sold through independently-owned distributors who sell to HVAC contractors. The site-built residential HVAC market is very competitive, and many suppliers of such equipment have substantially greater financial and marketing resources than the Segment and enjoy greater brand awareness. In these markets, the Segment competes with, among others, Carrier Corporation, Rheem Manufacturing Company, Lennox Industries, The Trane Company, York International Corporation, International Comfort Products Corporation and Goodman Manufacturing. The Segment competes in both the manufactured housing and site-built markets on the basis of breadth and quality of its product line, distribution, product availability and price. The Company believes that the Segment competes favorably with respect to these factors. The Company estimates that more than half of the Segment's sales of residential HVAC products in 1998 were attributable to the replacement market, which tends to be less cyclical than the new construction market. The Segment had eleven manufacturing plants and employed 2,279 full-time people as of December 31, 1998, 216 of whom are covered by a collective bargaining agreement which expires in 2001. The Company believes that the Segment's relationships with its employees are satisfactory. Windows, Doors and Siding Products Segment The Windows, Doors and Siding Products Segment is a manufacturer and distributor of vinyl and wood windows, doors, vinyl siding, aluminum trim coil, soffit, skirting and shutters for use in the residential construction, do-it-yourself and professional renovation markets. The Company's sales of windows accounted for approximately 18.7% of the Company's consolidated net sales in 1998. The Company's sales of non-wood siding material accounted for approximately 11.1% of the Company's consolidated net sales in 1998. The Segment competes with many other manufacture in the sale of its products. Windows and Doors. The Segment manufactures and sells wood, clad, composition (wood and vinyl) and vinyl windows and patio doors, glass and polycarbonate skylights, and wooden interior bifold doors under the Crestline(R), Vetter(R), Kenergy(R), AWC(R), Gold(R), PLY GEM(R), Uniframe(R), Monitor(TM) and American Comfort(R) brand names. The products are marketed to both the home improvement and new construction markets through wholesale, millwork and specialty distributors, large contractors, home centers and lumber yards. 8 NORTEK, INC. AND SUBSIDIARIES The Segment differentiates itself from its competition with a multiple brand strategy, multiple channels of distribution, an established distribution network utilizing custom design and manufacturing capabilities, and a trained field sales and service support network. Its ability to sell in full truckload and less than truckload quantities is tailored to the desires of large home center chains which prefer to purchase windows directly from the manufacturer. The Segment's ability to offer a broad product line is also important to the Segments' sales and marketing strategy together with the Segment's focus on one of the fastest growing segments in the industry - home centers. Siding. The Segment is also a manufacturer of vinyl siding, aluminum trim coil, soffit, skirting and accessories, which are available in a variety of woodgrains and colors. Aluminum trim coil is a product that is used in most vinyl siding applications to cover exterior areas of a home which are not appropriate for vinyl, such as fascia and corners. Its products are used in both remodeling and new construction applications, including manufactured housing. Vinyl siding's share of the overall market for exterior siding materials has been increasing due to its ease of installation, high performance, durability, low maintenance requirements and price stability as compared to alternative siding materials (including wood, aluminum and masonry). The Segment's products are marketed under the Varigrain Preferred(R), Duragrain(R), Timber Oak(R), Contractors Choice(R), Proguard(R), Varibest(R), American Comfort(R), American Herald(TM), American '76(TM) Collection and Georgia-Pacific(R) brand names. Vinyl siding is sold to either specialty distributors (one-step distribution) who, in turn, sell directly to remodeling contractors or builders, or to building materials wholesale distributors (two-step distribution) who sell to home centers and lumberyards who, in turn, sell to remodeling contractors and consumers. The Company believes that it is able to compete on favorable terms as a result of its distribution coverage, high quality, innovative products, and production efficiency. The Segment also manufactures a line of injection molded siding components for the remodeling and new construction markets. Siding components include blocks, which allow for the flush mounting of items like light fixtures to the exterior of a home, 9 NORTEK, INC. AND SUBSIDIARIES and gable vents that provide attic ventilation. These products are sold to home centers, lumberyards and wholesale distributors of building materials. The Segment operates 13 manufacturing plants in the United States and employed 3,705 full-time people as of December 31, 1998, 1,597 of whom are covered by collective bargaining agreements which expire in 1999, 2000 and 2001. The Company believes that the Segment's relationships with its employees are satisfactory. Other Operations The Company manufactures and distributes preservative and fire retardant treated lumber and plywood products. These products are marketed to cooperative buying groups, lumberyards and independent wholesale distributors for use generally in residential decking, roofing, siding and landscaping as well as various commercial construction applications. RECENT DEVELOPMENTS On March 8, 1999, the Company acquired Webco, Inc., a designer and manufacturer of custom air handling equipment with 1998 sales of approximately $14 million. GENERAL CONSIDERATIONS Employees The Company employed approximately 9,640 persons at December 31, 1998. Backlog Backlog expected to be filled during 1999 was approximately $148,213,000 at December 31, 1998 ($127,137,000 at December 31, 1997). Backlog is not regarded as a significant factor for operations where orders are generally for prompt delivery. While backlog stated for December 31, 1998 is believed to be firm, the possibility of cancellations makes it difficult to assess the firmness of backlog with certainty. Research and Development The Company's research and development activities are principally new product development and represent approximately 1% of net sales. 10 NORTEK, INC. AND SUBSIDIARIES Patents and Trademarks The Company holds numerous design and process patents that it considers important, but no single patent is material to the overall conduct of its business. It is the Company's policy to obtain and protect patents whenever such action would be beneficial to the Company. The Company owns or licenses numerous trademarks that it considers material to the marketing of its products, including Broan(R), NuTone(R), Nautilus(R), Venmar(R), Flair(R), vanEE(R), Rangaire(R), Best(R), Crestline(R), Vetter(R), AWC(R), Kenergy(R), Varigrain(R), Duragrain(R), Timber Oak(R), Contractors Choice(R), Proguard(R), Varibest(R), American Comfort(R), American Herald(TM), Gold(R), PLY GEM(R), Uniframe(R), Governair(R), Mammoth(R), Temtrol(R), Miller(R), Intertherm(R), Frigidaire(R), Tappan(R), Philco(R), Kelvinator(R), Gibson(R), Ventrol(R), and Webco(TM). The Company believes that its rights in these trademarks are adequately protected. Raw Materials The Company purchases raw materials and most components used in its various manufacturing processes. The principal raw materials purchased by the Company are rolled sheet, formed and galvanized steel, copper, aluminum, plate mirror glass, PVC, polypropylene, glass, vinyl extrusions, particle board, fiberboard, lumber, plywood, various chemicals, paints, resins, and plastics. The materials, molds and dyes, 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. 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. From time to time increases in raw material costs can affect future supply availability due in part to raw material demands by other industries. 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 11 NORTEK, INC. AND SUBSIDIARIES markets. The Ply Gem businesses, acquired in August 1997 and Napco, acquired in October, 1998, have in the past been more seasonal in nature than the Company's businesses owned prior to these acquisitions. 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, incorporated herein by reference. Executive Officers of the Registrant Name Age Position Richard L. Bready 54 Chairman, President and Chief Executive Officer Almon C. Hall 52 Vice President, Controller and Chief Accounting Officer Richard J. Harris 62 Vice President and Treasurer Kenneth J. Ortman 63 Senior Vice President - Segment Operations Kevin W. Donnelly 44 Vice President, General Counsel and Secretary The Executive Officers have served in the same or substantially similar executive positions with the Company for at least the past five years. Executive Officers are elected annually by the Board of Directors of the Company and serve until their successors are chosen and qualified. Mr. Bready has an employment agreement with the Company providing for his employment as Chief Executive Officer through 2003, which term is extended at the end of each year for an additional year until either party gives notice it will not be further extended. The Company's executive officers include only those officers of the Company who perform policy-making functions for the Company as a whole and have managerial responsibility for major aspects of the Company's overall operations. A number of other individuals who serve as officers of the Company's subsidiaries perform policy-making functions and have managerial responsibilities for the subsidiary or division by which they are employed, although not for the Company overall. Certain of these individuals could, depending on earnings of such unit, be more highly compensated than some executive officers of the Company. 12 NORTEK, INC. AND SUBSIDIARIES 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, 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. Approximate Location Description Square Feet - -------------------------------------------------------------------------------- Union, IL Manufacturing/Warehouse/Administrative 197,000 Hartford, WI Manufacturing/Warehouse/Administrative 477,000 Bensenville, IL Warehouse/Administrative 69,000* Mississauga, ONT Manufacturing/Administrative 110,000 Carlsbad, CA Administrative 30,000 Xiang, Boaon, PRC Manufacturing 106,000* Fabriano, Italy Manufacturing/Administrative 97,500* Cerreto D'Esi, Italy Manufacturing/Administrative 56,000 Montefano, Italy Manufacturing/Administrative 140,000 Cleburne, TX Manufacturing/Administrative 210,000 Los Angeles, CA Manufacturing/Administrative 177,000 Drummondville, QUE Manufacturing/Administrative 76,000 Cincinnati, OH Manufacturing 836,000 Coppell, TX Manufacturing 144,000* St. Leonard d'Aston, QUE Manufacturing/Administrative 94,000 St. Peters, MO Warehouse/Administrative 250,000* St. Louis, MO Manufacturing 214,000 St. Louis, MO Manufacturing 103,000 Boonsville, MO Manufacturing 250,000* Tipton, MO Manufacturing 50,000 Chaska, MN Manufacturing/Administrative 230,000* Oklahoma City, OK Manufacturing/Administrative 127,000 Okarche, OK Manufacturing/Administrative 203,000 Montreal, QUE Manufacturing 66,000* Toledo, OH Manufacturing/Warehouse/Administrative 258,000 Kearney, MO Manufacturing/Administrative 145,000 Martinsburg, WV Manufacturing 162,000 Jasper, TN Manufacturing 110,000 Mosinee, WI Manufacturing/Warehouse/Administrative 825,000* Stevens Point, WI Manufacturing 107,000 Huntington, WV Manufacturing/Warehouse 286,000* Butler, PA Manufacturing 110,000 13 NORTEK, INC. AND SUBSIDIARIES Approximate Location Description Square Feet - -------------------------------------------------------------------------------- Sarver, PA Manufacturing 126,000 Valencia, PA Manufacturing 174,000 Commerce, TX Manufacturing/Administrative 86,000 Pine Bluff, AR Manufacturing 35 Acres Thomson, GA Manufacturing 29 Acres Milford, VA Manufacturing 45 Acres Detroit, MI Manufacturing 10 Acres Providence, RI Administrative 23,900 Springfield, MO Manufacturing 60,000* 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 1997 and 1998 to evaluate and remediate such sites were not material. However, the Company is presently unable to estimate accurately 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 party ("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 14 NORTEK, INC. AND SUBSIDIARIES 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. A subsidiary of the Company is a defendant in a number of lawsuits alleging damage caused by alleged defects in certain pressure treated wood products. Many of the suits have been resolved by dismissal or settlement with amounts being paid out of insurance proceeds or other third party recoveries. The subsidiary continues to vigorously defend the remaining suits. Certain defense and indemnity costs are being paid out of insurance proceeds and proceeds from a settlement with suppliers of material used in the production of the treated wood products. The subsidiary has engaged in coverage litigation with certain insurers and has settled coverage claims with several of the insurers. The Company believes that the remaining coverage disputes will be resolved on a satisfactory basis and additional coverage will be available. In reaching this belief, the company analyzed insurance coverage and the status of the coverage litigation, considered the history of settlements with primary and excess insurers and consulted with counsel. In addition to the legal matters described above, the Company and its subsidiaries are parties to various legal proceedings incident to the conduct of their businesses. None of these proceedings is expected to have a material adverse effect, either individually or in the aggregate, on the Company's financial position or results of operations (See Note 8 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 Not applicable. PART II ITEM 5. Market for Registrant's Common Stock and Related Stockholder Matters Stockholders of record of Nortek Common and Special Common Stock at March 5, 1999, numbered 2,842 and 2,284, respectively. There were no dividends declared on the Common and Special Common in 1998 or 1997. The high and low sales prices of Nortek's Common Stock traded on the New York Stock Exchange in 15 NORTEK, INC. AND SUBSIDIARIES each quarter of 1998 and 1997 were: 1998 Quarter High Low First 34 1/2 25 Second 33 1/4 28 3/4 Third 36 1/16 22 13/16 Fourth 30 3/8 20 1997 Quarter High Low First 27 1/2 19 1/2 Second 25 17 3/4 Third 27 1/4 23 3/16 Fourth 26 15/16 21 13/16 See Note 6 of the Notes to the Consolidated Financial Statements, Item 8 of Part II of this report incorporated herein by reference. 16 NORTEK, INC. AND SUBSIDIARIES ITEM 6. CONSOLIDATED SELECTED FINANCIAL DATA
For the Five Years Ended December 31, ---------------------------------------------------- 1998 1997 1996 1995 1994 (In thousands except ratios and per share amounts) Consolidated Summary of Operations: Net sales $1,738,343 $1,134,129 $841,557 $656,800 $615,952 Operating earnings 133,128 82,981 60,951 42,973 44,393 Gain (loss) on Businesses sold 4,000 --- --- --- (1,750) Earnings from continuing operations before extraordinary gain (loss) 34,000 26,400 23,700 17,500 15,400 Earnings (loss) from discontinued operations 1,200 (5,200) (1,700) (2,500) 1,800 Extraordinary gain (loss) from debt retirements (200) --- --- --- 200 Cumulative effect of an accounting change --- --- --- --- 400 Net earnings 35,000 21,200 22,000 15,000 17,800 Financial Position: Unrestricted cash, investments and marketable securities $209,633 $161,830 $ 92,093 $103,313 $105,080 Working capital 337,207 341,821 163,133 180,218 194,330 Total assets 1,689,993 1,304,546 590,233 604,950 494,573 Total debt-- Current 17,738 17,739 36,486 41,948 4,452 Long-term 1,007,113 835,840 243,769 240,125 219,241 Current ratio 2.0:1 2.3:1 1.9:1 1.9:1 2.4:1 Debt to equity ratio 4.7:1 6.7:1 2.4:1 2.1:1 1.9:1 Depreciation and amortization including non-cash interest 45,321 28,407 20,995 16,225 15,539 Capital expenditures 41,428 22,464 19,798 15,665 14,375 Stockholders' investment 217,610 128,088 118,795 131,291 117,790 Common and Special Common shares outstanding 11,706 9,500 9,873 12,074 12,550
17 NORTEK, INC. AND SUBSIDIARIES ITEM 6. CONSOLIDATED SELECTED FINANCIAL DATA (CONTINUED)
For the Five Years Ended December 31, 1998 1997 1996 1995 1994 (In thousands except ratios and per share amounts) Per Share: Earnings from continuing operations Basic $3.11 $2.75 $2.26 $1.41 $1.23 Diluted $3.06 $2.68 $2.23 $1.39 $1.21 Net earnings Basic $3.20 $2.21 $2.10 $1.21 $1.42 Diluted $3.15 $2.15 $2.07 $1.19 $1.39 Stockholders' investment $18.59 $13.48 $12.03 $10.87 $9.39
See Notes 2, 9 to 11 and 13 of 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, Businesses sold and other matters. There have not been any cash dividends declared or paid on the Company's Common or Special Common Stock during the past five years. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Effective in 1998, the Company adopted Statement of Financial Accounting Standards No. 131 Disclosures About Segments of an Enterprise and Related Information ("SFAS 131"), and accordingly, the information for all years presented has been reclassified to conform to the presentation for 1998. (See Note 10 of the Notes to the Consolidated Financial Statements included elsewhere herein.) The Company is a diversified manufacturer of residential and commercial building products, operating within three principal segments: the Residential Building Products Segment, the Air Conditioning and Heating ("HVAC") Products Segment, and the Windows, Doors and Siding Segment. Other includes corporate related items, results of insignificant operations and certain income and expense not allocable to reportable segments. The results of operations and other data relating to Businesses sold have been presented separately. Through these principal segments, the Company manufactures and sells, primarily in the United States, Canada and Europe, a wide variety of products for the residential and commercial construction, manufactured housing, the do-it-yourself and professional remodeling and renovation markets. 18 NORTEK, INC. AND SUBSIDIARIES The Residential Building Products Segment manufactures and distributes built-in products primarily for the residential new construction, do-it-yourself (DIY) and professional remodeling and renovation markets including kitchen range hoods, bath fans and combination units (fan, heater and light combinations). The Air Conditioning and Heating Products Segment manufactures and sells heating, ventilating, and air conditioning ("HVAC") systems for custom-designed commercial applications and for manufactured and site-built residential housing. The Windows, Doors and Siding Segment manufactures and distributes vinyl and wood windows, doors, vinyl siding, aluminum trim coil, soffit, skirting and shutters for use in the residential construction, DIY and professional renovation markets. The Windows, Doors and Siding Segment was purchased in connection with the acquisition of Ply Gem on August 26, 1997 and, accordingly, information presented below excludes results of operations for this Segment for periods prior to the acquisition date. The Company acquired NuTone, Inc. ("NuTone") on July 31, 1998, Napco, Inc. and an affiliate ("Napco") on October 9, 1998 and Ply Gem Industries, Inc. and its subsidiaries ("Ply Gem") on August 26, 1997. These acquisitions have been accounted for under the purchase method of accounting. Accordingly, the results of NuTone, Napco and Ply Gem are included in the Company's consolidated results since the date of their acquisition. (See "Liquidity and Capital Resources" and Note 2 of the Notes to the Consolidated Financial Statements included elsewhere herein.) For the full year ended December 31, 1997, Napco had net sales, operating earnings and earnings from continuing operations before provision for income taxes of approximately $91,100,000, $8,600,000 and $8,000,000, respectively. For the period from January 1, 1998 to the date of acquisition, October 9, 1998, Napco had net sales, operating earnings and earnings from continuing operations before provision for income taxes of approximately $77,900,000, $9,200,000 and $8,900,000, respectively. In the fourth quarter of 1997, the Company adopted a plan to discontinue its plumbing products business. Accordingly, the results of the plumbing products business have been excluded from earnings from continuing operations and classified separately as discontinued operations for each of the three years ended December 31, 1998. On July 10, 1998, the Company sold its plumbing products business for approximately $33,700,000 in cash. (See Note 9 of the Notes to the Consolidated Financial Statements included elsewhere herein.) 19 NORTEK, INC. AND SUBSIDIARIES During 1998, the Company made several dispositions of non-strategic assets. On May 8, 1998, the Company sold Studley Products, Inc. ("Studley"). Studley had net sales and an operating loss of approximately $22,000,000 and $6,100,000 for the full year ended December 31, 1997, respectively, and net sales and an operating loss of approximately $7,300,000 and $1,600,000, respectively, for the period January 1, 1998 to May 8, 1998 and was treated as an operation held for sale since the acquisition of Ply Gem. Accordingly, the Company did not recognize any gain or loss on the sale of Studley and Studley's operating results are not included in the Company's consolidated financial results. On May 22, 1998, the Company sold Sagebrush Sales, Inc. ("Sagebrush") for approximately $9,100,000 in cash. Sagebrush had net sales, operating earnings and earnings from continuing operations before provision for income taxes of approximately $47,600,000, $400,000 and $400,000, respectively, for the full year ended December 31, 1997 and net sales, operating earnings and earnings from continuing operations before provision for income taxes of approximately $19,100,000, $200,000 and $200,000, respectively, for the five months ended May 22, 1998. On July 2, 1998, the Company sold Goldenberg Group, Inc. ("Goldenberg") for approximately $11,100,000 including approximately $2,000,000 in notes. Goldenberg had net sales, operating earnings and earnings from continuing operations before provision for income taxes of approximately $41,300,000, $500,000 and $500,000, respectively, for the full year ended December 31, 1997 and net sales, operating earnings and earnings from continuing operations before provision for income taxes of approximately $21,500,000, $500,000 and $500,000, respectively, for the six months ended July 2, 1998. On July 31, 1998, the Company sold another Ply Gem business, Ply Gem Manufacturing, which had net sales, operating earnings and earnings from continuing operations before provision for income taxes of approximately $48,300,000, $2,500,000 and $2,500,000, respectively, for the full year ended December 31, 1997 and net sales, operating earnings and earnings from continuing operations before provision for income taxes of approximately $23,300,000, $700,000 and $700,000, respectively, for the seven months ended July 31, 1998. On December 10, 1998, the Company sold Allied Plywood Corporation ("Allied") for approximately $16,500,000 in cash and approximately $7,000,000 in notes. Allied had net sales, operating earnings and earnings from continuing operations before provision for income taxes of approximately $84,400,000, $400,000 and $400,000, respectively, for the full year ended December 31, 1997 and net sales, operating earnings and earnings from continuing operations before provision for income taxes of approximately $80,300,000, $800,000 and $800,000, respectively, for the eleven months ended November, 1998. On December 30, 1998, the Company sold its M&S 20 NORTEK, INC. AND SUBSIDIARIES Systems LP ("M&S") subsidiary and Moore-O-Matic, Inc. ("MOM"), for approximately $27,500,000 in cash and recorded a pre-tax gain of approximately $4,000,000. For the year ended December 31, 1997, combined net sales, operating earnings and earnings from continuing operations before provision for income taxes of M&S and MOM were approximately $37,300,000, $3,400,000 and $3,400,000, respectively. For the year ended December 31, 1998, combined net sales, operating earnings and earnings from continuing operations before provision for income taxes of M&S and MOM were approximately $42,100,000, $3,600,000 and $3,600,000, respectively. The operating results of Sagebrush, Goldenberg, Ply Gem Manufacturing and Allied are included in the Company's 1997 and 1998 consolidated results from the date of the Ply Gem acquisition, August 26, 1997, to the date of sale. The disposition of these four businesses did not result in any significant gains or losses. Approximately $27,700,000 of the proceeds from the sale of these four businesses were used to pay down debt. The remaining proceeds (including the proceeds from the sale of the plumbing products business, Studley, M&S and MOM) of approximately $84,000,000 were used for general corporate purposes. (See Notes 2, 9 and 10 of the Notes to the Consolidated Financial Statements included elsewhere herein.) The Company does not expect the effect of Businesses sold during 1998 to be significant to the Company's future operations. 21 NORTEK, INC. AND SUBSIDIARIES Results of Operations The tables that follow present the net sales and operating earnings for the Company's principal segments for the three years ended December 31, 1998, and the dollar amount and percentage change of such results as compared to the prior year. The amounts in the tables for the prior years have been reclassified to conform to the presentation for 1998.
Net Change Year Ended December 31, 1998 to 1997 1997 to 1996 1998 1997 1996 $ % $ % (Dollar amounts in millions) Net Sales: Residential Building Products $475.0 $381.8 $368.7 $93.2 24.4% $13.1 3.6% Air Conditioning and Heating Products 465.2 419.4 423.1 45.8 10.9 (3.7) (0.9) Windows, Doors and Siding 536.8 189.0 --- 347.8 184.0 189.0 --- Other 69.3 21.3 --- 48.0 225.4 21.3 --- -------- -------- ------ ----- ------ ------- ------ 1,546.3 1,011.5 791.8 534.8 52.9 219.7 27.7 Businesses sold 192.0 122.6 49.8 69.4 56.6 72.8 146.2 -------- -------- ------ ------ ------ ------- ------ $1,738.3 $1,134.1 $841.6 $604.2 53.3% $292.5 34.8% ======== ======== ====== ====== ====== ======= ====== Operating Earnings: Residential Building Products $ 53.7 $40.3 $31.2 $13.4 33.3% $ 9.1 29.2% Air Conditioning and Heating Products 55.7 41.3 38.5 14.4 34.9 2.8 7.3 Windows, Doors and Siding 31.5 9.0 --- 22.5 250.0 9.0 --- Other (14.2) (14.5) (14.6) 0.3 2.1 0.1 (0.7) ------- ------ ------ ------ ------ ----- ----- 126.7 76.1 55.1 50.6 66.5 21.0 38.1 Businesses sold 6.4 6.9 5.9 (0.5) (7.2) 1.0 16.9 ------- ------ ------ ------ ------ ----- ----- $133.1 $83.0 $61.0 $50.1 60.4% $22.0 36.1% ======= ====== ====== ====== ====== ===== =====
22 NORTEK, INC. AND SUBSIDIARIES The tables that follow set forth, for the three years ended December 31, 1998, (a) certain consolidated operating results, (b) the percentage change of such results as compared to the prior year, (c) the percentage which such results bear to net sales and (d) the change of such percentages as compared to the prior year:
Percentage Change 1998 1997 Year Ended December 31, to to 1998 1997 1996 1997 1996 (Dollar amounts in millions) Net sales $1,738.3 $1,134.1 $841.6 53.3% 34.8% Cost of products sold 1,275.3 825.8 596.9 (54.4) (38.3) Selling, general and administrative expense 315.5 219.4 180.3 (43.8) (21.7) Amortization of goodwill and intangible assets 14.4 5.9 3.4 (144.1) (73.5) Operating earnings 133.1 83.0 61.0 60.4 36.1 Gain on Businesses sold 4.0 --- --- --- --- Interest expense (86.3) (50.2) (28.4) (71.9) (76.8) Investment income 10.5 9.9 6.0 6.1 65.0 Earnings from continuing operations before provision for income taxes 61.3 42.7 38.6 43.6 10.6 Provision for income taxes 27.3 16.3 14.9 (67.5) (9.4) Earnings from continuing operations before extraordinary loss 34.0 26.4 23.7 28.8 11.4 Earnings (loss) from discontinued operations 1.2 (5.2) (1.7) --- (205.9) Extraordinary loss from debt retirements (0.2) --- --- --- --- Net earnings 35.0 21.2 22.0 65.1 (3.6)
23 NORTEK, INC. AND SUBSIDIARIES
Percentage Change Percentage of Net Sales 1998 1997 Year Ended December 31, to to 1998 1997 1996 1997 1996 Net sales 100.0% 100.0% 100.0% ---% ---% Cost of products sold 73.4 72.8 70.9 (0.6) (1.9) Selling, general and administrative expense 18.1 19.4 21.4 1.3 2.0 Amortization of goodwill and intangible assets 0.8 0.5 0.4 (0.3) (0.1) Operating earnings 7.7 7.3 7.3 0.4 --- Gain on Businesses sold 0.2 --- --- 0.2 --- Interest expense (5.0) (4.4) (3.4) (0.6) (1.0) Investment income 0.6 0.9 0.7 (0.3) 0.2 Earnings from continuing operations before provision for income taxes 3.5 3.8 4.6 (0.3) (0.8) Provision for income taxes 1.6 1.4 1.8 (0.2) 0.4 Earnings from continuing operations before extraordinary loss 1.9 2.4 2.8 (0.5) (0.4) Earnings (loss) from discontinued operations 0.1 (0.5) (0.2) 0.6 (0.3) Extraordinary loss from debt retirements --- --- --- --- --- Net earnings 2.0 1.9 2.6 0.1 (0.7)
24 NORTEK, INC. AND SUBSIDIARIES Year Ended December 31, 1998 as Compared to the Year Ended December 31, 1997 - ---------------------------------------------------------------------------- Net sales increased approximately $604,200,000 or approximately 53.3%, as compared to 1997 (or increased approximately $610,400,000 or approximately 53.8% excluding the effect of changes in foreign exchange rates). Net sales increased in 1998 principally as a result of acquisitions. The acquisition of NuTone on July 31, 1998 contributed approximately $82,200,000 of the $93,200,000 increase ($99,400,000 increase excluding the effect of changes in foreign exchange rates) in net sales in the Residential Building Products Segment in 1998. The balance of the increase in net sales in this segment is as a result of higher sales levels of higher margin built-in ventilation products in North America, partially offset by lower sales levels of certain lower margin products. The increase in net sales in the Air Conditioning and Heating Products Segment of approximately $45,800,000 or 10.9%, is principally as a result of higher sales volume related to products sold to the residential and manufactured housing markets, partially offset by slightly lower sales of commercial HVAC products, in part, as a result of a seven week strike in 1998 at one of this segment's manufacturing facilities. The increase in net sales in the Windows, Doors and Siding Segment principally arose in connection with the August 26, 1997 acquisition of Ply Gem (a full twelve months of operating results in 1998 as compared to four months in 1997). The acquisition of Napco on October 9, 1998 contributed approximately $21,000,000 to this segment's increase in net sales in 1998. The net sales of Businesses sold increased approximately $69,400,000 principally as a result of certain non-strategic businesses, acquired in connection with the August 26, 1997 acquisition of Ply Gem, which were sold in 1998. Cost of products sold as a percentage of net sales increased from approximately 72.8% in 1997 to approximately 73.4% in 1998. Changes in the percentages were, in large part, affected by acquisitions and will be affected in the future by the effect of Businesses sold in 1998. The Ply Gem businesses have a higher level of cost of sales as a percentage of net sales than the overall group of businesses owned prior to the Ply Gem acquisition while NuTone's level of cost of sales as a percentage of net sales is lower. Excluding the effect of Businesses sold, cost of products sold as a percentage of net sales increased from approximately 72.4% in 1997 to approximately 72.9% in 1998. This increase in the percentage principally resulted from the acquisitions of Ply Gem and, to a lesser extent, Napco in the Windows, Doors and Siding Segment, partially offset by the acquisition of NuTone and the effect of 25 NORTEK, INC. AND SUBSIDIARIES higher sales levels in the Residential Building Products and Air Conditioning and Heating Product Segments without a proportionate increase in costs. Had all year-end inventory values been stated on a FIFO basis, year-end inventory would have been approximately $3,407,000 higher in 1998, approximately $5,041,000 higher in 1997 and approximately $6,015,000 higher in 1996. Overall, changes in the cost of products sold as a percentage of net sales for one period as compared to another period may reflect a number of factors including changes in the relative mix of products sold, the effect of changes in sales prices, the material cost of products sold and changes in productivity levels. Selling, general and administrative expense as a percentage of net sales decreased from approximately 19.4% in 1997 to approximately 18.1% in 1998. This decrease in the percentage was principally affected as a result of acquisitions and will be affected in the future by the effect of Businesses sold in 1998. Ply Gem and Napco have a lower level of selling, general and administrative expense as a percentage of net sales than the overall group of businesses owned prior to the acquisitions and NuTone has a higher level of expense as a percentage of net sales. Excluding the effect of Businesses sold, selling, general and administrative expense as a percentage of net sales decreased from approximately 19.5% in 1997 to approximately 18.0% in 1998. The Air Conditioning and Heating Products Segment, and to a lesser extent the Residential Building Products Segment, contributed to the decrease in the percentage as a result of the increases in sales noted above without a proportionate increase in expense. This was partially offset by increased corporate overhead, principally as a result of the acquisition of Ply Gem. Amortization of goodwill and intangible assets, as a percentage of net sales, increased from approximately .5% of net sales in 1997 to approximately .8% of net sales in 1998, principally as a result of the acquisitions of Ply Gem and NuTone. Consolidated operating earnings increased approximately $50,100,000 from approximately $83,000,000 in 1997 as compared to approximately $133,100,000 in 1998. Businesses acquired in 1998 contributed approximately $12,600,000 of the increase, of which approximately $2,300,000 was in the Windows, Doors and Siding Segment, and $10,300,000 was in the Residential Building Products Segment. Operating earnings increased substantially in 1998 in the Windows, Doors and Siding Segment, principally due to the effect of the August 26, 1997 acquisition of Ply Gem (a full twelve months of operating results in 1998 as compared to four months in 1997). Consolidated operating earnings have been reduced by depreciation and amortization expense of 26 NORTEK, INC. AND SUBSIDIARIES approximately $42,100,000 and approximately $26,700,000 for 1998 and 1997, respectively. Businesses acquired in 1998 contributed approximately $4,300,000 of the increase in depreciation and amortization expense in 1998, of which approximately $500,000 was in the Windows, Doors and Siding Segment and $3,800,000 was in the Residential Building Products Segment. Depreciation and amortization expense for the year ended December 31, 1998 related to the operating results of Businesses sold in 1998 was approximately $1,700,000. (See Note 10 of the Notes to the Consolidated Financial Statements included elsewhere herein.) The increase in operating earnings was also due to increased sales volume without a proportionate increase in cost and expense in the Air Conditioning and Heating Products Segment (approximately $14,400,000 or 34.9%) and, to a lesser extent, the Residential Building Products Segment (approximately $3,100,000 excluding the contribution from NuTone), as noted above, partially offset by increased other expense principally as a result of increased corporate overhead as a result of the acquisition of Ply Gem. Operating earnings of foreign operations, consisting primarily of the results of operations of the Company's Canadian and European subsidiaries which manufacture built-in ventilating products, were approximately 6.5% and 9.0% of operating earnings (before corporate overhead) in 1998 and 1997, respectively. The decline in foreign operating earnings as a percentage of net sales is principally as a result of the increased domestic sales and operating earnings from the Ply Gem acquisition. Sales and earnings derived from the international market are subject to the risks of currency fluctuations. The gain on Businesses sold before provision for income taxes in 1998 of approximately $4,000,000 arose in connection with the sale of M&S and MOM. Interest expense in 1998 increased approximately $36,100,000 or approximately 71.9% as compared to 1997, primarily as a result of the sale of the 9 1/4% Notes on March 17, 1997, the sale of the 9 1/8% Notes on August 26, 1997, indebtedness of Ply Gem existing at the date of acquisition and the sale of the 8 7/8% Notes on July 31, 1998. This increase was partially offset by the refinancing of certain outstanding indebtedness of the Company's subsidiaries in 1997. (See Notes 2 and 5 of the Notes to the Consolidated Financial Statements included elsewhere herein.) Investment income in 1998 increased approximately $600,000 or approximately 6.1% as compared to 1997, principally due to higher average invested balances partially offset by slightly lower yields earned on short-term investments and marketable securities. 27 NORTEK, INC. AND SUBSIDIARIES The provision for income taxes was approximately $27,300,000 for 1998, as compared to approximately $16,300,000 for 1997. The income tax rates differed from the United States Federal statutory rate of 35% principally as a result of state income tax provisions, nondeductible amortization expense (for tax purposes), changes in tax reserves, the effect of foreign income tax on foreign source income and the effect of product development tax credits from foreign operations. (See Note 4 of the Notes to the Consolidated Financial Statements included elsewhere herein.) Earnings from discontinued operations were approximately $1,200,000 in 1998 as compared to a loss of approximately $5,200,000 in 1997. In the fourth quarter of 1997, the Company adopted a plan of disposition of the Plumbing Products business and on July 10, 1998, this business was sold. The following is a comparison of the operating results of discontinued operations for the two years ended December 31, 1998. (See Note 9 of the Notes to the Consolidated Financial Statements included elsewhere herein.)
For the years ended December 31, 1998 1997 (Amounts in thousands) Loss before income taxes $(2,800) $(3,800) Allocated corporate interest expense (1,000) (1,900) -------- -------- (3,800) (5,700) Income tax benefit 5,000 2,100 -------- -------- 1,200 (3,600) Reserve for future operating expenses net of tax benefit of $900,000 --- (1,600) -------- -------- Earnings (loss) from discontinued operations $ 1,200 $(5,200) ======== ========
The income tax benefit in 1998 includes approximately $800,000 recorded as a result of the realization of a portion of the tax capital loss arising from the sale of the Plumbing Products business. Year Ended December 31, 1997 as Compared to the Year Ended December 31, 1996 - ---------------------------------------------------------------------------- Net sales increased approximately $292,500,000 or approximately 34.8%, as compared to 1996 (or increased approximately 28 NORTEK, INC. AND SUBSIDIARIES $300,500,000 or approximately 35.7%, excluding the effect of changes in foreign exchange rates). Net sales increased principally as a result of the acquisition of Ply Gem on August 26, 1997, which contributed approximately $284,200,000 to net sales of which approximately $189,000,000 is related to the Windows, Doors and Siding Segment and approximately $73,900,000 is related to certain non-strategic assets that were subsequently sold in 1998. Net sales of the Residential Building Products Segment increased by approximately $13,100,000 or 3.6%, as a result of higher sales levels of higher margin built-in ventilation products in North America, partially offset by lower sales levels of lower margin European ventilation (including the effects of changes in foreign exchange rates) and domestic products. Net sales of the Air Conditioning and Heating Products Segment decreased approximately $3,700,000 or .9%, principally as a result of approximately $3,600,000 lower sales resulting from the sale of a residential HVAC product line in 1997 and lower sales levels of commercial HVAC products, partially offset by increased sales levels of HVAC products to residential markets. Cost of products sold as a percentage of net sales increased from approximately 70.9% in 1996 to approximately 72.8% in 1997. Excluding the Ply Gem businesses, (which have a higher level of cost of sales than the overall group of businesses owned prior to the acquisition), cost of products sold as a percentage of net sales decreased from approximately 71.3% to approximately 70.4% in 1997, as compared to 1996. This decrease in the percentage principally resulted from a reduction in the cost of certain raw materials and components compared to 1996 and decreased labor as a percentage of net sales in the Residential Building Products and Air Conditioning and Heating Products Segments due to the increased volume of higher margin products and improved efficiency. Had all year-end inventory values been stated on a FIFO basis, year-end inventory would have been approximately $5,041,000 higher in 1997, approximately $6,015,000 higher in 1996 and approximately $7,873,000 higher in 1995. Overall, changes in the cost of products sold as a percentage of net sales for one period as compared to another period may reflect a number of factors, including changes in the relative mix of products sold, the effect of changes in sales prices, the material cost of products sold and changes in productivity levels. Selling, general and administrative expense as a percentage of net sales decreased from approximately 21.4% in 1996 to approximately 19.4% in 1997. Excluding the Ply Gem businesses, (which have a lower level of selling, general and administrative expense to net sales than the overall group of businesses owned prior to the acquisition), selling, general and administrative 29 NORTEK, INC. AND SUBSIDIARIES expense as a percentage of net sales decreased from approximately 21.4% in 1996 to approximately 21.2% in 1997. This decrease in the percentage was due principally to higher sales levels in the Residential Building Products Segment without a proportionate increase in expense and the effect of the sale of a residential HVAC product line noted above, partially offset by lower sales levels of commercial products by the Air Conditioning and Heating Products Segment without a proportionate decrease in expense. Amortization of goodwill and intangible assets, as a percentage of net sales, increased from approximately .4% of net sales in 1996 to approximately .5% of net sales in 1997, principally as a result of the acquisition of Ply Gem. Operating earnings increased approximately $22,000,000 from approximately $61,000,000 in 1996 to approximately $83,000,000 in 1997 primarily due to the factors previously discussed. The Ply Gem acquisition in late August 1997 contributed approximately $11,300,000 to operating earnings, of which approximately $9,000,000 was in the Windows, Doors and Siding Segment and $2,000,000 related to businesses that were subsequently sold in 1998. Operating earnings have been reduced by depreciation and amortization expense of approximately $26,700,000 and approximately $19,800,000 for 1997 and 1996, respectively. The acquisition of Ply Gem contributed approximately $6,300,000 of the increase in depreciation and amortization expense in 1997. Operating earnings also increased by approximately $9,100,000 or 29.2% in the Residential Building Products Segment and $2,800,000 or 7.3% in the Air Conditioning and Heating Products Segment as a result of increased sales volume without a proportionate increase in expense. Earnings of foreign operations, consisting primarily of the results of operations of the Company's Canadian and European subsidiaries, which manufacture built-in ventilating products, decreased to approximately 9.0% of operating earnings (before corporate overhead) in 1997 from approximately 9.1% of such earnings in 1996. The decrease in the percentage is due to an increase in domestic earnings in 1997, in part as a result of $11,300,000 contributed by Ply Gem, which has primarily domestic operations. Sales and earnings derived from the international market are subject to the risks of currency fluctuations. Interest expense in 1997 increased approximately $21,800,000 or approximately 76.8%, as compared to 1996, primarily as a result of the sale of $175,000,000 principal amount of 9 1/4% Senior Notes due 2007 ("9 1/4% Notes") in March, 1997, the sale of $310,000,000 principal amount of 9 1/8% Senior Notes due 2007 30 NORTEK, INC. AND SUBSIDIARIES ("9 1/8% Notes")in August, 1997 and the existing indebtedness of Ply Gem. This increase was partially offset by the refinancing of certain outstanding indebtedness of the Company's subsidiaries primarily in the second quarter of 1997. (See Notes 2 and 5 of the Notes to the Consolidated Financial statements included elsewhere herein.) Investment income in 1997 increased approximately $3,900,000 or approximately 65.0%, as compared to 1996, principally due to higher average invested balances of short-term investments and marketable securities. The provision for income taxes was approximately $16,300,000 for 1997, as compared to approximately $14,900,000 for 1996. The provision for income taxes was reduced by approximately $1,540,000 in 1997 and $481,000 in 1996 reflecting the reversal of tax reserves no longer required. The income tax rates differed from the United States Federal statutory rate of 35% principally as a result of state income tax provisions, nondeductible amortization expense (for tax purposes), changes in tax reserves, the effect of foreign income tax on foreign source income and the effect of product development tax credits from foreign operations. (See Note 4 of the Notes to the Consolidated Financial Statements included elsewhere herein.) In the fourth quarter of 1997, the Company adopted a plan of disposition of its Plumbing Products business. Loss from discontinued operations related to the Plumbing Products business increased approximately $3,500,000 from a loss of $1,700,000 in 1996 to a loss of $5,200,000 in 1997. Loss from discontinued operations in 1997 includes a net after tax loss of $1,600,000 for operating losses expected to occur during the disposal period and is net of an income tax benefit of $900,000. Loss from discontinued operations includes net after tax operating losses of $3,600,000 in 1997 and $1,700,000 in 1996 and are net of income tax benefits of $2,100,000 and $900,000 for 1997 and 1996, respectively. Operating results of discontinued operations reflect an allocation of corporate interest expense of approximately $1,900,000 and $1,700,000 in 1997 and 1996, respectively and are net of income tax benefits of $670,000 and $600,000 in 1997 and 1996, respectively. (See Note 9 of the Notes to the Consolidated Financial Statements included elsewhere herein.) Liquidity and Capital Resources - ------------------------------- The Company is highly leveraged and expects to continue to be highly leveraged for the foreseeable future. At December 31, 1998, the Company had consolidated debt of approximately 31 NORTEK, INC. AND SUBSIDIARIES $1,024,900,000 consisting of (i) $17,700,000 of short-term borrowings and current maturities of long-term debt, (ii) $112,300,000 of notes, mortgage notes and other indebtedness, (iii) $209,300,000 of the 8 7/8% Notes, (iv) $174,100,000 of the 9 1/4% Notes, (v) $203,800,000 of the 9 7/8% Notes and (vi) $307,700,000 of the 9 1/8% Notes. At December 31, 1998, the Company had consolidated unrestricted cash, cash equivalents and marketable securities of approximately $209,600,000 as compared to approximately $161,800,000 at December 31, 1997 and the Company's debt to equity ratio was approximately 4.7:1 at December 31, 1998 as compared to 6.7:1 at December 31, 1997. The Company's ability to pay interest on or to refinance its indebtedness depends on the successful integration of the operations of recent acquisitions and the Company's future performance, which, in part, is subject to general economic, financial, competitive, legislative, regulatory and other factors beyond its control. There can be no assurance that the Company will generate sufficient cash flow from the operation of its subsidiaries or that future financings will be available on acceptable terms or in amounts sufficient to enable the Company to service or refinance its indebtedness, or to make necessary capital expenditures. The Company has evaluated and expects to continue to evaluate possible acquisition transactions and the possible dispositions of certain of its businesses on an ongoing basis and at any given time may be engaged in discussions or negotiations with respect to possible acquisitions or dispositions. The indentures and other agreements governing the Company and its subsidiaries' indebtedness (including the indentures for the 8 7/8% Notes, the 9 7/8% Notes, the 9 1/4% Notes and the 9 1/8% Notes and the credit agreement for the Ply Gem credit facility) contain restrictive financial and operating covenants including covenants that restrict the ability of the Company and its subsidiaries to complete acquisitions, pay dividends, incur indebtedness, make investments, sell assets and take certain other corporate actions. The Company expects to meet its cash flow requirements through fiscal 1999 from cash generated from operations, existing cash, cash equivalents and marketable securities, and possible financings, which may include securitization of accounts receivables and mortgage or capital lease financings. In 1998 the Company improved its liquidity and reduced its leverage as a result of the sale of 2,182,500 shares of common stock for net cash proceeds of approximately $64,190,000 (the 32 NORTEK, INC. AND SUBSIDIARIES "Common Stock Offering") and net cash proceeds of approximately $111,700,000 from the sale of certain businesses. Approximately $44,800,000 of the proceeds received from the Common Stock Offering was used for the acquisition of NuTone and approximately $27,700,000 of the net proceeds received from the sale of businesses was used to reduce debt and the balance was used for general corporate purposes. (See Notes 2, 5, 6 and 9 of the Notes to the Consolidated Financial Statements included elsewhere herein.) On October 9, 1998, the Company acquired Napco, a manufacturer of exterior building products, for approximately $80,800,000 in cash (of which approximately $4,100,000 was paid in 1999), approximately $400,000 of forgiveness of Napco employee loans and the assumption of approximately $10,200,000 of debt. The acquisition was funded through the use of unrestricted cash, cash equivalents and marketable securities. On July 31, 1998, the Company acquired NuTone, a manufacturer of exhaust fans, range hoods, and other ventilation products and accessories, for an aggregate purchase price of $242,500,000 in cash plus fees and expenses. In connection with the acquisition, the Company assumed NuTone's operating liabilities (other than intercompany borrowings), including certain liabilities of NuTone concerning post retirement and other benefit obligations. The purchase price was funded from the net proceeds from the sale of the 8 7/8% Notes, which occurred on July 31, 1998, together with a portion of the cash proceeds from the Common Stock Offering. (See Notes 2, 5 and 6 of the Notes to the Consolidated Financial Statements included elsewhere herein.) As the Company begins the process of integrating the 1998 acquisitions into its businesses, it expects to achieve significant synergies, cost savings and reductions during 1999, partially offset by certain costs and expenses. The total expenditures associated with this effort, which are estimated to range between approximately $18,000,000 and $25,000,000, are expected to be funded from the Company's 1999 operating cash flow. The Company expects to finalize its integration plans and determine an estimated cost to complete such integration by the second quarter of 1999. If significant difficulty is encountered during the integration process, or if such synergies and cost savings are not realized, the results of operations, cash flow and financial condition of the Company likely will be adversely affected. There can be no assurance that the Company will be able to successfully manage and integrate the 1998 acquisitions. (See Note 12 of the Notes to the Consolidated Financial Statements included elsewhere herein.) 33 NORTEK, INC. AND SUBSIDIARIES Unrestricted cash and cash equivalents decreased from approximately $125,842,000 at December 31, 1997 to approximately $87,876,000 at December 31, 1998. Marketable securities available for sale increased from approximately $35,988,000 at December 31, 1997 to approximately $121,757,000 at December 31, 1998. The Company's investment in marketable securities at December 31, 1998 consisted primarily of certificates of deposit and bank issued money market instruments. At December 31, 1998, approximately $13,818,000 of the Company's cash and investments were pledged as collateral for insurance and other requirements and were classified as restricted in current assets in the Company's accompanying consolidated balance sheet. Capital expenditures were approximately $41,400,000 in 1998 and are expected to be approximately $40,000,000 in 1999. The Company's Board of Directors has authorized a program to purchase up to 500,000 shares of the Company's Common and Special Common Stock in open-market or negotiated transactions subject to market conditions, cash availability and provisions of the Company's outstanding debt instruments. As of March 5, 1999, the Company had purchased approximately 460,000 shares of its Common and Special Common Stock under this program for approximately $13,000,000 and accounted for such share purchases as Treasury Stock. At March 5, 1999, approximately $60,800,000 was available for the payment of cash dividends, stock payments or other restricted payments as defined under the terms of the Company's most restrictive Indenture. (See Note 5 of the Notes to the Consolidated Financial Statements included elsewhere herein.) 34 NORTEK, INC. AND SUBSIDIARIES The Company's working capital and its current ratio decreased from approximately $341,821,000 and 2.3:1, respectively, to approximately $337,207,000 and 2.0:1, respectively, between December 31, 1997 and December 31, 1998, principally as a result of the following:
Increase (decrease) in Working Capital Net proceeds from the Common Stock Offering $ 64,190,000 Net proceeds from theSale of the 8 7/8% Notes 203,492,000 Acquisition of NuTone, net of approximately $15,900,000 of acquired working capital (232,081,000) ------------- 35,601,000 Effect of Businesses sold or discontinued, net of $27,700,000 payment of long-term debt (15,417,000) Acquisition of Napco, net of approximately $16,360,000 of acquired working capital (60,340,000) Other, net 35,542,000 ------------- $ (4,614,000) =============
Accounts receivable increased approximately $24,945,000 or approximately 13.8%, between December 31, 1997 and December 31, 1998, while net sales increased approximately $22,319,000 or approximately 5.4% in the fourth quarter of 1998 as compared to the fourth quarter of 1997. The increase in accounts receivable is primarily attributable to the acquisitions of NuTone and Napco, which contributed approximately $52,000,000 to the increase, partially offset by a decrease of approximately $29,800,000 attributable to Businesses sold. The rate of change in accounts receivable in certain periods may be different than the rate of change in sales in such periods principally due to the timing of net sales. Increases or decreases in net sales near the end of any period generally result in significant changes in the amount of accounts receivable on the date of the balance sheet at the end of such period, as was the situation on December 31, 1998 as compared to December 31, 1997. The Company has not experienced any significant overall changes in credit terms, collection efforts, credit utilization or delinquency in accounts receivable in 1998. Inventories decreased approximately $13,546,000 or approximately 7.7%, between December 31, 1997 and December 31, 1998. The decrease is primarily attributable to Businesses sold which accounted for approximately $47,100,000 of the decrease, and is partially offset by an increase of approximately $35,200,000 attributable to the acquisitions of NuTone and Napco. Accounts payable increased approximately $28,613,000 or approximately 31.3%, between December 31, 1997 and December 31, 35 NORTEK, INC. AND SUBSIDIARIES 1998. The increase is primarily attributable to the acquisitions of NuTone and Napco, which contributed approximately $21,900,000 to the increase, partially offset by a decrease of approximately $7,100,000 attributable to Businesses sold. Unrestricted cash and cash equivalents decreased approximately $37,966,000 from December 31, 1997 to December 31, 1998, principally as a result of the following:
Condensed Consolidated Cash Flows Operating Activities-- Cash flow from operations, net $ 92,321,000 Increase in accounts receivable, net (4,554,000) Increase in inventories (979,000) Decrease in prepaids and other current assets 1,581,000 Increase in net assets of discontinued operations (7,426,000) Increase in accounts payable 12,532,000 Increase in accrued expenses and taxes 10,084,000 Investing Activities--- Net cash paid for businesses acquired (324,702,000) Proceeds from Businesses sold or discontinued 111,738,000 Purchase of marketable securities, net (84,439,000) Increase in restricted cash and investments (7,463,000) Capital expenditures (40,863,000) Financing Activities--- Sale of the 8 7/8% Notes 203,492,000 Net proceeds from the Common Stock Offering 64,190,000 Payment of borrowings and purchase of Notes, net (49,199,000) Purchase of Nortek Common and Special Common Stock (7,668,000) Other, net (6,611,000) ------------- $(37,966,000) ============= The impact of changes in foreign currency exchange rates on cash was not material and has been included in other, net.
The Company's debt-to-equity ratio decreased from approximately 6.7:1 at December 31, 1997 to 4.7:1 at December 31, 1998, primarily as a result of the increase in equity due to the Common Stock Offering, net earnings for 1998 and the payment of borrowings, partially offset by the effect of the sale of the 8 7/8% Notes. (See the Consolidated Statement of Stockholders' Investment for the year ended December 31, 1998 and Notes 5 and 6 of the Notes to the Consolidated Financial Statements included elsewhere herein.) 36 NORTEK, INC. AND SUBSIDIARIES At December 31, 1998, the Company had approximately $27,300,000 of net U.S. federal prepaid income tax assets which are expected to be realized through future operating earnings. Inflation, Trends and General Considerations The Company has evaluated and expects to continue to evaluate possible acquisition transactions and the possible dispositions of certain of its businesses on an ongoing basis and at any given time may be engaged in discussions or negotiations with respect to possible acquisitions or dispositions. The Company's performance is dependent to a significant extent upon the levels of new residential construction, residential replacement and remodeling and non-residential construction, all of which are affected by such factors as interest rates, inflation and unemployment. In the near term, the Company expects to operate in an environment of relatively stable levels of construction and remodeling activity. However, increases in interest rates could have a negative impact on the level of housing construction and remodeling activity. The demand for the Company's products is seasonal, particularly in the Northeast and Midwest regions of the United States 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. The Company's lower sales levels usually occur during the first and fourth quarters. Since a high percentage of the Company's manufacturing overhead and operating expenses are relatively fixed throughout the year, operating income and net earnings tend to be lower in quarters with lower sales levels. The Ply Gem businesses, acquired in August 1997 and Napco, acquired in October 1998, have in the past been more seasonal in nature than the Company's businesses owned prior to these acquisitions. In addition, the demand for cash to fund the working capital of the Company's subsidiaries is greater from late in the first quarter until early in the fourth quarter. Market Risk As discussed more specifically below, the Company is exposed to market risks related to changes in interest rates, foreign currencies and commodity pricing. The Company uses derivative financial instruments on a limited basis to hedge economic exposures. The Company does not enter into derivative financial instruments or other financial instruments for trading purposes. 37 NORTEK, INC. AND SUBSIDIARIES A. Interest Rate Risk The Company is exposed to market risk from changes in interest rates primarily through its investing and borrowing activities. In addition, the Company's ability to finance future acquisition transactions may be impacted if the Company is unable to obtain appropriate financing at acceptable interest rates. The Company's investing strategy, to manage interest rate exposure, is to invest in short-term, highly liquid investments and marketable securities. Short-term investments primarily consist of money market accounts and corporate commercial paper with original maturities of 90 days or less. At December 31, 1998, the fair value of the Company's short-term investments approximated market value. Marketable securities primarily consist of certificates of deposit and bank issued money market instruments, all with original maturities of between 91 and 183 days. Restricted investments and marketable securities primarily consist of money market accounts and commercial paper with original maturities of 90 days or less. At December 31, 1998, the fair value of the Company's unrestricted and restricted investments and marketable securities approximated market value. The Company manages its borrowing exposure to changes in interest rates by optimizing the use of fixed rate debt with extended maturities. In addition, as of December 31, 1998, the Company hedged its exposure on a substantial portion of its variable rate debt by entering into interest rate swap agreements to lock in a fixed rate. At December 31, 1998, approximately 98% of the carrying values of the Company's long-term debt were either at fixed interest rates or covered by interest rate swap agreements that fixed the interest rates. See table D (Long-term Debt) and Notes 1 and 5 of the Notes to the Consolidated Financial Statements included elsewhere herein for further disclosure of the terms of the Company's debt and interest rate swap agreements. B. Foreign Currency Risk The Company's results of operations are affected by fluctuations in the value of the U.S. dollar as compared to the value of currencies in foreign markets primarily related to changes in the Italian Lira and the Canadian Dollar. In 1998, the net impact of foreign currency changes was not material to the Company's financial condition or results of operations. The Company manages its exposure to foreign currency exchange risk principally by trying to minimize the Company's net investment 38 NORTEK, INC. AND SUBSIDIARIES in foreign assets through the use of strategic short and long-term borrowings at the foreign subsidiary level. Consistent with this strategy, notes payable and other short-term obligations at December 31, 1998 consist entirely of short-term borrowings by certain of the Company's foreign subsidiaries. At December 31, 1998, the Company's net investment in foreign assets was approximately $60,000,000. An overall unfavorable change in foreign exchange rates of 10% would result in an approximate $6,000,000 reduction in equity as a result of the impact on the cumulative translation adjustment. The Company generally does not enter into derivative financial instruments to manage foreign currency exposure. At December 31, 1998, the notional amounts of outstanding foreign currency hedging contracts, all of which expire in 1999, were not material. The Company does not expect the settlement of such contracts to have a material impact on financial condition or results of operations in fiscal 1999. The Company's operations in Europe are not significant and, therefore, the Company does not expect to be materially impacted by the introduction of a European single currency, the Euro. C. Commodity Pricing Risk The Company is subject to significant market risk with respect to the pricing of its principal raw materials, which include, among others, steel, copper, packaging material, plastics, resins, glass, wood and aluminum. 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 manages its exposure to commodity pricing risk by continuing to diversify its product mix, strategic buying programs and vendor partnering. The Company generally does not enter into derivative financial instruments to manage commodity-pricing exposure. At December 31, 1998, the Company did not have any outstanding commodity forward contracts. D. Long-term Debt The table that follows sets forth as of December 31, 1998, the Company's long-term debt obligations, principal cash flows by scheduled maturity, weighted average interest rates and estimated fair market values. Approximately 1.2% of the Company's total indebtedness is denominated in foreign currencies. The weighted average interest rates for variable rate debt are based on December 31, 1998 interest rates. In addition, the table that follows sets forth the outstanding notional amounts by year and weighted average interest rates of 39 NORTEK, INC. AND SUBSIDIARIES the Company's interest rate swap agreements. Long-term Debt:
Scheduled Maturity Average Interest Rate Fixed Variable Fixed Variable Year Ending Rate Rate Total Rate Rate Total (Amounts in thousands) December 31, 1999 $ 5,399 $ 1,377 $ 6,776 7.16% 7.26% 7.18% 2000 3,520 1,367 4,887 7.77 7.26 7.63 2001 2,284 1,368 3,652 7.21 7.26 7.23 2002 1,721 80,387 82,108 6.72 6.86 6.86 2003 1,592 24 1,616 6.65 7.75 6.67 Thereafter (1) 914,821 4,977 919,798 9.19 4.46 9.17 --------- ------- ----------- ----- ----- ----- Total Principal $929,337 $89,500 $1,018,837 9.16% 6.74% 8.95% Unamortized Debt Discount (4,948) --- (4,948) --------- ------- ----------- Total Long-term Debt at December 31, 1998 $924,389 $89,500 $1,013,889 ========= ======= =========== Fair Market Value of Long-term Debt at December 31, 1998 $959,631 $89,500 $1,049,131 ========= ======= ===========
Interest Rate Swaps:
Average Fixed Variable Notional Pay Receive Year Ending Amount Rate Rate (Amounts in thousands) Outstanding at December 31, 1999 $40,000 5.76% (2) 2000 40,000 5.76 (2) 2001 40,000 5.76 (2) 2002 40,000 5.76 (2) Fair Market Value of the liability related to Interest Rate Swaps at December 31, 1998 $1,600 (1) Senior and senior subordinated notes with a total principal of $899,822,000 and a weighted average interest rate of 9.26% mature at various times from 2004 through 2008. (2) The interest rate swap variable receive rate for all periods is the one month LIBOR rate.
40 NORTEK, INC. AND SUBSIDIARIES Year 2000 Disclosure The Year 2000 ("Y2K") issue refers to and arises from deficient computer programs and related products, such as embedded chips, which do not properly distinguish between a year that begins with "20" instead of "19" beginning on January 1, 2000. If not corrected, many businesses and other processes could fail or create erroneous results. The extent of the potential impact of the Y2K problem is not yet known, and if not timely corrected, it could affect the global economy. As required by recent guidance from the SEC applicable to all public companies, the following disclosure provides more detail regarding the Company's Y2K compliance than previous reports filed by the Company. A. The Company's Readiness: To manage its Y2K program, the Company established a corporate-wide initiative and has divided its efforts into five areas: awareness (communication to employees, vendors and suppliers of the Y2K issue), assessment (a complete inventory of all aspects of the business that might be affected), remediation/validation (develop plans to correct all issues identified from the assessment stage), implementation (corrective measures taken to solve the Y2K issues identified) and contingency (alternative actions developed in the event that all corrective measures are not implemented by Y2K). Further, the Company has identified three key areas of concentration: information technology systems, non-IT systems and third parties (suppliers and customers). The Company's subsidiaries are in various stages of completion of this readiness, including the assessment, remediation and implementation stages, for the Y2K issue. Certain of the Company's subsidiaries are simultaneously working on the assessment, remediation and implementation stages of this initiative. During the second and third fiscal quarters of 1999, the Company's subsidiaries expect to make significant progress in the remediation and implementation stages. Overall the Company believes that it is in the remediation stage of addressing the Y2K issue and expects by the end of the second fiscal quarter of 1999 to provide a more definitive assessment of the status of each stage. Although the Company believes that all modifications to information technology ("IT") and non-IT systems, material to the Company's business, will be Y2K compliant on or before December 31, 1999, it cannot predict the outcome or the success of its Y2K program, or that third party systems are or will be Y2K compliant, or that the costs required to address the Y2K initiative, or that the impact of a failure to achieve substantial Y2K compliance, will not have a material adverse effect on the Company's business, financial condition or results of operations. 41 NORTEK, INC. AND SUBSIDIARIES 1. Information Technology (IT) systems: The Company is conducting a comprehensive review of its computer systems to identify those that could be affected by the Y2K issue. The Company's operating systems and database systems are not all Y2K compliant. The Company presently believes that with minor modifications (conversion and testing in progress) to existing software and replacement of others, the Y2K problem will not pose significant operational problems for the Company's computer systems as so modified. 2. Non-IT systems: Non-IT systems are those that typically include "embedded" technology such as microcontrollers and chips. The Company is in the process of evaluating the effect of the Y2K problem on all non-IT systems including all telecommunications equipment, shop-floor controls, alarm systems and any other equipment that can potentially use microcontrollers, chips or other systems affected by the Y2K problem. 3. Third parties: Due to the pervasive use of computers by the Company in its dealings with suppliers, customers, financial institutions, and other third parties, the Y2K problem could have a material impact on the Company if not timely addressed by such third parties. To assess third party readiness, the Company is surveying its principal suppliers and financial institutions and receiving responses that indicate that such parties are in the process of adequately addressing the problem. In cases where key suppliers have not responded or are not adequately addressing the issue, the Company will determine what contingency plans will be necessary to protect the Company's interests. While the Company has not surveyed all its customers, it has received surveys from many of its principal customers that indicate that they are also addressing the problem. The Company operates in a decentralized environment and major computer systems are, therefore, in various states of readiness. The Company has nineteen businesses with various IT systems that support 100% of the Company's net sales for 1998 after excluding net sales of Businesses sold in 1998. The Company estimates that the remediation effort for IT systems Y2K issues of eight business units representing approximately 36% of net sales for 1998 are approximately 80-95% complete. The Company estimates 42 NORTEK, INC. AND SUBSIDIARIES that the remediation effort for the IT systems Y2K issues of seven business units representing approximately 43% of net sales for 1998 are approximately 60-75% complete. The Company estimates that the remediation effort for the IT systems Y2K issues of four business units representing approximately 21% of net sales for 1998 is approximately 30-50% complete. Substantially all of the non-IT systems, including telephone systems and office equipment, have been tested. Those found not to be Y2K compliant are in the process of being replaced or repaired. Machinery and equipment testing and remediation are in process and the Company estimates this phase to be approximately 30% complete overall. B. Cost: The Company's estimate for remediation directly related to fixing Y2K issues is approximately $6,500,000. The total estimated expenditures of approximately $6,500,000 consist of approximately $2,000,000 of IT computer hardware equipment costs, approximately $3,500,000 of IT software and non-IT computer hardware expenditures and approximately $1,000,000 of other non-IT expenditures. The Company has spent approximately $2,200,000 through December 31, 1998. All of the Company's Y2K compliance expenditures have been or are expected to be funded from the Company's operating cash flow. The Company's Y2K compliance budget does not include significant amounts for hardware replacement because the Company has historically employed a strategy to continually upgrade its computer systems. Consequently, the Company's Y2K compliance budget has not required the diversion of funds from or the postponement of the implementation of other planned IT projects. Actual costs to be incurred by the Company will depend on a number of factors which cannot be accurately predicted and may therefore deviate from the estimates above including, among others, the extent and difficulty of the remaining remediation and other work to be done, the availability and cost of consultants, and the extent of testing required to demonstrate Y2K compliance. C. Risks: Based on current information, the Company believes that the Y2K problem will not have a material adverse effect on the Company, its business or its financial condition. There can, however, be no assurances that Y2K remediation by the Company or third parties will be properly and timely completed, and failure to do 43 NORTEK, INC. AND SUBSIDIARIES so could have a material adverse effect on the Company, its business and its financial condition. The Company believes that the greatest risk presented by the Y2K problem is from third parties, such as suppliers, financial institutions, utility providers and customers, among others, who may not have adequately addressed the problem. A failure of any such third party's computer or other applicable systems in sufficient magnitude could materially and adversely affect the Company. The Company is not presently able to quantify this risk. The Company is unable to assess a reasonable worst case Y2K scenario given a number of factors outside of the Company's direct or indirect control, including, among others, the Company's current remediation status and the uncertainty of the readiness of vendors and customers. The Company recognizes the risks in its ability to conduct business if other key suppliers in utilities, communications, transportation, banking and government, both domestic (local, state and federal) and foreign, are not Y2K ready. The Company is in the process of surveying vendors and customers about their readiness. Upon completion of this survey, the Company will complete its own internal review of this information to verify the accuracy of the responses. The Company is monitoring news and progress reports pertaining to those critical services to determine the effect on the Company's ability to conduct business as a result of Y2K issues on the economy if those and other key suppliers in utilities, communications, transportation, banking and government, both domestic (local, state and federal) and foreign, cease to function. Once the Company has completed its remediation phase of the Y2K issue, the Company will develop appropriate worst-case scenarios and plans to deal with such contingencies while it develops its contingency plans which are expected to be completed in mid 1999. D. Contingency Plans: The Company is in the process of preparing appropriate contingency plans in the event that a significant internal or external exposure is identified. While the Company is not presently aware of any such significant exposure, there can be no guarantee that the systems of third parties on which the Company relies will be converted in a timely manner, or that a failure to properly convert by another company would not have a material adverse effect on the Company. The Company's contingency plans for IT systems have not been completely developed, but are expected to be complete by mid 1999. The Company expects to complete the preparation of its contingency plans once it evaluates its status after it has 44 NORTEK, INC. AND SUBSIDIARIES completed the remediation phase of the Y2K project for IT systems. In planning for issues not resolved or contemplated for IT systems, the Company plans to allocate internal resources and may retain dedicated consultants and vendor representatives to be available to take corrective action, if necessary. However, the Company will adjust and adopt additional plans if situations arise requiring modifications to existing contingency plans or new contingency plans, as required. The Company's contingency plans for non-IT systems have also not been completed. The Company's subsidiaries do, however, have various business interruption contingency plans in place. These plans are in the process of being evaluated for Y2K scenarios and will be adjusted as appropriate. The Company will develop, if necessary, appropriate contingency plans by mid 1999 upon completion of its remediation efforts in this area. Forward-Looking Statements This document contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this discussion and throughout this document, words such as "intends," "plans," "estimates," "believes," "anticipates" and "expects" or similar expressions are intended to identify forward-looking statements. These statements are based on the Company's current plans and expectations and involve risks and uncertainties, over which the Company has no control, that could cause actual future activities and results of operations to be materially different from those set forth in the forward-looking statements. Important factors that could cause actual future activities and operating results to differ include the availability and cost of certain raw materials costs, (including, among others, steel, copper, packaging materials, plastics, resins, glass, wood and aluminum) and purchased components, the level of domestic and foreign construction and remodeling activity affecting residential and commercial markets, interest rates, employment, inflation, Y2K readiness, currency translation, consumer spending levels, operating in international economies, the rate of sales growth, price, and product and warranty liability claims. Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by these cautionary statements. Readers are also urged to carefully review and consider the various disclosures made by the Company, in this 45 NORTEK, INC. AND SUBSIDIARIES document, as well as the Company's periodic reports on Forms 10-K, 10-Q and 8-K, filed with the Securities and Exchange Commission ("SEC"). ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Quantitative and qualitative disclosure about market risk required by this Item 7A is set forth in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Market Risk. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Financial statements and supplementary data required by this Item 8 are set forth at the pages indicated in item 14(a) included elsewhere herein. ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT See Election of Directors in the definitive Proxy Statement for the Company's 1999 Annual Meeting of Stockholders, incorporated herein by reference. See also Part I, Item 1, Business-General Considerations-Executive Officers of the Registrant. ITEM 11. EXECUTIVE COMPENSATION See Executive Compensation in the definitive Proxy Statement for the Company's 1999 Annual Meeting of Stockholders, incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT See Security Ownership of Certain Beneficial Owners and Management in the definitive Proxy Statement for the Company's 1999 Annual Meeting of Stockholders, incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS See Election of Directors in the definitive Proxy Statement for the Company's 1999 Annual Meeting of Stockholders, incorporated herein by reference. 46 NORTEK, INC. AND SUBSIDIARIES PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Financial Statements and Schedules The following documents are filed as part of this report: 1. Financial Statements: Page No. Consolidated Statement of Operations for the three years ended December 31, 1998 49 Consolidated Balance Sheet as of December 31, 1998 and 1997 50 Consolidated Statement of Cash Flows for the three years ended December 31, 1998 52 Consolidated Statement of Stockholders' Investment for the three years ended December 31, 1998 54 Notes to Consolidated Financial Statements 57 Report of Independent Public Accountants 90 2. Financial Statement Schedules: Schedule I Condensed Financial Information of Registrant 91 Schedule II Valuation and Qualifying Accounts 97 3. The exhibits are listed in the Exhibit Index, which is incorporated herein by reference. (b) Reports on Form 8-K No reports on Form 8-K were filed by the Registrant during the last quarter of the period covered by this report. 47 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 29, 1999. NORTEK, INC. By: /s/Richard L. Bready -------------------------- Richard L. Bready Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated, as of March 29, 1999. /s/Richard L. Bready /s/J. Peter Lyons - ------------------------------------------------------------------------------- Richard L. Bready, Chairman J. Peter Lyons, Director of the Board and President (principal executive officer) /s/Richard J. Harris /s/William I. Kelly - ------------------------------------------------------------------------------- Richard J. Harris, Vice President William I. Kelly, Director and Treasurer (principal financial officer) and Director /s/Almon C. Hall /s/Phillip L. Cohen - ------------------------------------------------------------------------------- Almon C. Hall, Vice President Phillip L. Cohen, Director and Controller (principal accounting officer) 48 Nortek, Inc. and Subsidiaries Consolidated Statement of Operations
For the Years Ended December 31, 1998 1997 1996 (In thousands except per share amounts) Net Sales $1,738,343 $1,134,129 $841,557 ---------- ---------- -------- Costs and Expenses: Cost of products sold 1,275,350 825,805 596,847 Selling, general and administrative expense 315,449 219,376 180,308 Amortization of goodwill and intangible assets 14,416 5,967 3,451 ---------- ---------- -------- 1,605,215 1,051,148 780,606 ---------- ---------- -------- Operating earnings 133,128 82,981 60,951 Gain on Businesses sold 4,000 --- --- Interest expense (86,298) (50,210) (28,400) Investment income 10,470 9,929 6,049 ---------- ---------- -------- Earnings from continuing operations before provision for income taxes 61,300 42,700 38,600 Provision for income taxes 27,300 16,300 14,900 ---------- ---------- -------- Earnings from continuing operations before extraordinary loss 34,000 26,400 23,700 Earnings (loss) from discontinued operations 1,200 (5,200) (1,700) Extraordinary loss from debt retirements (200) --- --- --------- ---------- -------- Net Earnings $ 35,000 $ 21,200 $ 22,000 ========= ========== ======== Earnings (loss) Per Share: Earnings from continuing operations: Basic $3.11 $2.75 $2.26 Diluted $3.06 $2.68 $2.23 Earnings (loss) from discontinued operations: Basic $ .11 $(.54) $(.16) Diluted $ .11 $(.53) $(.16) Extraordinary loss from debt retirements: Basic $(.02) --- --- Diluted $(.02) --- --- Net Earnings: Basic $3.20 $2.21 $2.10 Diluted $3.15 $2.15 $2.07 Weighted Average Number of Shares: Basic 10,923 9,605 10,485 Diluted 11,113 9,855 10,641 The accompanying notes are an integral part of these consolidated financial statements.
49 Nortek, Inc. and Subsidiaries Consolidated Balance Sheet
December 31, 1998 1997