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PGEM > SEC Filings for PGEM > Form 10-K on 14-Mar-2014All Recent SEC Filings

Show all filings for PLY GEM HOLDINGS INC

Form 10-K for PLY GEM HOLDINGS INC


14-Mar-2014

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations is intended to clarify the results of our operations, certain changes in our financial position, liquidity, capital structure and business developments for the periods covered by the consolidated financial statements included in this Annual Report on Form 10-K. This discussion should be read in conjunction with, and is qualified by reference to, the other related information including, but not limited to, the audited consolidated financial statements (including the notes thereto and the independent registered public accounting firm's reports thereon), and the description of our business, all as set forth in this Annual Report on Form 10-K, as well as the risk factors discussed below and in Item 1A.

Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" are "forward-looking statements." See "Cautionary Statement with Respect to Forward-Looking Statements" and "Risk Factors."

General

We are a leading manufacturer of exterior building products in North America, operating in two reportable segments: (i) Siding, Fencing, and Stone and
(ii) Windows and Doors, which comprised approximately 54% and 46% of our sales, respectively, for the fiscal year ended December 31, 2013. These two segments produce a comprehensive product line of vinyl siding, designer accents, cellular PVC trim, vinyl fencing, vinyl and composite railing, stone veneer and vinyl windows and doors used in both the new construction market and the home repair and remodeling market in the United States and Canada. Vinyl building products have the leading share of sales volume in siding and windows in the United States. We also manufacture vinyl and aluminum soffit and siding accessories, aluminum trim coil, wood windows, aluminum windows, vinyl and aluminum-clad windows and steel and fiberglass doors, enabling us to bundle complementary and color-matched products and accessories with our core products. We believe that our comprehensive product portfolio and geographically diverse, low cost manufacturing platform allow us to better serve our customers and provide us with a competitive advantage over other exterior building products suppliers.

Ply Gem Holdings was incorporated on January 23, 2004 by affiliates of CI Capital Partners for the purpose of acquiring Ply Gem Industries from Nortek. The Ply Gem acquisition was completed on February 12, 2004. Prior to the Ply Gem acquisition, our business was known as the Windows, Doors and Siding division of Nortek, where the business operated as a holding company with a broad set of brands. Since the Ply Gem acquisition, we have acquired eight additional businesses to complement and expand our product portfolio and geographical diversity. Gary E. Robinette, our President and Chief Executive Officer, joined Ply Gem in October 2006, and has employed the strategy of transitioning Ply Gem to an integrated and consolidated business model under the Ply Gem brand.

The following is a summary of Ply Gem's acquisition history:

On August 27, 2004, Ply Gem acquired MWM Holding, a manufacturer of vinyl, wood, wood-clad, composite, impact and aluminum windows, for a purchase price, net of cash acquired of $330.9 million.

On February 24, 2006, Ply Gem acquired Alenco, a manufacturer of aluminum and vinyl windows products, for a purchase price, net of cash acquired of $126.8 million. This acquisition supported our national window strategy. Alenco is part of our Windows and Doors segment and operates under common leadership with our other U.S. window businesses.

On October 31, 2006, Ply Gem completed the acquisition of MHE, a leading manufacturer of vinyl siding, aluminum siding, injection molded shutters and vinyl, aluminum and injection molded accessories, for a purchase price, net of cash acquired of $295.9 million. MHE became part of our Siding, Fencing, and Stone segment and operates under common leadership with our existing siding business.

On September 30, 2007, Ply Gem completed the acquisition of CertainTeed Corporation's vinyl window and patio door business, which we have named Ply Gem Pacific Windows, a leading manufacturer of premium vinyl windows and patio doors, for a purchase price, net of cash acquired, of $36.6 million. Pacific Windows is part of our Windows and Doors segment and operates under common leadership with our U.S. windows business.


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On October 31, 2008, Ply Gem acquired substantially all of the assets of Ply Gem Stone (formerly United Stone Veneer), a manufacturer of stone veneer products, for a purchase price, net of cash acquired of $3.6 million.

On July 30, 2012, Ply Gem acquired substantially all of the assets of Greendeck Products, LLC, a composite products development company, for a purchase price of approximately $1.0 million, subject to certain purchase price adjustments.

On April 9, 2013, Ply Gem acquired all of the capital stock of Gienow WinDoor Ltd. (which was amalgamated into Gienow Canada Inc.) ("Gienow"), a manufacturer of windows and doors in Western Canada, for a purchase price, net of cash acquired, of $20.4 million. Gienow is part of our Western Canadian windows business and is part of the Windows and Doors segment.

On May 31, 2013, Ply Gem acquired all of the capital stock of Mitten Inc. ("Mitten"), a manufacturer of vinyl siding and distributor of various other exterior building products in Canada, for a purchase price, net of cash acquired, of $76.8 million. The majority of Mitten's operations are part of the Siding, Fencing and Stone segment.

Prior to January 11, 2010, Ply Gem Holdings was a wholly owned subsidiary of Ply Gem Investment Holdings, which was a wholly owned subsidiary of Ply Gem Prime. On January 11, 2010, Ply Gem Investment Holdings was merged with and into Ply Gem Prime, with Ply Gem Prime being the surviving corporation. In May 2013, the Company issued 18,157,895 shares of common stock at an initial public offering price of $21.00 per share and received gross proceeds of approximately $381.3 million in an IPO of its common stock. The shares began trading on The New York Stock Exchange on May 23, 2013 under the symbol "PGEM". Immediately prior to the closing of the IPO, Ply Gem Prime merged with and into Ply Gem Holdings, with Ply Gem Holdings being the surviving entity. In the merger, all of the preferred stock of Ply Gem Prime (including the subordinated debt of Ply Gem Prime that was converted into preferred stock in connection with the IPO) was converted into a number of shares of the Company's common stock based on the IPO price of the common stock and the liquidation value of and the maximum dividend amount in respect of the preferred stock.

We are a holding company with no operations or assets of our own other than the capital stock of our subsidiaries. The terms of Ply Gem Industries' $250.0 million ABL Facility and the credit agreement governing the terms of its $430.0 million Term Loan Facility place restrictions on the ability of Ply Gem Industries and our other subsidiaries to pay dividends and otherwise transfer assets to us. Further, the terms of the indenture governing Ply Gem Industries' $500.0 million 6.50% Senior Notes place restrictions on the ability of Ply Gem Industries and our other subsidiaries to pay dividends and otherwise transfer assets to us.

Financial statement presentation

Net sales. Net sales represent the fixed selling price of our products plus certain shipping charges less applicable provisions for discounts and allowances. Allowances include cash discounts, volume rebates and returns among others.

Cost of products sold. Cost of products sold includes direct material and manufacturing costs, manufacturing depreciation, third-party and in-house delivery costs and product warranty expense.

Selling, general and administrative expense. Selling, general and administrative expense ("SG&A expense") includes all non-product related operating expenses, including selling, marketing, research and development costs, information technology, restructuring, and other general and administrative expenses.

Operating earnings (loss). Operating earnings (loss) represents net sales less cost of products sold, SG&A expense, amortization of intangible assets, and initial public offering costs.


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Impact of commodity pricing

PVC resin and aluminum are major components in the production of our products and changes in PVC resin and aluminum prices have a direct impact on our cost of products sold. Historically, we have been able to pass on a substantial portion of significant price increases to our customers. The results of operations for individual quarters can be negatively impacted by a delay between the time of raw material cost increases and price increases that we implement in our products, or conversely can be positively impacted by a delay between the time of a raw material price decrease and competitive pricing moves that we implement accordingly.

Impact of weather

Since our building products are intended for exterior use, our sales and operating earnings tend to be lower during periods of inclement weather. Weather conditions in the first and fourth quarters of each calendar year historically result in these quarters producing significantly less sales revenue than in any other period of the year. As a result, we have historically had lower profits or higher losses in the first quarter of each calendar year, and reduced profits in the fourth quarter of each calendar year due to the weather. Our results of operations for individual quarters in the future may be impacted by adverse weather conditions. In addition, favorable or unfavorable weather conditions may influence the comparability of our results from year to year or from quarter to quarter.

Critical accounting policies

The following discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. Certain of our accounting policies require the application of judgments in selecting the appropriate assumptions for calculating financial estimates. By their nature, these judgments are subject to an inherent degree of uncertainty. We periodically evaluate the judgments and estimates used for our critical accounting policies to ensure that such judgments and estimates are reasonable for our interim and year-end reporting requirements. These judgments and estimates are based upon our historical experience, current trends and information available from other sources, as appropriate. If different conditions result compared to our assumptions and judgments, the results could be materially different from our estimates. Management also believes that the nine areas where different assumptions could result in materially different reported results are (1) goodwill and intangible asset impairment tests, (2) accounts receivable related to estimation of allowances for doubtful accounts,
(3) inventories in estimating reserves for obsolete and excess inventory, (4) warranty reserves, (5) insurance reserves, (6) income taxes including the tax receivable agreement, (7) rebates, (8) pensions, and (9) environmental accruals and other contingencies. Although we believe the likelihood of a material difference in these areas is low based upon our historical experience, a 10% change in our allowance for doubtful accounts, inventory reserve estimates, and warranty reserve at December 31, 2013 would result in an approximate $0.4 million, $0.9 million, and $4.2 million impact on expenses, respectively. Additionally, we have included in the discussion that follows our estimation methodology for both accounts receivable and inventories. While all significant policies are important to our consolidated financial statements, some of these policies may be viewed as being critical. Our critical accounting policies include:

Revenue Recognition. We recognize sales based upon shipment of products to our customers net of applicable provisions for discounts and allowances. Generally, the customer takes title upon shipment and assumes the risks and rewards of ownership of the product. For certain products, it is industry standard that customers take title to products upon delivery, at which time revenue is then recognized by the Company. Revenue includes the selling price of the product and all shipping costs paid by the customer. Revenue is reduced at the time of sale for estimated sales returns and all applicable allowances and discounts based on historical experience. We also provide for estimates of warranty, bad debts, shipping costs and certain sales-related customer programs at the time of sale. Shipping and warranty costs are included in cost of products sold. Bad debt expense and sales-related marketing programs are included in SG&A expense. We believe that our procedures for estimating such amounts are reasonable and historically have not resulted in material adjustments in subsequent periods when the estimates are reconciled to the actual amounts.

Accounts Receivable. We maintain an allowance for doubtful accounts for estimated losses from the inability of our customers to make required payments, which is provided for in bad debt expense. We determine the adequacy of this allowance by regularly reviewing our accounts receivable aging and evaluating individual customers' receivables, considering customers' financial condition, credit history and other current economic conditions. If a customer's financial condition was to deteriorate, which might impact its ability to make payment, then additional allowances may be required.


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Inventories. Inventories in the accompanying consolidated balance sheets are valued at the lower of cost or market. We record provisions, as appropriate, to write-down obsolete and excess inventory to estimated net realizable value. The process for evaluating obsolete and excess inventory often requires subjective judgments and estimates concerning future sales levels, quantities and prices at which such inventory will be sold in the normal course of business. Accelerating the disposal process or incorrect estimates of future sales potential may cause actual results to differ from the estimates at the time such inventory is disposed or sold.

Goodwill Impairment. We perform an annual test for goodwill impairment during the fourth quarter of each year (November 23rd for 2013) and also at any other date when events or changes in circumstances indicate that the carrying value of these assets may exceed their fair value. We use the two-step method to determine goodwill impairment. If the carrying amount of a reporting unit exceeds its fair value (Step One Analysis), we measure the possible goodwill impairment based upon a hypothetical allocation of the fair value estimate of the reporting unit to all of the underlying assets and liabilities of the reporting unit, including previously unrecognized intangible assets (Step Two Analysis). The excess of the reporting unit's fair value over the amounts assigned to its assets and liabilities is the implied fair value of goodwill. An impairment loss is recognized to the extent that a reporting unit's recorded goodwill exceeds the implied fair value of goodwill.

To evaluate goodwill impairment, we estimate the fair value of reporting units considering such factors as discounted cash flows and valuation multiples for comparable publicly traded companies. A significant reduction in projected sales and earnings which would lead to a reduction in future cash flows could indicate potential impairment.

A summary of the key assumptions utilized in the goodwill impairment analysis at November 23, 2013, November 24, 2012, and November 26, 2011, as it relates to the Step One fair values and the sensitivities for these assumptions follows:

                                                              Windows and Doors
                                                As of               As of               As of
                                            November 23,        November 24,        November 26,
                                                2013                2012                2011
Assumptions:
Income approach:
Estimated housing starts in terminal
year                                            1,100,000           1,050,000           1,050,000
Terminal growth rate                                  3.5 %               3.5 %               3.5 %
Discount rates                                       20.0 %              18.0 %              20.0 %

Market approach:
Control premiums                                      5.0 %              20.0 %              20.0 %

Sensitivities:
(Amounts in thousands)
Estimated fair value decrease in the
event of a
1% decrease in the terminal year growth   $         4,500     $         8,000     $         7,768
Estimated fair value decrease in the
event of a
1% increase in the discount rate                   17,000              22,000              16,170
Estimated fair value decrease in the
event of a
1% decrease in the control premium                  3,000               3,000               2,143


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                                                        Siding, Fencing, and Stone
                                               As of              As of              As of
                                            November 23,       November 24,       November 26,
                                                2013               2012               2011
Assumptions:
Income approach:
Estimated housing starts in terminal
year                                           1,100,000          1,050,000          1,050,000
Terminal growth rate                                 3.0 %              3.0 %              3.0 %
Discount rates                                      11.5 %             13.0 %             17.0 %

Market approach:
Control premiums                                    10.0 %             10.0 %             10.0 %

Sensitivities:
(Amounts in thousands)
Estimated fair value decrease in the
event of a
1% decrease in the terminal year growth   $       89,000     $       62,000     $       32,974
Estimated fair value decrease in the
event of a
1% increase in the discount rate                 161,000            135,000             64,112
Estimated fair value decrease in the
event of a
1% decrease in the control premium                16,000             14,000              8,930

(Amounts in thousands)                           As of                  As of                As of
                                             November 23,            November 24,         November 26,
                                                 2013                    2012                 2011
Estimated Windows and Doors reporting
unit fair value increase in the event
of a 10% increase in the weighting of
the market multiples method              $                 -     $                -     $        4,000
Estimated Siding, Fencing, and Stone
reporting unit fair value increase in
the event of a 10% increase in the
weighting of the market multiples
method                                                20,000                 30,000             10,300

We provide no assurance that: (1) valuation multiples will not decline, (2) discount rates will not increase, or (3) the earnings, book values or projected earnings and cash flows of our reporting units will not decline. We will continue to analyze changes to these assumptions in future periods. We will continue to evaluate goodwill during future periods and further declines in the residential housing and remodeling markets could result in future goodwill impairments.


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Income Taxes. We utilize the asset and liability method in accounting for income taxes, which requires that the deferred tax consequences of temporary differences between the amounts recorded in our consolidated financial statements and the amounts included in our federal and state income tax returns be recognized in the consolidated balance sheet. The amount recorded in our consolidated financial statements reflects estimates of final amounts due to timing of completion and filing of actual income tax returns. Estimates are required with respect to, among other things, the appropriate state income tax rates used in the various states in which we and our subsidiaries are required to file, the potential utilization of operating and capital loss carry-forwards for both federal and state income tax purposes and valuation allowances required, if any, for tax assets that may not be realized in the future. We establish reserves when, despite our belief that our tax return positions are fully supportable, certain positions could be challenged, and the positions may not be fully sustained. We have executed a tax sharing agreement with Ply Gem Holdings and Ply Gem Investment Holdings (during 2010, Ply Gem Investment Holdings was merged with and into Ply Gem Prime, with Ply Gem Prime being the surviving corporation) pursuant to which tax liabilities for each respective party are computed on a stand-alone basis. The tax sharing agreement was amended in 2013 to reflect the merger of Ply Gem Prime Holdings with and into Ply Gem Holdings. Our U.S. subsidiaries file unitary, combined federal income tax returns and separate state income tax returns. Ply Gem Canada, Gienow, and Mitten file separate Canadian income tax returns.

At December 31, 2012, we were in a full federal valuation allowance position as we were no longer in a net deferred liability tax position and continued to incur losses for income tax purposes. Additionally, at December 31, 2012, we were in a full state valuation allowance position for certain legal entities primarily related to losses for income tax purposes. At December 31, 2013, we remained in a full federal valuation allowance position and a full state valuation allowance position as we continued to incur cumulative losses for income tax purposes. As of December 31, 2013 and 2012, we did not have a valuation allowance for our foreign operations. Refer to Note 11 to the consolidated financial statements for additional information regarding income taxes.

Results of Operations

The following table summarizes net sales and net income (loss) by segment and is derived from the accompanying consolidated statements of operations included in this report.

                                      Year ended December 31,
(Amounts in thousands)           2013          2012          2011
Net Sales
 Siding, Fencing, and Stone   $ 737,841     $ 658,045     $ 639,290
 Windows and Doors              627,740       463,256       395,567
Operating earnings (loss)
 Siding, Fencing, and Stone     111,918       110,456        90,849
 Windows and Doors              (38,537 )     (20,565 )     (31,134 )
 Unallocated                    (45,605 )     (19,871 )     (14,784 )
Foreign currency gain
 Siding, Fencing, and Stone        (217 )           -             -
 Windows and Doors               (1,316 )         409           492
Interest expense, net
 Siding, Fencing, and Stone         132            47            83
 Windows and Doors                  195            18            13
 Unallocated                    (92,011 )    (103,107 )    (101,480 )
Income tax expense
 Unallocated                       (298 )      (2,835 )        (683 )
Loss on modification or
extinguishment of debt
 Unallocated                    (18,948 )      (3,607 )     (27,863 )

Net loss                      $ (79,520 )   $ (39,055 )   $ (84,507 )


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The following tables set forth our results of operations based on the amounts and the percentage relationship of the items listed to net sales for the periods indicated. However, our results of operations set forth in the tables below may not necessarily be representative of our future operating results.

This review of performance is organized by business segment, reflecting the way we manage our business. Each business group leader is responsible for operating results down to operating earnings (loss). We use operating earnings as a performance measure as it captures the income and expenses within the management control of our business leaders. Corporate management is responsible for making all financing decisions. Therefore, each segment discussion focuses on the factors affecting operating earnings, while interest expense and income taxes and certain other unallocated expenses are separately discussed at the corporate level.

Siding, Fencing, and Stone Segment

                                                    Year ended December 31,
(Amounts in
thousands)                        2013                        2012                       2011
Statement of
operations data:
Net sales               $ 737,841        100.0  %   $ 658,045        100.0 %   $ 639,290        100.0 %
Gross profit              197,626         26.8  %     180,244         27.4 %     158,798         24.8 %
SG&A expense               73,846         10.0  %      61,201          9.3 %      59,646          9.3 %
Amortization of
intangible assets          11,862          1.6  %       8,587          1.3 %       8,303          1.3 %
Operating earnings        111,918         15.2  %     110,456         16.8 %      90,849         14.2 %
Currency transaction
loss                         (217 )          -  %           -            - %           -            - %

Net Sales

Net sales for the year ended December 31, 2013 increased from the year ended December 31, 2012 by approximately $79.8 million or 12.1%. Net sales increased as a result of the Mitten acquisition, which was completed on May 31, 2013 and contributed net sales of approximately $79.4 million for the year ended December 31, 2013. Excluding the Mitten acquisition, our Siding, Fencing, and Stone net sales increased $0.4 million or 0.1% during the year ended December 31, 2013 compared to the year ended December 31, 2012. The modest increase in net sales resulted from higher sales volume related to the improving U.S. new construction housing market offset by lower unit volume shipments of our metal accessory products that primarily resulted from the loss of sales to a large retail home center and lower selling price of these products, which were reduced in response to lower market costs for aluminum raw materials. According to the London Metal Exchange, the price of aluminum decreased approximately 8.9% for the year ended December 31, 2013 as compared to the year ended December 31, 2012. The sales decrease of our metal accessory products of approximately $16.5 million was partially offset by a $9.6 million sales increase of our vinyl siding products and a $4.6 million sales increase of our injection molded products both excluding Mitten for the year ended December 31, 2013 as compared to the year ended December 31, 2012.

While new construction industry trends continue to be favorable with single family housing starts for the year ended December 31, 2013 estimated to increase 15.6% according to the National Association of Home Builders ("NAHB"), we . . .

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