10-K 1 pgem2017123110k.htm 10-K Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

[X]        Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2017
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:   001-35930

plygembplogoinlinespotwtag23.jpg 

PLY GEM HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware
 
20-0645710
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
5020 Weston Parkway, Suite 400, Cary, North Carolina
 
27513
(Address of principal executive offices)
 
(Zip Code)

Registrant's telephone number, including area code: 919-677-3900

Securities registered pursuant to Section 12(b) of the Act:  
Title of each class:
 
Name of each exchange on which registered:
Common Stock, par value $0.01 per share
 
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by checkmark if the registrant is a well–known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [  ]    No [X]

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes [  ]    No [X]

Indicate by check mark whether the 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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes [X]    No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) 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 [ ].

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer   [   ]    Accelerated filer  [X]    Non-accelerated filer     [   ]    Smaller reporting company   [   ]    Emerging growth company   [   ]                                                               
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [  ]  No [X]
The aggregate market value of the voting stock held by non-affiliates of the registrant, as of July 1, 2017, was approximately $407.5 million. Such aggregate market value was computed by reference to the closing price of the common stock as reported on the NYSE on July 1, 2017. For purposes of making this calculation only, the registrant has defined affiliates as including only directors and executive officers and shareholders holding greater than 10% of the voting stock of the registrant as of July 1, 2017.
The Company had 68,556,650 shares of common stock outstanding as of March 5, 2018.

Documents incorporated by reference:  The information required by Part III (Items 10, 11, 12, 13 and 14) of this form 10-K, to the extent not set forth herein, is incorporated herein by reference to the Registrant's definitive Proxy Statement for the 2018 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission no later than 120 days after December 31, 2017.

  




Form 10-K Annual Report
Table of Contents

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



CAUTIONARY STATEMENT WITH RESPECT TO FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions.  Actual events or results may differ materially.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements.  All written and oral forward-looking statements made in connection with this Annual Report on Form 10-K that are attributable to us or persons acting on our behalf are expressly qualified in their entirety by the "Risk Factors" and other cautionary statements included herein. We are under no duty to update any of the forward-looking statements after the date of this Annual Report on Form 10-K to conform such statements to actual results or to changes in our expectations, except as required by federal securities laws.

There can be no assurance that other factors will not affect the accuracy of these forward-looking statements or that our actual results will not differ materially from the results anticipated in such forward-looking statements. While it is impossible to identify all such factors, factors which could cause actual results to differ materially from those estimated by us include, but are not limited to, the following:
 
• disruptions in our business caused by the proposed acquisition of us by CD&R (as defined below);
    
• failure to complete the Merger (as defined below) in a timely manner or at all;
    
• downturns or negative trends in the home repair and remodeling or the new construction end markets, or the U.S. and Canadian economies or the availability of consumer credit;
 
• competition from other exterior building products manufacturers and alternative building materials;

• an inability to successfully develop new products or improve existing products;
 
• changes in the costs and availability of raw materials, especially polyvinyl chloride ("PVC") resin, aluminum and glass;
 
• consolidation and further growth of our customers;
 
• loss of, or a reduction in orders from, any of our significant customers;
 
• the credit risk of our customers;

• inclement weather conditions;
 
• increases in the cost of labor, union organizing activity and work stoppages at our facilities or the facilities of our suppliers;

• our ability to attract, employ, train and retain qualified personnel at a competitive cost;

• failure to effectively manage labor inefficiencies associated with increased production and new employees added to the Company;
 
• claims arising from the operations of our various businesses prior to our acquisitions;
 
• products liability claims, including class action claims and warranties, relating to the products we manufacture;

• litigation costs of defense;
 
• loss of certain key personnel;

• operational problems or disruptions may cause significant lost production and increased lead times;

     • interruptions in deliveries of raw materials or finished goods;

• changes in building codes that could increase the cost of our products or lower the demand for our products;

• environmental costs and liabilities;

• failure to successfully consummate and integrate acquisitions, including any future acquisitions;

• manufacturing or assembly realignments;
 
• threats to, or impairments of, our intellectual property rights;
 
• increases in transportation, freight and fuel costs;

• increases in foreign currency exchange and interest rates;
 
• material non-cash impairment charges;
 
• our significant amount of indebtedness;

• non-compliance with covenants in the credit agreement governing our senior secured asset-based revolving credit facility (the "ABL Facility"), the credit agreement governing our senior secured term loan facility (the "Term Loan Facility") and the indenture governing our 6.50% senior notes due 2022 (the "6.50% Senior Notes");

• failure to generate sufficient cash to service all of our indebtedness and make capital expenditures;

• downgrades of our external credit ratings;

• recently enacted U.S. tax law revisions could impact our financial results;

• limitations on our net operating losses and payments under the tax receivable agreement to our stockholders;

• exposure of systems and IT infrastructure to security breaches and other cyber security incidents;

• control by the CI Partnerships (as defined below); and

• changes in factors and assumptions used to measure our defined benefit plan.


These and other factors are more fully discussed in the “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections and elsewhere in this Annual Report on Form 10-K. These risks could cause actual results to differ materially from those implied by forward-looking statements in this Annual Report on Form 10-K.




1



PART I

Item 1.      BUSINESS

Company Overview

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 47% and 53% of our sales, respectively, for the fiscal year ended December 31, 2017.  These two segments produce a comprehensive product line of vinyl siding, designer accents, cellular PVC trim, vinyl fencing, vinyl railing, stone veneer, roofing, 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.  

Additional information concerning our business is set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 of Part II of this report.

On January 31, 2018, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Pisces Midco, Inc. (“Parent”) and Pisces Merger Sub, Inc., a wholly owned subsidiary of Parent (“Merger Sub”), each a wholly owned subsidiary of funds sponsored by Clayton, Dubilier & Rice (“CD&R”). Pursuant to the Merger Agreement, subject to the satisfaction or waiver of specified conditions, Merger Sub will merge with and into the Company (the “Merger”), with Ply Gem Holdings surviving the Merger as a wholly owned subsidiary of Parent (the “Acquisition”).  At the effective time of the Merger (the “Effective Time”), each of our issued and outstanding shares of common stock, par value $0.01 per share, will be cancelled and extinguished and converted into the right to receive $21.64 in cash, without interest (the “Merger Consideration”), less any applicable withholding taxes. The consummation of the Merger remains subject to customary closing conditions. As a result of the Merger, we will cease to be a publicly traded company.

Unless the context indicates or requires otherwise, (i) the term “Ply Gem Holdings” refers to Ply Gem Holdings, Inc., (ii) the term “Ply Gem Industries” refers to Ply Gem Industries, Inc., our principal operating subsidiary, and (iii) the terms “we”, “our”, “us”, “Ply Gem”, and the “Company” refer collectively to Ply Gem Holdings and its subsidiaries. The use of these terms is not intended to imply that Ply Gem Holdings and Ply Gem Industries and its subsidiaries are not separate and distinct legal entities.

History

Ply Gem Holdings was incorporated as a wholly owned subsidiary of Ply Gem Investment Holdings, Inc. (“Ply Gem Investment Holdings”), on January 23, 2004 by affiliates of CI Capital Partners for the purpose of acquiring Ply Gem Industries from Nortek, Inc. (“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 ten additional businesses to complement and expand our product portfolio and geographical diversity.  Gary E. Robinette, our President, Chief Executive Officer and Chairman of the Board, 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.  On January 11, 2010, Ply Gem Investment Holdings was merged with and into Ply Gem Prime Holdings, Inc. (“Ply Gem Prime”), with Ply Gem Prime being the surviving corporation.  As a result, Ply Gem Holdings was a wholly owned subsidiary of Ply Gem Prime. On May 23, 2013, Ply Gem Holdings issued 18,157,895 shares of common stock in an initial public offering ("IPO"), receiving net proceeds of approximately $353.8 million. In connection with and prior to the IPO, Ply Gem Holdings also issued 48,962,494 shares of common stock in connection with the merger of Ply Gem Prime with Ply Gem Holdings being the surviving entity.

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

On April 9, 2013, Ply Gem acquired the capital stock of Gienow WinDoor Ltd. (which was amalgamated into Gienow Canada Inc. with our legacy Ply Gem Canada business effective January 2014) ("Gienow"), a manufacturer of windows and doors in Western Canada. Gienow is part of our Western Canadian windows business and is part of the Windows and Doors segment.

On May 31, 2013, Ply Gem completed the acquisition of Mitten Inc. ("Mitten"), a manufacturer of vinyl siding and distributor of various other exterior building products in Canada. The majority of Mitten's operations are part of the Siding, Fencing and Stone segment.

On September 19, 2014, Ply Gem acquired the capital stock of Fortune Brands Windows, Inc., and its direct and indirect wholly owned subsidiaries: Simonton Building Products LLC, Simonton Industries, Inc., Simonton Windows, Inc., and SimEx, Inc. (together "Simonton"). Simonton is a premier repair and remodeling window company with leading brand recognition and is part of the Windows and Doors segment.

On May 29, 2015, Ply Gem acquired substantially all of the assets of Canyon Stone, Inc. (“Canyon Stone”), a manufacturer of stone veneer. Canyon Stone has manufacturing facilities in Olathe, Kansas and Youngsville, North Carolina. Canyon Stone is included in our Siding, Fencing, and Stone segment.


Access to Company Information

The Company maintains a website with the address www.plygem.com. The Company is not including the information contained on the Company’s website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. The Company makes available through its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and proxy statements as soon as reasonably practicable after the Company electronically files such material with, or furnishes such material to, the Securities and Exchange Commission (“SEC”).
 
Business Strategy

We are pursuing the following business and growth strategies:

Capture Growth Related to Housing Market Continued Recovery.  As a leading manufacturer of exterior building products, we intend to capitalize on the continued recoveries in the new construction and the home repair and remodeling markets.  The National Association of Home Builders’ (“NAHB”) 2017 estimate of single family housing starts were approximately 849,000, which was 17% below the 50-year average, representing a significant opportunity for growth as activity improves to rates that are more consistent with historical levels.  Furthermore, we believe that the underinvestment in homes and the overall age of the U.S. housing stock will drive significant future spending for home repair and remodeling.

We expect homeowners’ purchases to focus on items that provide the highest return on investment, have positive energy efficiency attributes and provide potential cost savings.  Our broad product offering addresses expected demand growth from all of these key trends through our exposure to the new construction and the home repair and remodeling end markets, diverse price points, the high recovery value for home improvements derived from our core product categories and the ability to provide products that qualify for energy efficiency rebate and tax programs currently in effect or under consideration.

Continue to Increase Market Penetration.  We intend to increase the market penetration of our siding, fencing, and stone products and our window and door products by leveraging the breadth of our product offering and broad geographical footprint to serve customers across North America and by pursuing cross-selling opportunities.  Additionally, our continued investments in product innovation and quality, coupled with strong customer service, further enhance our ability to capture increased sales in each of our core product categories.  In 2017, our U.S. vinyl siding leading market position increased to approximately 40.4% from our 2016 market position of 39.8%.  Beginning in 2013 and continuing through 2017, we expanded our repair and remodeling presence with the Simonton acquisition and expanded our entry into new product categories such as PVC trim and engineered slate roofing.

Building Brand Equity and Driving Growth through Innovative Product Solutions.  We are a leading building products manufacturer with a vision to provide sustainable and innovative solutions that help families and businesses realize their dreams through better homes and workplaces.  We are committed to being the leading brand of choice in each market we serve.  We create value for our stakeholders using a business model that combines a broad portfolio of high-quality sustainable products and services, efficient operations and an unrelenting customer focus.  As a leader in vinyl siding, aluminum accessories, vinyl and aluminum windows, we are committed to marketing research, product innovation and marketing excellence to drive growth across the breadth of categories.

We utilize a fully integrated approach to leverage our marketing investment across businesses with a goal of optimizing results.  We have committed resources to advancements in digital marketing with new initiatives in search engine optimization, lead generation and website user experience to engage with our target audiences directly.  Our social marketing efforts across Ply Gem brands gives us direct daily access to over 190,000 people.  We are committed to building brand equity with a stronger master brand strategy for Ply Gem and continue to advertise using traditional media such as trade advertising, radio and digital.  We continue our commitment to our Home for Good project, to help raise awareness to the need for affordable housing.  During 2017, this brand campaign delivered over 500 million impressions for our brand while positively impacting over 70 communities in the U.S.  We have helped build over 450 homes with our donation to Habitat for Humanity and our relationship with Home For Good ambassador, Darius Rucker.

We remain focused on our customers and providing best in class product and customer marketing. We successfully launched Ply Gem Engineered Roofing in 2014 and cellular PVC Trim in 2013, and continue to develop innovative product solutions within our existing categories and explore new product solutions adjacent to our core categories. The 2016 launch of our "Insight Center" in Durham, North Carolina provides a dedicated resource for innovation and product development.

The result of our commitment to product development and innovation has been demonstrated in the approximately $530.6 million of incremental annualized sales that we recognized for new products introduced from 2015 to 2017 excluding any cannibalization of sales of pre-existing products.

We also invest in our future and further brand development by pursuing certain strategic acquisitions if they fit our strategic focus. For example, in April 2013 we acquired Gienow, a manufacturer of windows and doors in Western Canada, in May 2013 we acquired Mitten, a leading manufacturer of vinyl siding and accessories in Canada, in September 2014 we acquired Simonton, a premier repair and remodeling window company with leading brand recognition, and in May 2015 we acquired Canyon Stone, a manufacturer and distributor of stone veneer and accessories in the United States. These acquisitions provide us with access to new revenue streams and operating efficiencies to drive further market gains.

Drive Operational Leverage and Further Improvements.  While we reduced our production capacity during the housing downturn, we retained flexibility and have since brought back previously idled lines, facilities, and production shifts in order to increase our production as market conditions continue to improve.  This incremental capacity can be selectively restarted, providing us with the ability to match increasing customer demand levels as the housing market returns to historical levels of approximately one million or more single family housing starts without the need for significant capital investment.  In our Windows and Doors segment, our product platforms combined with strong customer relationships enable us to serve the new construction and repair and remodeling markets driving increased volumes through our manufacturing facilities and enhancing our operating margins.

Over the past several years, we have significantly improved our manufacturing cost structure; however, there are opportunities for further improvements.  During 2017, we announced a new initiative entitled “2x20” which represents a profitability improvement measure as a percentage of our net sales by 2020 of at least $40.0 million. We believe that the continued expansion of lean manufacturing and vertical integration in our manufacturing facilities, along with the further consolidation of purchases of key raw materials, supplies and services will continue to provide us with cost advantages compared to our competitors.  In addition, the integration of our sales and marketing efforts across our product categories provides an ongoing opportunity to significantly improve our customer penetration and leverage the strength of our brands.  Furthermore, we have centralized many back office functions into our corporate office in Cary, North Carolina and believe that additional opportunities remain including further synergies from the Simonton acquisition, continuous improvement of our manufacturing processes through automation, and further general and administration improvements.  We believe these factors should drive continued profitable growth while improving our cash flow and capital efficiency.

Continue to Improve Financial Leverage. As a result of the ten strategic acquisitions that we have completed since 2004, we incurred significant amounts of indebtedness to finance these acquisitions. This acquisition strategy combined with a severe housing market recession during 2009-2011 ultimately increased our financial leverage to 8.9 during 2011. Over the last several years, we have focused on improving our financial leverage. As the housing market continued to improve, so did our financial performance demonstrated by our significant cash flow generation over the last several years. During 2016 and 2017, we voluntarily elected to pay down $200.0 million on the Term Loan Facility and decreased our financial leverage to 3.4 as of and for the year ended December 31, 2017.

Industry Overview

Demand for exterior building products, including siding, fencing, stone, windows and doors, is primarily driven by construction of new homes and repair and remodeling of existing homes, which are affected by changes in national and local economic and demographic conditions, employment levels, availability of financing, interest rates, consumer confidence and other economic factors.
 
New Home Construction

Management believes that a U.S. housing recovery will continue on a national basis, supported by favorable demographic trends, historically low interest rates and consumers who are increasingly optimistic about the U.S. housing market. New home construction in the United States experienced strong growth from the early 1990s to 2006, with housing starts increasing at a compounded annual growth rate of 3.8%.  However, according to the U.S Census Bureau, from 2006 to 2017, single family housing starts are estimated to have declined 42%.  While the industry has experienced a period of severe correction, management believes that the long-term economic outlook for new construction in the United States is favorable and supported by an attractive interest rate environment, increasing consumer confidence, improving employment growth and strong demographics, as new household formations drive demand for starter homes.  According to the Joint Center for Housing Studies of Harvard University, net new household formations between 2015 and 2025 are expected to be approximately 13.6 million units. 

During 2017, single family housing starts are estimated to have increased 8.6% to approximately 849,000 compared to 2016. During 2016, single family housing starts increased 9.4% to approximately 782,000 compared to 2015. The NAHB is currently forecasting single family housing starts to further increase in 2018 and 2019 by 5.2% and 5.6%, respectively.  

Home Repair and Remodeling

Management believes that the U.S. home repair and remodeling products market is poised for a recovery. Since the early 1990s and through 2006, demand for home repair and remodeling products in the United States increased at a compounded annual growth rate of 4.3%, according to the U.S. Census Bureau, as a result of strong economic growth, low interest rates and favorable demographics.  However, beginning in 2007 the ability for homeowners to finance repair and remodeling expenditures, such as replacement windows or vinyl siding, has been negatively impacted by a general tightening of lending requirements by financial institutions and the significant decrease in home values, which limited the amount of home equity against which homeowners could borrow.  Management believes that expenditures for home repair and remodeling products are also affected by consumer confidence, economic conditions, debt ceiling and national budget deliberations, and unemployment levels. Management believes the long-term economic outlook of the demand for home repair and remodeling products in the United States is favorable and supported by the move towards more energy-efficient products, recent underinvestment in home maintenance and repair, and an aging housing stock.

Description of Business

Financial information about our segments is included in the Notes to Consolidated Financial Statements and incorporated herein by reference.


Building Products

The breadth of building products offered by us provides a competitive advantage as we manufacture a wide assortment of products for the exterior of the home as illustrated below.

2


houseproductpix2a01.jpg
Siding, Fencing and Stone segment

Products

In our Siding, Fencing and Stone segment, our principal products include vinyl siding and skirting, steel siding, vinyl and aluminum soffit, aluminum trim coil, aluminum gutter coil, fabricated aluminum gutters, aluminum and steel roofing accessories, cellular PVC trim and mouldings, J-channels, wide crown molding, window and door trim, F-channels, H-molds, fascia, undersill trims, outside/inside corner posts, rain removal systems, injection molded designer accents such as shakes, shingles, scallops, shutters, vents and mounts, vinyl fence, vinyl railing, engineered slate and cedar shake roofing, and stone veneer in the United States and Canada. We sell our siding and accessories under our Variform®, Napco®, Mastic® Home Exteriors, Mitten®, Ply Gem/Cellwood®, and Durabuilt® brand names and under the Georgia-Pacific brand name through a private label program. Our cellular PVC Trim products are sold under our Ply Gem® Trim and Mouldings brand name. Our vinyl fencing and railing products are sold under the Ply Gem brand name. Our stone veneer products are sold under our Canyon Stone and Ply Gem Stone brand name. Our engineered slate and shake roofing products are sold under our Ply Gem Roofing brand name. Our gutter protection products are sold under our Leaf Relief®, Leaf Relief® Snap Tight, Leaf Smart® and Leaf Logic® brand names. A summary of our product lines is presented below according to price point:

3


 
 
Mastic® Home
Exteriors
 
Variform® 
 
Napco® 
 
Ply Gem/Cellwood ® 
 
Durabuilt® 
 
Georgia Pacific
 
Mitten®
 
Ply Gem Fence/Rail
 
Ply Gem® Stone
Canyon Stone (1)
Ply Gem ® Trim and Mouldings (2)

Ply Gem Roofing (3)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Specialty/Super Premium
 
Cedar Discovery® 
Structure® 
Home Insulation System™
 
Heritage Cedar®™
Climaforce™
 
Cedar Select®
 American Essence™
 
Cedar Dimensions™
 
670 Series™ Hand Split
650 Series™ Shingle Siding
660 Series™ Round Cut Siding
800 Series Insulated Siding
 
Cedar Spectrum™
Caliber™ High Performance Insulated Siding
 
InsulPlankII
Grand River
 
 
 
Fieldstone Tuscan
Fieldstone Shadow
Ledgestone
Cut Cobblestone
Cobblestone
Ridgestone
Riverstone Brick
Cascade Ledge
True Stack
Manorstone
Canyon Ledge
Castle
Cathedral
Classic
Cobblestone
Country Ledge
Fieldstone
Limestone
Manchester
River Rock
Timber Ledge
Tuscan Field Stone
Southern Ledge
Strip Ledge
Brick
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Premium
 
Quest®
Barkwood® 
Liberty Elite® 
Board + Batten
Designer Series™
Carvedwood 44®
 
Vortex Extreme™
Board & Batten
Camden Pointe®
 
American Splendor®
American Accents
Board & Batten™
 
Dimensions®
 Board & Batten
 
480 Series™
Board & Batten

 
Compass™
Board & Batten
 
Sentry
Southern Beaded
 
Elegance Vinyl Fence
 
 
 
Trim Boards
Corners
Post Wraps
Mouldings
Beadboard
Skirtboard Sheets
J-Notch Trim
Post Accents
Engineered Slate
Engineered Shake
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Standard
 
Ovation™
Charleston Beaded®
 
 
Nottingham®
Ashton Heights® 
Victoria Harbor®
 
American Herald® 
American Tradition
American 76 Beaded®
 
Progressions® 
Colonial Beaded
 
440 Series™
450 Series™ Beaded
 
Forest Ridge® 
Shadow Ridge® 
Castle Ridge®  
Somerset™ Coastal
 
Highland
 Oregon Pride

 
Performance Vinyl Fence and Rail
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Economy
 
Mill Creek®
Eclipse™
 
Contractors Choice®
 
American Comfort®
 
Evolutions®
 
410 Series™
 
Vision Pro® 
Chatham Ridge®
Parkside® 
Oakside®
 
Entree

 
Classic Vinyl Fence
 
 
 
 
 

(1) The Canyon Stone product line was integrated in 2015 with the May 2015 acquisition of Canyon Stone Inc.
(2) The cellular PVC Trim product category launched during the first quarter of 2013.
(3) The Engineered Slate Roofing product category launched during the third quarter of 2014.
(4) The Cellwood brand transitioned to the Ply Gem brand during 2017.
 
The breadth of our product lines and our multiple brand and price point strategy enable us to target multiple distribution channels (wholesale and specialty distributors, retailers and manufactured housing) and end users (new construction and home repair and remodeling).

Customers and distribution

We have a multi-channel distribution network that serves both the new construction and the home repair and remodeling sectors, which exhibit different, often counter-balancing, demand characteristics.  In conjunction with our multiple brand and price point strategy, we believe our multi-channel distribution strategy enables us to increase our sales and sector penetration while minimizing channel conflict.  We believe our strategy reduces our dependence on any one channel, which provides us with a greater ability to sustain our financial performance through economic fluctuations.


4


We sell our siding and accessories to specialty distributors (one-step distribution) and to wholesale distributors (two-step distribution).  Our specialty distributors sell directly to remodeling contractors and builders.  Our wholesale distributors sell to retail home centers and lumberyards who, in turn, sell to remodeling contractors, builders and consumers.  In the specialty channel, we have developed an extensive network of approximately 800 independent distributors, serving over 22,000 contractors and builders nationwide.  We are well-positioned in this channel as many of these distributors are both the largest and leading consolidators in the industry.  In the wholesale channel, we are the sole supplier of vinyl siding and accessories to BlueLinx (formerly a distribution operation of the Georgia-Pacific Corporation), one of the largest building products distributors in the United States.  Through BlueLinx, our Georgia-Pacific private label vinyl siding products are sold at major retail home centers, lumberyards and manufactured housing manufacturers.  A portion of our siding and accessories is also sold directly to home improvement centers.  Our growing customer base of fencing and railing consists of fabricators, distributors, retail home centers and lumberyards.  Our customer base of stone veneer products consists of distributors, lumberyards, retailers, builders and contractors. Our customer base of roofing products consists of distributors, lumberyards, retailers and contractors. In Canada, our complete offering of vinyl siding, accessories, trim, and moldings, along with Ply Gem manufactured and third party sourced complimentary products are primarily distributed through our 18 Mitten branch locations, to retail home centers and lumberyards, and new construction and remodeling contractors.

Our largest customer, ABC Supply Co., Inc., comprised 17.4%, 17.1%, and 16.9% of the net sales of our Siding, Fencing, and Stone segment for the years ended December 31, 2017, 2016, and 2015, respectively.

Production and facilities

Vinyl siding, skirting, soffit and accessories are manufactured in our Martinsburg, West Virginia, Jasper, Tennessee, Stuarts Draft, Virginia, Kearney, Missouri, and Paris, Ontario facilities, while all metal products are produced in our Sidney, Ohio facility.  The majority of our injection molded products such as shakes, shingles, scallops, shutters, vents and mounts are manufactured in our Gaffney, South Carolina facility.  The cellular PVC trim and mouldings products are manufactured in St. Marys, West Virginia. The vinyl, metal, and injected molded plants have sufficient capacity to support planned levels of sales growth for the foreseeable future.  Our fencing and railing products are currently manufactured at our York, Nebraska and Fair Bluff, North Carolina facilities.  The fencing and railing plants have sufficient capacity to support our planned sales growth for the foreseeable future.  Our stone veneer products are manufactured at our Selinsgrove, Pennsylvania, Olathe, Kansas and Youngsville, North Carolina facilities.  Our engineered slate and cedar roofing products are currently manufactured at our Fair Bluff, North Carolina facility. Our manufacturing facilities are among the safest in all of North America with three of them having received the highest federal and/or state OSHA safety award and rating.

Raw materials and suppliers

PVC resin and aluminum are major components in the production of our Siding, Fencing, and Stone products. PVC resin and aluminum are commodity products and are available from both domestic and international suppliers. 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 the 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.

Recycled plastics are a major component in the production of our roofing products. The price of recycled plastics has risen above historical levels and is expected to remain high. The recycled plastic market is driven by supply and demand and therefore causes the recycled plastic market to be volatile.


5


Competition
We compete with other national and regional manufacturers of vinyl siding, aluminum, cellular PVC, fencing, and stone products. We believe we are currently the largest manufacturer of vinyl siding in North America. Our vinyl siding competitors include CertainTeed, Alside, Royal Building Products and smaller regional competitors. Based on our internal estimates and industry experience, we believe that we have a U.S. vinyl siding market position of 40.4% in 2017, and a Canadian market position of 32.7%. Our aluminum accessories competitors include Rollex, Euramax, Gentek and other smaller regional competitors. Significant growth in vinyl fencing and railing has attracted many new entrants, and the sector today is fragmented with numerous competitors including U.S. Fence, Homeland, Westech, Bufftech, and Azek. Our cellular PVC trim and moulding competitors include Azek, Inteplast, Kommerling (KOMA), Wolfpac (Versatex), Tapco (Kleer), CertainTeed and Royal Building Products. Our stone veneer competitors include Boral (Cultured Stone and Eldorado Stone), Coronado Stone and smaller regional competitors. We generally compete on product quality, breadth of product offering, sales and service support. In addition to competition from other vinyl siding, fencing and stone products, our products face competition from alternative materials, such as wood, metal, fiber cement and masonry. Increases in competition from other exterior building products manufacturers and alternative building materials could cause us to lose customers and lead to net sales decreases.

Intellectual property

We possess a wide array of intellectual property rights, including patents, trademarks, tradenames, licenses, proprietary technology and know-how and other proprietary rights.  In connection with the marketing of our products, we generally obtain trademark protection for our brand names in the Siding, Fencing, and Stone segment.  Depending on the jurisdiction, trademarks are valid as long as they are in use and/or their registrations are properly maintained and they have not become generic.   Registrations of trademarks can generally be renewed indefinitely as long as the trademarks are in use.  With Mitten Building Products in the Canadian market, we license our Procanna Windows and Doors brand for the production of exclusive Mitten distributed products from contracted, regional third-party fabricators. We license the Georgia-Pacific trademark for our Georgia-Pacific private label vinyl siding products sold through BlueLinx. While we do not believe the Siding, Fencing, and Stone segment is dependent on any one of our trademarks, we believe that our trademarks are important to the development and conduct of our business as well as the marketing of our products.  We vigorously protect all of our intellectual property rights.


Seasonality

Markets for our products are seasonal and can be affected by inclement weather conditions.  Historically, our business has experienced increased sales in the second and third quarters of the year due to increased construction during those periods.  Because a portion of our overhead and expenses are fixed throughout the year, our operating profits tend to be lower in the first and fourth quarters.  Inclement weather conditions can affect the timing of when our products are applied or installed, causing delayed profit margins when such conditions exist.

We generally carry increased working capital during the first half of a fiscal year to support those months where customer demand exceeds production capacity.  We believe that this is typical within the industry.

Backlog

Our Siding, Fencing, and Stone segment had a backlog of approximately $26.8 million at December 31, 2017 and a backlog of approximately $20.3 million at December 31, 2016.  We filled 100% of the backlog at December 31, 2016 during 2017. We expect to fill 100% of the orders during 2018 that were included in our backlog at December 31, 2017.

Windows and Doors segment

Products

In our Windows and Doors segment, our principal products include vinyl, aluminum-clad vinyl, aluminum, wood and clad-wood windows and patio doors and steel, wood, and fiberglass entry doors that serve both the new construction and the home repair and remodeling sectors in the United States and Canada.  Our products in our Windows and Doors segment are sold under the Ply Gem® Windows, Simonton® Windows, Great Lakes® Window, and Ply Gem® Canada brands.  A summary of our current product lines is presented below according to price point:

6


 
Ply Gem U.S. Windows
Great Lakes
Window
Ply Gem Canada
Simonton
 
New Construction
Replacement
Replacement
New Construction & Replacement
New Construction
Replacement
 
 
 
 
 
 
 
Specialty/Super-Premium
 
Mira® Premium Series
 
EcoSMART
Signature
 
Stormbreaker Plus
VantagePointeTM 6500

 
 
 
 
 
 
 
Premium
Mira® Premium Series
Premium Series
Comfort Smart
Design Enviro Fiber Stain

ProFinish® Brickmould 600


Reflections®  5500
Daylight MaxTM
LumeraTM
Madeira
Impressions 9800
VantagePointeTM 6400

 
 
 
 
 
 
 
Standard
Pro Series
Pro Series
HarborLight
Classic Comfort Fiber Tuff
Brickmould 300
ProFinish® Contractor
ProFinish® Master

VantagePointeTM 6100
VantagePointeTM 6200
VantagePointeTM 6060
ClearValue
Verona
Reflections®  5050
Reflections®  5300


 
 
 
 
 
 
 
Economy
Builder Series
Contractor Series
 
Vista
Steel
ProFinish® Builder

AsureTM



We continue introducing new products to the portfolio which allow us to enter or further penetrate new distribution channels and customers.  The breadth of our product lines and our multiple price point strategy enable us to target multiple distribution channels (wholesale and specialty distributors, retailers and manufactured housing) and end user markets (new construction and home repair and remodeling).


Customers and distribution

We have a multi-channel distribution and product strategy that enables us to serve both the new construction and the home repair and remodeling markets.  By offering this broad product offering and industry leading service, we are able to meet the local needs of our customers on a national scale.  This strategy has enabled our customer base (existing and new) to simplify their supply chain by consolidating window suppliers.  Our good, better, best product and price point strategy allows us to increase our sales and sector penetration while minimizing channel conflict.  This strategy reduces our dependence on any one channel, providing us with a greater ability to sustain our financial performance through economic fluctuations.

The new construction product lines are sold for use in new residential and light commercial construction through a highly diversified customer base, which includes independent building material dealers, regional/national lumberyard chains, builder direct/OEMs and retail home centers.  Our repair and remodeling window products are primarily sold through independent home improvement dealers, one-step distributors, and big box retail outlets.  Dealers typically market directly to homeowners or contractors in connection with remodeling requirements while distributors concentrate on local independent retailers.

In Canada, sales of product lines for new construction are predominantly made through direct sales to builders and contractors, while sales for repair and remodeling are made primarily through retail lumberyards but also direct to contractors and direct to consumers through our supply and install services.  Ply Gem Canada products are distributed through twelve Ply Gem distribution centers.

Our largest customer, The Home Depot, comprised 10.4%, 10.2%, and 9.7% of the net sales of our Windows and Doors segment for the years ended December 31, 2017, 2016, and 2015, respectively.
 
Production and facilities


7


Our window and door products leverage a network of vertically integrated production and distribution facilities located in Virginia, Ohio, North Carolina, Georgia, Texas, California, Washington, West Virginia, Illinois and Alberta, Canada.  Our window and door manufacturing facilities have benefited from our continued investment and commitment to product development and product quality combined with increasing integration of best practices across our product offerings.  In 2010, we began producing vinyl compound for our west coast facilities which improved our operating efficiency and resulted in lower production cost for these items.  In 2010, we continued making upgrades to insulated glass production lines in anticipation of more stringent energy efficiency requirements driven by changes in building codes and consumer demand for Energy Star rated products.

While market conditions will dictate future capacity requirements, we have the ability to increase capacity in a cost effective manner by expanding production shifts and lines.  Significant housing demand increases to historical levels may require additional capital investment in certain geographical areas to meet this increased demand. Any capacity increase may, however, initially be offset by labor inefficiencies or difficulties obtaining the appropriate labor force. Ongoing capital investments will focus on new product introductions and simplification, production automation, equipment maintenance and cost reductions.   

During 2014, our Windows and Doors segment further streamlined its product offerings by realigning its SKUs to simplify the structure and manufacturing process while maximizing product features for our customers at competitive prices. During 2014, we consolidated Canadian production and distribution facilities, and rationalized and rebranded product lines. As a result, during 2014 and 2015 four redundant distribution facilities were closed, and manufacturing was largely consolidated. During 2017, three additional Canadian distribution facilities were consolidated with our Canadian siding business to promote product cross selling.

Raw materials and suppliers

PVC compound, wood, aluminum and glass are major components in the production of our window and door products.  These products are commodity products available from both domestic and international suppliers. Historically, changes in PVC compound, aluminum billet and wood cutstock prices have had the most significant impact on our material cost of products sold in our Windows and Doors segment.  We are one of the largest consumers of PVC resin in North America and we continue to leverage our purchasing power on this key raw material.  The PVC resin compound that is used in our window lineal production is produced internally.  The leveraging of our PVC resin buying power and our PVC resin compounding capabilities benefits all of our window companies.  Our window plants have consolidated glass purchases to take advantage of strategic sourcing savings opportunities.  In addition, we have continued to vertically integrate aluminum extrusion in our window plants.

Competition

The window and patio door sector remains fragmented, comprised primarily of local and regional manufacturers with limited product offerings.  The sector’s competitors in the United States include national brands, such as Jeld-Wen, Pella and Andersen, and numerous regional brands, including MI Home Products, Atrium, Weathershield and Milgard.  Competitors in Canada include Jeld-Wen, All Weather, Durabuilt, and numerous regional brands.  We generally compete on service, product performance, product offering, sales and support.  We believe all of our products are competitively priced and that we are one of the only manufacturers to serve all end markets and price points.

Intellectual property

We possess a wide array of intellectual property rights, including patents, trademarks, tradenames, licenses, proprietary technology and know-how and other proprietary rights.  In connection with the marketing of our products, we generally obtain trademark protection for our brand names in the Windows and Doors segment.  Depending on the jurisdiction, trademarks are valid as long as they are in use and/or their registrations are properly maintained and they have not become generic.  Registrations of trademarks can generally be renewed indefinitely as long as the trademarks are in use. While we do not believe the Windows and Doors segment is dependent on any one of our trademarks, we believe that our trademarks are important to the Windows and Doors segment and the development and conduct of our business as well as the marketing of our products.  We vigorously protect all of our intellectual property rights.

Seasonality


8


Markets for our products are seasonal and can be affected by inclement weather conditions.  Historically, our business has experienced increased sales in the second and third quarters of the year due to increased construction during those periods.  Accordingly, our working capital is typically higher in the second and third quarters as well. Because much of our overhead and expense are fixed throughout the year, our operating profits tend to be lower in the first and fourth quarters.  Inclement weather conditions can affect the timing of when our products are applied or installed, causing lower profit margins when such conditions exist.

Because we have successfully implemented lean manufacturing techniques and many of our windows and doors are made to order, inventories in our Windows and Doors segment do not change significantly with seasonal demand.

Backlog

Our Windows and Doors segment had a backlog of approximately $57.6 million at December 31, 2017 and approximately $45.1 million at December 31, 2016.  We filled 100% of the backlog at December 31, 2016 during 2017. We expect to fill 100% of the orders during 2018 that were included in our backlog at December 31, 2017.


Environmental and Other Regulatory Matters

We are subject to United States and Canadian federal, state, provincial and local laws and regulations relating to pollution and the protection of the environment, including those governing emissions to air, discharges to water, use, storage, treatment, disposal and transport of hazardous waste and other materials, investigation and remediation of contaminated sites, and protection of worker health and safety. From time to time, our facilities are subject to investigation by governmental authorities. In addition, we have been identified as one of many potentially responsible parties for contamination present at certain offsite locations to which our entities or their predecessors are alleged to have sent hazardous materials for recycling or disposal. We may be held liable, or incur fines or penalties, in connection with such requirements or liabilities for, among other things, releases of hazardous substances occurring on or emanating from current or formerly owned or operated properties or any associated offsite disposal location, or for known or newly-discovered contamination at any of our properties from activities conducted by us or previous occupants. The amount of any liability, fine or penalty may be material, and certain environmental laws impose strict, and under certain circumstances joint and several, liability for the cost of addressing releases of hazardous substances upon certain classes of persons, including site owners or operators and persons that disposed or arranged for the disposal of hazardous substances at contaminated sites.

MW Manufacturers Inc. (“MW”), a subsidiary of MWM Holding, Inc., entered into an Administrative Order on Consent (the “Consent Order”), effective September 12, 2011, with the United States Environmental Protection Agency (“EPA”), under the Resource Conservation and Recovery Act (“RCRA”), with respect to its Rocky Mount, Virginia property. During 2011, as part of the Consent Order, MW provided the EPA, among other things, a RCRA Facility Investigation Workplan (the “Workplan”) as well as a preliminary cost estimate of approximately $1.8 million for the predicted assessment, remediation and monitoring activities to be conducted pursuant to the Consent Order over the remediation period, which is currently estimated through 2023. In 2012, the EPA approved the Workplan, which MW is currently implementing. We have recorded approximately $0.3 million of this environmental liability within current liabilities and approximately $1.1 million within other long-term liabilities in our consolidated balance sheets at December 31, 2017 and 2016, respectively.  We may incur costs that exceed our recorded environmental liability. We will adjust our environmental remediation liability in future periods, if necessary, as further information develops or circumstances change.

Environmental authorities are investigating groundwater contamination at a Superfund site in York, Nebraska. In 2010, sampling was conducted at the Kroy Building Products, Inc. (“Kroy”) facility in York, Nebraska. In February 2015, the EPA sent Kroy a request for information pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), and in May 2015, Kroy responded to the request for information. Kroy could have liability for investigation and remediation costs associated with the contamination. Given the current status of this matter, we have not recorded a liability in our consolidated balance sheets as of December 31, 2017 and December 31, 2016.

From time to time, we may incur investigation and remediation costs in connection with other facilities we currently own or operate or previously owned or operated. For example, we have a $0.1 million liability included in our consolidated balance sheets at December 31, 2017 and December 31, 2016, for potential contamination issues at our Calgary, Alberta property. In addition, we are required to contribute to investigation and remediation costs at various third party waste disposal facilities at which we or a related entity have been identified as a potentially responsible party.


9


We are a party to various acquisition and other agreements pursuant to which third parties agreed to indemnify us for certain costs relating to environmental liabilities. For example, we may be able to recover some of our Rocky Mount, Virginia investigation and remediation costs from U.S. Industries, Inc. and may be able to recover a portion of any costs incurred in connection with the Kroy contamination matter in York, Nebraska from Alcan Aluminum Corporation. Our ability to seek indemnification from parties that have agreed to indemnify us may be limited. There can be no assurance that we would receive any funds from these parties, and any related environmental liabilities or costs could have a material adverse effect on our financial condition and results of operations.

Based on current information, we are not aware of any environmental compliance obligations, claims or investigations that will have a material adverse effect on our results of operations, cash flows or financial position except as otherwise disclosed in our consolidated financial statements. However, there can be no guarantee that previously known or newly-discovered matters will not result in material costs or liabilities.

Employees

As of December 31, 2017, we had 9,471 full-time employees worldwide, of whom 8,279 were in the United States and 1,192 were in Canada.  Employees at our Calgary, Alberta plant are currently our only employees with whom we have a collective bargaining agreement.
Approximately 5.0% of our total employees are represented by the United Brotherhood of Carpenters and Joiners of America. These Canadian employees remain subject to the terms of the Collective Bargaining Agreement ("CBA") which expires in June 2021.



Financial Information about Geographic Areas

All of the Company’s operations are located in the United States and Canada.  

Revenue from external customers for the year ended December 31, 2017 consisted of:
$1,849.9 million from United States customers
$202.8 million from Canadian customers
$3.6 million from all other foreign customers

Revenue from external customers for the year ended December 31, 2016 consisted of:
$1,741.2 million from United States customers
$166.5 million from Canadian customers
$4.1 million from all other foreign customers

Revenue from external customers for the year ended December 31, 2015 consisted of:
$1,642.2 million from United States customers
$192.5 million from Canadian customers
$5.0 million from all other foreign customers


At December 31, 2017, 2016, and 2015, long-lived assets totaled approximately $55.4 million, $55.8 million, and $57.7 million, respectively, in Canada, and $700.8 million, $751.6 million, and $718.0 million, respectively, in the United States.  We are exposed to risks inherent in any foreign operation, including foreign exchange rate fluctuations.

 Item 1A.  RISK FACTORS

Risks Relating to the Merger
The proposed acquisition of us by CD&R may cause disruption in our business.
On January 31, 2018, we entered into the Merger Agreement with an affiliate of CD&R, pursuant to which we will be acquired by CD&R in an all cash transaction. The Merger Agreement generally requires us to operate our business in the ordinary course pending consummation of the Merger and restricts us, without CD&R’s consent, from taking certain specified actions until the Merger is completed. These restrictions may affect our ability to execute our business strategies and attain financial and other goals and may impact our financial condition, results of operations and cash flows.

10


In connection with the pending Merger, our current and prospective employees may experience uncertainty about their future roles with us following the Merger, which may materially adversely affect our ability to attract and retain key personnel while the Merger is pending. Key employees may depart because of issues relating to the uncertainty and difficulty of integration or a desire not to remain with us following the Merger, and may depart prior to the consummation of the Merger. Accordingly, no assurance can be given that we will be able to attract and retain key employees to the same extent that we have been able to in the past.
The proposed Merger further could cause disruptions to our business or business relationships, which could have an adverse impact on results of operations. Parties with which we have business relationships may experience uncertainty as to the future of such relationships and may delay or defer certain business decisions, seek alternative relationships with third parties or seek to alter their present business relationships with us. Parties with whom we otherwise may have sought to establish business relationships may seek alternative relationships with third parties.
The pursuit of the Merger may place a significant burden on management and internal resources. The diversion of management’s attention away from day-to-day business concerns could adversely affect our financial results.
We also could be subject to litigation related to the proposed Merger, which could result in significant costs and expenses. In addition to potential litigation-related expenses, we have incurred and will continue to incur other significant costs, expenses and fees for professional services and other transaction costs in connection with the proposed Merger, and many of these fees and costs are payable regardless of whether or not the proposed Merger is consummated.
Failure to complete the Merger in a timely manner or at all could negatively impact the market price of our common stock, as well as our future business and financial condition, results of operations and cash flows.
We currently anticipate the Merger will close in the second quarter of 2018, but it cannot be certain when or if the conditions for the proposed Merger will be satisfied or (if permissible under the Merger Agreement and applicable law) waived. The Merger cannot be completed until the conditions to closing are satisfied or (if permissible under the Merger Agreement applicable law) waived. In the event that the Merger is not completed for any reason, the holders of our common stock will not receive any payment for their shares of our common stock in connection with the proposed Merger. Instead, we will remain an independent public company and holders of our common stock will continue to own their shares.
Additionally, if the Merger is not consummated in a timely manner or at all, our ongoing business may be adversely affected as follows:
we may experience negative reactions from financial markets and our stock price could decline;
we may experience negative reactions from employees, customers, suppliers or other third parties;
our management’s focus would have been diverted from pursuing other opportunities that could have been beneficial to us; and
the costs of pursuing the Merger may be higher than anticipated and would be born entirely by us.

If the acquisition by CD&R is not completed, there can be no assurance that these risks will not materialize and will not materially adversely affect our stock price, business, financial conditions, results of operations or cash flows.
Risks Associated with Our Business

Downturns or negative trends in the home repair or the remodeling and new construction end markets, or the U.S. and Canadian economies or the availability of consumer credit, could adversely impact our end users and lower the demand for, and pricing of, our products, which in turn could cause our net sales and net income to decrease.

Our performance is dependent to a significant extent upon the levels of home repair and remodeling and new construction spending, which declined significantly beginning in 2008 and continued through 2013 with recovery commencing in 2014. Housing levels in 2017 remained slightly lower relative to historical averages, despite the recovery the last few years, and are affected by such factors as interest rates, inflation, consumer confidence, unemployment and the availability of consumer credit.


11


Our performance is also dependent upon consumers having the ability to finance home repair and remodeling projects and/or the purchase of new homes.  The ability of consumers to finance these purchases is affected by such factors as new and existing home prices, homeowners’ equity values, interest rates and home foreclosures, which in turn could result in a tightening of lending standards by financial institutions and reduce the ability of some consumers to finance home purchases or repair and remodeling expenditures.  Trends such as declining home values, increased home foreclosures and tightening of credit standards by lending institutions, negatively impacted the home repair and remodeling and the new construction sectors during the recession which began in 2008.  Despite the recent abatement of these negative market factors, any recurrence or worsening of these items may adversely affect our net sales and net income.

We face competition from other exterior building products manufacturers and alternative building materials. If we are unable to compete successfully, we could lose customers and our sales could decline.

We compete with other national and regional manufacturers of exterior building products.  Some of these companies are larger and have greater financial resources than we do.  Accordingly, these competitors may be better equipped to withstand changes in conditions in the industries in which we operate and may have significantly greater operating and financial flexibility than we do.  Competitors could take a greater share of sales and cause us to lose business from our customers.  Additionally, our products face competition from alternative materials, such as wood, metal, fiber cement, masonry and composites in siding, and wood, composites and fiberglass in windows.  An increase in competition from other exterior building products manufacturers and alternative building materials could cause us to lose our customers and lead to net sales decreases.
 
An inability to successfully develop new products or improve existing products could negatively impact our ability to attract new customer and/or retain existing customers.

Our success depends on meeting consumer needs and anticipating changes in consumer preferences with successful new products and product improvements. We aim to introduce products and new or improved production processes proactively to offset obsolescence and decreases in sales of existing products. While we devote significant focus to the development of new products, we may not be successful in product development and our new products may not be commercially successful. In addition, it is possible that competitors may improve their products more rapidly or effectively, which could adversely affect our sales. Furthermore, market demand may decline as a result of consumer preferences trending away from our categories or trending down within our brands or product categories, which could adversely impact our results of operations, cash flows and financial condition.

Changes in the costs and availability of raw materials, especially PVC resin, aluminum and glass, can decrease our profit margins by increasing our costs.

Our principal raw materials, PVC resin, aluminum and glass, have been subject to rapid price changes in the past and could change in the future from market conditions and other factors including potential tariffs which may be subject to change. While we have historically been able to substantially pass on significant PVC resin, aluminum, and glass cost increases through price increases to our customers, our results of operations for individual quarters can be and have been hurt by a delay between the time of PVC resin, aluminum, and glass cost increases and price increases in our products.  While we expect that any significant future PVC resin, aluminum, and glass cost increases will be offset in part or whole over time by price increases to our customers, we may not be able to pass on any future price increases.

Certain of our customers have been expanding and may continue to expand through consolidation and internal growth, which may increase their buying power, which could materially and adversely affect our sales, results of operations and financial position.

Certain of our important customers are large companies with significant buying power.  In addition, potential further consolidation in the distribution channels could enhance the ability of certain of our customers to seek more favorable terms, including pricing, for the products that they purchase from us.  Accordingly, our ability to maintain or raise prices in the future may be limited, including during periods of raw material and other cost increases.  If we are forced to reduce prices or to maintain prices during periods of increased costs, or if we lose customers because of pricing or other methods of competition, our sales, operating results and financial position may be materially and adversely affected.


12


Because we depend on a core group of significant customers, our sales, cash flows from operations and results of operations may decline if our key customers reduce the amount of products that they purchase from us.

Our top ten customers accounted for approximately 47.5% of our net sales for the year ended December 31, 2017.  Our largest customer for the year ended December 31, 2017, ABC Supply Co., Inc., distributes our products within its building products distribution business, and accounted for approximately 12.5% of our consolidated 2017 net sales.  We expect a small number of customers to continue to account for a substantial portion of our net sales for the foreseeable future.

The loss of, or a significant adverse change in our relationships with, our largest customer or any other major customer, or loss of market position of any major customer, could cause a material decrease in our net sales.  The loss of, or a reduction in orders from, any significant customers, losses arising from customers’ disputes regarding shipments, fees, merchandise condition or performance or related matters, or our inability to collect accounts receivable from any major customer could cause a decrease in our net income and our cash flow.  In addition, revenue from customers that have accounted for significant revenue in past periods, individually or as a group, may not continue, or if continued, may not reach or exceed historical levels in any period.

We are subject to the credit risk of our customers.

We are subject to the credit risk of our customers because we provide credit to our customers in the normal course of business. All of our customers are sensitive to economic changes and to the cyclical nature of the building industry. Especially during protracted or severe economic declines and cyclical downturns in the building industry, our customers may be unable to perform on their payment obligations, including their debts to us. Any failure by our customers to meet their obligations to us may have a material adverse effect on our business, financial condition, and results of operations. In addition, we may incur increased expenses related to collections in the future if we find it necessary to take legal action to enforce the contractual obligations of a significant number of our customers.

Our business is seasonal and can be affected by inclement weather conditions that could affect the timing of the demand for our products and cause reduced profit margins when such conditions exist.

Markets for our products are seasonal and can be affected by inclement weather conditions.  Historically, our business has experienced increased sales in the second and third quarters of the year due to increased construction during those periods.  Because much of our overhead and operating expenses are spread ratably throughout the year, our operating profits tend to be lower in the first and fourth quarters.  Inclement weather conditions can affect the timing of when our products are applied or installed, causing reduced profit margins when such conditions exist. For example, unseasonably cold weather or extraordinary amounts of rainfall may decrease construction activity.

Increases in union organizing activity and work stoppages at our facilities or the facilities of our suppliers could delay or impede our production, reduce sales of our products and increase our costs.

Our financial performance is affected by the cost of labor.  As of December 31, 2017, approximately 5.0% of our employees were represented by labor unions.  We are subject to the risk that strikes or other types of conflicts with personnel may arise or that we may become a subject of union organizing activity.  Furthermore, some of our direct and indirect suppliers have unionized work forces.  Strikes, work stoppages or slowdowns experienced by these suppliers could result in slowdowns or closures of facilities where components of our products are manufactured.  Any interruption in the production or delivery of our products could reduce sales of our products and increase our costs.

Our ability to operate and our growth potential could be materially and adversely affected if we cannot employ, train and retain qualified personnel at a competitive cost.

Many of the products that we manufacture and assemble require manual processes in plant environments. We believe that our success depends upon our ability to attract, employ, train and retain qualified personnel with the ability to design, manufacture and assemble these products. In addition, our ability to expand our operations depends in part on our ability to increase our skilled labor force as the housing market continues to recover in the United States and Canada. A significant increase in the wages paid by competing employers could result in a reduction of our qualified labor force, increases in the wage rates that we must pay, or both. In addition, we believe that our success depends in part on our ability to quickly and effectively train additional workforce to handle the increased volume and production while minimizing labor inefficiencies and maintaining product quality in a housing market recovery. If either of these events were to occur, our cost structure could increase, our margins could decrease, and any growth potential could be impaired.


13


We may be subject to claims arising from the operations of our various businesses arising from periods prior to the dates we acquired them.  Our ability to seek indemnification from the former owners of our subsidiaries may be limited, in which case, we would be liable for these claims.

We have acquired all of our subsidiaries, including Ply Gem Industries, MWM Holding, AWC Holding Company, MHE, Pacific Windows, Gienow, Mitten, Simonton, and substantially all of the assets of Ply Gem Stone, Canyon Stone, and Greendeck Products, LLC, in the last several years.  We may be subject to claims or liabilities arising from the ownership or operation of our subsidiaries for the periods prior to our acquisition of them, including environmental liabilities.  These claims or liabilities could be significant.  Our ability to seek indemnification from the former owners of our subsidiaries for these claims or liabilities is limited by various factors, including the specific limitations contained in the respective acquisition agreements and the financial ability of the former owners to satisfy such claims or liabilities. If we are unable to enforce any indemnification rights we may have against the former owners or if the former owners are unable to satisfy their obligations for any reason, including because of their current financial position, or if we do not have any right to indemnification, we could be held liable for the costs or obligations associated with such claims or liabilities, which could adversely affect our operating performance.
 
We could face potential product liability claims, including class action claims and warranties, relating to products we manufacture.

We face an inherent business risk of exposure to product liability claims, including class action claims and warranties, in the event that the use of any of our products results in personal injury or property damage.  In the event that any of our products is defective or proves to be defective, among other things, we may be responsible for damages related to any defective products and we may be required to cease production, recall or redesign such products.  Because of the long useful life of our products, it is possible that latent defects might not appear for several years.  Any insurance we maintain may not continue to be available on terms acceptable to us or such coverage may not be adequate for liabilities actually incurred.  Further, any claim or product discontinuance, recall or redesign could result in adverse publicity against us, which could cause our sales to decline, or increase our warranty costs.

We could face other types of litigation outside of product liability claims that could result in costly defense efforts.

We are from time to time involved in various claims, litigation matters and regulatory proceedings that arise in the ordinary course of our business which could have a material adverse effect on us. These matters may include contract disputes, workers compensation and other personal injury claims, warranty disputes, other tort claims, employment and tax matters and other proceedings and litigation, including class action lawsuits. We have generally denied liability and have vigorously defended these cases. Due to their scope and complexity, however, these lawsuits can be particularly costly to defend and resolve, and we have and may continue to incur significant costs as a result of these types of lawsuits. Although we intend to defend all claims and litigation matters vigorously, given the inherently unpredictable nature of claims and litigation, we cannot predict with certainty the outcome or effect of any claim or litigation matter. We maintain insurance against some, but not all, of these risks of loss resulting from claims and litigation. The levels of insurance we maintain may not be adequate to fully cover any and all losses or liabilities. If any significant accident, judgment, claim or other event is not fully insured or indemnified against, it could have a material adverse impact on our business, financial condition and results of operations.
We are dependent on certain key personnel, the loss of whom could materially affect our financial performance and prospects.

Our continued success depends to a large extent upon the continued services of our senior management and certain key employees.  To encourage the retention of certain key executives, we have entered into various equity-based compensation agreements with our senior executives, including Messrs. Robinette, Poe, and Wayne designed to encourage their retention.  Each member of our senior management team has substantial experience and expertise in our industry and has made significant contributions to our growth and success.  We do face the risk, however, that members of our senior management may not continue in their current positions and the loss of their services could cause us to lose customers and reduce our net sales, lead to employee morale problems and/or the loss of key employees, or cause disruptions to our production.  Also, we may be unable to find qualified individuals to replace any of the senior executive officers who leave our company.


14


Operational problems or disruptions at any of our facilities may cause significant lost production and increased lead times, which could have a negative impact on the efficiency of our production and profitability.

Our manufacturing processes could be affected by operational problems that could impair our production capability. Disruptions at any of our facilities could be caused by maintenance outages; prolonged power failures or reductions; a breakdown, failure or substandard performance of any of our equipment; disruptions in the transportation infrastructure, including railroad tracks, bridges, tunnels or roads; fires, floods, hurricanes, earthquakes or other catastrophic disasters; an act of terrorism; or other operational problems. Any prolonged disruption in operations at any of our facilities could cause a significant loss in production. As a result, we could incur significantly higher costs and longer lead times associated with distributing our products to our customers during the time that it takes for us to reopen or replace a damaged facility, which could cause our customers to purchase from our competitors either temporarily or permanently. If any of these events were to occur, it could adversely effect on our business, financial condition and results of operations.

Interruptions in deliveries of raw materials or finished goods could adversely affect our production and increase our costs, thereby decreasing our profitability.

Our dependency upon regular deliveries from suppliers means that interruptions or stoppages in such deliveries could adversely affect our operations until arrangements with alternate suppliers could be made.  If any of our suppliers were unable to deliver materials to us for an extended period of time, as the result of financial difficulties, catastrophic events affecting their facilities or other factors beyond our control, or if we were unable to negotiate acceptable terms for the supply of materials with these or alternative suppliers, our business could suffer.  We may not be able to find acceptable alternatives, and any such alternatives could result in increased costs for us.  Even if acceptable alternatives were found, the process of locating and securing such alternatives might be disruptive to our business.  Extended unavailability of a necessary raw material or finished goods could cause us to cease manufacturing one or more of our products for a period of time.

Additionally, our suppliers may be forced to cease operations unexpectedly due to equipment failures or events beyond their control, such as fires, floods, hurricanes, earthquakes or other environmental catastrophes. Any downtime or facility damage may impact their ability to deliver critical raw materials to us. If any of our key suppliers were to experience such issues and not be able to deliver raw materials for a prolonged period, it would reduce our ability to effectively produce our finished goods, which could materially and adversely affect our business, financial condition, operating results and cash flows.

Changes in building codes and standards could increase the cost of our products, lower the demand for our products, or otherwise adversely affect our business.
Our products and markets are subject to extensive and complex local, state, federal, and foreign statutes, ordinances, rules, and regulations. These mandates, including building design and safety and construction standards and zoning requirements, affect the cost, selection, and quality requirements of building components like windows and siding.
These statutes, ordinances, rules, and regulations often provide broad discretion to governmental authorities as to the types and quality specifications of products used in new residential and non-residential construction and home renovations and improvement projects, and governmental authorities can impose different standards. Compliance with these standards and changes in such statutes, ordinances, rules, and regulations may increase the costs of manufacturing our products or may reduce the demand for certain of our products in the affected geographical areas or product markets. Conversely, a decrease in product safety standards could reduce demand for our more modern products if less expensive alternatives that did not meet higher standards became available for use in that market. All or any of these changes could have a material adverse effect on our business, financial condition, and results of operations.


15


Environmental requirements may impose significant costs and liabilities on us.

Our facilities are subject to numerous United States and Canadian federal, state, provincial and local laws and regulations relating to pollution and the protection of the environment, including those governing emissions to air, discharges to water, use, storage, treatment, disposal and transport of hazardous waste and other materials, investigation and remediation of contaminated sites and protection of worker health and safety.  From time to time, our facilities are subject to investigation by governmental authorities.  In addition, we have been identified as one of many potentially responsible parties for contamination present at certain offsite locations to which we or our predecessors are alleged to have sent hazardous materials for recycling or disposal.  We may be held liable, or incur fines or penalties in connection with such requirements or liabilities for, among other things, hazardous substances used in or released from our current or former operations or products, releases of hazardous substances occurring on or emanating from current or formerly owned or operated properties or any associated offsite disposal location, or for known or newly-discovered contamination at any of our properties from activities conducted by previous occupants.  The amount of such liability, fine or penalty may be material.  For example, MW, a subsidiary of MWM Holding, entered into an Administrative Order on Consent with the EPA relating to contamination at its Rocky Mount, Virginia property. Certain environmental laws impose strict, and under certain circumstances joint and several, liability for the cost of addressing releases of hazardous substances upon certain classes of persons, including site owners or operators and persons that disposed or arranged for the disposal of hazardous substances at contaminated sites.

In addition, changes in environmental laws and regulations or in their enforcement, the discovery of previously unknown contamination or other liabilities relating to our properties and operations or the inability to enforce the indemnification obligations of the previous owners of our subsidiaries could result in significant environmental liabilities that could adversely impact our operating performance. In addition, we might incur significant capital and other costs to comply with increasingly stringent United States or Canadian environmental laws or enforcement policies that would decrease our cash flow.

Finally, while the purchase agreements governing certain of our acquisitions provide that the sellers will indemnify us, subject to certain limitations, for certain environmental liabilities, our ability to seek indemnification from the respective sellers is limited by various factors, including the financial condition of the indemnitor or responsible party as well as by the terms and limits of such indemnities or obligations. As a result, there can be no assurance that we could receive any indemnification from the sellers, and any related environmental liabilities, costs or penalties could have a material adverse effect on our financial condition and results of operations.

Our ability to consummate and effectively integrate future acquisitions, if any, will be critical to maintaining and improving our operating performance.

We will continue to pursue strategic acquisitions into our business if they provide future financial and operational benefits. Successful completion of any strategic transaction depends on a number of factors that are not entirely within our control, including our ability to negotiate acceptable terms, conclude satisfactory agreements and obtain all necessary regulatory approvals. There can be no assurance that we will consummate future acquisitions. In addition, our ability to effectively integrate these acquisitions into our existing business, culture, and financial reporting processes and internal controls may not be successful which could jeopardize future operational performance for the combined businesses.
Manufacturing or assembly realignments may result in a decrease in our short-term earnings, until the expected cost reductions are achieved, due to the costs of implementation.

We continually review our manufacturing and assembly operations and sourcing capabilities.  Effects of periodic manufacturing realignment, cost savings programs, and labor ramp-up costs could result in a decrease in our short-term earnings until the expected cost reductions are achieved and/or production volumes stabilize.  Such programs may include the consolidation and integration of facilities, functions, systems and procedures.  Such actions may not be accomplished as quickly as anticipated and the expected cost reductions may not be achieved or sustained.


16


We rely on a variety of intellectual property rights.  Any threat to, or impairment of, these rights could cause us to incur costs to defend these rights.

As a company that manufactures and markets branded products, we rely heavily on trademark and service mark protection to protect our brands.  We also have issued patents and rely on trade secret and copyright protection for certain of our technologies.  These protections may not adequately safeguard our intellectual property and we may incur significant costs to defend our intellectual property rights, which may harm our operating results.  There is a risk that third parties, including our current competitors, will infringe on our intellectual property rights, in which case we would have to defend these rights.  There is also a risk that third parties, including our current competitors, will claim that our products infringe on their intellectual property rights.  These third parties may bring infringement claims against us or our customers, which may harm our operating results.

We also rely on third party license agreements for certain trademarks and technologies we employ. There is a risk that third parties may modify or terminate such licenses, which may harm our operating results. While these license agreements generally provide that the licensors will indemnify us, subject to certain limitations, for certain infringement liabilities, our ability to seek indemnification from the respective licensors is limited by various factors, including the financial condition of the licensor as well as by the terms and limits of such indemnities or obligations. As a result, there can be no assurance that we could receive any indemnification from licensors, and any related infringement liabilities, costs or penalties could have a material adverse effect on our financial condition and results of operations.

Increases in transportation, freight and fuel costs could cause our cost of products sold to increase and net income to decrease.

Increases in transportation, freight and fuel costs could negatively impact our cost to deliver our products to our customers and thus increase our cost of products sold.  The Company estimates that a 10% increase in fuel costs for the year ended December 31, 2017 would have increased costs of products sold during such period by approximately $1.0 million. In addition to fuel costs, the availability of truck drivers and lane availability from third party carriers can also negatively impact our profit margins if market prices increase significantly for these freight services. If we are unable to increase the selling price of our products to our customers to cover any increases in transportation and fuel costs, net income may be adversely affected.

Changes in foreign currency exchange and interest rates could have a material adverse effect on our operating results and liquidity.

We have operations in Canada that generated approximately 10.9% of our revenues in 2017. As such, our net sales, earnings and cash flow are exposed to risk from changes in foreign exchange rates, which can be difficult to mitigate. For example, during 2017 the U.S. dollar weakened against the Canadian dollar by approximately 2.0%. Depending on the direction of changes relative to the U.S. dollar, Canadian dollar values can increase or decrease the reported values of our net assets and results of operations. The change in foreign currency exchange rates had a $4.3 million and $1.1 million net favorable translation impact on our net sales and gross profit, respectively, in 2017 compared to 2016 rates. We hedge this foreign currency exposure by evaluating the usage of certain derivative instruments which hedge certain, but not all, underlying economic exposures.
We are also exposed to changes in interest rates as the Term Loan and ABL Facility bear interest at variable interest rates. As a result, future interest rate increases will negatively impact our financial results. Our ability to access capital markets could also be impeded if adverse liquidity market conditions occur.
Declines in our business conditions may result in an impairment of our tangible and intangible assets, which could result in a material non-cash charge.

A negative long-term performance outlook could result in a net sales decrease, which could result in a decrease in operating cash flows, adversely impacting our business and results of operations, and have a material adverse effect on our financial condition.  These declines could result in an impairment of our tangible and intangible assets which results when the carrying value of the assets exceed their fair value.


17


The significant amount of our indebtedness may limit the cash flow available to invest in the ongoing needs of our business.

Our indebtedness could have important consequences. For example, it could:
 
require us to dedicate a substantial portion of our cash flow from operations to interest and principal payments on our indebtedness, reducing the availability of our cash flow for other purposes, such as capital expenditures, acquisitions and working capital;
limit our flexibility in planning for, or reacting to, changes in our business, the industry in which we operate and the general economy;
place us at a disadvantage compared to our competitors that have less debt;
expose us to fluctuations in the interest rate environment because the interest rates of our ABL Facility and our Term Loan Facility are at variable rates; and
limit our ability to borrow additional funds.

Any of the foregoing could have a material adverse effect on our business, financial condition, results of operations, and ability to satisfy our obligations under our indebtedness.

The terms of our debt covenants and the Merger Agreement could limit how we conduct our business and our ability to raise additional funds.

The agreements that govern the terms of our debt, including the credit agreement that governs the ABL Facility, the credit agreement that governs the Term Loan Facility and the indenture governing the 6.50% Senior Notes, contain covenants that restrict our ability and the ability of our subsidiaries to:

incur and guarantee indebtedness or issue equity interests of restricted subsidiaries;
repay subordinated indebtedness prior to its stated maturity;
pay dividends or make other distributions on or redeem or repurchase our stock;
issue capital stock;
make certain investments or acquisitions;
create liens;
sell certain assets or merge with or into other companies;
enter into certain transactions with stockholders and affiliates;
make capital expenditures; and
pay dividends, distributions or other payments from our subsidiaries.

These restrictions, in addition to the restrictions under the Merger Agreement, may affect our ability to grow our business and take advantage of market and business opportunities or to raise additional debt or equity capital.

In addition, under the ABL Facility, if (a) our excess availability is less than the greater of (x) 10.0% of the lesser of the aggregate commitments and the borrowing base and (y) $25.0 million or (b) an event of default has occurred and is continuing, we will be required to comply with a minimum fixed charge coverage ratio test. Our ability to meet the required fixed charge coverage ratio can be affected by events beyond our control, and we cannot assure that we will meet this ratio.  A breach of any of these covenants under the ABL Facility, Term Loan Facility or the indenture governing the 6.50% Senior Notes could result in an event of default under the ABL Facility, the Term Loan Facility, and/or the indenture. An event of default under any of our debt agreements would permit some of our lenders to declare all amounts borrowed from them to be due and payable and, in some cases, proceed against the collateral securing such indebtedness.

Moreover, the ABL Facility provides the lenders considerable discretion to impose reserves or availability blocks, which could materially impair the amount of borrowings that would otherwise be available to us.  There can be no assurance that the lenders under the ABL Facility will not impose such actions during the term of the ABL Facility and further, were they to do so, the resulting impact of this action could materially and adversely impair our liquidity.
 

18


We may be unable to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under such indebtedness, which may not be successful.  We may also be unable to generate sufficient cash to make required capital expenditures.

Our ability to make scheduled payments on or to refinance our debt obligations and to make capital expenditures depends on our financial condition and operating performance, which is subject to prevailing economic and competitive conditions and to financial, business and other factors.  We will not be able to control many of these factors, such as economic conditions in the industry in which we operate and competitive pressures.  We cannot assure that we will maintain a level of cash flows from operating activities sufficient to permit us to pay or refinance our indebtedness, including the 6.50% Senior Notes or our indebtedness under our ABL Facility or Term Loan Facility, or make required capital expenditures.  If our cash flows and capital resources are insufficient to fund our debt service obligations, we and our subsidiaries could face substantial liquidity problems and may be forced to reduce or delay capital expenditures, sell assets, seek additional capital or restructure or refinance our indebtedness.

In addition, if we do not have, or are unable to obtain, adequate funds to make all necessary capital expenditures when required, or if the amount of future capital expenditures are materially in excess of our anticipated or current expenditures, our product offerings may become dated, our productivity may decrease and the quality of our products may decline, which, in turn, could reduce our sales and profitability.
A downgrade of our external credit ratings could adversely impact our interest expense as well as future borrowings.

Our credit ratings are important to our cost of capital. The major debt rating agencies routinely evaluate our debt based on a number of factors, which include financial strength and business risk as well as transparency with rating agencies and timeliness of financial reporting. A downgrade in our debt rating could result in increased interest and other expenses on our existing variable interest rate debt, and could result in increased interest and other financing expenses on future borrowings. Downgrades in our debt rating could also restrict our access to capital markets and affect the value and marketability of our outstanding notes.
Recently enacted U.S. tax law revisions could materially impact our financial results.

On December 22, 2017, the U.S. government enacted comprehensive tax legislation, H.R. 1, originally known as the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act makes broad and complex changes to the Internal Revenue Code (the "Code") including, but not limited to, reducing the U.S. federal corporate tax rate from 35% to 21%, requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries, generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries, requiring a current inclusion in U.S. federal taxable income of certain earnings of controlled foreign corporations, eliminating the corporate alternative minimum tax ("AMT") and changing how existing AMT credits can be realized, creating the base erosion anti-abuse tax ("BEAT"), creating a general limitation on deductible interest expense, and changing rules related to the utilization of net operating loss carryforwards created in tax years after December 31, 2017.

ASC 740 Income Taxes requires a company to record the effects of a tax law change in the period of enactment. Due to the complexities involved in accounting for the recently enacted Tax Act, the U.S. Securities and Exchange Commission’s Staff Accounting Bulletin (“SAB”) 118 requires that we include in our financial statements a reasonable estimate of the impact of the Tax Act on earnings to the extent such reasonable estimate has been determined. Although we believe these provisional amounts represent a reasonable estimate of the ultimate enactment-related impact the Tax Act will have on our consolidated financial statements, the amounts could be adjusted materially as additional information becomes available and further analyses are completed. The impact of the Tax Act to our business in future periods is also subject to a variety of factors beyond our control including, but not limited to, (i) potential amendments to the Tax Act; (ii) potential changes to state, local, and foreign tax laws in response to the Tax Act; and (iii) potential new or interpretative guidance issued by the Financial Accounting Standards Board or the Internal Revenue Service and other tax agencies. Any of these factors could cause our actual results to differ materiality from our current expectations and/or investors' expectations and there can be no assurance that the Tax Act will not have a materially adverse impact on our financial results.

19


We will be required to pay an affiliate of Ply Gem Holdings’ stockholders for certain tax benefits, including net operating loss carryovers, we may claim, and the amounts we may pay could be significant.
In connection with Ply Gem Holdings’ initial public offering, Ply Gem Holdings entered into a tax receivable agreement (the "Tax Receivable Agreement") with an entity controlled by an affiliate of the CI Partnerships (the “Tax Receivable Entity”). The Tax Receivable Agreement generally provides for the payment by us to the Tax Receivable Entity of 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that we actually realize in periods after the initial public offering as a result of (i) NOL carryovers from periods (or portions thereof) ending before January 1, 2013, (ii) deductible expenses attributable to the transactions related to the initial public offering and (iii) deductions related to imputed interest deemed to be paid by us as a result of or attributable to payments under the Tax Receivable Agreement.
The amount and timing of any payments under the Tax Receivable Agreement will vary depending upon a number of factors, including the amount and timing of the taxable income we generate in the future and the tax rate then applicable, our use of NOL carryovers and the portion of our payments under the Tax Receivable Agreement constituting imputed interest.

The payments we will be required to make under the Tax Receivable Agreement could be substantial. We expect that, as a result of the amount of the NOL carryovers from prior periods (or portions thereof) and assuming that we earn sufficient taxable income to realize the potential tax benefit described above, future payments under the Tax Receivable Agreement, in respect of the federal and state NOL carryovers, would be approximately $74.7 million in the aggregate and may be paid within the next five years, assuming that utilization of such tax attributes is not subject to limitation under Section 382 of the Code as the result of an “ownership change” (within the meaning of Section 382 of the Code) of Ply Gem Holdings. These amounts reflect only the cash savings attributable to current tax attributes resulting from the NOL carryovers. It is possible that future transactions or events could increase or decrease the actual tax benefits realized and the corresponding Tax Receivable Agreement payments from these tax attributes.
In addition, although we are not aware of any issue that would cause the U.S. Internal Revenue Service (“IRS”) to challenge the benefits arising under the Tax Receivable Agreement, the Tax Receivable Entity will not reimburse us for any payments previously made if such benefits are subsequently disallowed. As a result, in such circumstances, we could make payments under the Tax Receivable Agreement that are greater than our actual cash tax savings and may not be able to recoup those payments, which could adversely affect our liquidity. However, any excess payments made to the Tax Receivable Entity will be netted against payments otherwise to be made, if any, after our determination of such excess.
Finally, because Ply Gem Holdings is a holding company with no operations of its own, its ability to make payments under the Tax Receivable Agreement is dependent on the ability of Ply Gem Industries and its subsidiaries to make distributions to it. We may be required to make payments to Ply Gem Holdings to fund payments under the Tax Receivable Agreement, and the indenture governing the notes will permit us to make such payments. To the extent that Ply Gem Holdings is unable to make payments under the Tax Receivable Agreement for any reason, such payments will be deferred and will accrue interest until paid, which could adversely affect our results of operations and could also affect our liquidity in periods in which such payments are made.
In addition, the Tax Receivable Agreement provides that, upon certain mergers, asset sales, or other forms of business combinations or certain other changes of control, Ply Gem Holdings’ or its successor’s obligations with respect to tax benefits would be based on certain assumptions, including that Ply Gem Holdings or its successor would have sufficient taxable income to fully utilize the NOL carryovers covered by the Tax Receivable Agreement. As a result, upon a change of control, Ply Gem Holdings may be required to make payments under the Tax Receivable Agreement that are greater than or less than the specified percentage of actual cash tax savings.


20


Our systems and IT infrastructure may be subject to security breaches and other cyber security incidents.

Purchase of our products may involve the transmission and/or storage of data, including in certain instances customers' business and personally identifiable information. Thus, maintaining the security of computers, computer networks and data storage resources is a critical issue for us and our customers, as security breaches could result in vulnerabilities and loss of and/or unauthorized access to confidential information. We may face attempts by experienced hackers, cybercriminals or others with authorized access to our systems to misappropriate our proprietary information and technology, interrupt our business, and/or gain unauthorized access to confidential information. The reliability and security of our information technology infrastructure and software, and our ability to expand and continually update technologies in response to our changing needs is critical to our business. To the extent that any disruptions or security breaches result in a loss or damage to our data, it could cause harm to our reputation or brand. This could lead some customers to stop purchasing our products and reduce or delay future purchases of our products or use competing products; state or federal enforcement action, which could result in fines, penalties and/or other liabilities and which may cause us to incur legal fees and costs, and/or additional costs associated with responding to a cyberattack. Increased regulation regarding cyber security may increase our costs of compliance, including fines and penalties, as well as costs of cyber security audits. Any of these actions could materially adversely impact our business and results of operations.

We have invested in industry appropriate protections and monitoring practices of our data and information technology to reduce these risks and continue to monitor our systems on an ongoing basis for any current or potential threats. There can be no assurance, however, that our efforts will prevent breakdowns or breaches to our third party providers' databases or systems that could adversely affect our business.

We are controlled by the CI Partnerships whose interest in our business may be different than yours.

The CI Partnerships own approximately 66.7% of the outstanding common stock of Ply Gem Holdings, the direct parent company of Ply Gem Industries. Ply Gem Holdings has entered into an amended and restated stockholders agreement with the CI Partnerships and certain of our members of management. Under the stockholders agreement, the CI Partnerships are currently entitled to nominate a majority of the members of Ply Gem Holdings' board of directors and all of the parties to the stockholders agreement have agreed to vote their shares of our common stock as directed by the CI Partnerships. Accordingly, the CI Partnerships will be able to exercise significant influence over our business policies and affairs. In addition, the CI Partnerships can control any action requiring the general approval of Ply Gem Holdings' stockholders, including the election of directors, the adoption of amendments to Ply Gem Holdings' certificate of incorporation or by-laws and the approval of mergers or sales of substantially all of our assets.

Significant changes in factors and assumptions used to measure our defined benefit plan obligations, actual investment returns on pension assets and other factors could negatively impact our operating results and cash flows.

The recognition of costs and liabilities associated with our pension plans for financial reporting purposes is affected by assumptions made by management and used by actuaries engaged by us to calculate the benefit obligations and the expenses recognized for these plans. The inputs used in developing the required estimates are calculated using a number of assumptions, which represent management’s best estimate of the future. The assumptions that have the most significant impact on reported results are the discount rate, the estimated long-term return on plan assets for the funded plans, retirement rates, and mortality rates. These assumptions are generally updated annually.
    
Our pension plans were underfunded by $14.2 million as of December 31, 2017. In recent years, the declining interest rates and changes to mortality assumptions have negatively impacted the funded status of our pension plans. In addition, volatile asset performance, most notably since 2008, has also negatively impacted the funded status of our pension plans. Funding requirements for our pension plans may become more significant. If our cash flows and capital resources are insufficient to fund our pension plan obligations, we could be forced to reduce or delay investments and capital expenditures, seek additional capital, or restructure or refinance our indebtedness.


Item 1B.  UNRESOLVED STAFF COMMENTS

None.

Item 2.      PROPERTIES

Our corporate headquarters is located in Cary, North Carolina.  We own and lease several additional properties in the United States and Canada.  We operate the following facilities as indicated, and each facility is leased unless indicated with “Owned” under the Lease Expiration Date column below.
Location
 
Square Footage
 
Facility Use
 
Lease
Expiration Date
 
 
 
 
 
 
 
Siding, Fencing, and Stone Segment
 
 
Jasper, TN
 
270,000
 
Manufacturing and Administration
 
Owned
Fair Bluff, NC (1)
 
198,000
 
Manufacturing and Administration
 
9/30/2024
Kearney, MO (1)
 
175,000
 
Manufacturing and Administration
 
9/30/2024
Valencia, PA (2)
 
104,000
 
Manufacturing and Administration
 
9/30/2024
Martinsburg, WV (1)
 
163,000
 
Manufacturing and Administration
 
9/30/2024
Martinsburg, WV
 
195,000
 
Warehouse
 
12/1/2019
York, NE (1)
 
76,000
 
Manufacturing
 
9/30/2024
Stuarts Draft, VA
 
257,000
 
Manufacturing and Administration
 
Owned
Sidney, OH
 
819,000
 
Manufacturing and Administration
 
Owned
Gaffney, SC
 
259,000
 
Manufacturing and Administration
 
Owned
Harrisonburg, VA
 
358,000
 
Warehouse
 
7/31/2023
Kansas City, MO
 
36,000
 
Administration
 
12/31/2022
South Pittsburgh, TN
 
95,000
 
Warehouse
 
10/31/2018
Gaffney, SC
 
150,000
 
Warehouse
 
12/31/2020
Paris, ON, Canada
 
132,000
 
Manufacturing and Administration
 
Owned
Brantford, ON, Canada
 
225,000
 
Warehouse and Administration
 
1/31/2020
Mount Pearl, NFLD, Canada
 
20,000
 
Warehouse
 
10/31/2019
Dartmouth, NS, Canada
 
16,000
 
Warehouse
 
4/30/2022
Dartmouth, NS, Canada
 
15,000
 
Warehouse
 
1/31/2019
Saint John, NB, Canada
 
14,000
 
Warehouse
 
3/31/2018
Moncton, NB, Canada
 
19,000
 
Warehouse
 
7/31/2020
Fredericton, NB, Canada
 
16,000
 
Warehouse
 
12/31/2020
Le Gardeur, QC, Canada
 
20,000
 
Warehouse
 
8/31/2019
St. Hubert, QC, Canada
 
9,000
 
Warehouse
 
3/31/2019
Ottawa, ON, Canada
 
26,000
 
Warehouse
 
12/31/2022
Scarborough, ON, Canada
 
20,000
 
Warehouse
 
2/28/2019
London, ON, Canada
 
18,000
 
Warehouse
 
4/30/2022
Calgary, AB, Canada
 
41,000
 
Warehouse and Administration
 
8/31/2024
Edmonton, AB, Canada
 
37,000
 
Warehouse
 
12/31/2018
Langley, BC, Canada
 
17,000
 
Warehouse
 
10/31/2021
Selinsgrove, PA
 
86,000
 
Warehouse
 
5/31/2021
Olathe, KS
 
95,000
 
Manufacturing and Administration
 
5/31/2025
Youngsville, NC
 
75,000
 
Manufacturing and Administration
 
5/31/2025
Apopka, FL
 
18,000
 
Warehouse and Administration
 
5/30/2019
Clive, IA
 
2,000
 
Warehouse and Administration
 
2/29/2020
Adamstown, MD
 
1,000
 
Warehouse and Administration
 
10/19/2018
Charlotte, NC
 
4,000
 
Warehouse and Administration
 
3/30/2020
Mineral Wells, WV
 
20,000
 
Warehouse
 
1/1/2020
 
 
 
 
 
 
 
Windows and Doors Segment
 
 
 
 
Walbridge, OH (1)
 
250,000
 
Manufacturing and Administration
 
9/30/2024
Walbridge, OH
 
20,000
 
Warehouse
 
5/30/2018
Rocky Mount, VA (1)
 
600,000
 
Manufacturing and Administration
 
9/30/2024
Rocky Mount, VA
 
163,000
 
Manufacturing
 
5/31/2023
Rocky Mount, VA
 
180,000
 
Manufacturing
 
12/31/2023
Rocky Mount, VA
 
70,000
 
Warehouse
 
11/1/2021
Rocky Mount, VA
 
80,000
 
Warehouse
 
12/31/2023
Rocky Mount, VA
 
120,000
 
Warehouse
 
12/31/2023
Fayetteville, NC
 
56,000
 
Warehouse
 
Owned
Peachtree City, GA
 
148,000
 
Manufacturing and Administration
 
8/20/2024
Peachtree City, GA
 
40,000
 
Manufacturing and Administration
 
Owned
Dallas, TX
 
213,000
 
Manufacturing and Administration
 
2/17/2019
Bryan, TX
 
273,000
 
Manufacturing and Administration
 
8/20/2024
Bryan, TX
 
75,000
 
Manufacturing
 
8/31/2019
Auburn, WA
 
262,000
 
Manufacturing and Administration
 
1/31/2022
Corona, CA
 
128,000
 
Manufacturing and Administration
 
12/31/2020
Sacramento, CA
 
234,000
 
Manufacturing and Administration
 
9/12/2019
Calgary, AB, Canada (1)
 
301,000
 
Manufacturing and Administration
 
9/30/2024
Edmonton, AB, Canada
 
29,000
 
Warehouse
 
4/30/2021
Red Deer, AB, Canada
 
12,000
 
Warehouse
 
4/30/2018
Medicine Hat, AB, Canada
 
9,000
 
Warehouse
 
12/31/2020
Regina, SK, Canada
 
19,000
 
Warehouse
 
3/31/2021
Saskatoon, SK, Canada (3)
 
35,000
 
Warehouse
 
10/31/2027
Calgary, AB, Canada
 
351,000
 
Manufacturing and Administration
 
10/30/2022
Kelowna, BC, Canada
 
15,000
 
Warehouse
 
6/30/2021
Prince George, BC, Canada
 
16,000
 
Warehouse
 
5/31/2021
Vancouver, BC, Canada
 
17,000
 
Warehouse
 
10/31/2021
Edmonton, AB, Canada
 
18,000
 
Warehouse
 
4/30/2018
Lethbridge, AB, Canada
 
3,000
 
Warehouse
 
12/31/2018
Winnipeg, MB, Canada (3)
 
28,000
 
Warehouse
 
6/30/2022
Clairmont, AB, Canada
 
4,000
 
Warehouse
 
12/31/2018
Vacaville, CA
 
193,000
 
Manufacturing and Administration
 
9/12/2019
St. Marys, WV
 
198,000
 
Manufacturing and Administration
 
Owned
Ellenboro, WV
 
200,000
 
Manufacturing and Administration
 
Owned
Harrisville, WV
 
55,000
 
Manufacturing
 
Owned
Pennsboro, WV
 
101,000
 
Manufacturing and Administration
 
Owned
Paris, IL
 
224,000
 
Manufacturing and Administration
 
Owned
Vienna, WV
 
131,000
 
Warehouse
 
6/30/2018
Paris, IL
 
120,000
 
Warehouse
 
3/31/2025
Columbus, OH
 
23,000
 
Administration
 
5/31/2021
 
 
 
 
 
 
 
Corporate
 
 
 
 
 
 
Cary, NC
 
38,000
 
Administration
 
10/31/2020
Durham, NC
 
95,000
 
Research & Development
 
12/31/2022

(1)
These properties are included in a long-term lease entered into as a result of a sale/leaseback agreement entered into in August 2004.
(2)
This property was subleased to a third party starting in 2010.
(3)
These properties are utilized by the Siding, Fence and Stone segment as well as the Windows and Doors segment.


Item 3.      LEGAL PROCEEDINGS

From time to time, we may be involved in legal proceedings and litigation arising out of our operations and businesses that cover a wide range of matters, including, among others, environmental, contract, employment, intellectual property, securities, personal injury, property damage, product liability, warranty, and modification, adjustment or replacement of component parts or units sold, which may include product recalls.


21


Environmental

We are subject to United States and Canadian federal, state, provincial and local laws and regulations relating to pollution and the protection of the environment, including those governing emissions to air, discharges to water, use, storage, treatment, disposal and transport of hazardous waste and other materials, investigation and remediation of contaminated sites, and protection of worker health and safety. From time to time, our facilities are subject to investigation by governmental authorities. In addition, we have been identified as one of many potentially responsible parties for contamination present at certain offsite locations to which our entities or their predecessors are alleged to have sent hazardous materials for recycling or disposal. We may be held liable, or incur fines or penalties, in connection with such requirements or liabilities for, among other things, releases of hazardous substances occurring on or emanating from current or formerly owned or operated properties or any associated offsite disposal location, or for known or newly-discovered contamination at any of our properties from activities conducted by us or previous occupants. The amount of any liability, fine or penalty may be material, and certain environmental laws impose strict, and under certain circumstances joint and several, liability for the cost of addressing releases of hazardous substances upon certain classes of persons, including site owners or operators and persons that disposed or arranged for the disposal of hazardous substances at contaminated sites.

MW Manufacturers Inc. (“MW”), a subsidiary of MWM Holding, Inc., entered into an Administrative Order on Consent (the “Consent Order”), effective September 12, 2011, with the United States Environmental Protection Agency (“EPA”), under the Resource Conservation and Recovery Act (“RCRA”), with respect to its Rocky Mount, Virginia property. During 2011, as part of the Consent Order, MW provided the EPA, among other things, a RCRA Facility Investigation Workplan (the “Workplan”) as well as a preliminary cost estimate of approximately $1.8 million for the predicted assessment, remediation and monitoring activities to be conducted pursuant to the Consent Order over the remediation period, which is currently estimated through 2023. In 2012, the EPA approved the Workplan, which MW is currently implementing. We have recorded approximately $0.3 million of this environmental liability within current liabilities and approximately $1.1 million within other long-term liabilities in our consolidated balance sheets at December 31, 2017 and 2016, respectively.  We may incur costs that exceed our recorded environmental liability. We will adjust our environmental remediation liability in future periods, if necessary, as further information develops or circumstances change.

Environmental authorities are investigating groundwater contamination at a Superfund site in York, Nebraska. In 2010, sampling was conducted at the Kroy Building Products, Inc. (“Kroy”) facility in York, Nebraska. In February 2015, the EPA sent Kroy a request for information pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), and in May 2015, Kroy responded to the request for information. Kroy could have liability for investigation and remediation costs associated with the contamination. Given the current status of this matter, we have not recorded a liability in our consolidated balance sheets as of December 31, 2017 and December 31, 2016.

From time to time, we may incur investigation and remediation costs in connection with other facilities we currently own or operate or previously owned or operated. For example, we have a $0.1 million liability included in our consolidated balance sheets at December 31, 2017 and December 31, 2016, for potential contamination issues at our Calgary, Alberta property. In addition, we are required to contribute to investigation and remediation costs at various third party waste disposal facilities at which we or a related entity have been identified as a potentially responsible party.

We are a party to various acquisition and other agreements pursuant to which third parties agreed to indemnify us for certain costs relating to environmental liabilities. For example, we may be able to recover some of our Rocky Mount, Virginia investigation and remediation costs from U.S. Industries, Inc. and may be able to recover a portion of any costs incurred in connection with the Kroy contamination matter in York, Nebraska from Alcan Aluminum Corporation. Our ability to seek indemnification from parties that have agreed to indemnify us may be limited. There can be no assurance that we would receive any funds from these parties, and any related environmental liabilities or costs could have a material adverse effect on our financial condition and results of operations.

Based on current information, we are not aware of any environmental compliance obligations, claims or investigations that will have a material adverse effect on our results of operations, cash flows or financial position except as otherwise disclosed in our consolidated financial statements. However, there can be no guarantee that previously known or newly-discovered matters will not result in material costs or liabilities.

Self-insured risks


22


We maintain a broad range of insurance policies which include general liability insurance coverage and workers compensation. These insurance policies protect the Company against a portion of the risk of loss from claims. However, we retain a portion of the overall risk for such claims through our self-insured per occurrence and aggregate retentions, deductibles, and claims in excess of available insurance policy limits. Our general liability insurance includes coverage for certain damages arising out of product design and manufacturing defects. Our insurance coverage is generally subject to a per occurrence retention and certain coverage exclusions.

Our reserves for costs associated with claims, as well as incurred but not reported losses (“IBNR”), based on an outside actuarial analysis of its historical claims. These estimates make up a significant portion of our liability and are subject to a high degree of uncertainty due to a variety of factors, including changes in type of claims, claims reporting and resolution patterns, frequency and timing of claims, third party recoveries, estimates of claim values, claims management expenses (including legal fees and expert fees), insurance industry practices, the regulatory environment, and legal precedent. Adjustments to estimated reserves are recorded in the period in which the change in estimate occurs.

Litigation

During the past several years, we incurred increased litigation expense primarily related to the claims discussed below. We believe we have valid defenses to the outstanding claims discussed below and will vigorously defend all such claims; however, litigation is subject to many uncertainties and there cannot be any assurance that we will ultimately prevail or, in the event of an unfavorable outcome or settlement of litigation, that the ultimate liability would not be material and would not have a material adverse effect on our business, results of operations, cash flows or financial position.

In John Gulbankian v. MW Manufacturers, Inc. (“Gulbankian”), a purported class action filed in March 2010 in the United States District Court for the District of Massachusetts, plaintiffs, on behalf of themselves and all others similarly situated, alleged damages as a result of the defective design and manufacture of certain MW vinyl clad windows. In Eric Hartshorn and Bethany Perry v. MW Manufacturers, Inc. (“Hartshorn”), a purported class action filed in July 2012 in the District Court, plaintiffs, on behalf of themselves and all others similarly situated, alleged damages as a result of the defective design and manufacture of certain MW vinyl clad windows. In April 2014, plaintiffs in both the Gulbankian and Hartshorn cases filed a Consolidated Amended Class Action Complaint, making similar claims against all MW vinyl clad windows.

MW entered into a settlement agreement with plaintiffs as of April 2014 to settle both the Gulbankian and Hartshorn cases on a nationwide basis (the “Vinyl Clad Settlement Agreement”). The Vinyl Clad Settlement Agreement provides that this settlement applies to any and all MW vinyl clad windows manufactured from January 1, 1987 through May 23, 2014, and provides for a cash payment for eligible consumers submitting qualified claims showing, among other requirements, certain damage to their MW vinyl clad windows. The period for submitting qualified claims is the later of: (i) May 28, 2016, or (ii) the last day of the warranty period for the applicable window. On December 29, 2014, the District Court granted final approval of this settlement, as well as MW’s payment of attorneys' fees and costs to plaintiffs' counsel in the amount of $2.5 million. The Company and MW deny all liability in the settlements with respect to the facts and claims alleged. We, however, are aware of the substantial burden, expense, inconvenience and distraction of continued litigation, and therefore agreed to settle these matters.

As a result of the Vinyl Clad Settlement Agreement, we have a liability of approximately $1.4 million as of December 31, 2017 and December 31, 2016, with $0.7 million as a current liability within accrued expenses and $0.7 million as a noncurrent liability within other long-term liabilities in our consolidated balance sheets as of December 31, 2017 and December 31, 2016. It is possible that we may incur costs in excess of the recorded amounts; however, we currently expect that the total net cost will not exceed this liability.


23


In Anthony Pagliaroni et al. v. Mastic Home Exteriors, Inc. and Deceuninck North America, LLC, a purported class action filed in January 2012 in the United States District Court for the District of Massachusetts, plaintiffs, on behalf of themselves and all others similarly situated, allege damages as a result of the defective design and manufacture of Oasis composite deck and railing, which was manufactured by Deceuninck North America, LLC (“Deceuninck”) and sold by Mastic Home Exteriors, Inc. (“MHE”). The plaintiffs seek a variety of relief, including (i) economic and compensatory damages, (ii) treble damages, (iii) punitive damages, and (iv) attorneys' fees and costs of litigation. The damages sought in this action have not yet been quantified. The hearing regarding plaintiffs’ motion for class certification was held on March 10, 2015, and the District Court denied plaintiffs’ motion for class certification on September 22, 2015. On October 6, 2015, plaintiffs filed a petition for interlocutory appeal of the denial of class certification to the U.S. Court of Appeals for the First Circuit, and on April 12, 2016, the Court of Appeals denied this petition for appeal, meaning the case continues to be litigated with the individual named plaintiffs. Deceuninck, as the manufacturer of Oasis deck and railing, has agreed to indemnify MHE for certain liabilities related to this claim pursuant to the sales and distribution agreement, as amended, between Deceuninck and MHE. MHE's ability to seek indemnification from Deceuninck is, however, limited by the terms and limits of the indemnity as well as the strength of Deceuninck's financial condition, which could change in the future.

In re Ply Gem Holdings, Inc. Securities Litigation is a purported federal securities class action filed on May 19, 2014 in the United States District Court for the Southern District of New York against Ply Gem Holdings, Inc., several of its directors and officers, and the underwriters associated with our initial public offering ("IPO"). It is filed on behalf of all persons or entities, other than the defendants, who purchased the common shares of the Company pursuant and/or traceable to our IPO and seeks remedies under Sections 11 and 15 of the Securities Act of 1933, alleging that our Form S-1 registration statement was negligently prepared and materially inaccurate, containing untrue statements of material fact and omitting material information which was required to be disclosed. The plaintiffs seek a variety of relief, including (i) damages together with interest thereon and (ii) attorneys’ fees and costs of litigation. On October 14, 2014, Strathclyde Pension Fund was certified as lead plaintiff, and class counsel was appointed. Pursuant to the Underwriting Agreement, dated May 22, 2013, entered into in connection with the IPO, we have agreed to reimburse the underwriters for the legal fees and other expenses reasonably incurred by the underwriters’ law firm in its representation of the underwriters in connection with this matter. Pursuant to Indemnification Agreements, dated as of May 22, 2013, between us and each of the directors and officers named in this action, we have agreed to assume the defense of such directors and officers. During 2017, the parties have reached an agreement in principle to settle the matter for approximately $26.0 million and notified the Court of this, which is subject to the finalization of the settlement agreement, Court approval and requests for exclusion by members of the settlement class. We accrued the $26.0 million within accrued expenses as of December 31, 2017 in our consolidated balance sheet, and also initially recognized an insurance receivable of $25.4 million within other current assets that was offset by 2017 insurance proceeds of $8.7 million, for a net insurance receivable of $16.7 million as of December 31, 2017 in our consolidated balance sheet as certain of our directors' and officers' liability insurance carriers are to fund the majority of the settlement amount with us agreeing to pay certain disputed litigation expenses of approximately $0.6 million. The defendants deny all liability in the settlement and with respect to the facts and claims alleged. We, however, are aware of the substantial burden, expense, inconvenience and distraction of continued litigation, and therefore agreed to settle this matter.

In Raul Carrillo-Hueso and Chec Xiong v. Ply Gem Industries, Inc. and Ply Gem Pacific Windows Corporation, a purported class action filed on November 25, 2015 in the Superior Court of the State of California, County of Alameda, plaintiffs, on behalf of themselves and all others similarly situated, allege damages as a result of, among other things, the defendants’ failure to provide (a) statutorily required meal breaks at the Sacramento, California facility, (b) accurate wage statements to employees in California, and (c) all wages due on termination in California. The plaintiffs seek a variety of relief, including (i) economic and compensatory damages, (ii) statutory damages, (iii) penalties, (iv) pre- and post-judgment interest, and (v) attorneys' fees and costs of litigation. On January 7, 2017, the parties agreed to settle this matter for approximately $1.0 million, and on June 29, 2017, the Court granted final approval of the settlement. We accrued for this amount in accrued expenses as of December 31, 2016 in our consolidated balance sheet and subsequently paid the settlement during the year ended December 31, 2017. We deny all liability in the settlement and with respect to the facts and claims alleged. We, however, are aware of the substantial burden, expense, inconvenience and distraction of continued litigation, and therefore agreed to settle this matter.


24


In Tina Morgan v. Ply Gem Industries, Inc. and Simonton Industries, Inc., a purported class action filed on December 11, 2015 in the Superior Court of the State of California, County of Solano, plaintiff, on behalf of herself and all others similarly situated, alleges damages as a result of, among other things, the defendants’ failure at the Vacaville, California facility to (a) pay overtime wages, (b) provide statutorily required meal breaks, (c) provide accurate wage statements, and (iv) pay all wages owed upon termination. The plaintiff seeks a variety of relief, including (i) economic and compensatory damages, (ii) statutory damages, (iii) penalties, (iv) pre- and post-judgment interest, and (v) attorneys' fees and costs of litigation. On December 9, 2016, the parties agreed to settle this matter for approximately $0.9 million, and on May 22, 2017, the Court granted final approval of the settlement. We accrued for this amount in accrued expenses as of December 31, 2016 in our consolidated balance sheet and subsequently paid the settlement during the year ended December 31, 2017. We deny all liability in the settlement and with respect to the facts and claims alleged. We, however, are aware of the substantial burden, expense, inconvenience and distraction of continued litigation, and therefore agreed to settle this matter.

In Kiefer et al. v. Simonton Building Products, LLC et al., a purported class action filed on October 17, 2016 in the United States District Court for the District of Minnesota, plaintiffs, on behalf of themselves and all others similarly situated, allege damages as a result of, among other things, the defective design and manufacture of certain Simonton windows containing two-pane insulating glass units. The plaintiffs seek a variety of relief, including (i) economic and compensatory damages, (ii) punitive or other exemplary damages, (iii) pre- and post-judgment interest, and (iv) attorneys' fees and costs of litigation. On April 17, 2017, the District Court granted the defendants’ motion to dismiss the complaint. Plaintiffs filed a notice of appeal and its appellant brief on May 16, 2017 and July 7, 2017, respectively, defendants filed its appellee brief on August 7, 2017, and plaintiffs filed its reply brief on August 21, 2017. The appeal is pending. The damages sought in this action have not yet been quantified.

In Gazzillo et al. v. Ply Gem Industries, Inc. et al., a purported class action filed on September 26, 2017 in the United States District Court for the Northern District of New York, plaintiffs, on behalf of themselves and all others similarly situated, allege damages as a result of, among other things, the defective design and manufacture of certain vinyl siding products. The plaintiffs seek a variety of relief, including (i) economic and compensatory damages, (ii) punitive or other exemplary damages, (iii) pre- and post-judgment interest, and (iv) attorneys' fees and costs of litigation. The damages sought in this action have not yet been quantified.

Other contingencies

We are subject to other contingencies, including legal proceedings and claims arising out of its operations and businesses that cover a wide range of matters, including, among others, environmental, contract, employment, intellectual property, securities, personal injury, property damage, product liability, warranty, and modification, adjustment or replacement of component parts or units sold, which may include product recalls.  Product liability, environmental and other legal proceedings also include matters with respect to businesses previously owned.  We have used various substances in products and manufacturing operations, which have been or may be deemed to be hazardous or dangerous, and the extent of its potential liability, if any, under environmental, product liability and workers’ compensation statutes, rules, regulations and case law is unclear.  Further, due to the lack of adequate information and the potential impact of present regulations and any future regulations, there are certain circumstances in which no range of potential exposure may be reasonably estimated.  Also, it is not possible to ascertain the ultimate legal and financial liability with respect to certain contingent liabilities, including lawsuits, and therefore no such estimate has been made as of December 31, 2017.



Item 4.     MINE SAFETY DISCLOSURES

Not applicable.

PART II


Item 5.    MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information


25


Our common stock is listed and traded on the New York Stock Exchange under the symbol “PGEM”. The following table sets forth, for our fiscal quarters indicated, high and low sale prices for a share of our common stock on the NYSE, as reported by the NYSE:
Year
 
High
 
Low
2017:
 
 
 
 
Fourth Quarter
 
$
18.80

 
$
15.20

Third Quarter
 
18.05

 
14.55

Second Quarter
 
20.00

 
16.10

First Quarter
 
20.00

 
15.40

 
 
 
 
 
2016:
 
 
 
 
Fourth Quarter
 
$
16.90

 
$
12.85

Third Quarter
 
16.09

 
12.96

Second Quarter
 
15.72

 
13.22

First Quarter
 
14.66

 
8.58




Stock Performance Graph

The following graph shows a comparison from May 23, 2013 (the date our common stock commenced trading on the NYSE) through December 31, 2017 of the cumulative return for our common stock (PGEM), the Standard & Poor's 500 Stock Index (S&P 500), and the Standard & Poor's Industrials Index (S&P Industrials Index). The graph assumes that $100 was invested at the market close on May 23, 2013 in the common stock of Ply Gem Holdings, Inc., the S&P 500 Index and the S&P Industrials Index, and assumes reinvestments of dividends, if any. The stock price performance of the following graph is not necessarily indicative of future stock price performance.

pgem201312_chart-29321a04.jpg

Holders

26


As of March 5, 2018, there were approximately 5 stockholders of record of our common stock, one of which was Cede & Co., a nominee for The Depository Trust Company. All of our common stock held by brokerage firms, banks and other financial institutions as nominees for beneficial owners are considered to be held of record by Cede & Co., who is considered to be one stockholder of record. A substantially greater number of holders of our common stock are “street name” or beneficial holders, whose shares of common stock are held of record by banks, brokers and other financial institutions. Because such shares of common stock are held on behalf of stockholders, and not by the stockholders directly, and because a stockholder can have multiple positions with different brokerage firms, banks and other financial institutions, we are unable to determine the total number of stockholders we have.

Unregistered Sales of Equity Securities and Use of Proceeds

No securities of ours which were not registered under the Securities Act of 1933 were issued or sold by us during the three months ended December 31, 2017.

Purchases of Equity Securities by the Issuer

There were no purchases by the Company of our common stock during the three months ended December 31, 2017.

Dividends

Ply Gem Holdings has paid no dividends in the years ended December 31, 2017 and 2016.

The indenture for the 6.50% Senior Notes, the Term Loan Facility and the ABL Facility restrict the ability of Ply Gem Industries and its subsidiaries to make certain payments and transfer assets to Ply Gem Holdings.  In addition, the ABL Facility imposes restrictions on the ability of Ply Gem Holdings to make certain dividend payments.  

Item 6.      SELECTED FINANCIAL DATA

The financial data set forth below is for the five-year period ended December 31, 2017.   The data should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the consolidated financial statements, related notes and other financial information included elsewhere in this report.
 
 
 
For the year ended December 31,
(Amounts in thousands, except per share data)
 
2017
 
2016
 
2015 (1)
 
2014 (2)
 
2013 (3)
Statement of operations data:
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
2,056,303

 
$
1,911,844

 
$
1,839,726

 
$
1,566,643

 
$
1,365,581

Cost of products sold
 
1,587,790

 
1,449,570

 
1,420,014

 
1,258,842

 
1,106,911

Gross profit
 
468,513

 
462,274

 
419,712

 
307,801

 
258,670

Operating expenses:
 
 

 
 
 
 
 
 
 
 
Selling, general and administrative expenses
 
272,984

 
268,714

 
271,874

 
224,163

 
187,131

Amortization of intangible assets
 
21,271

 
25,064

 
25,306

 
22,140

 
20,236

Initial public offering costs
 

 

 

 

 
23,527

Total operating expenses
 
294,255

 
293,778

 
297,180

 
246,303

 
230,894

Operating earnings
 
174,258

 
168,496

 
122,532

 
61,498

 
27,776

Foreign currency gain (loss)
 
1,363

 
299

 
(3,166
)
 
(992
)
 
(1,533
)
Interest expense
 
(69,361
)
 
(72,718
)
 
(74,876
)
 
(71,269
)
 
(92,046
)
Interest income
 
78

 
36

 
57

 
83

 
362

Tax receivable agreement liability adjustment
 
10,749

 
(60,874
)
 
(12,947
)
 
670

 
5,167

Loss on modification or extinguishment of debt
 
(2,106
)
 
(11,747
)
 

 
(21,364
)
 
(18,948
)
Income (loss) before provision (benefit) for income taxes
 
114,981

 
23,492

 
31,600

 
(31,374
)
 
(79,222
)
Provision (benefit) for income taxes
 
46,654

 
(51,995
)
 
(688
)
 
(105
)
 
298

Net income (loss)
 
$
68,327

 
$
75,487

 
$
32,288

 
$
(31,269
)
 
$
(79,520
)
 
 
 
 
 
 
 
 
 
 
 
Per basic common share:
 
 
 
 
 
 
 
 
 
 
Net income (loss) applicable to common shares
 
$
1.00

 
$
1.11

 
$
0.47

 
$
(0.46
)
 
$
(1.32
)
Per diluted common share:
 
 
 
 
 
 
 
 
 
 
Net income (loss) applicable to common shares
 
$
0.99

 
$
1.10

 
$
0.47

 
$
(0.46
)
 
$
(1.32
)
 
 
 
 
 
 
 
 
 
 
 
Total assets(4)
 
$
1,319,567

 
$
1,257,741

(5) 
$
1,266,572

 
$
1,232,711

 
$
1,025,836

Long-term debt, less current maturities (4)
 
$
807,334

 
$
836,086

 
$
975,531

 
$
967,053

 
$
801,890

 
(1)
Includes the results of Canyon Stone from the date of acquisition, May 29, 2015.
(2)
Includes the results of Simonton from the date of acquisition, September 19, 2014.
(3)
Includes the results of Gienow from the date of acquisition, April 9, 2013 and Mitten from the date of acquisition, May 31, 2013.
(4)
In accordance with ASU No. 2015-03 Interest-Imputed Interest: Simplifying the Presentation of Debt Issuance Costs, the Company reclassified $19.3 million in 2015, $21.9 million in 2014, and $15.1 million in 2013 of debt issuance costs to long-term debt. Total assets and total liabilities were each reduced by these amounts with no impact to net income (loss) or total shareholders’ equity (deficit) previously reported.
(5)
The Company elected to prospectively adopt ASU No. 2015-17 Income taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, during the year ended December 31, 2016. The impact of this adoption was a reclassification of current deferred tax assets to noncurrent deferred tax assets, prior years were not retrospectively adjusted.


27



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 years 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 47% and 53% of our sales, respectively, for the fiscal year ended December 31, 2017.  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.

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

On September 19, 2014, Ply Gem completed an acquisition for cash consideration of approximately $130.0 million to acquire the capital stock of Fortune Brands Windows, Inc., and its direct and indirect wholly owned subsidiaries Simonton Building Products LLC, Simonton Industries, Inc., Simonton Windows, Inc., and SimEx, Inc. Simonton is a premier repair and remodeling window company with leading brand recognition and is part of the Windows and Doors segment.

On May 29, 2015, Ply Gem acquired substantially all of the assets of Canyon Stone, Inc. (“Canyon Stone”), a manufacturer of stone veneer, for a purchase price of $21.0 million, subject to certain purchase price adjustments. Canyon Stone is included in our Siding, Fencing, and Stone segment.


28


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 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 in an initial public offering (“IPO”) and received gross proceeds of approximately $381.3 million in the IPO. 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.

On January 31, 2018, we entered into the Merger Agreement with Parent and Merger Sub, each a wholly owned subsidiary of funds sponsored by CD&R. Pursuant to the Merger Agreement, subject to the satisfaction or waiver of specified conditions, Merger Sub will merge with and into the Company (the “Merger”), with Ply Gem Holdings surviving the Merger as a wholly owned subsidiary of Parent (the “Acquisition”).  At the Effective Time, each of our issued and outstanding shares of common stock, par value $0.01 per share, will be cancelled and extinguished and converted into the right to receive $21.64 in cash, without interest (the “Merger Consideration”), less any applicable withholding taxes. The consummation of the Merger remains subject to customary closing conditions. As a result of the Merger, we will cease to be a publicly traded company.
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' $350.0 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' $650.0 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, and other general and administrative expenses.

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


Impact of commodity pricing

PVC resin, aluminum, and glass are major components in the production of our products and changes in PVC resin, aluminum, and glass 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 our second and third quarters of the year.  As a result, we have historically had lower profits or higher losses in the first and fourth quarters of each calendar year.  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.

29



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 occur 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 the 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 provision estimates, and warranty reserve at December 31, 2017 would result in an approximate $0.3 million, $0.8 million, and $7.7 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, 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 certain marketing expenses 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. Starting in fiscal 2018, in connection with the adoption of ASU No. 2014-09, Revenue from Contracts with Customers, we expect to include additional disaggregated revenue disclosures.

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.
    
Inventories.  Inventories in the accompanying consolidated balance sheets are valued at the lower of cost or net realizable value.  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 25th for 2017) 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 early adopted ASU No. 2017-04, Intangibles-Goodwill and other (Topic 350) during the year ended December 31, 2017. As such, we measure the goodwill impairment as the amount by which the reporting unit’s carrying value exceeds its fair value not to exceed the carrying amount of goodwill in a reporting unit. We have elected not to utilize the qualitative Step Zero impairment assessment. There was no goodwill impairment for the years ended December 31, 2017 and December 31, 2016. However, we will continue to evaluate goodwill during future years and future declines in the residential housing and repair and remodeling markets or our market capitalization could result in goodwill impairments.


30


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 25, 2017, November 26, 2016, and November 28, 2015, as it relates to the fair values and the sensitivities for these assumptions follows:
  
 
 
Siding, Fencing, and Stone
 
 
As of
November 25,
2017
 
As of
November 26,
2016
 
As of
November 28,
2015
Assumptions:
 
 
 
 
 
 
Income approach:
 
 
 
 
 
 
Estimated housing starts in terminal year
 
1,049,000

 
1,100,000

 
1,100,000

Terminal growth rate
 
3.0
%
 
3.0
%
 
3.0
%
Discount rate
 
11.5
%
 
11.0
%
 
11.5
%
 
 
 
 
 
 
 
Market approach:
 
 
 
 
 
 
Control premiums
 
5.0
%
 
5.0
%
 
5.0
%
 
 
 
 
 
 
 
Sensitivities:
 
 
 
 
 
 
(Amounts in thousands)
 
 
 
 
 
 
Estimated fair value decrease in the event of a
 
 
 
 
 
 
1% decrease in the terminal year growth
 
$
121,553

 
$
116,628

 
$
104,863

Estimated fair value decrease in the event of a
 
 
 
 
 
 
1% increase in the discount rate
 
203,109

 
203,838

 
189,363

Estimated fair value decrease in the event of a
 
 
 
 
 
 
1% decrease in the control premium
 
17,141

 
17,363

 
16,790

    

As of November 25, 2017, we reduced the terminal year estimated housing starts assumption from 1,100,000 in 2016 to 1,049,000 for the 2017 valuation, which reflects a normalized housing start level with an adjustment for potential pullback during the terminal period as the U.S. housing market has been in a growing market for over seven years. We estimate that normalized recurring housing starts will be in a range of 1,000,000 to 1,200,000 to keep up with U.S. population growth according to the Joint Center for Housing Studies of Harvard University. We also maintained our terminal growth rate assumption at 3.0% for the three-year period, which is 0.5% lower than the assumption utilized in the Windows and Doors analysis due to Windows and Doors' higher correlation with the new construction market, which provides higher growth levels as we return to a normalized housing market. As of November 25, 2017, we increased Siding, Fencing, and Stone’s discount rate by 0.5% to 11.5%, due to the risk associated with the decrease in operating earnings of $10.3 million or 6.6% from higher material costs not fully offset by higher net selling prices despite the net sales increase of $83.3 million achieved during 2017. As of November 26, 2016, we decreased Siding, Fencing, and Stone’s discount rate by 0.5% to 11.0%, due to the consistent profitable financial performance demonstrated by Siding, Fencing, and Stone increasing their operating earnings $22.4 million or 16.6% during 2016.


31


 
 
Windows and Doors
 
 
As of
November 25,
2017
 
As of
November 26,
2016
 
As of
November 28,
2015
Assumptions:
 
 
 
 
 
 
Income approach:
 
 
 
 
 
 
Estimated housing starts in terminal year
 
1,049,000

 
1,100,000

 
1,100,000

Terminal growth rate
 
3.5
%
 
3.5
%
 
3.5
%
Discount rate
 
18.0
%
 
16.0
%
 
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
 
$
18,582

 
$
14,695

 
$
12,554

Estimated fair value decrease in the event of a
 
 
 
 
 
 
1% increase in the discount rate
 
43,485

 
37,662

 
35,285

Estimated fair value decrease in the event of a
 
 
 
 
 
 
1% decrease in the control premium
 
5,568

 
4,885

 
4,451

As of November 25, 2017, we reduced the terminal year estimated housing starts assumption from 1,100,000 in 2016 to 1,049,000 for the 2017 valuation, which reflects a normalized housing start level with an adjustment for a potential pullback during the terminal period as the U.S. housing market has been in a growing market for over seven years. As of November 25, 2017, we increased the Windows and Doors’ discount rate by 2.0% to 18.0% to account for the risk associated with continuing projected gross margin expansion within the competitive building products industry combined with the risk of a pullback in the terminal year despite the $12.9 million or 29.5% improvement in operating earnings achieved during 2017. As of November 26, 2016, we decreased the Windows and Doors’ discount rate by 1.0% to 16.0% as a reflection of the improved operating performance of the Windows and Doors reporting unit which increased their operating earnings $25.4 million or 139.5% during the year ended December 31, 2016 due to improved gross profit margins resulting from higher selling prices and favorable material costs.
    As of November 25, 2017, we maintained the Windows and Doors’ control premium at 10.0%, consistent with the prior year due to the consistent performance of the business achieved during 2017.
Overall, we utilize the same key assumptions in preparing the prospective financial information (“PFI”) utilized in the discounted cash flow test for the Siding, Fencing, and Stone and Windows and Doors reporting units. However, each reporting unit is impacted differently by industry trends, how market factors are influencing the reporting units’ expected performance, competition, and other unique business factors as mentioned above. The Windows and Doors reporting unit has more exposure to the new construction market which experienced depressed housing market conditions during 2009-2011, which ultimately decreased operating performance for this reporting unit. Siding, Fencing, and Stone’s performance has been more consistent and profitable resulting in less risk in the PFI.


32


(Amounts in thousands)
 
As of
 
As of
 
As of
 
 
November 25,
 
November 26,
 
November 28,
 
 
2017
 
2016
 
2015
Estimated Windows and Doors reporting unit fair value increase (decrease) in the event of a 10% increase in the weighting of the market multiples method
 
$
(5,000
)
 
$
4,000

 
$
3,000

Estimated Siding, Fencing, and Stone reporting unit fair value increase (decrease) in the event of a 10% increase in the weighting of the market multiples method
 
(10,000
)
 
3,000

 
2,000


As of November 25, 2017, the discounted cash flow method valuation produced a higher value for both reporting units than the guideline public company method and as such the change to market multiple weighting would reduce the 2017 valuation.

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 future declines in the residential housing and remodeling markets could result in future goodwill impairments.

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, state, and foreign 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 federal, state, and foreign 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 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 a consolidated federal income tax return, unitary, combined, or separate state income tax returns.  Gienow Canada and Mitten file separate Canadian income tax returns.

During the year ended December 31, 2016, we determined that a valuation allowance was no longer required against our net federal deferred tax assets and a portion of our net state deferred tax assets. As a result, we released approximately $86.5 million of our valuation allowance since positive evidence outweighed negative evidence thereby allowing us to achieve the “more likely than not” realization threshold. We still remain in a valuation allowance position at December 31, 2017 against our deferred tax assets for certain state and Canadian jurisdictions as it is currently deemed “more likely than not” that the benefit of such net tax assets will not be utilized as the Company continues to be in a three-year cumulative loss position for these states and Canadian jurisdictions. Refer to Note 10 Income Taxes to the consolidated financial statements for additional information regarding income taxes.


33


Tax Receivable Agreement (“TRA”) Liability. The TRA liability generally provides for our payment to the Tax Receivable Entity of 85% of the amount of cash savings, if any, in the U.S. federal, state and local income tax that we actually realize in periods ending after the IPO as a result of (i) net operating loss carryovers ("NOLs") from periods ending before January 1, 2013, (ii) deductible expenses attributable to the IPO and (iii) deductions related to imputed interest. Since the inception of the TRA liability with the 2013 IPO, we have historically had a full valuation allowance for federal purposes and had partial valuation allowances on certain state and Canadian jurisdictions. As a result of the tax valuation allowance position for federal and state purposes, we historically calculated the TRA liability considering (i) current year taxable income only (due to the uncertainty of future taxable income associated with the Company’s previous cumulative loss position) and (ii) future income due to the expected reversal of deferred tax liabilities. During the year ended December 31, 2016, we released our discrete valuation allowance on our federal deferred tax assets and certain state deferred tax assets of approximately $55.2 million, due to positive factors outweighing negative evidence thereby allowing us to achieve the “more likely than not” realization threshold. The factors surrounding the release of this valuation allowance thereby eliminated any uncertainty as to future taxable income. Consequently, for purposes of calculating the TRA liability, we utilized future forecasts of taxable income beyond the 2016 tax year to determine the TRA liability. Our future taxable income estimate was used to determine the cumulative NOLs that are expected to be utilized and the TRA liability was accordingly adjusted using the 85% TRA rate as we retain the benefit of 15% of the tax savings. As of December 31, 2017 and 2016, we had a $69.5 million and $79.7 million liability, respectively, for the amount due pursuant to the Tax Receivable Agreement.

ASC 740 Income Taxes requires a company to record the effects of a tax law change in the period of enactment. Due to the complexities involved in accounting for the recently enacted Tax Act, the U.S. Securities and Exchange Commission’s Staff Accounting Bulletin (“SAB”) 118 requires that the company include in its financial statements a reasonable estimate of the impact of the Tax Act on earnings to the extent such reasonable estimate has been determined. Accordingly, we have performed an earnings and profits analysis associated with the one-time transition tax on certain unrepatriated earnings of foreign subsidiaries, and as a result of accumulated losses, there will be no income tax effect recorded for the year ended December 31, 2017 based on the reasonable estimate guidance provided by SAB 118. We are continuing to assess the impact from the Tax Act and may record further adjustments in 2018.


34


Results of Operations

The following table summarizes net sales and net income by segment and is derived from the accompanying consolidated statements of operations included in this report.
 
 
Year ended December 31,
(Amounts in thousands)
 
2017
 
2016
 
2015
Net Sales
 
 
 
 
 
 
  Siding, Fencing, and Stone
 
$
970,198

 
$
886,851

 
$
840,118

  Windows and Doors
 
1,086,105

 
1,024,993

 
999,608

Operating earnings (loss)
 
 

 
 

 
 

  Siding, Fencing, and Stone
 
146,753

 
157,058

 
134,654

  Windows and Doors
 
56,435

 
43,579

 
18,195

  Unallocated
 
(28,930
)
 
(32,141
)
 
(30,317
)
Foreign currency gain (loss)
 
 

 
 

 
 

  Siding, Fencing, and Stone
 
303

 
204

 
(954
)
  Windows and Doors
 
1,060

 
95

 
(2,212
)
Interest income (expense), net
 
 

 
 

 
 

  Siding, Fencing, and Stone
 
29

 
16

 
22

  Windows and Doors
 
21

 
12

 
17

  Unallocated
 
(69,333
)
 
(72,710
)
 
(74,858
)
Income tax benefit (expense)
 
 

 
 

 
 

  Unallocated
 
(46,654
)
 
51,995

 
688

Loss on modification or
 
 

 
 

 
 

extinguishment of debt
 
 

 
 

 
 

  Unallocated
 
(2,106
)
 
(11,747
)
 

Tax receivable agreement liability adjustment
 
 

 
 

 
 

  Unallocated
 
10,749

 
(60,874
)
 
(12,947
)
 
 
 
 
 
 
 
Net income
 
$
68,327

 
$
75,487

 
$
32,288


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.


35


Siding, Fencing, and Stone Segment

 
 
Year ended December 31,
(Amounts in thousands)
 
2017
 
2016
 
2015
Statement of operations data:
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
970,198

 
100.0
%
 
$
886,851

 
100.0
%
 
$
840,118

 
100.0
 %
Gross profit
 
248,249

 
25.6
%
 
259,485

 
29.3
%
 
238,326

 
28.4
 %
SG&A expense
 
92,541

 
9.5
%
 
89,704

 
10.1
%
 
90,760

 
10.8
 %
Amortization of intangible assets
 
8,955

 
0.9
%
 
12,723

 
1.4
%
 
12,912

 
1.5
 %
Operating earnings
 
146,753

 
15.1
%
 
157,058

 
17.7
%
 
134,654

 
16.0
 %
Currency transaction gain (loss)
 
303

 
%
 
204

 
%
 
(954
)
 
(0.1
)%

Net Sales

Net sales for the year ended December 31, 2017 increased $83.3 million or 9.4% compared to the year ended December 31, 2016. The 9.4% net sales increase was driven by a $76.5 million or 9.4% net sales increase for the U.S. market and a net sales increase of $6.8 million or 9.1% for the Canadian market for the year ended December 31, 2017 relative to the year ended December 31, 2016. In the U.S. market, the 9.4% net sales increase resulted from improved U.S. market demand for our products, new business wins, and higher average selling prices, which increased in response to higher material costs. The favorable U.S. demand factors increased our vinyl siding unit sales by 7.0% for the year ended December 31, 2017 compared to the year ended December 31, 2016. In addition, our average selling prices increased 0.5% in response to higher material costs resulting in higher net sales of approximately $15.0 million during the year ended December 31, 2017 compared to the year ended December 31, 2016. Overall, we achieved the 9.4% net sales increase in the U.S. market from improved volume, price, and market share gains that were partially offset by inventory buybacks of $2.7 million related to new business wins during the year ended December 31, 2017. In Canada, we achieved the 9.1% net sales increase from increased unit volume sales of 4.6% for our vinyl siding products in Canada and a favorable foreign currency impact of $2.2 million. Our improved net sales in the Canadian market continues to reflect the stabilization in the Canadian market despite the challenging conditions that currently exist in Canada from the significant decline in energy prices that have stymied housing and economic development particularly in Western Canada for the last several years.

Our building products are typically installed on a new construction home 90 to 120 days after the start of the home, therefore, single family housing starts commencing in the period from September 2016 to September 2017 directly impacts the demand for our products for the year ended December 31, 2017. According to the U.S. Census Bureau, single family housing starts increased 9.6% during this lag affected period reflecting these improved market conditions. Specifically, the heavy vinyl siding geographic areas in the Northeast increased 3.2% while the Midwest increased 9.4% during the lag affected year. In addition to the new construction market improvement, remodeling activity, according to the Leading Indicator of Remodeling Activity (“LIRA”), reflected the 2017 fourth quarter trailing twelve months increasing 6.6% compared to 2016. However, due to the relative high dollar value or “big ticket” nature of our replacement products, we believe that true remodeling market demand for our big ticket exterior products increased approximately 3.0%. Since our Siding, Fencing, and Stone segment is heavily weighted to the repair and remodeling market, we estimate the weighted average U.S. market increase to be 5.3% for the year ended December 31, 2017, which we exceeded with our 7.0% vinyl siding unit net sales increase in the U.S. for the year ended December 31, 2017. Our 7.0% vinyl siding unit sales increase also exceeded the market indicators as reported by the Vinyl Siding Institute which reported that U.S. vinyl siding industry shipments increased 5.7% during the year. The improved U.S. and Canadian market conditions accounted for the majority of the 9.4% net sales increase achieved during the year ended December 31, 2017, however our sales also benefited from new business wins, which we believe is demonstrated by the improvement in our U.S. market position in vinyl siding, which increased from 39.8% to 40.4% during 2017 relative to 2016, while our share of the Canadian vinyl siding market improved from 31.5% to 32.7% during 2017 relative to 2016. For the years ended December 31, 2017 and 2016, the percentage of net sales in vinyl siding and metal accessories represented approximately 57.0% and 25.2% and 58.0% and 24.7%, respectively, with our net sales of other products comprising approximately 17.8% and 17.3%, respectively.


36


Net sales for the year ended December 31, 2016 increased $46.7 million or 5.6% compared to the year ended December 31, 2015. The net sales increase resulted from a $52.0 million net sales increase or 7.1% in the U.S. market partially offset by a net sales decrease of $5.3 million or 4.9% for the Canadian market. In the U.S. market, the 7.1% net sales increase for the year ended December 31, 2016 was primarily driven by improved U.S. market demand for our products, new business wins of approximately $34.0 million, and $11.7 million of net sales attributed to our Canyon Stone acquisition, which was completed on May 29, 2015. Excluding Canyon Stone, our net sales in the U.S. market would have increased 5.5% for the year ended December 31, 2016 compared to the year ended December 31, 2015. Our net sales growth in the U.S. market resulted from increased unit sales of approximately 10.6% partially offset by lower average selling prices of approximately 4.4% that were reduced in response to lower raw material input costs experienced during the year ended December 31, 2016 as compared to the year ended December 31, 2015. The lower average selling prices for our products negatively impacted our net sales by approximately $35.2 million during the year ended December 31, 2016 as compared to the year ended December 31, 2015. The positive demand factors in the U.S. market were partially offset by continued weaker market demand in Canada which when combined with $3.8 million of negative foreign currency resulted in the $5.3 million Canadian net sales decrease. Market demand in Canada has been negatively impacted by the 2016 decline in energy prices, particularly in Western Canada, where housing starts have declined significantly in Alberta (21.0%).

Our building products are typically installed on a new construction home 90 to 120 days after the start of the home, therefore, single family housing starts commencing in the period from September 2015 to September 2016 directly impacts the demand for our products for the year ended December 31, 2016. According to the U.S. Census Bureau, single family housing starts increased 9.0% during this lag affected period reflecting the improved market conditions. In addition to the new construction market improvement, remodeling activity, according to the LIRA, reflected the 2016 trailing twelve months increasing 6.0% compared to the 2015 period. However, due to the relative higher dollar value or “big ticket” nature of our replacement products, we believe that true remodeling market demand for our big ticket exterior products increased 3.0% to 4.0%. Since our Siding, Fencing, and Stone segment is heavily weighted to the repair and remodeling market, we estimate the weighted average U.S. market repair and remodeling increase to be 5.4% for 2016. Our U.S. unit sales increase of 10.6% outperformed the estimated market increase but was partially offset by our lower average selling prices. The improvement in single family housing starts and remodeling expenditures as well as our ability to exceed these market indicators on a unit basis is evidenced by the Vinyl Siding Institute reporting that U.S. vinyl siding industry shipments increased 5.2% while shipments in Canada decreased 8.5% for 2016 relative to 2015 compared to our vinyl industry shipments increase of 8.1% in the U.S. and our 4.5% decrease in Canada.

The improved U.S. market conditions drove our 5.6% net sales increase during the year ended December 31, 2016; however our sales also benefited from new business wins of $34.0 million which we believe is demonstrated by the improvement in our U.S. market position in vinyl siding which increased from 38.8% to 39.8% for the year ended December 31, 2016 relative to the year ended December 31, 2015, while our share of the Canadian vinyl siding market improved from 30.2% to 31.5% for the year ended December 31, 2016 compared to the year ended December 31, 2015.


Gross Profit

37


Gross profit for the year ended December 31, 2017 decreased $11.2 million or 4.3% compared to the year ended December 31, 2016. The gross profit decrease resulted from higher raw material input costs that were not fully offset by increased average selling prices, higher freight costs and the near-term negative impact of Hurricanes Harvey and Irma. The increased raw material costs were largely related to aluminum and PVC resin which increased 22.2% and 10.3%, respectively, during the year ended December 31, 2017 relative to the year ended December 31, 2016. This unfavorable material cost pricing decreased gross profit by approximately $28.6 million during the year ended December 31, 2017 relative to the year ended December 31, 2016. Although we were able to partially offset this $28.6 million with selling price increases of $15.0 million that were implemented during the first and second quarters of 2017, our realization from the early price increases was below expectations due to timing and market acceptance and, as a result, we announced additional price increases during the second quarter of 2017. These additional price increases are expected to improve gross margins during 2018. While historically we have successfully demonstrated our ability to pass along these material cost increases to customers, which enables our gross margins to remain relatively stable over an annualized period, our gross profit margins may be compressed during periods of rising raw material costs and expand as our selling price increases take effect or material inflation abates. In addition to the higher material costs, we also incurred increased freight expenses during the year ended December 31, 2017 of $5.1 million due to a 15.1% increase in diesel costs for the year ended December 31, 2017 compared to 2016 as well as limited experienced drivers and route availability which impacted our common carrier cost, as well as higher operating costs relative to the year ended December 31, 2016 that negatively impacted our gross profit. Furthermore, we incurred unfavorable mix from the $25.6 million increase in metal sales during the year ended December 31, 2017 compared to the year ended December 31, 2016, which carry lower gross profit margins than vinyl sales. The negative trends within gross profit were partially offset by improved operating metrics within our Canadian business which experienced higher gross profit of $2.3 million for the year ended December 31, 2017 compared to the year ended December 31, 2016, which can be attributed to higher average selling prices, improved market conditions within Canada that led to unit volume increases, and favorable foreign currency rates.

In addition to the higher material, operating, and freight costs as well as unfavorable product mix, our siding, fencing and stone segment was also negatively impacted by Hurricanes Harvey and Irma by approximately $6.2 million during the year ended December 31, 2017. Hurricane Harvey’s torrential rainfall and flooding of the Houston, Texas area negatively impacted our raw material sourcing with two of the four domestic PVC resin producers declaring “force majeure”. In addition, we incurred higher freight charges related to moving our existing supply of PVC resin between our plants because of the temporary PVC resin shortage in the Houston chemical market which supplies a significant percentage of the total U.S. PVC resin market. Since Hurricanes Harvey and Irma occurred on August 24th and September 10th, respectively, the negative impact from these storms commenced during the later portion of our third quarter but permeated into our fourth quarter as well from continued negative raw material pricing, sourcing and freight costs. Overall, our gross profit declined during the year ended December 31, 2017 compared to the year ended December 31, 2016 despite volume increases and higher average selling prices as they were fully offset by higher material, freight, and operating costs.

As a percentage of net sales, gross profit decreased from 29.3% for the year ended December 31, 2016 to 25.6% for the year ended December 31, 2017. The 370 basis point decrease for the year ended December 31, 2017 resulted from increased raw material costs primarily for aluminum and PVC resin that were not fully offset during 2017 by increased selling prices. Also, our sales of our metal accessories, which typically carry lower gross profit margins, outpaced our vinyl siding sales, that resulted in a negative product mix impact on our gross profit percentage. In addition, our gross profit margins were unfavorably impacted by Hurricanes Harvey and Irma as well as higher operating and freight costs experienced during the year ended December 31, 2017.    

Gross profit for the year ended December 31, 2016 increased $21.2 million or 8.9% compared to the year ended December 31, 2015. The gross profit increase for the year ended December 31, 2016 primarily resulted from the 5.6% net sales increase and included approximately $3.4 million of gross profit from our Canyon Stone acquisition, which was completed on May 29, 2015. Excluding Canyon Stone, our gross profit increase would have been $17.8 million or 7.4% for the year ended December 31, 2016 as compared to the year ended December 31, 2015.

Overall, the higher sales volumes experienced during 2016 in the U.S. market of 5.5% enabled us to increase our operating leverage and gross profit relative to 2015. In addition, we experienced favorable material cost pricing during the year ended December 31, 2016 relative to the year ended December 31, 2015 specifically for aluminum and PVC resin. This favorable net material cost pricing favorably impacted gross profit by approximately $33.5 million during the year ended December 31, 2016 relative to the year ended December 31, 2015, but was offset by $35.2 million of lower net selling prices that were reduced as a result of lower material costs. In addition, our Canadian gross profit declined 12.7% or $4.2 million during the year ended December 31, 2016 relative to the year ended December 31, 2015 primarily as a result of an unfavorable foreign currency impact of $3.0 million as well as the declining Canadian economic conditions prevalent in Western Canada which are heavily dependent on energy prices to sustain their economy partially offset by favorable material costing of $0.9 million.

38



As a percentage of net sales, gross profit increased from 28.4% for the year ended December 31, 2015 to 29.3% for the year ended December 31, 2016 excluding the impact of the Canyon Stone acquisition. The 90 basis point increase for the year ended December 31, 2016 resulted mainly from improved operating leverage from the 5.6% net sales increase as well as favorable material cost pricing and freight expense partially offset by lower average sales prices, an unfavorable foreign currency impact from a weakening Canadian dollar as well as weakening demand in Canada due to the economic slowdown.
    
SG&A Expense

SG&A expense for the year ended December 31, 2017 increased from the year ended December 31, 2016 by approximately $2.8 million or 3.2%. The $2.8 million SG&A expense increase resulted from $2.9 million in higher selling and marketing expenses related to the 9.4% net sales increase, $0.9 million in higher legal and professional expenses, $0.7 million in unfavorable workers compensation expenses, $0.2 million in higher research and development expenses, and $0.5 million in increased SG&A expenses for the stone business partially offset by lower management compensation expense of $2.4 million for the year ended December 31, 2017 compared to the year ended December 31, 2016. As a percentage of net sales, SG&A expense decreased 60 basis points from 10.1% for the year ended December 31, 2016 to 9.5% for the year ended December 31, 2017 as a result of the lower management compensation expense and improved operating leverage related to the net sales increase.

SG&A expense for the year ended December 31, 2016 decreased from the year ended December 31, 2015 by approximately $1.1 million or 1.2%. Excluding the impact of the Canyon Stone acquisition which was completed on May 29, 2015 and incurred SG&A expense of approximately $2.6 million, SG&A expense for the year ended December 31, 2016 decreased $3.7 million or 4.0% compared to the year ended December 31, 2015. SG&A expense decreased primarily due to lower sales and marketing spending that resulted from our initiative to better leverage our marketing resources. The success of these initiatives is demonstrated with the SG&A expense reduction while achieving $34.0 million in market share gains during 2016.

As a percentage of net sales excluding Canyon Stone, SG&A expense decreased from 10.8% for the year ended December 31, 2015 to 10.1% for the year ended December 31, 2016. The decrease reflects improved leverage on the fixed component of our SG&A expenses relative to the net sales increase as well as the impact of certain sales and marketing cost initiatives which resulted in our sales and marketing expenses decreasing $3.6 million during the year ended December 31, 2016 relative to the year ended December 31, 2015.

Amortization of Intangible Assets

Amortization expense for the year ended December 31, 2017 decreased approximately $3.8 million or 29.6% compared to the year ended December 31, 2016 due to certain customer relationship intangible assets becoming fully amortized during the year ended December 31, 2016. As a percentage of net sales, amortization expense decreased to 0.9% for the year ended December 31, 2017 from 1.4% for the year ended December 31, 2016.

Amortization expense for the year ended December 31, 2016 was consistent with the year ended December 31, 2015 at approximately $12.7 million and 1.4% of net sales relative to $12.9 million and 1.5% of net sales, respectively.
    
Currency Transaction Gain (Loss)

A currency transaction impact was established in 2013 with the acquisition of Mitten within the Siding, Fencing, and Stone segment. The currency transaction gain for the year ended December 31, 2017 was $0.3 million. The currency transaction gain for the year ended December 31, 2016 was $0.2 million and for the year ended December 31, 2015 was a transaction loss of $1.0 million related to the Mitten entity. The $1.2 million increase in the foreign currency gain for the year ended December 31, 2016 was due to the positive movement in the Canadian dollar relative to the U.S. dollar during the year ended December 31, 2016.




39


Windows and Doors Segment

 
 
Year ended December 31,
(Amounts in thousands)
 
2017
 
2016
 
2015
Statement of operations data:
 
 
 
 
 
 
 
 
 
 
 
 
Net sales
 
$
1,086,105

 
100.0
%
 
$
1,024,993

 
100.0
%
 
$
999,608

 
100.0
 %
Gross profit
 
220,264

 
20.3
%
 
202,789

 
19.8
%
 
181,386

 
18.1
 %
SG&A expense
 
151,513

 
14.0
%
 
146,869

 
14.3
%
 
150,797

 
15.1
 %
Amortization of intangible assets
 
12,316

 
1.1
%
 
12,341

 
1.2
%
 
12,394

 
1.2
 %
Operating earnings
 
56,435

 
5.2
%
 
43,579

 
4.3
%
 
18,195

 
1.8
 %
Currency transaction gain (loss)
 
1,060

 
0.1
%
 
95

 
%
 
(2,212
)
 
(0.2
)%

Net Sales

Net sales for the year ended December 31, 2017 increased $61.1 million or 6.0% compared to the year ended December 31, 2016. The 6.0% net sales increase resulted from improved U.S. and Canadian market demand conditions, which primarily favorably impacted our new construction. For the year ended December 31, 2017 compared to the year ended December 31, 2016 our U.S. new construction business increased $54.1 million or 8.3% due in part to higher average selling prices of 2.7% and our U.S. repair and remodeling business decreased $11.4 million or 4.1% from lower unit volume sales of 1.9% partially offset by higher average selling prices of 3.9%. Our Canadian net sales increased $18.4 million or 19.4% for the year ended December 31, 2017 relative to the year ended December 31, 2016 due to an improving Western Canadian market which culminated in a unit volume increase of 14.1% and a favorable foreign currency impact of $2.1 million. Our Western Canada sales have been impacted by depressed market conditions that resulted from the significant decline in energy prices that have stymied housing and economic development in Western Canada, however recently we have begun to see some recovery in those markets.

The net sales increase for the U.S. market can be attributed to improved market conditions as evidenced by the U.S. Census Bureau reporting that single family housing starts increased 9.6% during the lag effected period which resulted in higher net sales for our new construction business. Our building products are typically installed on a new construction home 90 to 120 days after the start of the home, therefore single family starts commencing in the period from September 2016 to September 2017 directly impacts the demand for our products for the year ended December 31, 2017. For the repair and remodeling business, LIRA reported that the 2017 trailing twelve months increased 6.6% compared to the 2016 period creating a favorable demand environment. However, due to the relative high dollar value or “big ticket” nature of our replacement products, we believe that true remodeling market demand for our big ticket exterior products increased approximately 3.0%. Our vinyl unit net sales for new construction increased 4.4% which was less than the 9.6% new construction market increase while our repair and remodeling unit sales decreased 1.9% which was lower than the repair and remodeling demand market indicators for the year ended December 31, 2017. The lower unit volumes for new construction relative to market indicators resulted from our ability to realize higher average selling prices on our products combined with aggressive price action taken by certain competitors which suppressed our market gains. The lower unit volumes relative to the overall market for our repair and remodeling window products was caused by acquisition integration activities for certain customers, which adversely impacted unit volumes in certain geographic areas. In addition, Hurricanes Harvey and Irma negatively impacted our ability to ship product to significant markets in Houston and Florida for certain days in late third quarter and early fourth quarter resulting in estimated lost net sales of approximately $10.0 million for the year ended December 31, 2017. Despite these lower net sales amounts relative to demand market indicators for our new construction and repair and remodeling businesses, we achieved an overall 6.0% net sales increase due in part to higher average selling prices of 3.1% for the year ended December 31, 2017 compared to the year ended December 31, 2016. These higher average selling prices increased our U.S. and Canadian net sales by approximately $30.8 million and $3.2 million, respectively, for the year ended December 31, 2017 compared to the year ended December 31, 2016.

Net sales for the year ended December 31, 2016 increased $25.4 million or 2.5% compared to the year ended December 31, 2015. The net sales increase for the year ended December 31, 2016 can be attributed to the improved U.S. market conditions favorably impacting both our new construction business as well as our repair and remodeling business. For the year ended December 31, 2016 compared to the year ended December 31, 2015, our new construction business increased $38.7 million or 6.7% while our repair and remodeling business increased $6.1 million or 2.0%. This U.S. net sales increase was partially offset by a $19.4 million net sales decline or 17.0% for our Canadian net sales for the year ended December 31, 2016 relative to the year ended December 31, 2015 due to a weakening Canadian market.

40



The net sales increase for the U.S. market can be attributed to improved market conditions as evidenced by the U.S. Census Bureau reporting that single family housing starts increased 9.0% during the lag effected period which resulted in higher net sales for our new construction products. Our building products are typically installed on a new construction home 90 to 120 days after the start of the home, therefore single family starts commencing in the period from September 2015 to September 2016 directly impacts the demand for our products for the year ended December 31, 2016. As previously mentioned, we believe that true market demand for big ticket repair and remodeling products increased 3.0% to 4.0%. Our net sales for new construction and repair and remodeling were lower than the demand market indicators for the year ended December 31, 2016 due primarily to lower sales in certain geographical areas, namely Texas, specifically Houston, due to extraordinary levels of rainfall which negatively impacted the construction industry and economic conditions in the Houston market related to the oil and gas industry. Our net sales of window products in the Houston market declined $7.9 million during the year ended December 31, 2016 compared to the year ended December 31, 2015. In addition to Houston, we incurred lost sales in our repair and remodeling business of $11.3 million and $2.2 million in our new construction business from competitive price action taken by certain competitors in other geographic regions in which we maintained our pricing discipline in the marketplace.

Despite these lower net sales amounts relative to demand market indicators for the year ended December 31, 2016 compared to the year ended December 31, 2015, we achieved higher average selling prices of 3.3% for the year ended December 31, 2016 compared to the year ended December 31, 2015. These higher average selling prices increased our U.S. net sales by approximately $26.2 million for the year ended December 31, 2016 compared to the year ended December 31, 2015. The overall U.S. net sales increase of $44.8 million was partially offset by a $19.4 million or 17.0% net sales decline for our Western Canadian business which endured challenging market conditions negatively impacted by demand softness due to declining energy prices and poor economic growth as well as a negative foreign currency impact of $3.1 million.

    
Gross Profit

Gross profit for the year ended December 31, 2017 increased $17.5 or 8.6% compared to the year ended December 31, 2016. The gross profit increase for the year ended December 31, 2017 resulted from the continued improvement in our new construction business partially offset by declining gross profit performance for our repair and remodeling business within the U.S. while our Canadian business experienced improved gross profit of $5.9 million relative to the prior year period. Gross profit for our U.S. new construction business increased $12.7 million while our repair and remodeling gross profit declined $1.1 million for the year ended December 31, 2017 compared to the year ended December 31, 2016. The gross profit net improvement for our U.S. businesses was driven by increased selling prices of 3.1%, improved operating efficiencies and favorable product mix, which improved gross profit by $30.8 million partially offset by lower gross margins within our repair and remodeling business which experienced reduced unit volumes during the year decreasing our manufacturing operating leverage. Our Canadian business also experienced favorable pricing of $3.2 million from higher average selling prices for the year ended December 31, 2017 relative to the year ended December 31, 2016. These factors coupled with improved manufacturing leverage from the unit volume increases and a favorable foreign currency impact of $0.5 million enabled our Canadian business to realize improved gross profit of $5.9 million despite the challenging economic and demand conditions that exist in Western Canada due to lower energy prices. For the Windows and Doors segment, we achieved higher average selling prices during the year ended December 31, 2017 compared to the year ended December 31, 2016 from announced price increases implemented to offset the aforementioned raw material cost increases for aluminum and PVC resin as well as glass costs. These higher material costs negatively impacted our gross profit by approximately $14.0 million during the year ended December 31, 2017 compared to the year ended December 31, 2016. In addition to the higher material costs, we also incurred increased freight expenses during the year ended December 31, 2017 of $4.0 million due to a 15% increase in diesel costs for the year ended December 31, 2017 compared to 2016 as well as limited experienced drivers and route availability which impacted our common carrier cost.


41


In addition to the higher material and freight costs, our gross profit was negatively impacted by Hurricanes Harvey and Irma during the year ended December 31, 2017. We incurred lost sales of approximately $10.0 million with an estimated gross profit of approximately $2.8 million from the hurricanes impacting our significant new construction and repair and remodeling window markets in Florida and Houston as well as higher material costs of approximately $1.1 million and higher freight expenses of approximately $0.6 million from moving our existing supply of PVC resin between our plants because of the temporary shortages in the Houston area. Since Hurricanes Harvey and Irma occurred on August 24th and September 10th, respectively, the negative impact from these storms commenced during the later portion of our third quarter but permeated into our fourth quarter as well from continued negative raw material pricing, sourcing, and freight costs. Overall, our net sales increase of 6.0% achieved through improved market conditions and higher selling prices was mitigated by higher material costs and the negative hurricane impact resulting in a gross profit improvement of 8.6% during the year ended December 31, 2017 compared to the year ended December 31, 2016.

As a percentage of net sales, gross profit increased from 19.8% for the year ended December 31, 2016 to 20.3% for the year ended December 31, 2017. The 50 basis point increase in gross profit reflects improvements of 110 basis points for our U.S. new construction businesses and 190 basis points for our Canadian business partially offset by an 80 basis point deterioration in our repair and remodeling business due to lower operating leverage on reduced unit sales volume. These net gross margin improvements resulted from improved demand levels and higher average selling prices partially offset by rising material costs for the year ended December 31, 2017 compared to the year ended December 31, 2016.
Gross profit for the year ended December 31, 2016 increased $21.4 or 11.8% compared to the year ended December 31, 2015. The gross profit increase for the year ended December 31, 2016 primarily resulted from the continued improvement in our new construction and repair and remodeling businesses partially offset by the negative impact from lower net sales in Canada. Gross profit for our U.S. new construction and repair and remodeling business increased $16.1 million and $6.9 million, respectively, during the year ended December 31, 2016 compared to the year ended December 31, 2015. The gross profit improvement for our U.S. businesses was driven by increased selling prices of 3.3%, favorable product mix and lower raw material costs and cost savings and synergies that were realized from our Simonton acquisition. These favorable factors were partially offset by higher costs in our U.S. new construction window business related to labor and freight. These overall net gross profit improvements in the U.S. were partially offset by a gross profit decrease of $1.6 million for our Western Canadian business which experienced weaker market demand due to depressed economic conditions including a negative foreign currency impact of $4.0 million during the year ended December 31, 2016 compared to the year ended December 31, 2015.

As a percentage of net sales, gross profit increased from 18.1% for the year ended December 31, 2015 to 19.8% for the year ended December 31, 2016. The 170 basis point gross profit increase reflects improvements for both our U.S. new construction and repair and remodeling window businesses from improved demand levels, higher average selling prices, and favorable material costs partially offset by a decrease for our Canadian business driven by the 17.0% net sales decrease which decreased operating leverage during the year ended December 31, 2016 as compared to the year ended December 31, 2015.

    
SG&A Expense

SG&A expense for the year ended December 31, 2017 increased $4.6 million or 3.2% compared to the year ended December 31, 2016. The $4.6 million SG&A expense increase primarily resulted from increased selling and marketing expenses of $2.0 million related to the net sales increase of 6.0% and higher bad debt expense of $1.3 million. In addition, we experienced a favorable $1.3 million movement for a severance accrual reversal during the year ended December 31, 2016. As a percentage of net sales, SG&A expense decreased 30 basis points from 14.3% for the year ended December 31, 2017 to 14.0% for the year ended December 31, 2017.


42


SG&A expense for the year ended December 31, 2016 decreased $3.9 million or 2.6% compared to the year ended December 31, 2015. The SG&A expense decrease was attributable primarily to 2015 activity for acquisition integration and restructuring activities related to our repair and remodeling window acquisition which originally occurred in September 2014 as well as combining our Canadian window manufacturing facilities into a single facility. Specifically, our U.S. window repair and remodeling business incurred lower severance expenses of $1.3 million during the year ended December 31, 2016 compared to the year ended December 31, 2015. In addition, our U.S. window businesses experienced $5.0 million in lower management incentive compensation and lower sales and marketing expenses during the year ended December 31, 2016 compared to the year ended December 31, 2015 partially offset by increased legal fees of approximately $2.8 million primarily related to legal settlements completed in December 2016 and January 2017 as well as increased legal expense associated with the 2015 resolution of class action litigation for our new construction business of $3.2 million. Our Canadian window business experienced lower restructuring and integration charges of $2.2 million, as well as lower personnel costs of $1.7 million during the year ended December 31, 2016 compared to the year ended December 31, 2015 due to the economic slowdown with lower demand levels as well as integration activities that occurred during 2015 finalizing our combination of our Western Canadian manufacturing facilities into a single location in Alberta.

As a percentage of net sales, SG&A expense decreased from 15.1% for the year ended December 31, 2015 to 14.3% for the year ended December 31, 2016. The 80 basis point decrease primarily resulted from lower severance expense for our U.S. repair and remodeling window business, lower management compensation expense, lower selling and marketing expenses partially offset by increased legal expenses for the year ended December 31, 2016 compared to the year ended December 31, 2015. In addition, our Canadian window business incurred lower restructuring and personnel expenses during the year ended December 31, 2016 compared to the year ended December 31, 2015 from integration activities that were incurred during 2015 finalizing our combination our manufacturing operations into a single location in Alberta.


Amortization of Intangible Assets

Amortization expense for the year ended December 31, 2017 was consistent with the year ended December 31, 2016 at $12.3 million and 1.1% of net sales and $12.3 million and 1.2% of net sales, respectively. Amortization expense for the year ended December 31, 2016 was consistent with the year ended December 31, 2015 at $12.3 million and 1.2% of net sales and $12.4 million and 1.2% of net sales, respectively.

Currency Transaction Gain (Loss)

The currency transaction gain for the year ended December 31, 2017 was $1.1 million increasing $1.0 million from a gain of $0.1 million for the year ended December 31, 2016 as a result of the fluctuation in the Canadian dollar as compared to the U.S. dollar for 2017. The currency transaction gain for the year ended December 31, 2016 was $0.1 million increasing $2.3 million from a loss of $2.2 million for the year ended December 31, 2015 as a result of the fluctuation in the Canadian dollar as compared to the U.S. dollar for 2016. Our Gienow acquisition during the year ended December 31, 2013, increased our transactional exposure to the Canadian currency. Management continues to evaluate methodologies to effectively hedge this foreign currency risk.

Unallocated Operating Earnings, Interest, and (Provision) Benefit for Income Taxes
 
 
Year ended December 31,
(Amounts in thousands)
 
2017
 
2016
 
2015
Statement of operations data:
 
 
 
 
 
 
SG&A expense
 
$
(28,930
)
 
$
(32,141
)
 
$
(30,317
)
Operating loss
 
(28,930
)
 
(32,141
)
 
(30,317
)
Interest expense
 
(69,363
)
 
(72,716
)
 
(74,863
)
Interest income
 
30

 
6

 
5

Tax receivable agreement liability adjustment
 
10,749

 
(60,874
)
 
(12,947
)
Loss on modification or extinguishment of debt
 
(2,106
)
 
(11,747
)
 

(Provision) benefit for income taxes
 
$
(46,654
)
 
$
51,995

 
$
688


Operating loss/SG&A Expense


43


Unallocated SG&A expense includes items which are not directly attributed to or allocated to either of our reporting segments.  Such items include legal costs, corporate payroll, and unallocated finance and accounting expenses.  The unallocated operating loss for the year ended December 31, 2017 decreased by $3.2 million or 10.0% compared to the same period in 2016 due to decreased management incentive compensation of $3.9 million and lower stock compensation expense of $0.6 million partially offset by increased centralization activities of certain functional areas such as research and development ($0.1 million) and marketing ($0.3 million), along with an increase various other professional fees and personnel expenses of ($0.9 million).

The unallocated operating loss for the year ended December 31, 2016 increased by $1.8 million or 6.0% compared to the same period in 2015 due primarily to increased centralization of certain functional areas such as research and development ($1.0 million), marketing ($1.0 million), and information technology ($0.7 million) along with increased incentive compensation of approximately $0.4 million partially offset by decreases in stock compensation expense of $0.9 million and various other professional fees and personnel expenses of $0.4 million. One element that drove the increased research and development expense within the unallocated segment was the opening of the Insight Center in Durham, NC during 2016, a facility that supports product development and innovation.

    
Interest expense

Interest expense for the year ended December 31, 2017 decreased by approximately $3.4 million or 4.6% compared to the year ended December 31, 2016 as a result of the reduction in the Term Loan Facility principal balance year over year. During March, August and November 2016, we made a total of $160.0 million in voluntary payments on the Term Loan Facility and another $40.0 million voluntary payment on the Term Loan Facility was made in November 2017, in addition to our normal quarterly amortization payments of $1.1 million, or $4.3 million annually, which reduced our outstanding borrowings and our annual interest expense.

Interest expense for the year ended December 31, 2016 decreased by approximately $2.1 million or 2.9% compared to the same period in 2015 as a result of the reduction in the Term Loan Facility principal balance year over year and lower average borrowings on the ABL Facility year over year. During 2016, we made $160.0 million of voluntary payments on the Term Loan Facility in addition to our normal quarterly amortization payments of $1.1 million, or $4.3 million annually, which reduced our outstanding borrowings and our annual interest expense.

Interest income

 Interest income for the year ended December 31, 2017 was consistent with the years ended December 31, 2016 and December 31, 2015.

Tax receivable agreement liability adjustment

Since the inception of the TRA liability with the Company’s 2013 initial public offering, we have historically been in a full valuation allowance for federal purposes and a partial valuation allowance for certain state and Canadian jurisdictions. As a result of the Company’s tax valuation allowance position for federal and state purposes, we historically calculated the TRA liability considering (i) current year taxable income only (due to the uncertainty of future taxable income associated with our previous cumulative loss position) and (ii) future income due to the expected reversals of deferred tax liabilities. During the year ended December 31, 2016, we released our federal valuation allowance and a portion of our state valuation allowance for $55.2 million, due to positive factors outweighing negative evidence, specifically no longer being in a cumulative loss position. The factors surrounding the release of this valuation allowance thereby eliminated any uncertainty as to future taxable income. Consequently, we were able to utilize future forecasts of taxable income beyond the 2016 tax year to determine the TRA liability as of December 31, 2016. Our future taxable income estimates were used to determine the cumulative net operating loss carryforwards ("NOLs") that are expected to be utilized and the TRA liability was accordingly adjusted using the 85% TRA rate. As a result of including future taxable income beyond 2016, we recognized a $60.9 million adjustment to the TRA liability during the year ended December 31, 2016 bringing the total TRA liability to $79.7 million as of December 31, 2016.


44


The TRA liability as of December 31, 2017 was $69.5 million. This amount represents the originally anticipated TRA liability at the IPO date with approximately $5.2 million remaining to be expensed through operations for state purposes as we remain in a state tax valuation allowance position as of December 31, 2017 for certain states. This remaining liability will be recognized as the state valuation allowances are released in future years. The $10.2 million decrease in the TRA liability for the year ended December 31, 2017 resulted primarily from a $10.7 million decrease for the reduction in the future federal corporate tax rate from 35% to 21% due to the enactment of the Tax Act on December 22, 2017, which reduces the value of the NOLs to be utilized in future periods. The $10.7 million was partially offset by $0.5 million of imputed interest accrual related to the 2016 TRA payment.
The $47.9 million increase for the TRA liability adjustment for the year ended December 31, 2016 relative to the year ended December 31, 2015 resulted primarily from the $55.2 million discrete federal valuation allowance release along with our ability to utilize future forecasts of taxable income beyond the 2016 tax year to determine the TRA liability as of December 31, 2016, as described above.
The $12.9 million TRA liability adjustment for the year ended December 31, 2015 resulted from increases in taxable income estimates resulting from the reversal of deferred tax liabilities as well as increases in our 2015 taxable income compared to the 2014 period. The $115.9 million increase in our 2015 taxable income can be attributed to the following factors (i) the continued U.S. housing recovery which is estimated to have had a 10.0% year over year increase in single family housing starts according to the U.S. Census Bureau, (ii) improvements in the repair and remodeling market evidenced by the 5.6% increase in homeowner improvements during 2015 versus 2014 according to LIRA, (iii) the positive income contributions from our acquisition of Simonton which was completed in September 2014, and (iv) continued improvements in our existing operations specifically for our U.S. windows business which increased its operating earnings by approximately $45.9 million during the year ended December 31, 2015 compared to the year ended December 31, 2014. All of these items increased our taxable income estimate for the year ended December 31, 2015 and, as a result, our estimate of the TRA liability.

Loss on modification or extinguishment of debt

During November 2017, we voluntarily paid $40.0 million on the Term Loan Facility to reduce our outstanding indebtedness as allowable under the terms of the agreement governing the Term Loan Facility. We performed an analysis to determine the proper accounting treatment for this voluntary payment by evaluating the change in cash flows and determining that there were no changes in the creditors as a result of the payment. Consequently, we recognized a loss on debt modification or extinguishment of approximately $2.1 million for the year ended December 31, 2017 consisting of the proportionate write off of the related debt issuance costs and debt discount.

During 2016, we voluntarily paid $160.0 million on the Term Loan Facility to reduce our outstanding indebtedness as allowable under the terms of the agreement governing the Term Loan Facility. We performed an analysis to determine the proper accounting treatment for these voluntary payments by evaluating the change in cash flows and determining that there were no changes in the creditors as a result of the payment. Consequently, we recognized a loss on debt modification or extinguishment of approximately $11.7 million for the year ended December 31, 2016 consisting of the proportionate write off of the related debt issuance costs and debt discount.
        
Income taxes

The income tax provision for the year ended December 31, 2017 increased $98.6 million compared to the year ended December 31, 2016. The increase is primarily related to an increase in pre-tax income for the year ended December 31, 2017 and the reversal of the valuation allowance for federal and certain state jurisdictions during the year ended December 31, 2016. The income tax provision of approximately $46.7 million is comprised of $40.7 million of federal tax expense, $6.5 million of state tax expense, and a $0.5 million foreign income tax benefit. Our pre-tax income for the year ended December 31, 2017 was approximately $115.0 million including the $10.7 million Tax Receivable Agreement liability adjustment compared to pre-tax income of $23.5 million including the $60.9 million Tax Receivable Agreement liability adjustment for the year ended December 31, 2016.  As of December 31, 2017, we remain in a valuation allowance position for certain state and Canadian jurisdictions.


45


The income tax benefit for the year ended December 31, 2016 increased to an approximate $52.0 million tax benefit compared to an approximate $0.7 million tax benefit for the year ended December 31, 2015. The income tax benefit of approximately $52.0 million is comprised of $53.6 million of federal tax benefit, $2.6 million state tax expense, and $1.0 million foreign income tax benefit. The increase in tax benefit is primarily due to the release of the discrete valuation allowance of $55.2 million partially offset by state income tax, remaining valuation allowances, and foreign income taxes.  Our pre-tax income for the year ended December 31, 2016 was approximately $23.5 million including the $60.9 million tax receivable agreement liability adjustment compared to pre-tax income of $31.6 million including the $12.9 million tax receivable agreement liability adjustment for the year ended December 31, 2015.      

The Tax Act enacted on December 22, 2017, makes broad and complex changes to the Code including, but not limited to, reducing the U.S. federal corporate tax rate from 35% to 21%, requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries, generally eliminating U.S. federal income taxes on dividends from foreign subsidiaries, requiring a current inclusion in U.S. federal taxable income of certain earnings of controlled foreign corporations, eliminating the corporate AMT and changing how existing AMT credits can be realized, creating the BEAT, creating a general limitation on deductible interest expense, and changing rules related to the utilization of net operating loss carryforwards created in tax years after December 31, 2017.

As of December 31, 2017, as a result of the corporate income tax rate reduction from 35% to 21% effective January 1, 2018 enacted in the Tax Act, we recorded an expense of $4.3 million due to the re-measurement of the deferred tax assets at the reduced income tax rate which reduced the future benefit we will realize associated with these assets. This expense has been recognized in income taxes within our consolidated statement of operations.

ASC 740 Income Taxes requires a company to record the effects of a tax law change in the period of enactment. Due to the complexities involved in accounting for the recently enacted Tax Act, SAB 118 requires that we include in our financial statements a reasonable estimate of the impact of the Tax Act on earnings to the extent such reasonable estimate has been determined. Accordingly, we have performed an earnings and profits analysis associated with the one-time transition tax on certain unrepatriated earnings of foreign subsidiaries, and as a result of accumulated losses, there will be no income tax effect recorded for the year ended December 31, 2017 based on the reasonable estimate guidance provided by SAB 118. We are continuing to assess the impact from the Tax Act and may record further adjustments in 2018.
        
Liquidity and Capital Resources

2015 Debt Transaction

On November 5, 2015, Ply Gem Industries entered into a second amended and restated ABL Facility. Among other things, the second amended and restated ABL Facility: (i) increased the overall facility to $350.0 million, (ii) provided an accordion feature of $50.0 million, and (iii) established the applicable margin for borrowings under the ABL Facility to a range of 1.25% to 2.00% for Eurodollar rate loans, depending on availability. All outstanding loans under the second amended and restated ABL Facility are due and payable in full on November 5, 2020.


General cash flow movements
    
During the year ended December 31, 2017, cash and cash equivalents increased to $71.4 million compared to approximately $51.6 million as of December 31, 2016.   The increase in cash was driven by a $5.8 million improvement in operating earnings, $5.0 million lower TRA payments and $120.0 million less in voluntary payments on the Term Loan Facility in 2017 versus 2016 partially offset by $43.1 million lower operating cash flow. The improved operating performance was offset by a $38.1 million increase in working capital during the year ended December 31, 2017 relative to the year ended December 31, 2016. Accounts receivable increased $24.7 million and inventory increased $22.9 million offset by a $9.5 million improvement in trade payables during the year ended December 31, 2017 compared to year ended December 31, 2016. The approximate $24.7 million accounts receivable increase from December 31, 2016 to December 31, 2017 resulted primarily from the increase in December sales year over year. The net sales for December 2017 were approximately $177.4 million and the net sales for December 2016 were approximately $152.2 million. The approximate $22.9 million inventory increase from December 31, 2016 to December 31, 2017 resulted from higher raw material costs in 2017 combined with higher inventory levels at December 31, 2017 in anticipation of higher sales volumes in 2018. During the year ended December 31, 2016, cash and cash equivalents decreased approximately $57.8 million to $51.6 million as of December 31, 2016.


46


Our business is seasonal because inclement weather during the winter months reduces the level of building and remodeling activity in both the home repair and remodeling and the new home construction sectors, especially in the Northeast and Midwest regions of the United States and Canada.  As a result, our liquidity typically increases during the second and third quarters as our borrowing base increases under the ABL Facility reaching a peak early in the fourth quarter, and decreases late in the fourth quarter and throughout the first quarter.

Our primary cash needs are for working capital, capital expenditures and debt service.  Our annual cash interest charges for debt service under the current organizational structure, including the ABL Facility, are estimated to be approximately $54.0 million for fiscal year 2018.  As of December 31, 2017, we did not have any scheduled debt maturities until 2020.  The specific debt instruments and their corresponding terms and due dates are described in the following sections.  Our capital expenditures have historically averaged approximately 1.5% to 2.0% of net sales on an annual basis.  For the year ending December 31, 2018, we estimate that our capital expenditures will be in a range from 2.00% to 2.25% of net sales. We finance these cash requirements through internally generated cash flow and funds borrowed under Ply Gem Industries’ ABL Facility.
     
Ply Gem’s specific cash flow movement for the year ended December 31, 2017 is summarized below:

Cash provided by operating activities

Net cash provided by operating activities for the year ended December 31, 2017 was approximately $101.9 million.  Net cash provided by operating activities for the year ended December 31, 2016 was approximately $145.0 million, and net cash provided by operating activities for the year ended December 31, 2015 was approximately $139.4 million.  The decrease in cash provided by operating activities in 2017 was driven by improved housing conditions that drove the 7.6% net sales increase offset by decreases in cash flows related to our working capital increase as a result of the net sales increase, rising commodity costs, and our aggressiveness in taking early pay discounts. These conditions resulted in an unfavorable $38.1 million impact in our primary working capital for the year ended December 31, 2017 compared to the year ended December 31, 2016.

The relative consistency in net cash provided by operating activities between 2016 and 2015 was primarily driven by the $43.2 million increase in net income during the year ended December 31, 2016 compared to the year ended December 31, 2015 partially offset by the $40.1 million working capital increase.

Cash used in investing activities

Net cash used in investing activities for the years ended December 31, 2017, 2016, and 2015 was approximately $37.9 million, $35.8 million, and $54.7 million, respectively.  The cash used in investing activities during 2017 was primarily for capital expenditures which were approximately 2.0%, consistent with our historical average. Additionally, during the year ended December 31, 2017, the Company sold a building in Saskatoon, Canada for approximately $2.1 million. The Company moved to another leased facility within the Saskatoon area that more closely aligns with the Company's needs in that area.

The cash used in investing activities during 2016 was primarily for capital expenditures on numerous ongoing capital projects across all business segments. Capital expenditures for 2016 were approximately 1.9% of net sales, consistent with our historical average.

The cash used in investing activities in 2015 was primarily for the acquisition of Canyon Stone and capital expenditures on various ongoing capital projects. The Canyon Stone acquisition was approximately $21.0 million net of cash acquired. Capital expenditures for 2015 were approximately 1.8% of net sales, consistent with our historical average.


Cash used in financing activities

Net cash used in financing activities for the year ended December 31, 2017 was approximately $44.3 million, primarily from the $40.0 million voluntary Term Loan Facility payment made in November 2017, the 1.0% principal repayment of $4.3 million required by the Term Loan Facility, and $1.2 million in tax withholding related to employee stock grant issuances. These payments were offset by $1.2 million in cash provided by the exercise of stock options.


47


Net cash used in financing activities for the year ended December 31, 2016 was approximately $168.2 million, primarily from the three separate voluntary Term Loan Facility payments that totaled $160.0 million and the 1.0% principal repayment of $4.3 million required by the Term Loan Facility and the Tax Receivable Agreement payment of $5.0 million. These payments were offset by $1.1 million in cash provided by the exercise of stock options.

Net cash used in financing activities for the year ended December 31, 2015 was approximately $3.6 million, primarily related to the 1.0% principal repayment of $4.3 million required by the Term Loan Facility and the payment of $1.4 million in debt issuance costs. These payments were offset by $2.2 million in cash provided by the exercise of stock options.

Ply Gem’s specific debt instruments and terms are described below:

6.50% Senior Notes due 2022

On January 30, 2014, Ply Gem Industries issued $500.0 million aggregate principal amount of 6.50% Senior Notes at par. On September 19, 2014, Ply Gem Industries issued an additional $150.0 million aggregate principal amount of 6.50% Senior Notes (the "Senior Tack-on Notes") at an issue price of 93.25%. Interest accrues at 6.50% per annum and is paid semi-annually on February 1 and August 1 of each year. The 6.50% Senior Notes will mature on February 1, 2022. At any time on or after February 1, 2017, Ply Gem Industries may redeem the 6.50% Senior Notes, in whole or in part, at declining redemption prices set forth in the indenture governing the 6.50% Senior Notes plus, in each case, accrued and unpaid interest, if any, to the redemption date. The effective interest rate for the 6.50% Senior Notes is 8.39% after considering each of the different interest expense components of this instrument, including the coupon payment and the deferred debt issuance costs.

The 6.50% Senior Notes are fully and unconditionally and jointly and severally guaranteed on a senior unsecured basis by Ply Gem Holdings and all of the wholly-owned domestic subsidiaries of Ply Gem Industries (the “Guarantors”).  The indenture governing the 6.50% Senior Notes contains certain covenants that limit the ability of Ply Gem Industries and its restricted subsidiaries to incur additional indebtedness, pay dividends or make other distributions or repurchase or redeem their stock, make loans and investments, sell assets, incur certain liens, enter into agreements restricting their ability to pay dividends, enter into transactions with affiliates, and consolidate, merge or sell assets.  In particular, Ply Gem Industries and its restricted subsidiaries may not incur additional debt (other than permitted debt (as defined in the indenture) in limited circumstances) unless, after giving effect to such incurrence, the consolidated interest coverage ratio of Ply Gem Industries would be at least 2.00 to 1.00.  

In the absence of satisfying the consolidated interest coverage ratio test, Ply Gem Industries and its restricted subsidiaries may only incur additional debt under certain circumstances, including, but not limited to, debt under credit facilities (as defined in the indenture) (x) in an amount not to exceed the greater of (a) $350.0 million and (b) the borrowing base (as defined in the indenture) and (y) in an amount not to exceed the greater of (A) $575.0 million and (B) the aggregate amount of indebtedness (as defined in the indenture) that that would cause the consolidated secured debt ratio (as defined in the indenture) to be equal to 4.00 to 1.00; purchase money indebtedness in an aggregate amount not to exceed the greater of (x) $35.0 million and (y) 10% of consolidated net tangible assets (as defined in the indenture) at any one time outstanding; debt of foreign subsidiaries in an aggregate amount not to exceed the greater of (x) $60.0 million and (y) 15% of consolidated net tangible assets (as defined in the indenture) at any one time outstanding; debt pursuant to a general basket in an aggregate amount at any one time outstanding not to exceed the greater of (x) $75.0 million and (y) 20% of consolidated net tangible assets; and the refinancing of debt under certain circumstances.

On September 5, 2014, Ply Gem Industries completed an exchange offer with respect to the 6.50% Senior Notes issued in January 2014 to exchange $500.0 million 6.50% Senior Notes registered under the Securities Act for $500.0 million of the issued and outstanding 6.50% Senior Notes. Upon completion of the exchange offer, all $500.0 million of issued and outstanding 6.50% Senior Notes were registered under the Securities Act.  On January 23, 2015, Ply Gem Industries completed an exchange offer with respect to the Senior Tack-on Notes issued in September 2014 to exchange $150.0 million Senior Tack-on Notes registered under the Securities Act for $150.0 million of the issued and outstanding Senior Tack-on Notes. Upon completion of the exchange offer, all $150.0 million of issued and outstanding Senior Tack-on Notes were registered under the Securities Act. 


Term Loan Facility due 2021


48


On January 30, 2014, Ply Gem Industries entered into a credit agreement governing the terms of its $430.0 million Term Loan Facility. Ply Gem Industries originally borrowed $430.0 million under the Term Loan Facility on January 30, 2014, with an original discount of approximately $2.2 million, yielding proceeds of approximately $427.9 million. The Term Loan Facility will mature on January 30, 2021. The Term Loan Facility requires scheduled quarterly payments in an aggregate annual amount equal to 1.00% of the original aggregate principal amount of the Term Loan Facility with the balance due at maturity. Interest on outstanding borrowings under the Term Loan Facility is paid quarterly.
  
Borrowings under the Term Loan Facility bear interest at a rate equal to, at Ply Gem Industries’ option, either (a) a base rate determined by reference to the highest of (i) the prime rate of the administrative agent under the credit agreement, (ii) the federal funds rate plus 0.50% and (iii) the adjusted LIBO rate for a one-month interest period plus 1.00% or (b) a LIBO rate determined by reference to the cost of funds for eurocurrency deposits in dollars for the interest period relevant to such borrowing, adjusted for certain additional costs, subject to a 1.00% floor, plus, in each case, an applicable margin of 3.00% for any eurocurrency loan and 2.00% for any alternate base rate loan. As of December 31, 2017, the Company's interest rate on the Term Loan Facility was 4.00%. The effective interest rate for the Term Loan is 8.60% after considering each of the different interest expense components of this instrument, including the coupon payment, the deferred debt issuance costs and the original issue discount.

The Term Loan Facility allows Ply Gem Industries to request one or more incremental term loan facilities in an aggregate amount not to exceed the greater of (x) $140.0 million and (y) an amount such that Ply Gem Industries’ consolidated senior secured debt ratio (as defined in the credit agreement), on a pro forma basis, does not exceed 3.75 to 1.00, in each case, subject to certain conditions and receipt of commitments by existing or additional financial institutions or institutional lenders.

The Term Loan Facility requires Ply Gem Industries to prepay outstanding term loans, subject to certain exceptions, with: (i) 50% (which percentage will be reduced to 25% if our consolidated senior secured debt ratio is equal or less than 2.50 to 1.00 but greater than 2.00 to 1.00 and to 0% if our consolidated senior secured debt ratio is equal to or less than 2.00 to 1.00) of our annual excess cash flow (as defined in the credit agreement), to the extent such excess cash flow exceeds $15.0 million, commencing with the fiscal year ended December 31, 2015; (ii) 100% of the net cash proceeds of certain non-ordinary course asset sales or certain insurance and condemnation proceeds, in each case subject to certain exceptions and reinvestment rights; and (iii) 100% of the net cash proceeds of certain issuances of debt, other than proceeds from debt permitted under the Term Loan Facility. Ply Gem Industries may voluntarily repay outstanding loans under the Term Loan Facility at any time without premium or penalty, other than customary “breakage” costs with respect to LIBOR loans. As of and for the year ended December 31, 2017, the Company's consolidated senior secured debt ratio was 0.66 and as a result no excess cash flow payment under the Term Loan Facility will be required. However, we elected on November 3, 2017 to voluntarily prepay $40.0 million on the Term Loan Facility to reduce our outstanding indebtedness bringing our cumulative voluntary 2016 and 2017 Term Loan Facility payments to $200.0 million as we elected on March 10, 2016 and August 4, 2016 to voluntarily prepay $30.0 million on each date and elected on November 4, 2016 to voluntarily pay an additional $100.0 million on the Term Loan Facility.
    
The Term Loan Facility is secured on a first-priority lien basis by the stock of Ply Gem Industries and by substantially all of the assets (other than the assets securing the obligations under the ABL Facility, which primarily consist of accounts receivable, inventory, cash, deposit accounts, securities accounts, chattel paper, contract rights, instruments, documents related thereto and proceeds of the foregoing) of Ply Gem Industries and the Guarantors that are subsidiaries of Ply Gem Industries and on a second-priority lien basis by the assets that secure the ABL Facility.

The Term Loan Facility includes negative covenants, subject to certain exceptions, that are substantially the same as the negative covenants in the 6.50% Senior Notes but does not contain any restrictive financial covenants. The Term Loan Facility also restricts the ability of Ply Gem Industries’ subsidiaries to enter into agreements restricting their ability to grant liens to secure the Term Loan Facility and contains a restriction on changes in fiscal year.


Senior Secured Asset Based Revolving Credit Facility due 2020


49


On November 5, 2015, Ply Gem Holdings, Inc., Ply Gem Industries, Inc., Gienow Canada Inc., and Mitten Inc. (together with Gienow, the “Canadian Borrowers”) entered into a second amended and restated credit agreement governing the ABL Facility. Among other things, the second amendment and restatement of the credit agreement governing the ABL Facility: (i) increased the overall facility to $350.0 million from $300.0 million, (ii) established an accordion feature of