Ply Gem 060614


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Ply Gem 060614

  1. 1. HIGH YIELD RESEARCH REPORT MILLER TABAK ROBERTS SECURITIES, LLC________________________________________________________________________ Ply Gem Holdings, Inc. (PLYGEM)Coupon Description Maturity Mdys/S&P Amt O/S Bond Price Curr. Yield Spread YTW 9.0% Senior Subordinated Notes 2/15/2012 B3/B- $ 360MM 90.50 9.95% 628 11.31%CUSIP # 729416AG2. Moodys and S&Ps outlooks are negative. June 14, 2006 Ronald A. Rich (212) 692-5185 rrich@mtrdirect.comOPINIONWe initiate coverage of Ply Gem with a BUY recommendation on the 9.0% SeniorSubordinated Notes. Faced with an increasingly challenged new home construction marketand a volatile raw material cost environment, Ply Gem is positioned to mitigate negative macrotrends. We project positive free cash flow generation in the coming years, despite assumptionsthat incorporate a slowdown in certain of the company’s business lines. While investorconcern regarding the residential construction sector may cause further volatility in the bondsand a widening in spreads, we expect the Notes to outperform comparably rated sector peers inthe medium-term. Based on our pricing analysis of the bonds of Ply Gem’s peer group, aswell as our view to company fundamentals, we find the 9.0% Senior Subordinated Notescurrently priced at a 230bp discount to comparable residential construction-related securities.SUMMARY• While Ply Gem has significant exposure to a slowing new home construction market (68% of net sales), we believe that it is positioned to partially offset this macro trend with new siding business at 84 Lumber; increased Window and Door sales in Alberta, Canada and the southern U.S. (the latter through its February 2006 acquisition of AWC Holding); and cost- side synergies that should be achieved through enhanced purchasing savings and broadened vertical integration.• With the balance of Ply Gem’s business targeted to the less volatile repair and remodel market, we project a rebound in repair/remodel Windows and Doors unit volumes in 2007, due to improved service levels following product re-launches.• Ply Gem’s gross margins have material exposure to raw materials that include PVC, aluminum, glass, and fuel used in transportation. While the company has successfully passed through higher resin costs, it is still working to recover higher aluminum costs.• With pro forma, for its latest acquisition, LTM adjusted EBITDA at $135.5 million for the period ending March 31, 2006, we project adjusted EBITDA to be slightly down from the pro forma figure through 2006 and to increase 7.5% year-over-year in 2007. We anticipate that liquidity will improve to $118.0 million and $133.2 million in the fourth quarters of 2006 and 2007, respectively, from $92.2 million at the end of 2005.• Future acquisitions and possible dividend recapitalizations place the company’s credit quality at risk, though the company’s near-term acquisition appetite may currently be tempered given the slowing housing market, the ongoing integration of recent acquisitions and the planned retirement of its CEO, Lee Meyer. 331 MADISON AVENUE NEW YORK, NEW YORK 10017 (212) 867-7959 FAX (212) 867-6492 (800) 452-4528 (888) HI-YIELD Please refer to the last page of this report for important disclosures
  2. 2. BUSINESS OVERVIEWPly Gem Holdings, Inc. (“Ply Gem” or “Company”) is a leading manufacturer of residentialexterior building products in the U.S. and Alberta, Canada. The Company produces a full line ofvinyl siding and skirting, aluminum trim coil, composite fencing, railing and decking, vinyl,wood and aluminum windows, vinyl, steel and fiberglass doors, as well as vinyl and aluminumsoffit and siding accessories. Ply Gem sells these products into both the new home constructionand home repair and remodeling markets; after giving effect to Ply Gem’s February 2006acquisition of AWC Holding, approximately 68% of pro forma net sales are derived from newhome construction, as compared with the Company’s fiscal 2003 concentration of 60%. PlyGem organizes its financial reporting across two business segments: (1) Siding, Fencing, Deckingand Railing (“SFDR”), which comprises 40% of pro forma fiscal 2005 net sales, and (2)Windows and Doors, which accounts for the balance. Net sales for the twelve months endedMarch 31, 2006 were $883.4 million, with EBITDA of $121.3 million. Pro forma (for its latestacquisition) LTM net sales were approximately $1.0 billion, with pro forma LTM EBITDA of$135.5 million.ACQUISITIONSOwned by Caxton-Iseman Capital, Ply Gem Industries has served as a platform for aportfolio build-up in the building materials space, and we anticipate that add-onacquisitions will continue to be core to Ply Gem’s growth strategy. With fiscal 2005 U.S.window and door sales down in Ply Gem’s legacy divisions (pre-acquisition of MWM Holdingand AWC Holding, herein referred to as “Ply Gem Industries”) as a result of service issuesrelating to product re-launches, much of the Company’s recent growth and profitability in thesegment has stemmed from its acquisitions of MWM Holding and AWC Holding. Thefollowing section provides an overview of the three business groupings that comprise Ply GemHoldings, each differentiated by its product mix, geographic focus, customer base anddistribution channels (see Figure 1).Ply Gem IndustriesFormerly known as the Windows, Doors and Siding division of Nortek, Ply Gem Industries wasacquired on February 12, 2004 by an affiliate of Caxton-Iseman Capital, Inc. for $570.0 million,or an 8.5x multiple to fiscal 2003 EBITDA of $67.1 million. Principal products include vinylsiding, windows, patio doors, fencing, railing, decking and accessories, which are marketedunder the Variform, Great Lakes, Napco, CWD and Kroy brand names. With fiscal 2005 netsales of $546.7 million, the legacy Ply Gem business represents 56% of Ply Gem Holdings’ totalbusiness following its latest acquisition.Geographic Footprint. The SFDR product lines accounted for 72% of Ply Gem Industries’ fiscal2005 net sales. Manufactured at six facilities throughout the Northeast, Midwest and South,these products are readily transported and sold across all 50 states; over two-thirds of Ply Gem’sSFDR products are sold to the home repair and remodel markets. The windows and doorsproducts are distributed in regional proximity to manufacturing facilities located in Pennsylvania,Ohio and Calgary, Canada, with approximately 37% ultimately sold into new home construction,primarily in Canada. 2
  3. 3. Figure 1 PLY GEM HOLDINGS Business Structure Distribution Manufacturing 2005 Corporate Entity Operating Segments Brands Regions Served Channels Locations Competition PF Net Sales (1) Missouri, West Specialty Owens Corning, Georgia-Pacific, Virginia, Variform, Patriot Siding and distributors (1-step), Alcoa, Napco, Variform, Nationwide Tennessee, Manufacturing Accessories wholesale distributors CertainTeed, Durabuilt (Lowes) Pennsylvania (2-step) Alside (metals) U.S. Fence, $ 390.9MM Homeland, Fabricators, Kroy, Assurance, Westech, Kroy Building Fencing, Railing, distributors, retail Nebraska, North Georgia-Pacific, Nationwide Bufftech, Products Decking home centers, Carolina Fusion Fence (Lowes) Outdoor lumberyards Technologies, Royal (2) Great Lakes Building material Windows and Doors Great Lakes East North Central Ohio Window dealers, distributors $ 97.6MM Napco Window Building material Windows and Doors Napco Mid-Atlantic Pennsylvania Systems dealers, distributors Builder buying MI Home CWD Windows and Windows and Doors CWD Calgary, Canada groups, retail Calgary, Canada Products, $ 58.2MM Doors lumberyards Silverline, Building material Simonton, Mid-Atlantic, East dealers, large New Jersey, Milgard (Masco), MW Manufacturers Windows and Doors MW, Patriot, Twinseal South Central, South regional chains, Virginia, Atrium, Alside $ 292.1MM Atlantic builders, retail home Mississippi centers West South Central, Building material Texas, Georgia, AWC Holding Windows and Doors Alenco South Atlantic, $ 135.2MM dealers Arizona MountainSource: Company reports and MTR.(1) Specialty distributors sell directly to remodeling contractors and builders. Wholesale distributors sell to retail home centers and lumberyards who, in turn, sell to remodeling contractors, builders and consumers.(2) Building material dealers typically market directly to homeowners or contractors in connection with repair/remodel while distributors concentrate on local independent retailers.Customers. With 41% of SFDR products sold to BlueLinx (formerly a distribution arm ofGeorgia-Pacific Corporation) under the GP brand, recent acquisitions have helped to reduce PlyGem’s exposure to this large customer; the relationship accounted for approximately 16% of proforma consolidated 2005 net sales, with another 10% of segment sales made to Lowe’s andHome Depot (see Figure 2). Management has recently mentioned that it will be leveraging itsstrong windows and doors relationship with 84 Lumber to sell more siding, a deal which itexpects to account for tens of millions of dollars in sales. Ply Gem Industries’ windows anddoors products are sold through a diversified customer base of dealers and distributors (dealerstypically market directly to homeowners and contractors). CWD Windows and Doors is theone division of Ply Gem Industries that is discernibly thriving, growing 19.0% in fiscal2005. Eighty percent of window and door sales in Canada are made to the new constructionmarket, which the Canada Mortgage and Housing Corporation expects to remain robust due tostrong demand created by increased oil exploration in Alberta, Canada (see Markets). 3
  4. 4. Figure 2 PLY GEM HOLDINGS Customer Concentration (a) Ply Gem 05 Rev Co. Sales Growth Customer CompanyCompany Business Dollars % PF 05 2003 2004 2005 End-Markets Regions Served 2005 Sales Notes 50% New Home Focusing on specialty BlueLinx Distributor $ 158.7MM 16.3% 7.2% 16.0% 9.4% (b) Construction, 15% Nationwide $ 2.1BN product growth. Repair/Remodel Washington, DC and 98% New Home Mid-Atlantic, Baltimore, MD metro areas NVR Homebuilder $ 40.3MM 4.1% 17.7% 18.0% 21.9% (c) Construction, 2% South Atlantic, $ 5.2BN account for 52% of 2005 Mortgage Banking Midwest homebuilding revenue. 100% New Home Southern and Targets production Builders FirstSource Distributor $ 34.5MM 3.5% NA 10.3% 14.4% (d) $ 447.5MM Construction Eastern U.S. homebuilders. Lowes Distributor $ 29.3MM 3.0% 18.3% 21.8% 23.6% (e) Repair/Remodel Nationwide $ 43.2BN Nationwide, 87% New Stock Building Supply Distributor $ 25.5MM 2.6% 0.0% 30.0% 27.2% (f) operating in 30 $ 2.5BN Subsidiary of Wolseley plc. Construction states Nationwide, Canada, Home Depot Distributor $ 9.8MM 1.0% 11.8% 18.6% 10.6% (g) Repair/Remodel $ 81.5BN Mexico, Puerto Rico 85% New Home 84 Lumber Distr/Manuf NA NA 20.5% 30.6% 13.3% Nationwide $ 3.9BN ConstructionSource: Company reports and MTR.(a) Percentages are pro forma of the AWC Holding acquisition.(b) Sales and growth figures reflect specialty products which include vinyl siding, composite decking, moulding, insulation, roofing, hardwood plywood and engineered lumber. Comprised 39.9% of siding, fencing, railing, decking segment.(c) Sales and growth figures reflect homebuilding segment.(d) Sales and growth figures reflect Windows & Doors product category.(e) Ply Gem figures have been estimated. Lowes sales growth reflects its building materials product category.(f) As reported in the U.S. Building Materials segment of Wolseley plc.(g) Ply Gem figures have been estimated. Home Depot sales growth reflects its building materials, lumber and millwork product category.MW WindowsOn August 27, 2004, Ply Gem acquired MWM Holding (“MW”) from Investcorp for $320.0million, at an estimated trailing EBITDA multiple of 8.5x and an estimated post-synergiesEBITDA multiple of 7.2x. MW is a leading low-cost, vertically-integrated manufacturer ofvinyl, vinyl clad-wood, wood and composite windows that also manufactures vinyl patio doorsand marketing steel and fiberglass exterior doors. With fiscal 2005 net sales of $292.1 millionand EBITDA of $47.6 million, MW was a very significant addition to Ply Gem’s Windows andDoors segment.Synergies. The acquisition of MW in 2004 provided Ply Gem with the opportunity to leverage anumber of sales and cost-side synergies; total cost-side synergies were estimated at $7.0 millionat the time of acquisition. On the cost-side, the purchase of MW has allowed Ply Gem toimprove raw material purchasing power (PVC, wood, aluminum and glass), source PVC fromthe siding business for the manufacture of vinyl lineals (used in the construction of the vinylwindow frame) at MW, and leverage the vertical integration of MW’s manufacturing capabilitiesto produce vinyl lineals for the repair/remodel window business (traditionally outsourced). With$2.0 million of cost-side savings achieved in 2005, management expects to phase-in additionalsavings of $5.0 million beginning in the third quarter of 2006, which are anticipated to be fullyrealized by the first quarter of 2007. As for sales-side synergies, the acquisition presents theopportunity to exploit economies of scope across markets and customers.Geographic Footprint. With a network of vertically-integrated production and distributionfacilities located in New Jersey, North Carolina, Virginia and Mississippi, the acquisition of MWexpanded Ply Gem’s footprint to include the Mid-Atlantic and South Atlantic regions. Windowdistribution is closely tied to proximity to manufacturing facilities, given on-time deliveryrequirements and the potential for glass breakage. As discussed below in the Markets section,new home construction remains near historical highs in the Northeast, though down significantlyin the Southeast; net sales orders of the major home builders have declined materially in bothregions. 4
  5. 5. Customers. MW’s product lines are sold for use in new home construction and home repair andremodeling through a diverse customer base that includes independent building material dealers,large regional chains, builder direct/OEMs and retail homecenters. MW’s emphasis on newhome construction (80% of net sales) and its alliance with strong customers has provided PlyGem with a near-term beneficial sales allocation-shift from some of its softer repair/remodelmarkets. The subsidiary’s focus on windows and doors has also reduced Ply Gem’s dependenceon siding sales, which have experienced a volume decline at the Company and industry levels.With 800 customers across four distribution channels, three customers represented 34.3% ofMW’s fiscal 2005 net sales; in fiscal 2005, NVR, Builders FirstSource and Stock BuildingSupply accounted for 13.8%, 11.8% and 8.7% of MW net sales, respectively (see Figure 2). Asreferenced above, 84 Lumber is also a strong customer of MW’s, and that relationship iscurrently being expanded to include vinyl siding.AlencoPly Gem acquired AWC Holding Company (“Alenco”) on February 24, 2006 from LinsalataCapital for $120.0 million. With an estimated pre-synergies fiscal 2005 EBITDA of $16.3million and post-synergies fiscal 2005 EBITDA of $20.3 million, we calculate acquisitionEBITDA multiples of 7.4x and 5.9x, respectively. Headquartered in Bryan, TX, Alenco is amanufacturer of residential aluminum and vinyl windows and doors, largely used in single andmulti-family new construction. Alenco’s sales for the twelve months ended March 31, 2006were $139.7 million, with aluminum products accounting for 66% of net sales.Synergies. Management estimates that the Alenco acquisition will initially produce $4.0 millionof cost-side synergies, primarily through purchasing savings on PVC, aluminum and insurance;MW will supply Alenco with vinyl lineals, while Alenco will provide MW with aluminumextrusions. The PVC-based synergies are not expected to be achieved until fiscal 2007, due tothe retooling that must occur at MW’s manufacturing facilities. Ply Gem anticipates that theAlenco acquisition’s sale-side synergies will ultimately exceed those of the MW acquisition.Some of MW’s larger customers are working to consolidate their supplier base, and the additionof Alenco will allow Ply Gem to grow its footprint along with that of its customers.Geographic Footprint. Alenco’s sales are concentrated in the South region of the U.S. Withmanufacturing facilities historically operating in Georgia and Texas, Alenco has expanded itspresence into the Southwest with the opening of a new 150,000 square foot facility in Phoenix,AZ. Management has discussed expansion into Nevada, further leveraging the new facility, aswell as into Florida where the aluminum window is particularly competitive.Customers. Alenco’s customer base is comprised primarily of independent building materialsdistributors located in the Southeastern and Southwestern U.S. According to The FreedoniaGroup, an industry research company, the southeastern U.S. and the Gulf Coast comprise 41% ofthe total U.S. window and door market, driven by population growth rates above the nationalaverage and growing second home ownership.MARKETSWhile management’s success in driving growth, business integration and corporate synergies isextremely relevant to Ply Gem’s story, its near-term future is also dependent upon exogenous 5
  6. 6. factors that affect the Company’s product, raw material and geographic markets. The followingsection will discuss those markets that directly impact Ply Gem and their corresponding drivers.Windows and DoorsPro forma for the Alenco acquisition, Ply Gem’s Windows and Doors segment comprised 61%of 2005 net sales, up from 30% in 2003. While Ply Gem’s product line has historicallyconcentrated on vinyl windows and doors, the purchase of Alenco has increased theCompany’s focus on aluminum products, which comprised an estimated $90 million ofAlenco’s 2005 net sales. Domestic window and door demand has grown rapidly over the pastten years, driven by growth in remodeling and an increasing trend toward larger homes thatrequire a greater number of windows. The vinyl window’s initial success in the marketplacecame at the expense of aluminum, but it is increasingly taking market share from wood. Vinyl’ssuccess in the repair/remodel market stems from the manufacturing flexibility required toproduce a wide variety of custom sizes. In 2004, Ducker Research, a market intelligence firm,estimated that vinyl windows accounted for 35.1% of all windows used in new construction and52.3% of windows used in the repair and remodel market (see Figures 3,4). The FreedoniaGroup has estimated that window demand for the year-ended 2004 was comprised of 47%vinyl, 41% wood and 10% aluminum, with vinyl window demand growing at acompounded annual rate of 5.0% between 2002 and 2012. Due primarily to the aluminumwindow’s higher transference of cold air, high strength-to-weight ratio and lower price, thematerial garners greater market share in warmer climates and coastal areas; Ducker Researchdetermined that aluminum had a 48% market share of Florida window shipments in 2003, whilevinyl and wood’s market shares were 28% and 23%, respectively. As for future market shareallocation, industry participants expect vinyl to continue to take share from wood and aluminum,except in regions where aluminum has a competitive advantage.Figure 3 Figure 4 VINYL WINDOW SHARE OF WINDOW MARKET RESIDENTIAL WINDOW MARKET (In Millions of Units) 0.355 0.525 32 New Construction Repair/Remodel 0.52 0.35 30 28 Units 0.515 0.345 26 0.51 24 0.34 0.505 22 2000 2001 2002 2003 2004 2000 2001 2002 2003 2004 Percentage of New Construction Percentage of Repair/Remodel New Construction Repair/RemodelSource: Ducker Research Co. from National Fenestration Rating Council Source: Ducker Research Co. from National Fenestration Rating CouncilSidingThe National Association of Home Builders expects the exterior cladding market as a whole tobe flat through 2006 at 12.0 billion square feet, versus 11.9 billion square feet in 2003. Asshown in Figure 5, exterior cladding in the repair/remodel segment is expected to continue togrow to 6.5 billion square feet in 2006, while the new construction market is projected to remainrelatively flat at 5.5 billion square feet. 6
  7. 7. Figure 5 Figure 6 U.S. AND CANADA EXTERIOR CLADDING U.S. SHIPMENTS OF VINYL SIDING AND SOFFIT* (In Billions of SF) (In Millions of Squares) 6.6 45 40 Squares (10x10SF) 6.2 Square Feet 35 5.8 30 5.4 25 5 20 2002 2003 2004 2005P 2006P 15 New Construction Repair/Remodel 1991 1993 1995 1997 1999 2001 2003 2005Source: NAHB from James Hardie Industries * Data reflects only companies reporting shipments to VSI, except 1991 data. Source: Vinyl Siding Institute from Plastics NewsVinyl siding has grown tremendously over the past twenty years, peaking at an estimated 41.3million squares (1 square=100 sq.ft. of coverage) in 2004 (see Figure 6). Much of its marketshare growth has been rooted in its low installation and maintenance costs. Recently, rising resinand micro-ingredient costs have driven the price of vinyl siding higher and closer to that ofpotential substitutes, such as fiber-cement. Vinyl siding industry unit volumes were down 2.6%year-over-year in 2005, and some industry participants believe that the category has matured.We have had a number of conversations with building materials distributors and extrusionequipment manufacturers, and we believe that Figure 7fiber-cement siding may very well be taking NATIONAL NEW HOME STARTS Seasonally Adjusted Annual Ratemarket share from vinyl siding. 2,200 Units In ThousandsNew Home Construction 2,100 2,000New home construction currently accounts for 1,90068% of Ply Gem’s pro forma 2005 net sales. 1,800While sales in the new home construction 1,700market are lower margin than those in the 06 03 03 03 03 04 04 04 04 05 05 05 05 06 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q pr Arepair/remodel market, the pursuit of Source: U.S. Department of Commerceadditional new construction business alignsPly Gem with large, growing customers that are increasing their footprint and acquiringmarket share from smaller competitors; the increased focus on the new constructionmarket also raises volatility and decreases visibility to future earnings.Since 1991, housing starts have increased at a compounded annual growth rate of 4.9%. Drivenby low mortgage interest rates, favorable demographics, increasing immigrant demand for starterhomes, and maturing baby boomers seeking second homes, this rate has accelerated to 12.3%over the past two years; new home starts increased from a seasonally adjusted annual rate of 1.7million units in the first quarter of 2003 to a peak of 2.13 million units in the first quarter of 2006(see Figure 7). The Homeownership Alliance predicts that these demand drivers will lead to1.85 million to 2.17 million new U.S. housing starts per year through 2014. The recent declinein new home starts has been driven by softening demand that has resulted from rising mortgagerates.The regional trends in new home construction are distinct, with new home start data for the firstfour months of 2006 mixed: 1) while down from an exceptionally high January, the Northeast isbasically flat at a strong level; 2) the South has declined the most of the four regions, 26.4%down from its January peak; 3) the Midwest has trended sideways with April data higher thanthat of February and March; and 4) the West is basically flat, though down from the fourth 7
  8. 8. quarter of 2005. While Ply Gem’s SFDR business has a national presence and greaterrepresentation in the repair/remodel market, the Company’s Windows and Doors business hasgradually shifted to the south and west and into the new construction market. Following theacquisitions of MW and Alenco, the Company’s regional manufacturing capacity (on a squarefoot basis) as a percentage of total manufacturing capacity in the Windows and Doors segmentchanged from 42% to 20% in the Midwest, 17% to 46% in the Northeast, and 0% to 16% in theSouth. While expansion into the South has provided Ply Gem with access to larger andfaster growing markets, it also exposes the Company to greater volatility and potentialdecline in sales.Figure 8 Figure 9 U.S. REGIONAL NEW HOME STARTS U.S. REGIONAL NEW HOME STARTS Seasonally Adjusted Annual Rate Seasonally Adjusted Annual Rate South New Home Starts 220 420 1,100 560 West New Home Starts Northeast New Home Midwest New Home 210 400 1,050 540 200 1,000 520 190 380 950 Starts Starts 500 180 360 900 170 480 340 850 160 800 460 150 320 750 440 140 300 700 420 03 03 03 03 04 04 04 04 05 05 05 05 A 06 06 06 03 03 03 03 04 04 04 04 05 05 05 05 A 6 0 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q pr pr Northeast Midwest South WestSource: U.S. Department of Commerce Source: U.S. Department of CommerceThe National Association of Home Builders’ chief economist, David Seiders, currentlyexpects overall housing starts to decline 6% to 7% in 2006, down from 2.07 million units in2005. Mr. Seiders has speculated that a lot of the recent build-up of inventory of new single-family homes represents temporary weather-related factors and is still projecting a “soft landing”for the single-family market in 2006.A likely leading indicator of new home starts, net sales orders (the number of new salescontracts executed with customers, net of cancellations) of the major new homebuilders arein decline across all markets (see Figure 10). The decrease in net sales orders has beenattributed to an increase in cancellations and has resulted in an increase in housing inventory.With the supply of new homes rising at a greater rate than demand, many homebuilders arehopeful that a more favorable supply/demand balance will be reached when inventory generatedby speculators flows through the channel. This sentiment was affirmed by Robert Toll, CEO ofToll Brothers, during the company’s second quarter fiscal 2006 earnings conference call. 8
  9. 9. Figure 10 NET SALES ORDERS New Homebuilders (Based on Units) DR Horton Pulte Lennar Centex KB Beazer Ryland Hovnanian Latest Quarter Ending 3/31/06 3/31/06 2/28/06 3/31/06 2/28/06 3/31/06 3/31/06 4/30/06 East Qtr Change, Y/Y - - 12.4% - - - - - % of Total - - 32.1% - - - - - Northeast Qtr Change, Y/Y - -29.2% - - - - -21.5% 3.7% % of Total - 8.5% - - - - 25.9% 19.2% Mid-Atlantic Qtr Change, Y/Y 8.7% - - -5.2% - -7.8% - - % of Total 8.8% - - 16.8% - 10.7% - - Midwest Qtr Change, Y/Y -32.4% -13.1% - -13.5% - -16.5% - - % of Total 6.1% 12.6% - 19.0% - 12.3% - - Central Qtr Change, Y/Y - 6.7% 10.9% - -9.7% 27.6% - - % of Total - 13.4% 30.1% - 30.3% 7.7% - - Texas Qtr Change, Y/Y - - - - - - 2.0% - % of Total - - - - - - 19.7% - Southeast Qtr Change, Y/Y 24.1% -9.2% - -26.7% 0.7% -5.0% -17.0% -17.8% % of Total 13.7% 30.8% - 17.9% 22.0% 32.5% 29.7% 31.5% Southwest Qtr Change, Y/Y 12.8% - - -17.8% -30.3% - - 1.1% % of Total 39.2% - - 30.0% 25.5% - - 31.2% West Qtr Change, Y/Y 7.5% -14.6% -9.9% 12.8% -24.7% -46.3% -44.3% -41.0% % of Total 32.3% 34.7% 37.8% 16.4% 22.2% 36.8% 24.7% 18.1% Source: Company reportsCanada. Accounting for 13% of Ply Gem’s windows and doors business, Alberta, Canadaposted 19.0% growth in net sales in 2005. In the midst of soaring oil prices, the region hasbecome home to an economic boom driven by Figure 11oil sands exploration. Oil sands in the region are ALBERTA, CANADA NEW HOME STARTS Seasonally Adjusted Annual Rateestimated to hold reserves equivalent to as much 50as 175 billion barrels of oil. The drive to 48 46 In Thousandsincrease crude production has led to a shortage 44 42of workers, which has resulted in rising wages 40 38and the importation of labor from the eastern 36 34Canadian provinces and Europe. Income growth 32 03 Q03 Q03 Q03 Q04 Q04 Q04 Q04 Q05 Q05 Q05 Q05 Q06 06and population inflow have, in turn, led to a rise 1Q 2 3 4 1 2 3 4 1 2 3 4 1 A prin new home starts, which are projected to Source: Canadian Statisticsincrease 10.9% to 45,000 in 2006 from 40,600 in2005 (see Figure 11). With oil sands production at just over one million barrels a day andprojected to rise to 2.7 million barrels by 2015, and with residential building permits atrecord levels, we anticipate that new home starts will remain strong in the region in themedium-term. 9
  10. 10. Repair and RemodelWith volumes down approximately 10% from 2004 levels, sales into the repair/remodel marketaccount for approximately 30% of Ply Gem’s pro forma 2005 net sales. Strength in therepair/remodel market is driven by underlying demand and the consumer’s ability to pay for thisdemand. During the recent market expansion, demand has been driven by favorabledemographics led by the baby boom generation, an aging housing stock, increased average homesize and low financing rates. While remodeling spending has increased from $153 billion in1995 to an estimated $275 billion in 2005, it has grown at a slower rate than new constructionspending.In a recent presentation on the state of the U.S. Figure 12home improvement industry, the Joint Center for CONSUMER CONFIDENCEHousing Studies (JCHS) at Harvard University East North Central Region Spread to Entire U.S. 40.0addressed a number of concerns regarding thefuture of the repair/remodel market. Firstly, 30.0 Spreadwith regard to rising mortgage interest rates, the 20.0JCHS points out that less than one-third of all 10.0home remodeling is financed (though studies by -the Federal Reserve Board have found that a 03 03 03 03 04 04 04 04 05 05 05 05 06 E 06 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Qsignificant share of recent refinancings was used Source: The Conference Boardfor home improvements). Secondly, Center datasuggests that high-end income growth has kept pace with home price inflation, allowing recenthomebuyers to continue to afford home improvements. Lastly, as baby boomers age beyondtheir prime remodeling years, their consumption is being replaced by Generation X’ers thatpossess greater spending power than their predecessors, compensating for the variance inpopulation size.In the near-term, the JCHS expects remodeling spending to continue to grow modestly, askey drivers of home improvement spending, such as home sales, employment increases andincome growth, remain steady. The latter two elements directly affect consumer confidence,which is a leading indicator for remodeling expenditures. In Figure 12, we have graphed thespread between the Consumer Confidence Index, as reported by The Conference Board, of theEast North Central region and the nation. Comprised of Ohio, Indiana, Illinois, Michigan andWisconsin, the East North Central region is not only lagging the rest of the country, but it is alsodiverging. With vinyl siding highly represented in the Midwest region and in therepair/remodel marketplace, Ply Gem siding volumes were down in fiscal 2005, thoughthey rebounded in the fourth quarter; window volumes were also weaker in therepair/remodel market, but the decline was more likely related to Company service levels.As shown in Figures 13 and 14, residential spending on home improvements on an LTM basishas increased in the third and fourth quarters of 2005. While spending in the Northeast andMidwest regions is down from recent highs, it has reached new levels in the South and West. 10
  11. 11. Figure 13 Figure 14 LTM TOTAL IMPROVEMENTS SPENDING LTM TOTAL IMPROVEMENTS SPENDING Not Seasonally Adjusted Not Seasonally Adjusted 28,000 45,000 40,000 Millions of Dollars Millions of Dollars 26,000 35,000 24,000 30,000 22,000 25,000 20,000 20,000 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 Northeast Midwest South WestSource: U.S. Census Bureau Source: U.S. Census BureauRaw MaterialsPly Gem’s greatest exposure to raw materials includes PVC and aluminum. Along with theindustry as a whole, the Company, to date, has been successful in passing through price increasesto its customer base. While gross margins have been slightly compromised, Ply Gem has, forthe most part, recovered unit gross contribution. Its continued success in passing throughfuture cost increases will be highly dependent upon the strength of demand in its end-markets.PVC. Resin is an important component of Ply Figure 15Gem’s raw material mix, accounting for PRIME PVC PRICINGapproximately 60% of siding cost of goods sold 75and 30% of window cost of goods sold. The 70Company’s vinyl siding and vinyl window 65 Cents per Pound 60products utilize PVC, as well as micro- 55 50ingredients that are responsible for a variety of 45physical properties. PVC is a widely used 40 35plastic found in products ranging from clothing P P P 03 03 03 03 04 04 04 04 05 05 05 05 06 06 06 06 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Qto plumbing fixtures, and its presence is so Source: Plastics Newspervasive in the building industry through its usein pipe, conduit, frames and siding, that its demand cycles with construction trends. TheAmerican Plastics Council estimates that rigid pipe and tubing account for half of all domesticPVC sales in the United States and Canada, while other construction-related uses account foralmost 22%. PVC is produced from its monomer, vinyl chloride, which is dependent upon thefeedstocks natural gas, chlorine and ethylene.PVC pricing is not only dependent on petrochemical pricing but also on the supply and demanddynamic of its chemical and monomer feeds. Dow Chemical is expected to close its vinylchloride monomer plant in the first half of 2006, accounting for an estimated 10% reduction indomestic production capacity. It has been speculated that PVC pricing has increased to a levelthat will spur the use of substitutes such as concrete and ductile iron for rigid pipe in theconstruction industry. While there appears to be a number of opposing forces on pricing, wehave based our projections on our conversations with PVC producers, who predict pricing reliefover the coming year.Pricing on prime PVC is currently up 80% since the first quarter of fiscal 2003, having peaked at72.5 cents per pound in the fourth quarter of 2005 (see Figure 15). In response to the recentincrease in the cost of PVC, Ply Gem successfully increased its price on siding and fencing by15% year-over-year in the fourth quarter of 2005, giving back some pricing in the first quarter of 11
  12. 12. 2006. Currently priced at 66.5 cents per pound, we have forecast PVC pricing to continueto gradually abate to 60 cents per pound in the second quarter of 2007; the decrease will bedriven by increased supply due to normalized domestic production capacity followingHurricanes Katrina and Rita, as well as augmented production capacity in China.Aluminum. With the acquisition of Alenco, Ply Gem has increased its exposure to aluminumpricing. In addition to its use in aluminum windows, aluminum is a key raw material in theCompany’s metal offerings, including trim coil and flatstock. Since 2003, aluminum hasconsistently trended upward, increasing 73.8% through the first quarter of 2006 (see Figure 16).According to American Metal Market, many industry sources believe that speculation byinvestment funds has driven the steep rise of aluminum pricing, given that aluminum supply isnot that constrained; it has been estimated that, by the end of 2005, there had been $80 billioninvested in commodity index funds, up from $50 Figure 16billion twelve months earlier. The demand for ALUMINUM PRICING As of June 8, 2006aluminum will also be affected by its cost 1.20differential with copper; as the differential 1.10 Dollars per Poundwidens, aluminum becomes an increasingly 1.00more attractive substitute. Offsetting these 0.90demand drivers is the possible start-up of idled 0.80 0.70smelting capacity, as well as substitute products 0.60that become more competitive as aluminum t 03 03 03 03 04 04 04 04 05 05 05 05 06 en 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q es Prpricing increases. With the base metals market’s Source: The London Metal Exchangerecent cooling, it is unclear whether the price ofaluminum will continue to move higher in the medium-term.CORPORATE STRUCTURE Figure 17 PLY GEM HOLDINGS, INC. (no operations) Guarantees Credit Facilities Guarantees Senior Sub Notes PLY GEM INDUSTRIES, INC. Guarantees Canadian Term Loan $ 70MM Revolving Credit Facility $ 375MM U.S. Term Loan $ 360MM 9.0% Senior Sub Notes U.S. SUBSIDIARIES CWD WINDOWS AND DOORS Canadian subsidiary Guarantees Credit Facilities Guarantees Senior Sub Notes US$ 25MM Canadian Term Loan Source: Company reports 12
  13. 13. CAPITAL STRUCTUREAs shown in Figure 17, Ply Gem’s capital structure is comprised of a bank facility and a SeniorSubordinated Note issue, with Ply Gem Industries the borrower of the revolving credit facilityand the U.S. term loan, and its Canadian subsidiary, CWD Windows and Doors, the borrower ofthe Canadian term loan. The Senior Subordinated Notes were issued by Ply Gem Industries.Senior Credit FacilityIn connection with its acquisition of Alenco on February 24, 2006, Ply Gem Industriesrefinanced its credit facility pursuant to the Third Amended and Restated Credit Agreement. Thesenior credit facility is currently comprised of a revolver with a maximum availability of $70million, a $375 million U.S. term loan and a US$25 million Canadian term loan. As of March15, 2006, $13.2 million had been drawn under the revolver to fund working capital requirements.The revolving credit facility bears interest at LIBOR plus 2.50%, declining as low as 1.75% asthe Company’s Total Leverage Ratio decreases below 4.5x. The revolver pays interest quarterlyand is scheduled to mature on February 24, 2011. The credit facility’s term loan bears interest atLIBOR plus 2.25% as long as Ply Gem’s corporate family rating from Moody’s and S&P equalsor exceeds B1 and B+, respectively. The term loan amortizes at the rate of $4.0 million perannum, payable in equal quarterly installments beginning June 30, 2006, and matures on August15, 2011. The credit facility also incorporates an annual Excess Cash Flow sweep to reduceoutstanding term borrowings.All indebtedness under the senior credit facilities is secured by a perfected first priority securityinterest in all tangible and intangible assets, as well as a first priority pledge of all of Ply Gem’sequity interests and those of its subsidiaries; however, assets of the Canadian subsidiary onlysecure debt of the Canadian borrower. The credit facilities are guaranteed by Ply Gem Holdingsand all of Ply Gem’s subsidiaries, while the indebtedness of the Canadian borrower is guaranteedby Ply Gem Holdings, Ply Gem Industries and all of the Canadian borrower’s subsidiaries.Financial covenants delineated in the credit agreement include: (1) Maximum Total LeverageRatio of 6.50:1.00 through June 30, 2007, thereafter declining from 6.40:1.00 to 4.75:1.00; (2)Minimum Interest Coverage Ratio of 1.50:1.00 through December 31, 2006, increasing over timeto 1.90:1.00; and (3) Limitation on Capital Expenditures of $37.5 million in any fiscal year,subject to carryover amounts.Notable Permitted Additional Indebtedness clauses under the credit agreement include: (1)indebtedness assumed in connection with an acquisition not to exceed $40.0 million at any timeoutstanding; (2) unsecured indebtedness of Ply Gem Holdings, such that the pro forma ParentConsolidated Leverage ratio is less than 5.5:1.0 and the pro forma Total Leverage ratio is lessthan 4.0:1.0; and (3) indebtedness incurred by foreign subsidiaries not to exceed $30.0 million.In addition, the Third Amended and Restated Credit Agreement provides for the repurchase ofup to $40.0 million of the Company’s Senior Subordinated Notes through the use of excess cashflow and/or a portion of the revolving credit facility, an increase from the $25.0 million allowedin the Second Amended and Restated Credit Agreement. Assuming no further acquisitions,which we consider unlikely, we anticipate that Ply Gem will be in compliance with the financialcovenants delineated in the credit agreement. The relatively limited tightening of near-termcovenant metrics may have intentionally been structured to provide Ply Gem with the flexibilityto make additional acquisitions. 13
  14. 14. 9.0% Senior Subordinated NotesIn connection with the acquisition of Ply Gem Industries from Nortek on February 12, 2004, andthe acquisition of MWM Holding on August 27, 2004, Ply Gem issued $225.0 million and$135.0 million of 9.0% Senior Subordinated Notes (“Notes”), respectively, for a total of $360million. The Notes bear interest at 9.0% per annum, payable on February 15 and August 15 ofeach year, and mature on February 15, 2012.The 9.0% Notes are general unsecured obligations of the Company, and are subordinated in rightof payment to all current and future senior debt, including the credit facilities. The Notes areguaranteed on a senior subordinated basis by Ply Gem Holdings and the domestic subsidiaries ofPly Gem; Ply Gem’s Canadian subsidiary is not a guarantor.The 9.0% Notes indenture allows the Company to incur additional indebtedness such that theConsolidated Interest Coverage ratio would be at least 2.0:1.0. The Consolidated InterestCoverage Ratio is defined as the ratio of Consolidated Cash Flow for the most recent four fiscalquarters to Consolidated Interest Expense for the same period; Consolidated Cash Flow isdefined as the sum of, among other items, net income, income tax expense, depreciation expense,interest expense, restructuring expense, and payment pursuant to the Advisory Agreement, net ofall other non-cash items. Notwithstanding this ratio, key Permitted Indebtedness clauses, asdefined in the indenture, include: (1) indebtedness under the credit facility not to exceed thegreater of (a) $250 million less permanent repayments and (b) 2.5 times the trailing four quarterConsolidated Cash Flow; (2) Acquired Indebtedness not to exceed $20 million at any timeoutstanding; (3) indebtedness of foreign subsidiaries not to exceed $30 million at any timeoutstanding and resulting in a Consolidated Interest Coverage ratio of at least 2.0:1.0; and (4) abasket for indebtedness not to exceed $25 million at any time outstanding. According tomanagement, permitted additional indebtedness as of March 31, 2006, was $150 million and waslimited by the Interest Coverage ratio in section 4.10 of the Note indenture.The Notes are callable on or after February 15, 2008 at 104.50%, February 15, 2009 at 102.25%,and February 15, 2010 and thereafter at 100.00%. The Notes carry a change of control put at101%.Leverage / LiquidityAs of March 31, 2006, Ply Gem pro forma leverage Figure 18 PLY GEM HOLDINGSthrough its bank credit facility and the Senior Pro Forma Leverage *Subordinated Notes was 3.0x and 5.7x, respectively (see As of March 31, 2006Figure 18). The Company’s leverage ratio increased Amount Leverage ($ millions) Thrurecently as a result of the refinancing and expansion of Revolving Credit Facility $ 13.2its credit facility, which was done in connection with its Term Loans 400.0 3.0x 9.0% Senior Sub Notes 360.3 5.7xpurchase of Alenco. LTM net interest coverage at Total Debt 773.5 5.7xquarter-end was 2.1x, up from 2.0x in the prior quarter. Pro Forma LTM Adj. EBITDA $ 135.5Net of outstanding borrowings of $13.2 million and Source: Company reports and MTR estimates.outstanding LC’s of $2.4 million, revolver availability * Pro forma of Alenco acquisiton, not acquisition synergies.was $54.4 million. Together with a cash balance of $17.9 million, total liquidity as of March 31,2006 was $72.3 million, an increase of $28.1 million over liquidity levels at the end of the firstquarter of fiscal 2005. 14
  15. 15. OWNERSHIP / MANAGEMENTOn February 12, 2004, Ply Gem Investment Holdings, through Ply Gem Holdings, acquired allof the outstanding shares of Ply Gem Industries. Ply Gem Investment Holdings is owned by aninvestor group led by Caxton-Iseman Capital, a private equity firm that specializes in leveragedbuyouts, and its affiliates. As defined in the General Advisory Agreement, Ply Gem paysCaxton-Iseman a 2% annual advisory fee based on the Company’s EBITDA. Management has asignificant stake in Ply Gem, with an 8.9% ownership of outstanding common stock as of March27, 2006.On November 4, 2005, Lee Meyer, Ply Gem’s president and chief executive officer since 2002,informed the Board of Directors of his intention to retire in 2006. Mr. Meyer has agreed toremain with the Company in his current role until a successor has been identified and for anytransition period thought necessary by the Company. Following his departure, Mr. Meyer willstill have a significant financial interest in Ply Gem and his services will be retained on anadvisory basis.RECENT FINANCIAL RESULTSConsolidatedNet sales increased 25.9% year-over-year to a record level of $216.3 million in the first quarterof 2006, in part due to the acquisition of Alenco; excluding the acquisition, strong year-over-yearorganic growth of 17.9% was driven by unit growth in siding and new construction windows, aswell as price increases (see Figure 19). Unit volume growth resulted from the company’salignment with customers that continue to take market share; excluding the share shift from alarge account, siding unit volumes increased over 10% year-over-year (an easy comparableperiod), while window unit volumes (pre-Alenco) rose 5.6%. Gross margin improved 20bpsyear-over-year, while SG&A expense increased to $26.5 million from $23.0 million in the prioryear’s quarter, declining as a percentage of net sales to 12.3% from 13.4%. Adjusted EBITDAincreased 42.6% to $21.5 million from $15.1 million in the first quarter of 2005, with adjustedEBITDA margin up 116bps year-over-year.Windows and DoorsNet sales increased 24.6% year-over-year to $115.8 million in the first quarter of 2006;excluding $13.9 million of net sales contributed through the Alenco acquisition, the increase wasdue primarily to higher volumes in new construction window and door products sold in the U.S.and Canada and to price increases of approximately 3.5%, partially offset by weakness in theCompany’s repair and remodel product line. Gross margin declined 210bps year-over-year,driven primarily by increased raw material costs that resulted from the transition to producingvinyl lineals at the MW Windows’ lineal facility; management expects the transition to continuethrough 2006. The $2.4 million increase in SG&A expense over the prior year’s quarter was dueto the acquisition of Alenco. Adjusted EBITDA for the first quarter of 2006 was $10.1 million,up 11.0% year-over-year; excluding Alenco, adjusted EBITDA was down 5.5% over the sameperiod.Alenco’s net sales increased approximately 15% year-over-year, while its earnings as apercentage of net sales declined as the cost of aluminum increased. The Company has not fullyrecovered these raw material costs, and it is currently evaluating its next steps in passing throughprice increases. Aluminum pass-throughs may prove more difficult to implement than thoseassociated with PVC, given that the aluminum window is a lower-cost alternative to vinyl and 15