INCOME TAXES
The following is a summary of the components of income before provision (benefit) for income taxes:
|
| | | | | | | | | | | | |
| | For the year ended December 31, |
(Amounts in thousands) | | 2017 | | 2016 | | 2015 |
Domestic | | $ | 117,750 |
| | $ | 35,258 |
| | $ | 47,901 |
|
Foreign | | (2,769 | ) | | (11,766 | ) | | (16,301 | ) |
| | $ | 114,981 |
| | $ | 23,492 |
| | $ | 31,600 |
|
The following is a summary of the provision (benefit) for income taxes included in the accompanying consolidated statement of operations:
|
| | | | | | | | | | | | |
| | For the year ended December 31, |
(Amounts in thousands) | | 2017 | | 2016 | | 2015 |
Federal: | | | | | | |
Current | | $ | 989 |
| | $ | 1,043 |
| | $ | 692 |
|
Deferred | | 39,692 |
| | (54,692 | ) | | (2,833 | ) |
| | 40,681 |
| | (53,649 | ) | | (2,141 | ) |
State: | | |
| | |
| | |
|
Current | | $ | 5,204 |
| | $ | 4,674 |
| | $ | 2,688 |
|
Deferred | | 1,259 |
| | (2,020 | ) | | (779 | ) |
| | 6,463 |
| | 2,654 |
| | 1,909 |
|
Foreign: | | |
| | |
| | |
|
Current | | $ | 838 |
| | $ | 277 |
| | $ | 833 |
|
Deferred | | (1,328 | ) | | (1,277 | ) | | (1,289 | ) |
| | (490 | ) | | (1,000 | ) | | (456 | ) |
| | | | | | |
Total | | $ | 46,654 |
| | $ | (51,995 | ) | | $ | (688 | ) |
The table that follows reconciles the federal statutory income tax rate to the effective tax rate of approximately 40.6% for the year ended December 31, 2017, 221.3% for the year ended December 31, 2016, and 2.2% for the year ended December 31, 2015.
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| | | | | | | | | | | | |
| | For the year ended December 31, |
(Amounts in thousands) | | 2017 | | 2016 | | 2015 |
Income tax provision at the federal statutory rate | | $ | 40,243 |
| | $ | 8,222 |
| | $ | 11,060 |
|
| | | | | | |
Net change from statutory rate: | | |
| | |
| | |
|
Valuation allowance-US | | 165 |
| | (88,653 | ) | | (30,446 | ) |
Valuation allowance-Canada | | 207 |
| | 1,714 |
| | 3,551 |
|
State income tax provision, net of federal income tax benefit | | 4,462 |
| | 5,937 |
| | 4,986 |
|
Taxes at non-U.S. statutory rate | | (283 | ) | | 348 |
| | (153 | ) |
Additional provisions/reversals of unrecognized tax benefits | | (281 | ) | | 187 |
| | (116 | ) |
Canadian rate differential | | 142 |
| | 808 |
| | 1,284 |
|
Attribute reduction | | — |
| | (3,118 | ) | | 3,118 |
|
Tax Receivable Agreement | | 162 |
| | 21,306 |
| | 4,531 |
|
Alternative minimum tax | | 1,463 |
| | 1,483 |
| | 1,298 |
|
Minimum tax credit | | (1,463 | ) | | (1,483 | ) | | (1,298 | ) |
Meals and entertainment | | 676 |
| | 675 |
| | 595 |
|
Executive compensation | | 748 |
| | 599 |
| | — |
|
Work opportunity tax credit | | (474 | ) | | (438 | ) | | — |
|
Tax Reform - Deferred Taxes | | 4,272 |
| | — |
| | — |
|
Tax Reform - Tax Receivable Agreement | | (3,746 | ) | | — |
| | — |
|
Other, net | | 361 |
| | 418 |
| | 902 |
|
| | $ | 46,654 |
| | $ | (51,995 | ) | | $ | (688 | ) |
The tax effect of temporary differences, which gave rise to significant portions of deferred income tax assets and liabilities as of December 31, 2017 and 2016 are as follows:
|
| | | | | | | | |
(Amounts in thousands) | | 2017 | | 2016 |
Deferred tax assets: | | | | |
Accounts receivable | | $ | 615 |
| | $ | 824 |
|
Insurance reserves | | 2,004 |
| | 3,302 |
|
Warranty reserves | | 18,616 |
| | 26,826 |
|
Pension accrual | | 3,837 |
| | 6,292 |
|
Deferred compensation | | 4,683 |
| | 10,946 |
|
Inventories | | 2,936 |
| | 4,898 |
|
Federal, net operating loss carry-forwards | | 12,621 |
| | 48,732 |
|
State, net operating loss carry-forwards | | 12,580 |
| | 10,496 |
|
Non-capital losses - foreign jurisdiction | | 13,116 |
| | 11,743 |
|
Related party interest | | 3,347 |
| | 18,055 |
|
Professional fees | | 1,087 |
| | 2,031 |
|
Environmental reserves | | 374 |
| | 576 |
|
Alternative minimum tax | | 4,244 |
| | 2,782 |
|
Other assets, net | | 5,008 |
| | 7,530 |
|
Valuation allowance | | (26,553 | ) | | (22,889 | ) |
Total deferred tax assets | | 58,515 |
| | 132,144 |
|
Deferred tax liabilities: | | |
| | |
|
Property and equipment, net | | (18,851 | ) | | (27,589 | ) |
Intangible assets, net | | (20,873 | ) | | (36,894 | ) |
Deferred financing | | (8,991 | ) | | (18,063 | ) |
Other liabilities, net | | (807 | ) | | (1,973 | ) |
Total deferred tax liabilities | | (49,522 | ) | | (84,519 | ) |
Net deferred tax asset | | $ | 8,993 |
| | $ | 47,625 |
|
Tax Act
The Tax Act enacted on December 22, 2017, 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, a new tax named global intangible low taxed income ("GILTI") which requires 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.
Due to the complexity of the new GILTI tax rules, The Company is currently evaluating the impact of this new tax. Under U.S. GAAP, the Company is allowed to make an accounting policy choice of either treating taxes due under GILTI as a current-period expense when incurred or factoring these amounts into the Company’s measurement of deferred taxes. The Company has not made a policy decision regarding whether to record deferred taxes on GILTI since we are still in the process of evaluating this new tax provision under the Tax Act.
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 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, the Company has 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. The Company is continuing to assess the impact from the Tax Act and may record adjustments in 2018.
For the year ended 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, the Company 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 the Company will realize associated with these assets. This expense has been recognized within income taxes in the Company's consolidated statement of operations and was recognized during the fourth quarter of 2017.
ASU 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, was issued in November 2015 and it establishes simplification of the presentation of deferred income taxes. Under the new standard, both deferred tax liabilities and assets are required to be classified as noncurrent in a classified balance sheet. During the fourth quarter of 2016, the Company elected to prospectively adopt this standard, thus reclassifying the current deferred tax assets to noncurrent (netted within noncurrent liabilities) on the accompanying consolidated balance sheet. The adoption of this guidance had no impact on the Company's consolidated results of operations or cash flows.
Debt Transaction
On September 19, 2014, Ply Gem Industries issued $150.0 million aggregate principal amount of its 6.50% Senior Tack-on Notes with a $10.1 million debt discount. These Senior Tack-on Notes have the same terms and covenants as the original $500.0 million of 6.50% Senior Notes issued in January 2014 that were issued at par and will mature in 2022. These Senior Tack-on Notes are not considered Applicable High Yield Discount Obligation ("AHYDO"). The discount and deferred financing costs related to these notes will be amortized over the life of the notes utilizing the constant yield method.
Valuation allowance
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.
During the year ended December 31, 2016, the Company determined that a valuation allowance was no longer required against its federal net deferred tax assets and a portion of its state deferred tax assets. As a result, the Company released $86.5 million of its total valuation allowance during the year ended December 31, 2016 since positive evidence outweighed negative evidence thereby allowing the Company to achieve the “more likely than not” realization threshold. Of the total valuation allowance reversal of $86.5 million, $31.3 million was offset against 2016 current year tax expense with the remaining $55.2 million representing the discrete valuation allowance release.
As of December 31, 2016, the Company was no longer in a three-year cumulative pre-tax loss position due to the significant improvement in the Company’s profitability from the housing market recovery. The housing market has experienced steady improvement from a demand perspective over the last several years which has benefited the Company’s financial performance and profitability for both new construction and repair and remodeling reflected in the Company’s net sales and earnings growth. This annual financial improvement was further evidenced by the Company continuing to have net sales and profitability growth in the Company’s second and third quarters which are traditionally the Company’s strongest financial quarters based on seasonality. Finally, the consensus expectation and outlook for both new construction and repair and remodeling both showed positive growth rates over the next few years which result in future forecasted profitability for the Company. Based on the preponderance of these positive factors, the valuation allowance for federal and certain state NOL carry-forwards was released during the year ended December 31, 2016. The valuation allowance release is reflected within our benefit for income taxes in the accompanying consolidated statement of operations for the year ended December 31, 2016.
Based on the level of historical federal taxable income, projections of future taxable income, and the forecasted realization of deferred tax assets, the Company has determined that a federal valuation allowance is not required as of December 31, 2017. However, as of December 31, 2017, the Company remains in a valuation allowance position against its 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. The Company will continue to monitor the positive and negative factors for these jurisdictions and make further changes to the valuation allowances as necessary. The Company’s state valuation allowance increased to $12.3 million as of December 31, 2017 compared to $10.0 million for the year ended December 31, 2016.
As of December 31, 2017 and December 31, 2016, the Company had a full valuation allowance on its deferred tax assets for Gienow Canada of approximately $14.3 million and $13.0 million, respectively, as of as a result of its operating performance and challenges associated with the Canadian economy and energy prices.
The Company had book goodwill of approximately $28.0 million that was not amortized resulting in a deferred tax liability of approximately $7.1 million at December 31, 2017. Therefore, the reversal of deferred tax liabilities related to this goodwill is not considered a source of future taxable income in assessing the realization of its deferred tax assets. The Company continues to evaluate the realizability of its net deferred tax assets and its estimates are subject to change.
Other tax considerations
As of December 31, 2017, the Company has approximately $92.1 million of federal gross operating loss carry-forwards which can be used to offset future taxable income. These federal carry-forwards will begin to expire in 2028 if not utilized. The Company has approximately $330.7 million of gross state NOL carry-forwards and $12.6 million (net of federal benefit) of deferred tax assets related to these state NOL carry-forwards which can be used to offset future state tax liabilities. The Company has established a valuation allowance which offsets the deferred tax asset associated with certain state NOL carry-forwards. Future tax planning strategies implemented by the Company could reduce or eliminate future NOL expiration.
As of December 31, 2017, the Company has not established U.S. deferred taxes on unremitted earnings for the Company's foreign subsidiaries. Notwithstanding the provisions within the American Jobs Creation Act of 2004, the Company continues to consider these amounts to be permanently invested. Enactment of the Tax Act imposed a one-time U.S. federal tax on the deemed repatriation of unremitted earnings indefinitely reinvested abroad, which did not have a material impact on the Company’s financial results. The indefinite reinvestment assertion continues to apply for the purpose of determining deferred tax liabilities for U.S. state and foreign withholding tax purposes.
Unrecognized tax benefits
The Company records reserves for unrecognized tax benefits based on the likelihood of an unfavorable outcome. Of this amount, approximately $1.7 million, if recognized, would have an impact on the Company’s effective tax rate. As of December 31, 2017, the reserve was approximately $4.5 million which includes interest and penalties of approximately $1.9 million. As of December 31, 2016, the reserve was approximately $3.9 million which included interest and penalties of approximately $1.6 million. The difference between the total unrecognized tax benefits and the amount of the liability for unrecognized tax benefits represents unrecognized tax benefits that have been netted against deferred tax assets related to net operating losses in accordance with ASC 740 in addition to accrued penalties and interest.
The Company has elected to treat interest and penalties on unrecognized tax benefits as income tax expense in its consolidated statement of operations. Interest and penalty charges have been recorded in the contingency reserve account within other long term liabilities in the Company's consolidated balance sheet.
The following is a rollforward of unrecognized tax benefits from January 1, 2016 through December 31, 2017.
|
| | | |
(Amounts in thousands) | |
Unrecognized tax benefits balance at January 1, 2016 | $ | 15,910 |
|
Additions based on tax positions related to current year | 208 |
|
Additions for tax positions of prior years | 603 |
|
Reductions for tax positions of prior years | (13 | ) |
Settlement or lapse of applicable statutes | (39 | ) |
Unrecognized tax benefits balance at December 31, 2016 | 16,669 |
|
Additions based on tax positions related to current year | 182 |
|
Additions for tax positions of prior years | 161 |
|
Reductions for tax positions of prior years | (90 | ) |
Settlement or lapse of applicable statutes | (400 | ) |
Unrecognized tax benefits balance at December 31, 2017 | $ | 16,522 |
|
Unrecognized tax benefits are reversed as a discrete event if an examination of applicable tax returns is not begun by a federal or state tax authority within the statute of limitations or upon effective settlement with federal or state tax authorities. During the year ended December 31, 2017, the Company reversed approximately $0.4 million of unrecognized tax benefits due to the expiration of the statute of limitations in certain state jurisdictions. The Company's open tax years that are subject to federal examination are 2008 through 2016.
During the year ended December 31, 2016, the Company reversed approximately $0.1 million of unrecognized tax benefits due to the expiration of the statute of limitations for the tax year ended December 31, 2008.
During the next 12 months, the Company does not anticipate the reversal of any material tax contingency reserves.
Tax Receivable Agreement
On May 22, 2013, the Company entered into a Tax Receivable Agreement (the “Tax Receivable Agreement”) with PG ITR Holdco, L.P. (the “Tax Receivable Entity”). The Tax Receivable Agreement generally provides for the payment by the Company 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 the Company actually realizes in periods ending after the IPO as a result of (i) net operating loss ("NOL") carryovers from periods (or portions thereof) ending before January 1, 2013, (ii) deductible expenses attributable to the transactions related to the IPO and (iii) deductions related to imputed interest deemed to be paid by the Company as a result of or attributable to payments under the Tax Receivable Agreement. The term of the Tax Receivable Agreement will continue until all such benefits have been utilized or expired. The Company will retain the benefit of the remaining 15% of these tax savings. The Tax Receivable Agreement will obligate the Company to make payments to the Tax Receivable Entity generally equal to 85% of the applicable cash savings that is actually realized as a result of utilizing NOL carryovers once the tax returns are filed for that respective tax year.
As a result of the future federal corporate tax rate reduction from the Tax Act enacted on December 22, 2017, the
Company estimates that the total anticipated amount of future payments under the Tax Receivable Agreement would be approximately $74.7 million assuming no additional material changes in the relevant tax law or federal rates, that the Company earns sufficient taxable income to utilize the net operating loss carry forwards, and that utilization of such tax attributes is not subject to limitation under Section 382 of the Internal Revenue Code of 1986, as amended (the "Code") as the result of an “ownership change”. It is possible that future transactions or events or changes in estimates could increase or decrease the actual tax benefits realized from these tax attributes and the corresponding Tax Receivable Agreement payments and liability. As of December 31, 2017, the Company estimates the Tax Receivable Agreement liability to be approximately $69.5 million with the remaining $5.2 million estimated for the state NOLs associated with the Tax Receivable Agreement which have a valuation allowance. Future changes in the Company's state valuation allowance position including the reversal of all or a portion of the Company's remaining state valuation allowance may increase the Tax Receivable Agreement liability up to the $74.7 million estimate as the Company at that point in time will project future taxable income beyond the current fiscal year for certain state income tax purposes and expense the remaining $5.2 million.
As of December 31, 2017 and 2016, the Company had a $69.5 million and $79.7 million liability, respectively, for the amount due pursuant to the Tax Receivable Agreement. The Company has $51.4 million and $25.4 million as current liabilities in the Company's consolidated balance sheets as of December 31, 2017 and December 31, 2016, respectively. The Company has $18.1 million and $54.3 million of this liability recorded as noncurrent as of December 31, 2017 and December 31, 2016, respectively, in the consolidated balance sheets as these amounts will not be paid in cash within the next 12 months. The $10.7 million Tax Receivable Agreement liability adjustment for the year ended December 31, 2017 recognized in the Company's consolidated statement of operations resulted primarily from the future federal tax rate reduction enacted as part of the December 2017 Tax Act which reduced the value of the NOLs to be utilized in future years at the lower 21% corporate tax rate.
The $60.9 million Tax Receivable Agreement liability adjustment for the year ended December 31, 2016 resulted primarily from the $55.2 million discrete valuation allowance release. 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, the Company during the year ended December 31, 2016 utilized future forecasts of taxable income beyond the 2016 tax year to determine the TRA liability. The $12.9 million Tax Receivable Agreement liability adjustment for the year ended December 31, 2015 resulted from a $115.9 million increase in 2015 taxable income partially offset by the timing of reversals of deferred tax assets and liabilities.